Mariano Rajoy has recently sent a letter to Brussels committing to take additional measures in the second half of the year if he wins on 26-J. It should not be forgotten that Spain closed 2015 with a deficit of 5.1 percent of GDP, 10,000 million euros above the target, and this could entail a penalty of up to 2,100 million. At the moment Brussels has postponed this decision until after the electoral appointment.
Rajoy had been maintaining that additional cuts are not necessary, beyond the agreement on the non-availability of spending for 2016, which represents savings of 4,000 million between the Central Administration and the autonomous regions, and which could be extended to 2017. Despite the fact that Brussels is asking for cuts around 8,000 million, Rajoy has come to be favorable to a future tax cut. In the aforementioned letter, Rajoy maintains a different discourse and one more in line with the requests from Brussels.
Minister De Guindos maintains that Spain does not need adjustments at this time, such as an absolute cut in the level of spending and a tax increase, and considers that there is room for a tax cut as long as growth remains at current levels. But is this claim realistic? Let’s contextualize:
The main objectives of fiscal policy are to accelerate economic growth, full employment of society’s productive resources, both human and material and capital, and price stability. We find two types of fiscal policy:
Expansive fiscal policy: occurs when measures are taken to increase public spending or reduce taxes, with the aim of stimulating aggregate demand, especially when the economy is going through a period of recession and needs a boost to expand. As a result, a deficit tends or can even cause inflation.
The effects of this policy are the increase in private consumption due to the increase in disposable income; in investment, the increase in the interest rate negatively affects investment and the increase in income favors sales and therefore stimulates investment spending, therefore, investment will increase or decrease depending on the strength of each effect; private savings will increase due to the increase in disposable income; On the one hand, public savings decrease due to the increase in public spending, but the increase in income causes savings to increase due to tax collection.
Contractive fiscal policy: occurs when decisions are made that seek reduced public spending, tax increases, or a combination of both, with the objective of curbing aggregate demand, for example when the economy is in a period of excessive expansion and has need to curb the excessive inflation it is creating.
As a result, a surplus tends. It is the one that reduces aggregate demand, in order to generate an excess of aggregate supply of goods, which will ultimately reduce the level of income. In this case, the effects are the decrease in private consumption due to the drop in disposable income; the investment remains indeterminate because on the one hand it increases due to the drop in interest rates and on the other hand it increases due to the drop in income that makes sales less; private saving decreases and public saving remains indeterminate because on the one hand it increases due to the increase in taxes but the fall in income also decreases tax collection.
And finally we add the unemployment component. Spain has a level of unemployment of around 20 percent of the active population, so although the tax cut would favor the income of these people, it would be necessary to analyze the impact it has on consumption, and therefore growth , via the marginal propensity to consume and the marginal propensity to save.
Historically, the PP has tended to activate the economy via tax reduction, but the situation was different, the unemployment rate was not as high as it is now, nor was the pressure from the EU in terms of adjustments, especially the reduction of deficits, so big. We are in the electoral period, we still have to see many adjustments, which although hard, it is necessary to finish implementing them.
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