State budget 2013: fact or fiction?

The 2013 budget plan released at the end of September and currently awaiting approval by Congress underpins the long-term austerity package outlined by Prime Minister Mariano Rajoy in July, aimed at reducing the central government's budget deficit by 65 billion euros over two-and-a-half years. Rajoy says the 2013 budget, 64 percent of which is comprised of social spending cuts rather than tax hikes, "guarantees" that Spain will meet a pledge to the rest of the euro zone to cut its deficit to 4.5 percent of gross domestic product next year, from a target of 6.3 percent this year -- one that is widely expected to prove too tight.

As expected, the new measures include an end to mortgage rebates, which is expected to raise 90 million euros, while an extension of the wealth tax is expected to raise 700 million euros in 2013. In total, the government says this and other fiscal measures will increase revenue by 4.4 billion euros next year.

In a specific gesture toward older people and one made to maintain one of Rajoy's election pledges, the 2013 budget includes a one-percent increase in pension payments, although many economists say the Popular Party (PP) government will eventually need to cut pension payments to meet budgetary targets.

The 2013 budget includes some updates to the tax code as well. In 2013 and 2014, Spain will limit tax write-offs for large companies. And it will raise the short-term capital gains tax to discourage speculation, which is expected by the Spanish government to raise 90 million euros. A new tax on lottery winnings over 2,500 euros will raise 824 million euros, says the government.

Acceding to the fiscal discipline demanded by other euro-zone leaders is essential if the government wants to tap the new bond-buying program the European Central Bank announced recently, designed to help reduce the borrowing costs of beleaguered euro-zone members like Spain. Spain faces debt refinancing needs of 38.6 billion euros next year, according to the draft budget. That is almost 10 billion euros more than the maturities included in the 2012 state financial plan, underscoring the extent to which the government is struggling to contain its borrowing costs.

A troubling aspect of Spain's 2013 budget, highlighted by Jonás Fernández of consultants Solchaga & Recio, is the government's optimistic economic forecasts, upon which its budget targets hinge. Finance Minister Cristóbal Montoro has said he sees GDP falling by only 0.5 percent next year, and that Spain aims to make 2013 "the end of the recession." Montoro said the government's deficit target for 2012 remains unchanged at 6.3 percent of GDP -- and he expects tax revenue to rise 3.8 percent next year.

"The budget is born into sin twice over: it assumes that the deficit objective of 2012 will be met; and it is based on an extremely optimistic macroeconomic picture," Jonás Fernández says.

Francisco de la Torre of the Organization of Tax Inspectors adds that the budget's other main problem is that it is based on estimates of tax revenue "that will be very hard to meet." Even with the government's majority in Congress, the opposition and regional parties will be raising several issues in relation to the following points:

Insufficient tax hikes

"The tax crisis in Spain is about lack of revenue," says José Ignacio Conde-Ruiz, the deputy director of economic think-tank FEDEA. "Most countries have maintained fiscal pressure during the crisis, but in Spain tax revenue's contribution to GDP has fallen from 41 percent to 35 percent. This shows that the collection system doesn't work and requires serious reform."

Speaking in Congress after the budget was presented, Pedro Saura, the opposition Socialist Party's tax spokesman said: "There is a shortfall of almost 14 billion euros between what the government says that it is going to collect this year and what it will really be able to collect." Saura added that the sales tax hike and changes to corporate tax will not be enough to make up the difference.

Francisco de la Torre points out that this year's budget tax collection goal is currently falling short by some five billion euros compared to the same period last year. He says that if the government is to meet its goal of collecting seven billion euros more than last year, it will have to raise 12 billion euros in the last quarter of the year.

He adds that the government's recent tax changes will not be as effective as hoped. The most critical being the move to reduce the time limit that companies currently enjoy to pay their back taxes in installments. "It will mean more tax revenue, but will limit companies' abilities to invest," De la Torre points out.

Elsewhere, the government can expect little benefit from Spain's growing exports: more and more companies now pay their taxes in other countries. And then there is the impact of the crisis on consumer confidence, which will limit the impact of the sales tax hike.

Pensions: the big issue

Pensions increases have been calculated in the 2013 budget on the basis of inflation for 2012, an approach that many economists say is mistaken.

So far this year, contributive pensions spending, which consumes 90 percent of the pension system's resources, has been growing at 4.4 percent on the previous year. The 2012 budget foresaw an increase of 2.9 percent. This will likely mean that in December, the total amount spent will have reached 104 billion euros, and not the 102 billion that the Finance Ministry anticipated. Those two billion euros will throw the government's calculations out for 2013.

