A general equilibrium evaluation of tax policies in Spain during the Great Recession. María Teresa Álvarez-Martínez. Clemente Polo 1.

Transcription

1 A general equlbrum evaluaton of tax polces n Span durng the Great Recesson María Teresa Álvarez-Martínez Clemente Polo 1 May 14, 2012 Abstract The man goal of the paper s to assess the effects of several permanent tax rate hkes mplemented by the Spansh Government n 2009 and 2010 to counteract the rapd ncrease of the publc defct and debt regstered n 2009 and It uses a numercal general equlbrum model calbrated to a socal accountng matrx elaborated by the authors for the year The effects of ncreases n excse, value added and personal ncome taxes are smulated separately and jontly. The results ndcate that the extra revenues obtaned from each tax fgure are lower than ex-ante calculatons estmated by the Government. Moreover, the reductons n the publc defct accomplshed are consderably smaller due to general equlbrum effects generally gnored, such as the fall n producton levels, ncreased unemployment, hgher prces of publc consumpton and nvestment and larger Government transfers. The jont results also ndcate that addtonal measures should be mplemented to contnue closng the defct gap n the next future. Keywords: Computable General Equlbrum models, tax reforms. JEL: C68, H20. 1 María Teresa Álvarez-Martínez (mta60@rc.rutgers.edu), Rutgers Unversty, and Clemente Polo (clemente.polo@uab.es), Unversdad Autónoma de Barcelona. They are ndebted to the Spansh Mnstry of Educaton and Scence, grant SEJ

2 1. Introducton As other developed economes, Span entered nto recesson n the fourth quarter of Snce 1995, t had enjoyed a sustaned expanson fueled by three powerful shocks: frst, the four devaluatons of the peseta mplemented by the Government between September 1992 and May 1995; second, the sustaned reducton of the nterventon rate of the Bank of Span untl t reached 3 % at the end of 1998, the target accorded by EMU members; and, thrd, the avalablty of nternatonal credt at low nterest rates snce the launchng of the euro on January 1 st, At the heght of the boom n 2007, gross fx captal formaton absorbed 30.7 percent of GDP, although a good share of t (33.5 %) was real estate nvestment n resdental and other type of constructons. 2 In the meanwhle, the prvate sector (fnancal nsttutons and nonfnancal busnesses) accumulated a huge external debt (close to 1.6 tmes GDP n 2007) whle the current account surplus (0.76 % of GDP n 1996) soon evaporated and turned nto a defct that reached 10% of GDP n The closure of nternatonal fnancal markets and the start of a global recesson n the second semester of 2008 reduced exports and put an abrupt end to the captal accumulaton process. The average volume ndex of exports (excludng toursm) and toursts servces from the thrd quarter of 2008 untl the second quarter of 2009 fell 9.4 and 8.75 percent, respectvely, relatve to ther average values n the prevous four quarters. In the same tme span, the average volume ndex of gross fx captal formaton fell %, GDP dropped 2.16 % and the unemployment rate ncreased 5.96 percentage ponts (pp). 2 Total nvestment n all agrculture and ndustry branches of the economy amounted to just 13.0 % of gross fx captal formaton. 2

3 The sudden turnabout of the economc scenaro put hghly ndebted credt nsttutons, non-fnancal busnesses and famles under serous stress. 3 Although the expansonary budget of 2008 (an electon year) and the fall of tax revenues had already turned the 2007 budget surplus (20,057 EUR mllons) nto a large defct n 2008 (45,162 EUR mllons), the Government approached the stuaton convnced that t would be enough to back fnancal nsttutons debt emssons and temporarly ncrease government expendtures and transfers to weather the storm. Numerous ntatves were approved to that end durng the last quarter of 2008, ncludng the 2009 budget that contemplated a publc defct of 70,654.4 EUR mllon. By June, the Government had to approve an extraordnary credt (19,821 EUR mllons) to pay rapdly growng unemployment benefts. It also decded to ncreased excse taxes on ol products and tobacco. As fscal revenues contnued fallng, the Government changed tracks and ncluded n the 2010 budget two measures to boost revenues: t rased value added tax (VAT) rates effectve on July 1 st, and elmnated the 400 EUR tax rebate ntroduced a year earler closed wth a publc defct of 117,268 EUR mllons or 11.1 percent of GDP. The effect of changes n VAT rates has receved some attenton n recent years. Crossley, Low and Wakefeld (2009), Barrell and Weale (2009) and Blundell (2009) dscuss the effects of a temporary cut rate 4 n the central VAT rate (from 17.5 to 15 per cent) mplemented by the U.K Government n December In the case of Span, Fernández de Córdoba and Torres (2010) and Conesa et al. (2010) have estmated the effects of a permanent ncrease n VAT rates n Span employng ntertemporal aggregated models of a close economy. Snce the measure was known three quarters n 3 Out of a total external debt of 1,563,730 EUR mllons, the general Government was only responsble for 197,835 EUR mllons at the end of The temporary reducton lasted untl December At the begnnng of 2011, the U.K Government ncreased the central VAT rate from 17.5 to 20 per cent. Portugal also rased VAT rates from 20 to 21 percent n May 2010 and then to 23 per cent n September

