Spain ? More Austerity Measures Needed?

14.03.12

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In February the Organisation for Economic Co-Operation and Development (OECD) praised the tax measures introduced in Spain as a crucial first step to bringing the country?s finances o

In February the Organisation for Economic Co-Operation and Development (OECD) praised the tax measures introduced in Spain as a crucial first step to bringing the country?s finances onto a sustainable footing. Taxpayers in Spain may be less complimentary when they receive their tax bills for 2012. The European Commission may also have less praise for Spain now that it is breaching deficit reduction targets and testing the new EU budget rules.

At the beginning of March the European Commission (EC) warned that Spain could potentially be fined for a ?serious, grave? breach of deficit limits. Madrid was meant to bring the public deficit down from 9.24% of gross domestic product (GDP) in 2010 to 6% in 2011. As recently as December the former government insisted the target would be met.

When the new government took over in December, however, it realised the target had been overshot by two percentage points and had to announce an 8% deficit. At the same time it introduced austerity measures of spending cuts and tax rises.

At the end of February it revealed that the deficit was actually half a percentage more at 8.51%. This means the state spent ?90 billion more than it took in last year, and the deficit had barely declined in 2011 despite earlier austerity plans.

EU Economy Commissioner Olli Rehn asked Spain for ?clarity? on the figures, saying it was important to understand what went on in Spain in 2011. ?It is clear we need these hard figures, validated, in order to do a full assessment?, he said.

The problem then, of course, was what would happen with this year?s deficit target. Spain was obligated to bring it down to 4.4%, but considering last year?s overshoot this will be much harder to achieve.

The 4.4% target was based on 2.3% growth for 2012, but that is now very unrealistic. Commission forecasts now show the economy is likely to contract by 1%.

It would mean the Spanish government has to come up with more than ?40 billion of spending cuts or tax increases to reach the target – more than double those already imposed this year. This would be unprecedented, particularly when output is falling.

By the end of February Prime Minister Mariano Rajoy had sent signals to the EU that the target should not be binding. At the beginning of March he said Madrid could not hope to close such a huge gap when it is grappling with soaring unemployment and negative growth and his government forecasted a deficit of 5.8% for this year – around ?15 billion above target.

Rajoy said he is ?backing austerity and aim to reduce the deficit from 8.5% to 5.8%, that?s significant austerity?. He said he had not consulted other European leaders and that the step was a ?sovereign decision by Spain?. While he is not disputing that the deficit needs to be cut, he says this should not be at the expense of creating jobs ? a top priority for a country with unemployment over 20%.

He defended shifting the 2012 target, arguing that his government is still ?scrupulously fulfilling our commitments? on cutting the deficit and stressed that they still intend to lower it to 3% by the end of 2013 as planned. While the timing and the pace has been adjusted, ?the ultimate aim has not changed?.

Spain is bound to reduce the deficit to 3% by 2013 under the EU?s excessive deficit procedure, which places EU States with budget gaps measuring over 3% of annual output under close watch. New powers introduced last year allow the Commission to fine Eurozone countries up to 0.5% of their GDP if they repeatedly miss targets.

European Commission head Jose Manuel Barroso backed Spain, saying he has ?no doubt? that the government will ?honour its commitment? because it is very much in the interests of both Spain and the Euro area.

On 12th March Eurozone finance ministers agreed to ease the deficit target for Spain for this year, but insist is must be brought down to 5.3% which is lower than Rajoy?s 5.8%. Eurogroup President Jean-Claude Juncker told reporters that it ?assesses that the timely correction of the excessive deficit should be ensured by an additional frontloaded effort of the order of 0.5 percentage of GDP?. Madrid needs to stick to the 2013 target of 3%.

Spain?s economic slowdown will reduce tax revenues for the government and its social welfare costs are mounting with 4.71 million people unemployed. Last year the government reluctantly abolished the 100% tax credit on wealth tax to bring in more revenue, but some autonomous communities have said they will continue to give their residents the credit, so wealth tax will be bring in much less revenue than hoped and needed.

All in all, even if Spain does get its way and has a deficit target of 5.8% this year, it still needs to bring it down to 3% within 22 months and right now it is hard to see how it will achieve that. While the government has already introduced tax increases, residents of Spain need to be prepared for further tax hikes because the government will need to look for ways to bring in much more revenue.

For advice on effective tax planning solutions in Spain speak to an experienced wealth management adviser like Blevins Franks.

By Bill Blevins, Managing Director, Blevins Franks

13th March 2012

The tax rates, scopes and reliefs may change. Any statements concerning taxation are based upon our understanding of current taxation laws and practices which are subject to change. Tax information has been summarised; an individual must take personalised advice.

Tax rates, scope and reliefs may change. Any statements concerning taxation are based upon our understanding of current taxation laws and practices which are subject to change. Tax information has been summarised; individuals should seek personalised advice.

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