It is relatively easy to calculate how much spending on pensions will be from one year to the next. There are three variables: the number of pensioners; the average amount of pensions; and the increase decreed by the government, in this case one percent. The equation for 2013 on that basis is 4.3 percent. But as Miguel Ángel García, an economist at the CCOO labor union points out: "That figure is close to reality, but the calculation isn't made on what will be spent this year, but on the budget." García says this means pensions spending will be close to 108 billion euros, and not the government's calculation of 106.3 billion.

There are also problems with the amount the government calculates will be paid into the Social Security system. The Social Security department estimates that contributions for next year will be 105.8 billion euros, barely 0.4 percent down on this year. The labor market will continue to shrink, and unemployment rise -- but by how much? Again it is all a question of who is right about the outlook for 2013 -- the government, or international organizations such as the IMF? The latter said last week that Spain's GDP is set to fall by 1.3 percent in 2013, almost a full percentage point more than the PP administration's figure.

The Madrid government is predicting that unemployment will increase by just 0.5 percent next year, and that salaries will rise by 1.5 percent. Furthermore, the government's calculations for pensions spending are, by any objective standards, also overly optimistic. Up until August the fall in contributions was 2.6 percent on the previous year. If that rhythm is maintained until the end of the year, contributions for this year will be 102.5 billion euros, and 102 billion for next year.

In any event, 2012 will end with spending well above budget estimates. For the government to meet its target of almost 27 billion euros, the fall in spending on unemployment benefits will have to be much greater than the 1.5 billion it has calculated.

The Spanish government will restrict programs that allow people to take early retirement as part of overhauls to rein in the country's debt and shore up its shrinking economy, said Rajoy on September 28. "The retirement age is reasonable in Spain if it is actually met," he said referring to the mandated age of 65 years. "So we are going to deal with those issues of early retirement."

The prime minister explained that the government would not eliminate the option of early retirement, but would limit the capacity of individuals to stop working at around 60, as many do now. In the past, large companies such as Iberia and Telefónica have offered early retirement packages to staff, who are then paid unemployment benefit until they reach pensionable age.

More jobless, less unemployment payments

As part of the cuts he announced in July, Rajoy reduced spending on unemployment benefit, one of the areas likely to continue draining the state's resources. The Finance Ministry had been predicting that this year would see spending fall for the first time since the depression kicked in, but up to August, spending was up 5.7 percent on last year as the recession drags on. Montoro had predicted that benefit payments, which fall over time for the long-term unemployed, would actually come down by five percent this year. By the end of the year, unemployment benefit payments will have reached 31 billion euros.

The only way to reduce spending on unemployment benefit in a country where there are almost six million out of work is to make it harder to qualify for payment. Which is what the government did this summer.

Interest on loans

The government's calculations will have been made more unreliable by the amount it has to pay on borrowing, currently estimated at 38.5 billion euros. To put the figure into perspective, spending on all ministries is only slightly higher at 39.7 billion.

Montoro said in late September that interest payments on borrowing have more to do with the size of the country's debt than the risk premium it has to pay on Treasury Bonds. Spain's debt will reach 90.5 percent of GDP in 2013, including the bank bailout; five years ago it was just 37 percent. Meeting those interest payments could be made easier by auctioning more short-term debt to take advantage of the reduced cost and the advantages offered by the European Central Bank.

"If the interest bill is the same as in 2012, the consolidated financial costs would only fall by one percent instead of increasing by 2.2 percent, which means that, excluding interest rate costs, the budget is not as restrictive as the government is trying to make out," say José Ignacio Conde-Ruiz and Juan Rubio Ramírez in their blog on the FEDEA website.

Investment hits new low

The hardest-hit area of public spending is investment, which has fallen by 56 percent since 2008. The 2013 budget reduces investment in infrastructure and public works to 10.5 billion euros, a 15.6-percent drop on this year. "We will soon see the moment when it will not even be covering depreciation costs, which will have a huge impact on the quality and functioning of public services," say Conde-Ruiz and Rubio-Ramírez.

Further pay cuts for public sector employees

At the same time as state enterprises and services are cutting staff, public sector employees have already lost around a quarter of their spending power over the last three years. Nevertheless, spending on wages will increase by 0.4 percent in next year's budget, largely due to pension contributions. Jonás Fernández says that the result will be further pay cuts. "This will be done by not paying the summer or Christmas extra payment."