On budget consolidation 2011

22. November, 2010

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.

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. raksts

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