Time and Money

September 28, 2012 Leave a comment Go to comments

Thanks to the Financial Times of a couple of weeks ago, I have read an interesting paper on tax evasion in Greece. Interesting because it quantifies what everybody already knew: the Greek government is structurally incapable to collect taxes. The study estimates a lower bound of 28 billion euros of unreported income for Greece. As a consequence, the foregone government revenues amount to 31 percent of the deficit for 2009. We are talking about lower bounds here, so both figures could be substantially higher.

The excessive weight of the informal economy, and the inefficiency in tax collection had already been pointed out repeatedly, for example in the last OECD Economic Survey of Greece before the crisis hit (2009). A sentence of the accompanying Policy Brief best summarizes what we already knew before the crisis

Structural fiscal reforms should be a key priority going forward. Sustainability calls for improvements in a tax system which is beset with widespread evasion. Apart from simplifying and widening tax bases, the fight against tax and social security contribution evasion should be stepped up, and tax collection improved (p. 1).

The brief also gave some hints as of how to address the problem:

Reducing extensive tax evasion will be key to putting public finances on a strong footing. […] tax evasion remains widespread, especially among the self-employed. This reflects weak collection procedures, a large informal sector, frequent tax amnesties and a complex tax system. Collection can be improved by strengthening auditing activities through a better qualified personnel and a more comprehensive exchange of information among agencies. The collection of taxes and social security contributions should be combined in a single authority. This would also reduce the cost of compliance borne by taxpayers and the tax administration, which is among the highest in the OECD. Repeated tax amnesties need to be discontinued, as they only discourage compliance. Broadening of the tax base hinges upon a more simplified tax system. Revenue can be boosted by reducing the number of VAT rates and shortening the list of goods and services that are eligible for reduced rates, and by eliminating exemptions in income taxation. Balancing the level of taxation between employees and the self-employed, who currently face a lower burden, would make the tax system fairer (p. 6)

This is a sensible diagnosis, and the measures suggested make sense. I take three things from this:

  • The problem with Greek public finances is quality, not quantity.
  • Furthermore, this diagnosis calls for a very long term effort. You don’t turn a complex fiscal system upside down overnight. We experience delays and difficulties in adjusting far more efficient systems.
  • Building an efficient tax system is nothing less than an investment, whose potential return, by the way is immense. And investment needs frontloaded resources.

To summarize, if we take the OECD analysis seriously, then we need to help Greece in a long term effort, that will require more resources today, in exchange for a better (less costly and more capable of collecting revenues) system in the future. In a sentence, Greece needs time and money.
And instead, guess what? they are getting austerity, and fast. Under pressure from the Troika, Greece is going for immediate fiscal consolidation which has, necessarily, to imply across the board expenditure cuts (around 10 bn euros, mostly from reduced pensions, but also reduced public wages and health care expenditure) and tax increases (3 bn euros) that will anyway probably not be collected.

And of course the whole package is self defeating, as Christine Lagarde acknowledges. It will always be. Austerity is contractionary, and eventually bad for public finances  (just look at yesterday’s column by Paul Krugman: nothing new, but as usual clearly explained).

It is tiring to say it over and over again: Greece, and more generally Europe, need different recipes.

  • First, as the crisis is not over yet, we need an aggregate expansionary fiscal stance. That would probably mean milder consolidation in the periphery, accompanied by robust expansion in the core.
  • Second, structural reforms, yes, but not the ones usually advocated. Much more important than increasing flexibility in markets, that are way less rigid than people usually think, we should address the structutural causes of the current situation. Increasing inequality and chronic demand stagnation, poor quality of public expenditure (once again: quality, not quantity), inefficient (not excessive: inefficient) regulation.

There is no discussion of this in the European public arena. Instead, we get the same old same old: Reduce wages, increase flexibility of labour markets  (by the way, why is rigidity in product markets not as emphasized?), reduce public expenditure. For example in Italy.

In the meantime Athens and Madrid (and Lisbon, and…)  burn, and spreads are increasing again. The new OMT announcement, important as it may be, fails to reassure markets. The ECB should be buying sovereign bonds no questions asked. But  it does not, because of conditionality, endless discussions on whether Spain or Italy should ask for help, and so on.

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