Spain’s Deficit Higher Than Expected, Taxes Hiked

Spain’s new government embarks on an austerity agenda with budget cuts and tax increases.

Spain’s new right-wing government on Friday warned that the nation’s deficit will be higher than expected this year and unveiled an austerity package of nearly €9 billion in spending cuts as well as income and property tax increases to regain long-term fiscal balance.

The conservative administration of Prime Minister Mariano Rajoy was elected in November to tackle the Southern European nation’s fiscal crisis. On entering office, it found that the public deficit for 2011 would come in at 8 percent of gross domestic product, well above the 6 percent target set by the previous socialist government.

The last administration had to implement unpopular austerity measures when Spain seemed on the brink of being drawn into the eurozone’s spiraling debt crisis this summer. The socialists froze public pensions, cut government salaries, raised the retirement age and trimmed union bargaining rights to the dismay of traditional left-wing constituencies.

With more than one out of five workers unemployed, labor market reform is a priority for the new conservative prime minister. Since entering the currency union in 1999, Spain has lost competitiveness relative to other eurozone economies as wages rose by nearly 21 percent between 2003 and 2008. Salaries in Germany, by contrast, increased by less than 10 percent during the same period.

The government is reportedly in talks with unions and employers’ representatives to produce a reform plan in the first two weeks of January.

Madrid’s reform agenda and fiscal projections are closely watched by international bond markets as Europe’s sovereign debt crisis unfolds. Rajoy was under pressure to roll out a credible plan for fiscal consolidation. Under current trajectories, Spain would manage to bring its deficit below the European treaty limit of 3 percent of GDP by 2014.

Income taxes will be hiked temporarily between now and then to raise revenue by some €6.2 billion. Levies will also be raised on homes although there will be exemptions for low-income households.

Despite this year’s shortfall, Spain has been able to borrow on financial markets at a fairly affordable rate of 5 percent because its central government’s debt burden is relatively low at around 66 percent of GDP. Italy’s, by contrast, is over 120 percent, one of the highest debt rates in the world.