IREF - Institute for Research in Economic and Fiscal issues
Fiscal competition and economic freedom
Looking for budget savings
Some analysts are suspecting that the current fragile economic recovery will be damaged by the policy of government spending cuts that many countries undertook in order to reduce their public budget deficits. The debate is perfervid, in particular in the US where the government has opted for the keynesian policy of massive public spending. The effects of this policy, as was to be expected, have been so far calamitous and the American deficit is not about to be absorbed. Furthermore, tax reductions introduced by Bush in 2005 will expire next December and, most probably, will not be extended. An additional fiscal burden will therefore hit an already suffering economy.
In the UK, David Cameron made an intermediate choice by drastically reducing public spending, moderating the current expenses of the State while increasing VAT and other taxes. The recently elected prime minister is struggling to fix the damages resulting from twelve years of Labour government. His ambitious plan is to trim the fat of the “Big Society” by returning the power into the hands of local administrations and citizens. Based on the subsidiarity principle, this reform is almost a revolution and, if successful, could serve as a model to other European countries.
Berlusconi’s Italy is starting an important reform of local public finances. The objective is to stop the permanent increase of local communities’ budgets that are representing at that point € 426 billion per year (to draw a parallel, the budget of the State is € 543 billion). The problem is that local communities are independent regarding their expenses, but depend on the State for their resources. The idea is to progressively transfer to them their fiscal revenues. The plan looks like fiscal federalism and has its advantages but will Italy be able to achieve it? Italians are often complaining that Berlusconi spends more time talking than doing.
Viktor Orban’s Hungary introduced a more radical change, betting that liberalizing private initiative will deliver economic growth. To curb a public debt of 80% of GDP and a budget deficit of 9.3% in 2009, Orban has decreased government spending (operating costs, pensions reform…) and increased some taxes (VAT, tax on banks), but, above all, he diminished direct taxation—to the great displeasure of the IMF. Let us bet that this policy will be more successful that the one followed in the United States.
Also to be noticed is the, somehow surprising report issued by the IMF on the restrictions or even bans on short selling of securities voted in some European countries, notably Germany. “In general, short selling is a symptom not a cause of the problem”, says the report. It is also mentioned that short selling increases market liquidity and conveys price information. Would Mr. Strauss-Kahn and his colleagues be finally discovering the virtues of free market?
The end of subprimes?
Meanwhile, subprimes continue to have an impact on the economy. Fannie Mae and Freddie Mac, two quasi governmental organizations, are still accumulating deficits that have cost so far $ 148 billion to American taxpayers. The two credit market giants have been refinancing without any caution nearly 90% of home loans in the United States notwithstanding the facts that to encourage people that do not have enough revenues to take out a loan is a perverse way to help them and that the situation of those relatively poor people is likely to become worse once they realize that they have to urgently sell their home. After those two companies misled millions of buyers with their abnormally low interest rates, the Secretary of the Treasury, Timothy Geithner, announced a radical reform of home loans regulation. Did he finally understand that the subprime crisis could have been avoided had Fannie Mae and Freddie Mac been not supported by the State and had they respected the rules and the logic of the credit market?