Europe’s Growth Deficit


WSJ Editorial – December 9, 2011

The Continent tries to tax its way back to prosperity.

European leaders are meeting in Brussels today to craft their third attempt—or is it the sixth?—to end the Continent’s debt crisis and avert a deep recession. So it seems an apt moment to review the economic policy record of the leaders seeking to set Europe back on course. It isn’t pretty.

A large part of the problem is the state of Europe’s intellectual debate, which pits government spending against “austerity” as the only two economic policy choices. The Keynesians are blaming Europe’s looming slowdown on belt-tightening governments, as if public spending is the only way to spur economic growth. But the problem across most of Europe isn’t a lack of government spending that typically represents about half of GDP. It’s the failure to create the conditions for private investment and growth.

When the financial panic hit in 2008, the EU and International Monetary Fund urged governments across the Continent to spend like crazy to avoid recession. So they spent, only to discover that such spending is unsustainable. Now the same wise men are urging governments to raise taxes to offset all that spending and even to spend more “in the short term.” The one policy none of these leaders has tried is the Reagan-Thatcher model of cutting taxes to spur growth.

Let’s run through Europe’s policy lowlights:

• Britons are congratulating each other for not joining the euro zone a decade ago, but on fiscal policy there’s little distinction between the U.K. and the euro area. The Tory-Liberal Democrat government raised the VAT rate to 20% at the beginning of this year—from 17.5% when it took office and 15% two years ago. The previous Labour government raised the top marginal income-tax rate to 50% from 40% in 2009.

• French President Nicolas Sarkozy quipped this week that “With the way they are increasing taxes in London, we’re going to get our young people back.” Not based on his economic record. The French President has responded to his country’s wobbling credit rating by raising the VAT on a variety of purchases and by soaking corporations and wealthy individuals.

Capital-gains exemptions from property sales will be canceled, and individuals whose incomes exceed €500,000 will have to pay an additional 3% surtax on taxable earnings—an “exceptional contribution,” the measure is called. Prime Minister François Fillon declared that the proposed increase in the effective capital-gains tax, to 32.5% from 31.3%, is a way for the rich to show “solidarity.” In all, the French government has proposed some €31 billion in new taxes in the past year.

• In Italy, new Prime Minister Mario Monti is increasing the main VAT rate to 23% from 21% and introducing other new levies, including a duty on bank accounts, stocks and financial instruments, and a retroactive 1.5% tax on capital brought into the country last year from abroad. Of the €18 billion in new taxes he signed into law this week, two-thirds is expected to be raised by reintroducing a property tax that Silvio Berlusconi, for all his other failings as Prime Minister, had abolished.

Greece raised its VAT rate to 23% last year, and it is introducing a new property tax and has raised taxes on alcohol, cigarettes and food. In June the finance ministry unveiled a “solidarity tax” of up to 5%, which even the jobless will have to pay so long as they have worked even a single day this year. Greeks weren’t paying taxes when rates were lower, so it’s hard to see how higher rates will have the revenue effect that Athens wants.

In September, then-Deputy Prime Minister Theodoros Pangalos told Greek television that “I believe that the tax limits of Greek society have been exhausted. I would say they have been exhausted for some time.”

• Spain’s government reintroduced a wealth tax in September, to be levied on individuals with €700,000 in assets excluding their primary homes. Madrid expects to hit 160,000 people with the new tax, an optimistic assessment given the extent to which rich Spaniards avoid income tax. Only 7,000 people in Spain declare annual taxable income above €600,000, according to one estimate.

• Portugal has increased the VAT on certain goods and reduced tax deductions to fill its budget gap, though spending cuts still account for a higher portion of proposed savings this year. But the greater tragedy in both Portugal and Spain is the failure to tackle their biggest threat to long-term growth: their cripplingly rigid labor laws. Spain’s jobless rate is the highest in the EU at 22.8%. Youth unemployment is 48.9%. Laws that guarantee lifetime employment with gold-plated contracts force young people to shuffle endlessly between short-term, low-paying jobs—or not to work at all.

• Ireland has wisely resisted pressure to raise its 12.5% corporate tax rate, among the lowest in Europe. That has helped the country maintain its export competitiveness. But this week Dublin announced it is raising the VAT rate to 23% on most purchases, starting in January, up from 20% two years ago. The new budget also raises taxes on interest income, fossil fuels and car ownership.

***

There are a few dissenters from the conventional wisdom that Europe can tax its way back to economic health. Estonia, one of the EU’s top GDP performers this year, responded to the financial crisis by trimming government salaries while maintaining its flat corporate and personal income taxes.

In the Netherlands, labor unions are reluctantly surrendering pension benefits and workers’ ability to retire early so that the Dutch labor market remains competitive. Slovakia has fought the IMF to keep its flat 19% rate of corporate and personal income tax, which has helped the country become a hot destination for foreign capital since its introduction in 2004.

Among Europe’s large economies, only Germany deserves partial kudos. Angela Merkel’s center-right coalition resisted the IMF-Obama Administration pleas to join the global spending spree in 2009. And it has agreed, at least in principle, to cut the income tax before 2013, though so far only minor cuts have been enacted.

Mrs. Merkel’s coalition also fought opposition by state governments to pass a package of tax simplification measures in September. The law, which includes a new electronic billing system and streamlined regulations, will amount to an estimated €590 million in relief for German taxpayers.

With so much additional taxation, and so little reform, it’s no wonder that Europe is slipping back into recession. As Europe’s leaders debate the economic governance of the Continent, all eyes will be on whether Germany and the European Central Bank agree to bankroll the welfare states of southern Europe. But as the post-2008 record shows, the biggest deficit in Europe these days is in ideas to spur growth and the political will to enact them.

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