Will the VAT hike be enough?

Unprecedented cutbacks in public spending and more indirect taxes threaten an already shrinking economy

Finance Minister Cristóbal Montoro refused to answer journalists’ questions following Friday’s Cabinet meeting about the details of the package of spending cuts and tax hikes that aims to remove 56.4 billion euros from the public deficit over the next 30 months. Instead, he decided to outline the measures in a document written in English — seemingly putting the concerns of the international investment community over those of the Spanish electorate — uploaded to the Economy Ministry’s website on Saturday.

The document explains that of the 56.4 billion euros, some 29 billion will come from tax hikes, with the remainder from spending cuts that will see unemployment benefit reduced, along with civil servants’ pay.

The government is pinning its hopes of denting the deficit on the three-percent hike in sales tax that takes VAT to 21 percent, and which it claims will net an extra 22.1 billion by 2014. Spain’s lower rate of VAT will rise from eight percent to 10 percent, while the net covering the higher rate will be extended to include cinemas, theaters, flowers, funerals, night clubs, digital television and hairdressers — all of which will cost 13 percent more overnight as of September 1. The super-reduced rate levied on medicines, basic foodstuffs and books and newspapers stays at four percent.

With the economy showing no signs of recovery, the government says that it expects to raise just 2.3 billion euros in the fall — but it hopes to generate 10.1 billion in 2013, and 9.7 billion the following year.

The unprecedented measures were first announced on Wednesday by Prime Minister Mariano Rajoy in a rare appearance before Congress breaks for summer. Rajoy said he intended to remove 65 billion euros from the public deficit. The 8.6 billion euro shortfall will be covered by other measures such as new taxes on the energy sector which are expected to be announced later this month.

The Cabinet also approved an overhaul of city and regional governments, wage cuts for public workers and cuts in unemployment benefits. Later this month the government will pass a reform of the energy sector and laws to liberalize the rail, road and air transport sectors.

Spaniards are living one of the most difficult and traumatic moments of our history"

As expected, the ministers approved a new mechanism to help Spain’s 17 semi-autonomous regions, currently shut out of international financial markets, to fund themselves and repay their debts. The instrument, which will have a maximum capacity of 18 billion euros, will be funded through a six-billion-euro loan from the state lottery and by the Treasury. The regions will however retain full responsibility to repay any loan they obtain from the fund and they will have to meet conditions including more work on cutting their public deficits.

Economy Minister Luis de Guindos said the Treasury, whose credit rating is already on the verge of junk territory and could be affected by this new burden, would not change its debt-issuance calendar. The government also indicated that it would soon pass deep reforms of the energy as well as rail, road and air transport sectors. It will also eliminate tax breaks on properties.

Deputy Prime Minister Soraya Sáenz de Santamaría said the government would discuss with other political parties a bill to guarantee the “sustainability” of the pension system. Such a reform — which would break one of the last campaign pledges that Rajoy has so far managed to keep — is a long-standing demand of the International Monetary Fund and the European Commission. Rajoy said on Wednesday the discussion would be based on recommendations from the European Union to establish a stronger link between the pension schemes and life expectancy.

The announcements have sparked anger among the electorate. On Wednesday, a miners’ march against a cut in subsidies was swelled by protestors against the cuts, while on Friday public sector workers blocked streets and railways in Madrid to draw attention to cutbacks they said hurt ordinary people more than the bankers and politicians blamed for the country’s economic crisis.

More than 100 civil servants gathered outside the presidential palace, whistling and booing as Rajoy’s ministers convened under pressure from euro zone leaders and financial markets to approve the new budget plan.

“Spaniards are living today one of the most difficult and traumatic moments of our history, a crisis which has mutated into a daily drama for millions of Spaniards,” Sáenz de Santamaría would later admit at Friday’s news conference. Acknowledging the widespread economic pain, she added: “Thousands of Spaniards have been pushed to the edge, and millions are unemployed.”

I said I would reduce taxes and I am increasing them... the circumstances have changed"

Spain enjoyed 30 years of almost uninterrupted economic growth until 2007, but is now on the front line of the euro-zone debt crisis after crippled banks, indebted regions and a new, deep recession are stretching the country’s public finances and unnerving investors.

Its borrowing costs have soared in recent months and many investors believe that after seeking up to 100 billion euros from the European Union’s rescue fund for its banks, the government could soon follow Greece, Ireland and Portugal in seeking a state bailout. The question is whether this latest austerity package, in spite of possibly winning Spain a little more time from the markets, could deepen the country’s economic woes rather than solve them.

The government has few cards left to play to avoid a state bailout. Falling revenues will make it hard to control spiraling debt and meet deficit targets, even after they were eased this week.

Rajoy’s announcement followed European officials agreeing earlier this month to allow Spain an extra year to meet its budget deficit reduction targets and iron out further details of the 100 billion euros to be pumped into the country’s banking sector. Having repeatedly pledged that his government would not waver on a plan to reduce Spain’s budget deficit to 5.3 percent of economic output for this year, Rajoy’s government was last week permitted to reduce the target to 6.3 percent by Brussels, and was given an extra year to come within the three-percent EU agreed limit.

Spain has been punished by the international investors it needs to buy its government debt, who have pushed up the country’s 10-year borrowing costs in recent months to euro-era highs as Rajoy battles to clean up the country’s banking sector and bring down public spending.

By raising VAT, the conservative leader was forced to add to a growing list of policy reversals in his time in office, having stood against tax increases made by the previous government when in opposition. “I said I would reduce taxes and I am increasing them... the circumstances have changed and I have to adapt myself to them,” Rajoy said.

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