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On budget consolidation 2011 23

There is much that could be said about the government's plan for budget consolidation. I could point that the share of tax increases in this consolidation package (about half) contradicts what government's pledge in its declaration (i.e. one third). I could point to how planned net increase in the employment taxes contradicts this government's numerous earlier statements of how doing so is unacceptable.

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I could point to how higher VAT and employment taxes would induce even more tax evasion and 'envelope wages'.

I could point to the (un)employment effects of raising the minimum wage to 200 LVL. I could point to the mindlessness of 'compensating social tax rate increases with personal tax rate reductions' just because some people seem to (unknowingly) suffer from a mental wall in their brains, separating social budget from the rest of the public expenditure. I could point to the long run effects of, effectively, cementing contributions to the 2nd pillar of the pension system at just 2 pp of the social tax. And there are many other (not pretty) things I could say about this plan.

However, I think this plan signals existence of an even bigger problem with this government. But before I get to this, let me dispense with two companion questions. First, is there a better solution? I think there are. For one, reduce social tax rate with a drastic increase in the real estate tax so that the combined effect of the two were revenue-neutral. Then, abolish reduced rates of VAT, combining these with compensation mechanisms to the needy ones. Finally, reduce expenditures of the social budget, including the tax on high pensions. In the short run, some groups of population will be hurt more than others, of course. But in the long run (not the one in which we're all dead) "a rising tide lifts all boats", i.e. everyone will gain from faster growth.

Why did they do it? We see political economy in action here. This consolidation does not reflect the interests of a median voter, but of a politically more powerful groups. In other words, the government's plan is very bad economics, but (they must think) it's good politics. For example, taxing pensions would provoke particular outrage from the pensioners, who, on average, vote much more often as compared with an average 30-40 years old. The same goes for abolishing reduced VAT rates. They would all provoke outrage (and political pressure) from some very specific groups. Thus, the government must be thinking that taking a little bit from everybody is a politically safer option. Of course, some people (who are too few to be of any electoral significance) might interpret this a sign of indecisiveness and inability to make difficult but necessary decisions.

So here comes the biggest problem. I might be reading too much into this, of course, but I've experienced a certain waking up moment re this government. I mean, if this was the first (or even second) example of this government's indecisiveness, it would be too early to tell. But is it? When Dombrovskis government balked at devaluing, I wrote it off to the futility of a public standoff between the government and Governor Rimsevics. When Dombrovskis government dragged its feet over budget consolidation (which resulted in a near disaster in June 2009), I wrote it off to sabotage from the People's Party. When a reelected version of this government turned coalition building into a pathetic show, I wrote it off to the need for members of the 'Unity' to get to know each other better. Now, however, I wonder whether, all this time, I was simply blind. Perhaps, I ask myself, this is what this government was about all along. Procrastination, indecisiveness, chronic inability to take initiative, absence of a clear long-term vision...

If my suspicions are correct, we will not see any "structural reforms". If this government couldn't do a decent job on what was a relatively straightforward task of consolidating the next year's budget, how can it cope with much more complex and sensitive issues of much needed reforms in higher education, healthcare, pension system, and regional policy? Without there reforms, this country will be mired in backwardness for many years to come.

Incidentally, when I asked a friend of mine (a well-known economist in this country) about what he thought about this consolidation package, he admitted his first though was to "pack his suitcases". I have to admit to some very similar feelings that have been growing over the last couple of years.

PS By the way, congratulations to the BoL people (and other 'internal devaluators')! Hope you're enjoying these 'structural reforms' that you've waited for so long. More will surely follow.

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Komentāri (23) secība: augoša / dilstoša

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J. M. Keynes 20.12.2010 13:35
In your blog you refer to "budget consolidation". Would you be so kind as to explain what that means. From the gist of your writing it would seem you are referring to budget cuts. Is that accurate? If so, why would someone want to call it a consolidation instead of what it actually is? A consolidation, as used by accountants, means something completely different.