4 advance of the date t was actually mplemented, Fernández de Córdoba and Torres estmate that n the nterm perod snce the polcy was announced untl t was mplemented, the expectaton of prce ncreases rases consumpton (0.6 %) and VAT revenues (0.5 %), but reduces output (0.6 %), employment (0.7 %), nvestment (5.4 %) and government revenues (0.4%). In the long run, output, consumpton, nvestment and employment fall 0.74 %, VAT revenues ncrease 9.2 % and total revenues 1.9 %. The fgures reported by Conesa et al., although slghtly dfferent, confrm the fall n producton (0.85 %), consumpton (1.1 %), nvestment (-1.0 %) and employment (1.0 %), as well as the ncrease n VAT revenues (10.5 %) and total revenues (1.7 %) n the long-run. Both models share two controversal features. Frst, the labor market clears n all perods. On ths respect, t seems approprate to recall that the unemployment rate clmbed from 8.03 % n the thrd quarter of 2007 to 21.3 % n the frst quarter of Even acceptng that offcal fgures probably overstate the unemployment problem, few economsts would accept that market clearng s an accurate descrpton of the Spansh labor market. Second, they take for granted that n response to an ncrease n VAT rates households substtute workng hours n the labor market by hours dedcated to non pad actvtes (Conesa et al., p. 7). 5 What they mean by non pad actvtes s unclear, but assumng the category ncludes readng, joggng, playng musc, gong to moves and concerts, dnng n restaurants, drnkng n bars, shoppng, preparng meals at home, etc., dong more of them requres payng more taxes for books, runnng shoes, CD s, cnema and concert tckets, drnks, food, electrcty, etc. Therefore, one would expect less (not more) consumpton of them when VAT rates go up. All that can be sad 5 Gonzalo de Córdoba-Torres (2010) assume that the representatve household optmally allocates ts tme endowment of 96 (6x18) hours between workng hours and lesure. Conesa et al. (2010) talk of pad and unpad hours. 4

5 n favor of ths assumpton s that havng ruled out unemployment n the model economy, reducng the labor supply s the only way they can obtan a fall n producton. Ths paper smulates the effects of ncreases n ol products and tobacco, VAT rates and personal effectve ncome taxes mplemented by the Spansh Government to reduce the publc defct n 2009 and It employs a statc dsaggregated general equlbrum model that provdes a much more detaled pcture of the Spansh economy than aggregate models. It dstngushes thrty dfferent products and servces and sx types of dfferent captal goods. Producton and consumpton commodtes are dfferent and so are producton and consumpton prces. Demand of products and servces s satsfed wth a mx of domestc products and equvalent mports. There are sx types of taxes: socal securty contrbutons, personal ncome tax, corporate tax, VAT, other taxes on producton, and mport taxes. Prvate nvestment (except resdental constructon) and exports are VAT exempted, but publc consumpton and nvestment do pay VAT rates. Most parameters of the model have been calbrated wth a 2000 socal accountng matrx (SAMES-00) elaborated by the authors. Another mportant dfference wth prevous models s that the labor market does not clear and the real wage depends on the unemployment rate. Fnally, the model provdes nformaton on sectoral prces and producton levels, government revenues and expendtures and major aggregate varables. The rest of the paper s dvded n three sectons. Frst, the man features of the model are presented. In secton 3, the polces smulated are explaned and the smulaton results obtaned dscussed. The man fndngs are summarzed n the concludng secton. 5

