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Spain's growing budget deficit
11 September 2009 @ 00:58

The prime minister plans to raise taxes to restore the public finances

FIRST it was spend, spend, spend. Now it is tax, tax, tax. As Spain’s budget deficit soars and economic recovery remains elusive, the Socialist prime minister, José Luis Rodríguez Zapatero, has made clear how he expects to start balancing the books. “I am going to ask for a share of people’s incomes out of solidarity and to meet the demands of the most needy,” Mr Zapatero told parliament on September 9th.

He said the 2010 budget would aim to raise overall taxes by 1.5% of GDP, which should earn the government about €15 billion ($22 billion). Mr Zapatero did not spell out how he would do this, leaving the matter to negotiations with parties whose support he needs to get the budget passed.

Still, Mr Zapatero is performing a U-turn. In previous years he cut the top rate of income tax, slashed company tax and brought in a populist €400 ($560) annual rebate for all Spanish taxpayers. But that was when Spain was booming. The latest data shows that GDP is shrinking by 4.2% annually. Spain also has Europe’s worst unemployment, at 18% and climbing.

Respite will not come soon. Spain’s recession, made worse by a burst housing bubble, is different from those of other European countries. Some economies are already starting to look up, but Spain’s will not recover for another year. The construction industry is in tatters and, with hundreds of thousands of unsold new houses, is not about to recover.

An €8 billion public-works stimulus combined with a dramatic fall in revenues has blown an enormous hole in the public accounts (see chart). This year’s budget deficit is expected to be around 10% of GDP. Yet Mr Zapatero has promised extra money to everyone, from regional governments to the long-term unemployed. Next year will see an extra €5 billion given to town halls.

Unless he is prepared to cut spending, Mr Zapatero can only keep his promise to cut the deficit to 3% of gdp by raising taxes. “I have always thought of fiscal policy as an instrument that should respond to changes in the state of the economy,” he said recently. Mr Zapatero will probably scrap his income-tax rebate, or most of it. But he is cautious about raising income tax. The public-works minister José Blanco, a Socialist heavyweight, floated the idea of higher taxes for big earners during the summer, but the prime minister firmly squashed it.

The main target, apart from obvious things like alcohol, tobacco and petrol, is likely to be capital-gains tax. This was set at 18% in 2007, far below a top tax rate on earned income of 43%. Investors are anxiously waiting to hear how much they will have to pay. The opposition People’s Party (PP) which wants tax and spending cuts, mocks such moves. “No tax rise is capable of covering up the hole you have made,” the PP leader, Mariano Rajoy, told the prime minister in parliament.

Mr Zapatero shows little appetite for long-term spending cuts of the kind that countries such as Britain are starting to think about. He looks as if he is storing up problems for the future.

Source: The Economist

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