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... 04.12.2010 10:41
Tas, cik situacija ar komputences trukumu ir graujosa, atklaj ta saucamais Enu ekonomikas apkarosanas plans, kas parada pilnigu ekonomikas un uznemejdarbibas procesu izpratnes trukumu starp ieredniem.

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Observer 27.11.2010 17:36
Oh, the structural reforms! Gotta love these two words! Best strutural eforms ever - raise the socil tax on labour! Fantastic!

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Jaņdžs 26.11.2010 23:42
I believe that this is a good time for Lembergs to make a comeback. His suggestion to get Latvia contracts for making military goods (socks, underwear, that sort of thing)shows the man is thinking about the future--even if I disagree with this particular proposal.

Someone has to think of how to make money. No one in the new (soon to be late) administration seems to have the vaguest idea. All anyone can think is to raise the taxes.

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j. 26.11.2010 00:42
Totally agree with Slava. In my humble opinion, the core problem in everything our bureaucrats do is their unbelievable lack of competence. Imagine, people who could not foresee the devastating effects of pro-cyclical fiscal policy or who realized the State was on the brink of insolvency just 2 days before there would have been 0 Ls in the Government's account (and rushed to Stockholm immediately)are still in charge of crucial stuff. Have they learned anything? No! Why? Because their intellectual capacity is far below the one that is needed in situations like this. Can they guess of something "out of the box"? No! This is why we're probably the one and only country in the world to which the IMF recommends hiring 20-40 people at the Ministry of Finance who would actually understand what economics is all about.

The new budget is in no way "new", as it is the same old stuff - dealing with consequences instead of the root of our problems. This government had perfect momentum for implementing painful but necessary policies, as they would definitely appear to be fruitful over the horizon of 4 years; hence, the average voter would see that these guys have what it takes to manage the country. Currently it's definitely not the case.

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G.D. 26.11.2010 00:40
Lielaka problema par sha package kvalitati (kas kopuma un nemot vera koaliciju valdibas un velesanas nemaz nav tik slikta, un gan jau vel uzlabosies) ir tas, ka valdiba ir noraustijusies pazinot, ko vini daris 2012. gada. Pat ja taisas palauties uz paroptimistisku IKP prognozi - to vajag pazinjot, lai velak var sekot progresam. Taa, manuprat, ir kljuda, kuras rezultata var gadities IKP nemaz neaugs tik ljoti kaa gribetos Vilkam vai Strautinjam. Lai saktu apgrozit naudu cilvekiem vajag zinat speles noteikumus. Speles noteikumu neskaidriba ir galvenais, kas visas krizes kave ekonomiku. Ja lidz sim to diez vai vareja ietekmet, jo 2010 velesanas gadaja par neskaidribu, tad tagad tada iespeja ir.

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Nav svarigi 25.11.2010 11:09
Un tas tragiskakais, ka atbildigie tiesam tic, ka tie ir veidi ka apkarot enu ekonomiku un ka tiesam tiek samazinats darbaspeka nodoklu slogs - it ka tas butu tik svarigi, kuram uz papira lielaks nodoklu slogs vai no kura budzeta tiek finanseti socialie transferti - laikam LV ekonomikas izglitibas rezultats. Ta teikt - zinu, par ko runaju. Kada tur political economy vai kas cits - ja ta turpinasies emigracija, tad aiznakamgad bus liela atmosanas pec Tautas skaitisanas ar tadu political economy, ka visi nakamie politiki, lai tiktu ieksa Saeima, ka vienigie solijumu, kas piesaistis veletaju balsis, teiks, liks prieksa pensiju paaugstinasanu (vienigi bez lidzekliem, ar ko paaugstinat vai vispar noturet socialos transfertus pasreizeja limeni).

