Greece deal needs to have longer-term view for growth revival

There are three ways a state’s public finances can be improved – lower spending, higher taxes or a rise in economic growth.

Greece’s latest plans focus mainly on hiking taxes, with the Syriza-led government wanting to stick to its commitments not to cut social spending.

There are some measures to reduce the cost of pensions, but the vast bulk to be raised over the next 18 months comes from tax hikes, including VAT rises, a hike in corporation tax and new charges on higher income households.

The document submitted by the Greek government estimates that the measures will reduce the deficit by €5 billion when fully implemented in 2016.

Greece has already implemented very significant austerity – amounting to over 20 per cent of the value of its GDP, very roughly split 50:50 between tax and spending measures. There have been massive cuts in public sector pay and pensions, in public sector numbers and big tax hikes in a number of austerity programmes.

One measure of the underlying progress was a move in what is called the underlying budget – which excludes debt interest payments – from a deficit of 10.6 per cent of GDP in 2009 to a surplus now.

The problem Greece has faced is that it has been trying to catch a falling knife, cutting and taxing against a backdrop of rapid economic decline, which makes the job much harder.

This is why, despite the cuts and the improved budget position, its ratio of debt to GDP has shot up to over 170 per cent – its overall debts have risen modestly in recent years to €315 billion, but GDP has collapsed.

There are reports that the IMF would prefer its new adjustments to be focused more on cutting spending and less on hiking taxes. The orthodox economic view is that this is less damaging to growth, but opponents argue it hurts the less well-off – who depend more on government spending. Business and tourist groups in Greece also complain that the plan will stifle growth.

Ireland’s €28 billion adjustment – about 17 per cent of our GDP – was two-thirds spending cuts and one third tax hikes. However, while Ireland has managed to return to growth, Greece remained stuck in recession until a pick up last year.

The latest uncertainty will have hit Greek growth again and has also had a major impact on government revenues.

There have been some similarities and some differences between the tax raising measures used by Greece and Ireland – notably unpopular property taxes. Both countries have imposed new income tax charges, with the heavier burden on higher income households, but the Greek tax measures have also involved major VAT hikes.

Its income tax structure has considerable shortcomings, while in Ireland crude extra taxes on income are efficient revenue raisers.

The latest list of proposed Greek measures continue this trend, but with a Syriza twist. VAT changes are a major item, along with an increase in the main corporation tax rate from 26 to 29 per cent and a special 12 per cent profits levy on bigger firms.

Pension savings will be achieved mainly through higher contributions in the short term. It is a package that contrasts with Ireland’s tax strategy, which has focused on hiking income taxes and charges but holding corporation tax down and avoiding major hikes in most indirect taxes.

The difficulty for Greece is that the package will certainly reduce growth by hitting spending power and it remains to be seen if it can bolster confidence, which might counteract this to some extent.

Having returned to growth last year and with some signs of economic improvement, the six months of uncertainty as the talks have dragged on have damaged the economic picture and led to significant financial instability.

To counteract this, a comprehensive agreement is needed which also points the way to a longer-term deal between Greece and its creditors which creates some basis for a growth revival.

As Ireland has seen, once growth revives, improving the public finances becomes much easier.