6 2. The model Ths secton presents the man features of the dsaggregated general equlbrum model employed to smulate tax polces. Agents and commodtes There are 30 producers, one representatve consumer, the government, the corporate sector and two external sectors and foregn consumers, the European Unon (EU) and the rest of the world (ROW). There are 30 produced commodtes, 30 consumpton goods and servces, labor and captal and sx types of prvate and publc captal goods. Producers Products are obtaned wth domestc producton and equvalent mports. Domestc products are aggregates of products and value added; and value added s, n turn, produced wth labor and captal servces. The producton technology s represented by a nested producton functon wth constant returns to scale. At the top level, total output, Y, s a CES aggregate of domestc products, Y d, and mports from the EU, Y eu ROW, Y row., and the Y / 1 Y Y Y, 1 (1) d d eu eu row row where d, eu and row are, respectvely, the domestc and foregn dstrbutve parameters and the parameter that determnes the constant elastcty of substtuton between domestc producton and equvalent mports. At the second level, domestc producton s obtaned combnng ntermedate nputs and value added n fxed proportons 6

7 X 1 X 2 X 30 V Y d mn,,...,, a1 a2 a30 v (2) beng X j and V are the amounts of product j and value added used to produce domestc output, Y d, and a j and v the correspondng techncal coeffcents. Fnally, valued added s a Cobb-Douglas aggregate of labor, L, and captal servces, K V L l K 1 l (3) where, s a scale parameter and l and 1 l the dstrbuton parameters. Frms maxmze profts. At the lowest level of the nest, they mnmze labor and captal cost subject to the value added functon ssc 1 L rk mn w s.t. V L l K 1 l (4) where w and r are the prces of labor and captal and ssc are the socal securty contrbuton rate pad by employers and employees. The soluton provdes the labor, * L, and captal, * K, demands. The prce of value added s set equal to the mnmum average producton cost pv * * * ssc L K w 1 r (5) V V to nsure profts are zero. Smlar problems are set at the ntermedate and upper levels of the nest. Taxes (net of subsdes) on products enter n the equatons of domestc prces and mport taxes n the equatons of prces of products. The consumpton commodtes are produced by a Leontef technology C c Z 1 c Z2c Z30 c mn,,..., (6) z1 c z2c z30 c where Z c s the amount of product employed to produce commodty c, and zc s the untary requrement. VAT rates enter n the prce equatons of products. 7

8 Household The representatve household derves utlty from consumpton commodtes, C c and savngs. Preferences are represented by a Cobb-Douglas utlty functon 30 1 U C c c1, C,..., C S C S , c1 c 30 c 0 1, 1. (7) c 30 c1 c The household sells ts labor, L, and captal, K, servces to frms. It also receves unemployment and welfare benefts, property ncome and other current transfers GI h ul rk wu L EISSC p ADJ TRR PIR WFR w 1 (8) c where w and r are the prces of labor and captal servces, respectvely; L, and K the endowments of labor and captal; u the unemployment rate; the proporton of the wage rate pad to unemployed; EISSC employers mputed socal securty contrbutons; ADJ transfers to households due to changes n net equty n penson funds reserves; TRR current transfers; PIR property ncome recepts; and, WFR welfare benefts other than socal transfers n knd. Dsposable ncome, DI h, s obtaned by subtractng personal ncome tax, self-employees socal securty contrbutons, current transfers, property ncome payments and resdents consumpton n the EU and the ROW. Consumpton and savngs demands are the soluton to max 30 c1 C 30 1 c c S c1 c 30 s. t. DI h pccc pi S (9) c1 where p I s a weghted prce ndex of nvestment goods. It s assumed that a fxed proporton of savngs r s devoted to purchase resdental nvestment RI p RI p S (10) r r s 8

9 where p r s the producton prce of constructon (sector 17). Snce resdental nvestment s subject to the VAT, ts prce s vat pr p (11) Government The Government collects taxes from labor, ncome, producton and consumpton, whch together wth captal ncome and transfers are used to fnance publc consumpton and nvestment, unemployment benefts and transfers. Publc consumpton and nvestment are exogenous but snce prces, revenues and some expendtures are endogenous, the budget surplus, GS, s also endogenous. It s mportant to keep n mnd that publc purchases are subject to the VAT. Foregn sectors There are two foregn sectors, the EU and the ROW. Revenues stem from labor and captal endowments, mports of commodtes, resdents consumpton out of the terrtory and taxes and transfers receved from domestc agents. These revenues are used to pay exports, ncome payments to resdents and transfers. Exports and transfers are exogenously fxed, but snce mports and prces are endogenous, the current account balance CAB s also endogenous. Factors markets For the captal servces market, the demand of servces by all producers equals the endowment. In the case of labor, however, the model ncludes a real wageunemployment rate equaton 9