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Nasing spešal 25.11.2010 08:48
@Slava
You may call it as 'indecisiveness', 'political economy', 'lobbying' or whatever, but the government is not only executive power - it is also political power. Of course, in your opinion or in any other economist's opinion many things seem to be economically inefficient or short-sighted, but any economist's opinion has no stakeholders. However, the government has many stakeholders that should not be ignored (entrepreneurs, employees, pensioners, creditors, etc.). Would it be ethical from the top to say that some of stakeholders to be ignored in favor of great future of Latvia in unforeseeable time? I doubt. Yes, yes, yes - many decisions are not very efficient or obey some social groups, but political economics is something more than just simple economics as you know. Is it the worst solution of the government? I guess it is better than any of previous ones. And if there is progress shall we pack a baggage?

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Mārtiņš Zemītis 25.11.2010 00:12
Maybe this is just another sabotage of Tautas Partija?

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Jānis Ozols 24.11.2010 11:32
Well, as the author points out it is how the political economy works here. It is hard to disagree that any structural reforms will follow partly because the ZZS is in coalition. In departments which are under the control of Lembergs & co it will be hard to push through any austerity measures, and this is nothing new. First of all Unity has vwry limited options of coalition partners, and as the coalition theory says, median voter is that who controls which side has the majority. So it can blackmail its coalition partners.

However, very interesting blog post.

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John W -> blain 24.11.2010 09:21
OK, for some reason it isn't posting the full url. Let's try it this way: The first part ishttp://www.fm.gov.lv/faili/bildes/and the second part is2010-09-02_starpt_aizdevuma_izlietosana.bmpIf this doessn't work, I am not going to continue spamming Slava's blog, but will direct you to the home page of the Finance Ministry. The only thing is that the info in English is only up until January of this year.

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John W 24.11.2010 09:16
Link broken: Let's try this
http://www.fm.gov.lv/faili/bildes/2010-09-02_starpt_aizdevum...

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John W -> blain 24.11.2010 09:15
Hi, I got this information from the Finance Ministry: http://www.fm.gov.lv/faili/bildes/2010-09-02_starpt_aizdevum...
The figures are as of July this year, I believe.

If I have misinterpreted anything, please let me know - I am not an economist: my aim is simply to uncover what is going on. I take the figure as approx. 10%, as up until July of this year 5.1 billion had been taken (again according to data from the finance ministry), but hasn't yet been spent.

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blain 24.11.2010 07:46
John W., what is the source for your claim that 10% of the loan has been used for budget financing? or that 20% is used for servicing debt. Neither can be true. Before this crisis Latvia had only 2 euro bonds, neither of which has matured, the total state debt was miniscule before this crisis. and T-bills have been a tiny part of that.

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John W -> Arzemnieks 23.11.2010 23:05
A fellow Brit, rather (didn't read your post carefully enough)..

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John W -> Arzemnieks 23.11.2010 22:34
Labvakar from another Englishman abroad!

It was interesting to read your thoughts. Here are my two pennies:
I'm not sure it would be a disaster to abandon the austerity measures, for both practical and ethical reasons.
The first ('ethical' - ok I know it's a dirty word among economists) reason is that so far, as far as I am aware, only about 10% of the loan money has been spent on financing the state budget. This raises important questions about where the money is going (especially with regard to any private debt being turned into public obligations) and who is paying for it.
Also, it seems pretty poor planning in the long term to be taking on more loans to pay off previous loans. I think 20% of the loan money has gone to pay of existing state debt. I am not an economist, so maybe someone can tell me what debt this is. I am assuming its treasury bonds that are due to be paid up.
I read Morton Hansen stating that it is good news that Latvia managed to raise 12 million at 5.6% interest. Well, maybe, the interest rate is coming down with better credit ratings, but we are still taking on loans, and becoming more and more indebted - this can't be a sensible plan.
From the point of view of someone running a small business, I can also safely say that the cuts are hurting the private sector hard too as there is simply less and less money going around. If the idea of internal devaluation is to make the workforce more competitive by lowering wages, well I am not sure how much lower they can possibly go. An inflexible wall of debt (mortgage) repayments fuels the exodus, with the resultant loss of tax revenue.

