Additional taxes may threaten rebound

The European Union wants to defuse the refugee and migrant crisis and successfully conclude the first review of the third Greek bailout program before the debate about a British departure from the EU (Brexit) heats up. This means it is highly likely that the review will be done by May 1, as some senior EU officials have suggested. However, the seemingly heavy reliance on revenues from taxes and social security contributions to meet the fiscal targets spells trouble for the Greek economy down the road.

According to Eurostat, the sum of taxes and net social security contributions as a percentage of GDP stood at 40 percent in the EU in 2014 compared with 39.9 percent in 2013 and 39 percent in 2005. Revenues from these two sources stood at 41.5 percent in the euro area in 2014 from 39.4 percent in 2005.

In Greece, total revenues from taxes and net social contributions jumped to 39 percent of GDP in 2014 from 33.5 percent in 2005 with the biggest rise recorded between 2010 and 2014. No other country in the EU, as well as non-members Iceland, Norway and Switzerland, has experienced such a big rise in the tax-to-GDP ratio during this period. It is not surprising that no other country has experienced such an economic contraction either.

The comparison is bound to weigh even more against Greece when Eurostat publishes the 2015 figures. The tax-to-GDP ratio will rise further because of hikes and a 6 percent rise in contributions on pensions imposed last year.

Unfortunately, the ratio will keep on rising this year and perhaps in 2017. This is because negotiations between the lenders and the government on closing the fiscal gap for the 2016-2018 period appear to result in new, sizeable income and other tax increases. Some pension cuts are also part of the package but the government wants the bulk of pension cuts to be put into effect from 2018 and beyond to minimize the political cost.

It is ironic that Greece managed to lower the targets for the primary budget surplus in last summer’s third bailout program spanning the 2016-2018 period but has to make a much greater fiscal effort to meet the new lower targets than warranted under the second program.

It is reminded that total revenues have to exceed expenditures, excluding interest payments, by 0.5 percent of GDP this year and go up to 1.7 percent of GDP in 2017 en route to the 3.5 percent of GDP target in 2018.

The IMF estimated a few weeks ago that Greece has to take measures worth between 7.5 and 9 billion euros to meet these targets. On the other hand, the European creditors are asking for restrictive measures equal to 5-5.5 billion euros, according to Greek government sources.

At the end of 2014, the lenders had identified a fiscal gap of about 1.7 billion euros to attain the primary surplus target of 3.5 percent of GDP in 2015 en route to the target of 4.5 percent of GDP in 2016 under the second bailout program. In other words, Greece had to take fewer austerity measures than it does now to meet much more ambitious fiscal targets at the time, leading to lower debt levels as well.

It is obvious that the underperformance of the economy in 2015 explains the difference. Real GDP shrank by 0.3 percent last year compared to a projected growth rate of 2.9 percent at the end of 2014.

Although there are signs the economy may have hit rock-bottom in 2015 and therefore a rebound may be in the offing, the additional tax burden casts some doubts. This is more so given the government’s insistence that the income tax scale becomes even more progressive than it is, penalizing people earning more than 20,000 euros annually.

In addition to transferring sizeable resources from the private sector to the public sector, which has almost never helped economic activity, the additional tax burden creates disincentives for labor productivity and encourages tax avoidance and evasion.

Of course, leftist officials and others see things differently. They view taxation as a tool to redistribute income from the highest income earners to the lowest. In reality, the bulk of the budget revenues finances the salaries of public sector workers and subsidizes pensions. These are not necessarily the lowest paid individuals. By putting redistribution first, they tend to either ignore or downplay the so-called reciprocity principle. That is, people pay taxes because they expect to get some public goods and services free in return. In Greece’s case, public services are usually of poor quality and people often double pay for them as tax payers and users, i.e. supposedly free public education with private lessons usually paid under the table.

In any case, the large increase of revenues from taxes and social security distributions as a percentage of GDP in Greece and the prospect of an even greater increase in 2016-2018, following the completion of the first review, bode ill for the future of the economy. Although a rebound could be realized in the second half of 2016 due to base effects and some help from the external sector, the damage done on productivity and growth potential by the increase in taxes and social contributions is bound to take hold and be long-lasting.

[Kathimerini English Edition]