Thursday, May 26, 2005

€uro deficit limits - one size should not fit all

Portugal on Wednesday introduced sweeping tax increases and big cuts in benefits for state employees as part of an emergency plan to tackle the country's ballooning budget deficit. The package of tough measures, aimed at averting European Commission sanctions and a debt downgrade, includes a controversial plan to raise the retirement age for Portugal's 730,000 public sector workers from next year.

The move comes just two days after a national audit commission said Portugal's budget deficit could soar to 6.8 per cent of gross domestic product this year, more than double the 3 per cent limit set by the European Union's stability and growth pact. Measures to increase value-added tax from 19 to 21 per cent and increases in sales taxes on tobacco and fuel will have an immediate impact.

The moves also include a new maximum personal income tax rate of 42 per cent on annual earnings above €60,000. The prime minister said the minimum retirement age for state employees - who account for one in six workers in Portugal - would be raised in stages from 60 to 65, starting in 2006. In a further attack on the "unfair privileges" enjoyed by state employees, sickness pay would be cut from 100 per cent to 65 per cent, bringing public sector workers into line with the private sector.
A "vast list" of tax benefits and exemptions would be abolished and a maximum limit set on corporate tax benefits, Mr Sócrates said.

The FT @ Portugal introduces emergency plan to cut deficit
Given that there has just been an election in Portugal the government will probably get away with this. Had it been the case that an election was due within a year to eighteen months I would suggest that Mr. Socrates would not be implementing such vigorous measures.

This is one of the fundamental problems the €uro, the EU, and the rules that underpin them, face - the conflict between domestic national interest and the wider European interest. As I have alluded before similar 'defict busting' measures are likely to have to be put in place by those new EU member states that plan to adopt the single currency in the period 2008 to 2010; it is going to be difficult and deeply unpopular. When such steps are taken in Germany or France – public sector workers, unions etc. come out on the streets, and the political left adopts anti-capitalist rhetoric.

In many respects states like France, Germany and Italy deserve less sympathy if they break deficit limits. There is however a very good case for arguing that less developed EU member states should be permitted to run a higher deficit whilst they are bringing their economies and social models up to parity with the rest of the EU. Clearly there would need to be a fair degree of supervision / accountability in such circumstances, but in the absence of a more understanding attitude towards deficits I can see a situation arising where some EU member states are going to remain the poor relations for many, many years to come.