Politics is the art of spending regardless of whether there is money to do so. This seems to be the motto of Pedro Sánchez, the new prime minister of Spain, who has recently revealed his intentions to boost public spending until the end of his term, presumably in 2020.
The good performance of the Spanish economy, which has been growing at a an annual rate of 3% since 2015, has resulted in higher fiscal revenues, providing the new government with the perfect pretext to increase spending and thereby win back the support of those voters that turned their backs on the socialists in the last three elections.
After just a month in office, Sánchez’s government has proposed reforms that would increase spending by €4bn in 2019 alone. His reforms include the elimination of tolls on some motorways; the suppression of pharmaceutical co-payments for pensioners; and the abolition of the 2013 pension reform that, among other things, de-indexed pension increases from inflation, and whose repeal would dramatically increase the social security deficit, compelling the government to finance contributory pensions via the national budget.
However, Sánchez will find some obstacles on his quest to send public spending through the roof. Spain is still under the Excessive Deficit Procedure (EDP), which means that Brussels will keep a close eye on the Spanish government to avoid further budget imbalances. Yet this mechanism has proven to be ineffective so far: since Spain entered the EDP in 2009, it has only met the deficit target imposed by the EU in 2017 (even though the deadlines have been revised several times) and it is expected not to fulfill its fiscal obligations again in 2018 and 2019.
In addition, the so-called Regla de Gasto passed by Congress in 2013 prevents public spending from increasing beyond the long-term growth of the economy, which, in the case of Spain, is 2.7 per cent annually. This implies that the new government will need to punish taxpayers and draw upon tax rises to fund its spending plans, something that it is already considering.
In fact, if we take a look at the budget that then opposition leader Sánchez set out back in April as an alternative to ex-Prime Minister Rajoy’s plans, we can gain some insights about the new government’s fiscal agenda. Sanchez’s proposals would imply increasing the tax burden, understood as the ratio between taxes collected and GDP, by 8 percentage points, from 34 in 2017 to 42 per cent in the long term.
This would be done mainly by increasing direct taxation. A new marginal tax rate would apply to those earning more than €150,000, and capital income over €50,000 would be taxed at a 30 per cent rate (currently 23 per cent). The text also reflects an increase in corporate tax rates, including a special tax on banks that would reduce their yearly benefits considerably.
More recently, Sánchez has proposed to remove the ceiling on social security contributions, which would push labour costs up by more than €4.5 billion. To understand the impact of such a measure, here is an example: for a business hiring a qualified worker who earns an annual salary of €75,000, social security contributions would increase by 67% – a tremendous blow to the growth prospects of the private sector.
Fortunately, all these measures will be difficult to implement due to the Socialists’ wafer-thin majority in Spain’s lower house. Nonetheless, some of them will likely pass Congress thanks to the support of the same populists and nationalists who helped make Sánchez prime minister last month.
Although the economic outlook is currently positive, Spain will face some challenges starting in 2020, as the Institute of Economics Studies has recently pointed out. First, Madrid will have to increase its contributions to the EU budget due to Brexit and the reform of the Common Agricultural Policy.
Furthermore, the European Central Bank has recently announced the end of its bond-buying programme for December this year. This means the end of the zero interest rate era is near, which will have an impact on Spain’s public finances by driving up the cost of debt. Finally, the effects of Trump’s protectionist policies, which have already begun to be visible, will no doubt harm the export sector, undermining long-term economic growth along the way.
In this context, an unbalanced budget, a more burdensome taxation system and the undoing of structural reforms, all of which are likely outcomes if Sánchez follows the above policies, would negatively impact the Spanish economy down the road, bringing to an end the period of relative prosperity that Spain has enjoyed over the past few years.