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Kaspars Gasūns 23.11.2010 19:14
My total agreement!!!

I have been arguing with the other commenters at the IR magazine web-page about the exact points all though the day. They just find excuses for anything "rockstar" Dombrovskis or Vienotiba does!

Present government reminds me that of Godmanis - only in reverse sequence to the crisis. See no evil, hear no evil. As if there were no obvious problems and (potential) solutions at all.

The fetish of Euro 2014 starts to look ever sillier in this context. Is there anything other at all they can do? Is currency an economic policy?
For long time I had the impression that slogan of joining EU was covering lack of any actual policy or even vision during pre-joining period. Now it repeats with the Euro.

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G.D. 23.11.2010 17:30
Considering that 2010 was an election year, the consolidation package is actually quite fine. Could have been worse. Of course, we all want this and that, but in the real world… The Irish, UK and any other consolidation packages looks pretty much the same (good luck with “packing suitcases” to the friend). Off topic: it is interesting that Latvians start and end every sentence with “packing bags”, though, in the end, survey based unemployment figures are close to 20 percent… Indecisiveness? The gvmnt has consolidated 13 percent of GDP. How exactly then we define “decisiveness”? BTW, it is also amazing that it turns out that parliamentary democracy works quite well.

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Arzemnieks 23.11.2010 13:51
I'm inclined to agree partly with Diesel and Krisjanis D above. I doubt there is a better option (and we have to be realistic - no country has a perfect democracy, or a perfect set of candidates for PM). And anyway, isn't this the nature of coalition politics? i.e. the opinions of a greater number of more diverse parties has to be taken into account, which takes more time?
I didn’t agree with the decision to internally devalue initially, but since the decision has been taken, it would be a disaster to abandon it now. Dombrovskis has shown great resilience and staying power in pushing through the cuts. And he got re-elected, which is apparently very unusual for a government which has pushed through severe austerity measures.
Latvia does seem to have stabilised, partly due to the fact that when the bad times came, Latvia had no cash reserves, so had to push through severe cuts immediately. The UK (my country) had reserves to live off, so the Labour party delayed the cuts, and only now are the Tory party pushing the cuts through. Ireland, Greece Spain etc are also just beginning to make their cuts now. Two years after Latvia....
Sorry if the above is too simplistic. I’m not an economist. However, I’m glad to be in Latvia not elsewhere, and I’m glad that Dombrovskis is still PM.

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Diesel 23.11.2010 12:01
It is very easy to criticize the government's approach. However, I personally do not believe that everything is so simple like just Mr. Dombrovsksi and whoever just raises his finger up and just says "emm...housing tax/social tax... well, lets choise social tax then and now let's have a good dinner!!!"

I just refuse to believe that those options provided by author were not considered and just declined given the potential political pressure. I mean if that is so simple (just some short term losses againts 100% long term gains)is everypone in the government blind? And where is opposition then - great chance for them to come out with alternative and "right" programme, huh?

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Krisjanis Dombrovskis 23.11.2010 10:48
Sadly I must agree. However, the question remains - is there a better option than Unity? I think that there is not.

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Р 23.11.2010 06:19
Слава, ты где-то раскопал ранцевый огнемёт? Примерно об этом летом я и пытался тебе сказать (хотя, с ЦС, надо признать, всё ещё хуже, да). Отлично написано, но надо же как-то аккуратнее :)

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BoL people 22.11.2010 14:55
What do you mean in your PS para? That the lack of reforms speaks in favor of your devaluation theory? Or what?
The truth is, you need structural reforms in any case. The US have not followed an internal devaluation approach. But they need serious structural reforms & total overhaul of budget expenditures nevertheless... same for UK...

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