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Back to Los Presupuestos del Estado, el 'rescate' y la subida del IVA

Javier Díaz-Giménez, Professor, IESE, University of Navarra

The State Budget, the 'bailout' and the VAT increase

Sun, 21 Mar 2010 15:27:31 +0000 Published in El Mundo (Madrid)

I apologize for starting with a truism that seems to escape the Spanish Government. As everyone knows, budgets -all of them, those of the State, those of all families and those of all companies- have two sides: the revenue side and the expenditure side. Based on this knowledge, any prudent person or entity considering a decision on expense takes into account the unavoidable need to finance it before deciding whether it is worthwhile. And, sitting comfortably in my rocking chair, I have the feeling that the Spanish Government has not done so.

Neither at the end of 2008, when the bailout was decided, nor at the end of 2009, when fiscal consolidation was decided. It seems as if, like a cyclops, the Spanish Government had looked at the Budget with only one eye. In 2008, it only looked at the items of expense without worrying about its financing. And in 2009, it only looked at the revenue items without worrying about their negative impact on growth and employment.

In the 2009 Budget, the Government should have better calculated the cost of the automatic components of the bailout. The official forecasts for the growth of Economics were too optimistic, and the consequences were that neither the reduction in tax revenues nor the unprecedented increase in unemployment benefits were correctly anticipated. If we add to that the 25,000 million euros in round numbers of the discretionary components of the bailout we arrive at 11.4% of the deficit of all public administrations. An unprecedented figure in our history, although it can be argued that it is at least partially justified by an unprecedented recession.

And so we arrive at the 2010 Budget. The automatic components of the bailout -the fall in revenue and the increase in unemployment benefits- continue to act, but its discretionary components have been exhausted. We will never know what their real impact has been on Economics. Nor will we know what would have happened if there had been no discretionary bailout, or if it had been done differently. For example, we could have used the funds from the Local Investment Plan or the Revitalization Plan to pay the debts of public administrations with companies, or to computerize the administration of justice. But the four and a half million unemployed seriously question the effectiveness of the measures that have been taken. And once again the Government closes its eyes again and only looks at one part of the Budget, although now it is the turn of the revenue. It refuses to freeze or reduce expenses and, in exchange, proposes increases in the tax on the added value and other taxes.

The answer to the question of which expenses should be frozen or reduced, which is sold as if it were very complicated, is actually simple: all those in chapters 1 and 2 corresponding to the expenses of staff and current expenses in goods and services. This measure should be complemented by identical measures in all the autonomous regions and local corporations. Its justification is also simple: the majority of public employees have their work jobs guaranteed and have not had to bear the costs of the adjustment. Moreover, this measure would serve to set an example and would give the Government moral strength to demand similar measures in private sector wage negotiations.

As for the added value tax increase, why is it a bad idea? Mainly because it is recessionary and because, like all tax increases, it reduces activity and employment. It does not matter if the increase is passed on to the prices that consumers will pay as of July 1, or if it is absorbed by the margins that companies will no longer receive. Consumption, investment, growth and employment will be lower than they would have been if VAT rates had been maintained.

According to our calculations, the VAT hike will cost us around half a point of growth (see Conesa, Díaz-Giménez, Díaz-Saavedra and Pijoan-Mas, La Subida del IVA: Demasiado Cara y Demasiado Pronto, available at In addition, revenue growth will be lower than expected, because the increase in VAT rates reduces the collection of social contributions and direct taxes. Let us hope that, when drawing up the 2011 budget, the government will finally decide to look at revenue and expenditure at the same time and, if possible, with its eyes wide open.