Wednesday, December 07, 2011

Does Greece’s 2012 Budget Make Sense?

On December 6, the Greek parliament approved a budget for 2012. The goal is to shrink the deficit from a projected 9% of GDP in 2011 to 5.4% in 2012. But this €8.2 bn adjustment is primarily driven by more revenues – and as such, it is more likely to fail.

For 2011, the Ministry of Finance has projected a €19.6 bn budget deficit; the target for 2012 is to lower this deficit to $11.4 bn. First, the Greek government is negotiating a reduction in its private sector debt (see here); the Ministry of Finance estimates that this haircut will lower interest expenses by €3.1 bn. There is a also category labeled “adjustments” that will *increase* the deficit by €1.6 bn, thus offsetting some of the gains from the haircut. If we assume that these adjustment are a given, on a net basis, the Greek government is left with a need to raise revenues and/or cut spending by €6.7 bn (€8.2 – €3.1 + €1.6 = €6.7 bn).

Of that €6.7 bn, two thirds (€4.6 bn) will come from a revenue increase versus a third that will come spending cuts. On the revenue side, the increase comes from three sources: (a) a 29% rise in direct taxes from individuals; (b) a 217% increase in property taxes; (c) and a 24% reduction in tax returns. On the spending side, the two main sources of reduction come from (a) lower salaries and (b) the unhelpfully named “other spending.”

Let us focus a bit on the revenue side of the equation. In a shrinking economy (GDP is forecasted to fall by 2.8%) collecting more taxes will be a great challenge. What is more, the property tax remains hugely contentious and many people want to not pay it as a form of civil disobedience. As for the budgeted €3.8 bn in tax returns, this is exactly what the government budgeted for 2011 – except that the actual figure out turned out to be €5 bn, which the government attributes to one-off effects.

But if you step back and look at the revenue side more broadly, two figures stand out – both of which are included, by the way, in the budget document itself. The first is the ratio of direct taxes to GDP: since 2004, this number has averaged 9.1% and it has ranged from 8.9% of GDP to 9.5% of GDP. In 2012, the government expects this number to increase to 11.4% of GDP, a full two percentage points higher than at any point since 2004 (and much before that).
The second is tax buoyancy, which is effectively an elasticity which measures how much taxes increase relative to GDP. From 2004 to 2008, buoyancy averaged 1.14 which means a 1% increase in GDP led to a 1.14% increase in tax revenue. That makes sense. Then came 2009 where tax revenues fell at a much higher than GDP, followed by 2010, when buoyancy turned negative because tax revenues rose despite a contraction in the economy. By 2011, however, the relationship returned to a more normal 0.7. By contrast, the 2012 budget is forecasting a -3 buoyancy – which means that not only will tax revenues increase when GDP is shrinking but the tax elasticity will be twice as much as it was in 2010 when the government institute a myriad new tax measures. As I said, these two figures are generated using data directly from the budget – so there is no much ambiguity.
If there is one common theme in the literature of fiscal consolidation is that spending cuts work better than tax increases, a lesson that the Greek government seems progressively intent to ignore. In the case of Greece, of course, this ignorance has both economic ramifications (by deepening the recession) and political ramifications by signaling to the public that higher taxes will take precedent over cutting spending in the inefficient public sector. Neither of these two signals is positive.

When Greece first announced that it would reach an agreement to shave off some of its debt, I noted that the true implications of that decision would depend on what the government did with the reprieve it got: I wrote, “Ideally, the government can put this windfall to good use by providing some tax relief that can stimulate consumption and hence economic growth. Or, it can waste the chance by only relaxing its resolve to reform.” In truth, the government has wasted it by sticking by its plan to keep taxes high rather than cut spending more aggressively. And by signing a budget that tries to squeeze more revenue from an atrophying economy, it is laying the seeds of its own failure. What a shame.


  1. As always a very good analysis. ISTM that most people spend all the money that they earn, which is then used to pay other people. So by recursive taxation the government (of any country) will end up with more or less the same amount of money no matter what they set base taxation at. By increasing taxation all you achieve is less money in circulation.
    Greece should have put more emphasis on collecting tax and privatising their public industries.

    You know there are DEKO like the aerospace and the electricity industries. These are private companies under government control. The salaries are paid from the profits of the companies and, of course taxed.
    When the government reduced public sector pay they also reduced pay for DEKO workers. But since DEKO workers pay comes from profits and not from the budget this move actually caused a reduction in income via taxation. I could not understand why they would do such a thing. Then I heard an MP talking she said it would be "unfair" not to cut DEKO pay. So that explains it - LOL.

    I am self employed working in Greece. I have paid my property tax, my extra tax, but I have had to dig into the money put aside for my income tax. I am sure there are others in the same boat, I seriously fear that come April 2012 I will not have enough money to pay my income tax. No civil disobedience - I just won't have the cash.

  2. I find it somewhat disappointing that no revenue seems to be expected from privatizations. For at least a year now there had been talk of raising around 50 bn euros from that source. Was that just a fantasy figure, or is it the political will that is missing?

    I don't know how much of the increase in direct taxes is expected to com from measures against tax evasion. Time and again I have read about a list of tax evaders which was going to be published, for example here:
    and here:
    di .
    But, as far as I know, this famous list is not published to this day. Why not?

  3. Thanks Stuart. I think you're spot on...

    @ Anon: There is revenue from privatizations (EUR 6 bn or EUR 9.3 bn depending on which page of the budget you trust) but these go straight to paying down debt rather than being channeled through the budget. So like the haircut, the net impact is just on the debt over GDP figure rather than on any prospect for tax relief.

    As for tax evasion that is indeed part of the plan - but we have been hearing about cracking down on tax evasion for a while, no?

  4. Good work.

    The long-promised list of tax cheats, the imminent publication of which was announced many, many times, was very abruptly classified. It can be seen only by MPs, who to have to wait 15 days from application, and who cannot coppy or take noted when they're finally allowed a peek.

  5. Dear Niko,

    thanks for this analysis and for maintaining a very nice blog. I have very poor understanding of economics, but it is easy to follow your writings.

    After reading this analysis, I am not sure what to think. How is it possible for a person to find so many obvious problems with the budget plan, just looking at some plots only one day after data on this plan were released, while a whole goverment, advisors (from inside or outside Greece) who work on this for weeks(?), months(?) do not notice the issues?

    Two answers are possible for me: either you are wrong somewhere and I cant identify the mistake because I don't unerstand economics, or politicians still do not care. Maybe they have the feeling somebody will always bail them out...

    We have heard a lot of things over the years about the incompetence of the Greek politicians, but know, decisions of the Greek goverment are also heavily influenced from abroad. Isn't it obvious to politicians abroad that the budget plan will probably fail? Is there any risk management in all these European plans? Isn't it obvious that this budget plan has a huge risk?

  6. Ilia, this is an excellent question and it, in fact, prompted me to write a whole post on it:

  7. Good article, this insanity is now going to be attempted on the rest of Southern Europe as well, raising taxes and cutting spending in to the teeth of a recession.

    Whilst Greece is a more extreme case it is logical to expect the rest of southern Europe to follow Greece's path in to permanent recession where the deficit and debt become impossible to control.

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