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by Euro Reporter
2012-09-27 08:44:27
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Portugal's Tax Blunder

The talk out of Portugal this week is that Prime Minister Pedro Passos Coelho has committed a serious political blunder in backing down on his proposed social-security reform. Mr. Passos Coelho's about-face is a blow to his government's credibility—another European capital kowtowing to the wisdom of the streets. But a closer look at the scotched plan suggests that the streets might have had a point.  Lisbon's proposal, endorsed by Brussels and the International Monetary Fund, would have reduced employers' social-security contributions by 5.75 percentage points, to 18% of their total wage bill. This would have been financed by increasing workers' contributions by seven percentage points, to 18% of their salaries. The idea was that transferring the tax burden to consumers from employers would be a revenue-neutral way to decrease labour costs and encourage Portuguese businesses to grow and invest. This sort of "fiscal devaluation" has been widely studied as a way for struggling euro-zone countries to enhance their competitiveness given that straightforward internal devaluation—wage and price cuts—is politically difficult.

Yet shifting social-security taxes to workers from employers doesn't fundamentally reduce the cost of employing people. Even if employers' costs are lower up front, a permanent cut in workers' take-home pay simply decreases workers' incentives to seek employment or remain employed. Over time, compensation would have risen as employees demanded more net pay for their services. The burden would still eventually fall on employers to make up the difference. Other means of financing a cut in employers' payroll taxes could enhance competitiveness in a more permanent way. Economist Steve H. Hanke, writing in these pages in 2010, recommended that Greece raise new revenue by replacing its various rates of VAT with a single, uniform rate. Portugal could benefit from the same. In the case of Mr. Passos Coelho's social-security reform, there was another complication. A ruling by the country's constitutional court in July found that a previous austerity package had discriminated against government workers. This forced Lisbon to share the burden of this month's measures across all workers by increasing payroll taxes.

Evidently, that wasn't viewed as an improvement by the opposition-party supporters and union members who marched through Portuguese city centres in the thousands this month. Now the Prime Minister looks set to raise personal income taxes and cut government workers' wages to meet Portugal's deficit targets. He has also suggested special levies on property and capital gains, as Mario Monti has imposed in Italy. This policy mix is starting to look dangerously like Greece's, too. And if Athens has proved anything in the past two years, it's that you can't tax your way to a balanced budget in the face of rising unemployment and a shrinking private sector.  Portugal has been held up as a model pupil for fiscal consolidation and structural reform. But hitting the EU and IMF's deficit targets should never be treated as an end in it. Portugal needs growth, and another round of tax hikes is no way to get it.


Portugal's government eyes new income taxes

Portugal's coalition government said Monday it is preparing new income tax increases as the bailed-out country struggles to meet its debt-reduction targets at a time of deep recession. Prime Minister Pedro Passos Coelho said he is ready to scrap an earlier – and deeply unpopular – proposal to raise workers' social security contributions next year while cutting corporate taxes. Many people deemed that unfair. That proposal triggered massive street protests, split the coalition government and enraged business leaders and trade unions, shattering the broad consensus around austerity measures enacted in return for last year's (EURO) 78 billion ($101 billion) bailout from Portugal's euro partners and the International Monetary Fund.

The uproar threatened to knock Portugal's economic recovery program off track and add to Europe's difficulties as it strives to surmount the continent's financial crisis. Passos Coelho took the rare step of leading a government negotiating team that met Monday with the leaders of national business and trade union confederations to find alternative policies. He said the centre-right government is willing to backtrack on social security hikes next year but has to find new revenue elsewhere in order to restore the debt-laden country's fiscal health. "The only way to do that is through taxes," he told reporters after three hours of talks. "Income tax will be the main way of achieving it." He also indicated that taxes on assets and capital gains will also rise and that fuller details will be announced in the coming days. Initial reaction from the confederations was unenthusiastic. The unions and business leaders urged the government to make savings on public spending instead of increasing the tax burden. Luis Reis, head of the Confederation of Portuguese Service Companies, said raising taxes was "unreasonable" and would cut household spending and further depress consumption.

The climb-down represents a setback for Passos Coelho's government, which has won plaudits from international creditors for getting on with the business of austerity. The government had intended to increase workers' social security contributions to 18 percent of their monthly salary from 11 percent – a cut equivalent to a net monthly wage. At the same time it proposed cutting companies' welfare contributions to 18 percent from 23.75 percent, saying it would encourage hiring in a country where unemployment is at a record 15.7 percent. Workers complained the government was taking money out of their pockets and giving it to employers. The government is gambling that across-the-board tax hikes, covering the public and private sectors, will be more palatable.


Portugal prepares U-turn on social security payment increase

Portugal's government is preparing a U-turn on an announced rise in social security contributions that would have instantly increased workers' payments by nearly two-thirds amid a growing popular revolt against austerity measures. Hundreds of thousands of people took to town squares across the country a week ago to protest at the announced rise, which raised contributions from 11 to 18% of salaries, sparking a pledge by the government this weekend to reconsider the unpopular move. The centre-right Prime Minister, Pedro Passos Coelho, had solemnly announced the measure to shocked Portuguese workers, who would have lost the equivalent of almost a month's salary, during a televised speech a fortnight ago. "The financial emergency that the country sank into in 2011 is still not over," he said at the time. "We have begun to attack the problems we face but have not yet dominated them."

But an eight-hour meeting of the presidential state council was besieged by protesters in the small hours of Saturday morning and ended with a government pledge to renegotiate deficit-cutting measures with trade unions and employers. "The council was informed of the government's readiness to study, within the framework of the social bargaining process, alternatives to changes in the social security rate," a statement said after the council meeting. The council is presided over by the president, Anibal Cavaco Silva, and Passos Coelho is one of its members. Half a dozen protesters who were arrested outside the presidential palace on Friday night are due to appear in court on Monday. Demonstrators had demanded the government's resignation and chanted: "Thieves, thieves!"

The mounting anger in Portugal about the austerity imposed by the bailout came as France appeared ready to offer concessions to Greece, the first country to need help from eurozone partners. The French Prime Minister, Jean-Marc Ayrault, told the news website Mediapart: "The answer must not be a Greek exit from the eurozone.”We can already offer it more time … on the condition that Greece is sincere in its commitment to reform, especially fiscal reform," he said. Aid to Greece from the IMF and European bodies is reliant on the cash-strapped country meeting tough austerity measures. Last week there were reports – later denied – that the latest inspection by the troika could be delayed until after the US presidential elections in November. The Portuguese rethink marked a turning point in the country's patience with austerity, which was imposed on it after it asked for a €78bn bailout from the troika of the European Union, the European Central Bank (ECB) and the International Monetary Fund (IMF) last year.

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