Why Spain's Austerity Budget Is Doomed To Fail

spain strike march 29 2012A demonstrator spraypaints the main door of the stock exchange during a general strike in Barcelona, Thursday, March 29, 2012. Spanish unions angry over economic reforms are waging a general strike, challenging a conservative government not yet 100 days old and joining other troubled European workers in venting their frustration on the street.

Photo: AP/Manu Fernandez

Spain’s blockbuster budget, announced yesterday, may look disappointing at first sight. The only truly dramatic figure to emerge was the total size of the adjustment: 27 billion. This, said Cristobal Montoro, the budget minister, made it the most austere budget Spain had faced since Franco’s death in 1975.By most measures it would indeed be a mighty adjustment. But much of the figure was accounted for by income-tax rises and other measures announced in a separate adjustment, worth 15 billion, in December.

Moreover, yesterday’s budget only covered Spain’s central government, not those troublesome regional governments and town halls that have so many people worried. These have to make their own adjustments, worth another 14 billion or so. Since regional governments run health services and schools, they are faced with the task of making cuts that many people will feel the most acutely.

Mr Montoro, who was talking the day after a general strike saw massive protests across Spain, was careful not to hit ordinary Spaniards too hardor at least not directly. The cost of electricity, gas and cigarettes will go up. But most of the rest will come from corporate taxes, a fiscal amnesty, a civil-service pay freeze and individual ministries (which must make cuts worth an average 17%).

It will take a closer study to see whether all this delivers the goods (a fuller explanation is due from the government next Tuesday). But Mr Montoro is not the kind to fiddle the numbers. And he can control the spending of ministries directly, which he cannot do for the regional governments.

Assuming that accountants do not find ways to sidestep the new rules, the government should be able to pull in the extra 5.3 billion or so it wants from tighter corporate taxes.

The amnesty is less of a sure thing. Mr Montoro is assuming that 25 billion or more will be dug out from under floorboards (if that is where all those 500 notes hoarded during the building boom went), or from offshore company accounts. People holding such funds will pay taxes worth 8% or 10%, no questions asked.

The amnesty is supposed to produce 2.5 billion, a figure is based on the experiences of countries like Italy. But who is to say that Spaniards will respond the same way?

Mr Montoro stuck to his previous pledge not to hike sales tax, which at 18% is low by European standards, saying he did not want to hit consumers. Antonio Argandoa of the IESE business school in Barcelona is among those who are surprised. “A 1% raise, for example, would not have affected consumer spending,” he says.

Sceptics see a sales-tax increase as inevitable if Mr Montoro is to get last year’s budget deficit of 8.5% of GDP down to 3% by the end of next year, as the government has promised Spain’s European partners.

It has been a tough week for Spain’s ruling People’s Party. The general strike came just four days after the PP failed to win control of Andalusia, Spain’s largest state, in an election. Still, the government’s commitment to austerity seems undimmed. Ministers insist they are fully aware that their credibility is at stake.

The real test will come later in the year, if Mr Montoro sees that the measures he has introduced are insufficient to meet this year’s deficit target of 5.3%, or if the regions, despite central government having new powers to fine them, fail to deliver on their part of the bargain. The government may then feel obliged to turn the screw tighter.

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