10 w 1 cs 1 h p c k 1 u, 0 (12) where w s the wage rate; cs pc the consumpton prce ndex, h the socal contrbutons tax rate on households, the personal ncome tax rate; k a calbraton constant; the parameter that determnes the response of the real wage to the unemployment rate and u the endogenous unemployment rate. In ths case, the demand of labor servces by producers equals the labor endowment multpled by one mnus the unemployment rate. Notce that the smaller the value of, the larger the elastcty of the real wage to the unemployment rate: 6 w p c 1 u u. (13) 1 u Prvate non-resdental nvestment The level of non-resdental prvate nvestment determned by households and corporate savngs, the publc defct and the current account surplus of the foregn sectors: p I I nr p S ( 1 ) S GS CAS CAS. (14) I h r cs EU ROW Equlbrum The equlbrum can be defned as a set of prces, producton plans for producers, a consumpton-savngs plan for the representatve household, an unemployment rate, a publc defct and a current account defct such that producers maxmze profts, the household maxmze utlty, all commodty markets and the captal market clear, effectve labor supply equals labor demand and the dfference between revenues and 6 The unemployment rate s % n 2000, the base year. 10

11 expendtures for the government and the two foregn sectors equal government surplus and the current account surpluses. Calbraton of the model The 2000 SAM for the Spansh economy (SAMES-00) elaborated by the authors s the database used to specfy the parameters and the exogenous varables of the model. It s a 128x128 square matrx wth accounts for 30 products, 30 consumpton commodtes, 6 captal goods, labor and captal, a representatve household, a corporate sector, the Government, two foregn consumers and two foregn sectors. The elastctes of substtuton between domestc products and equvalent mports have been taken from Blake (2000). Fnally, the central value chosen for n the real wage-unemployment equaton (1.2) was derved from Andrés et al. (1988). More recent estmates of wage curves by Montuenga et al. (2003) and García-Manar and Montuenga (2005) confrm 1.2 as a central estmate Smulatons and results Ths secton presents the results of smulatng three tax polces mplemented by the Spansh Government n 2009 and 2010 to cut down the publc defct. 8 Smulaton S1 estmates the effects of tobacco and ol products tax rates ncreases enacted n June Usng the nput-output supply table, t was estmated that the new effectve producton tax rates of Food, beverages and tobacco and Extracton of energetc products, coke and refned petroleum, the two producton sectors affected, would ncrease by and 10.5 percent, respectvely. Smulaton S2 quantfes the 7 The wage curves estmated by Montuenga et al. (2003) and García-Manar and Montuenga(2005) mply values for n the range ( ). Sanz-de-Galdeano and Turunen (2006) results for a panel of 11 EU countres pont to a value of Gven the commtment of the Government to brng down the defct to 3% of GDP n 2013, those changes can be assumed to be permanent. 11

12 consequences of VAT rate ncreases mplemented n July Although the ncrease n VAT rates s not unform, the smulaton assumes all effectve VAT rates ncreased 12.5 %. 9 Fnally, the scenaro S3 smulates the elmnaton of the 400 EUR tax rebate n personal ncome tax fled n Usng nformaton provded by the government, the effectve ncome tax rate n the model has been rased by 7.2%. The results of the three smulatons appear n the frst three columns of Tables 1-5. Column S4 presents the results of jontly smulatng the three stated polces. Effects of ncreases n ol and tobacco tax rates The ncrease of tax rates on tobacco and ol has a notceable mpact on the domestc prces of a few producton commodtes. Domestc prces of the two sectors drectly affected by the tax rates hkes go up: the prce of Extracton of energetc products, coke and refned petroleum ncreases by 4.75 % and that of Food, beverages and tobacco 0.94 %. Prces of other energy ntensve sectors (Electrcty, Gas and water, Chemcal ndustry, Extracton of other mnng and quarryng, Transportaton and Accommodaton and caterng, etc.) also go up. There are, however, other sectors whose prces are smaller due to the fall of the prce of captal servces. Changes n domestc prces are passed through and the consumer prce ndex (CPI) ncreases by 0.26 %. Domestc producton levels fall n those sectors most affected by the tax hke but go up n nvestment orented sectors because the tax ncrease reduces the publc defct. 9 The Government ncreased the reduced VAT rate from 6 to 7 percent (14.3%) and the normal VAT rate from 16 to 18 percent (12.5%). Snce the dfference s small, the ncrease n the normal rate has been appled to all effectve rates n the base year. 12

13 Table 1. Varaton n domestc producton prces (In percentage) Sector S1 S2 S3 S4 I1 Agrculture, fshng and aquaculture I2 Extracton of other mnng and quarryng I3 Extracton of energetc products, coke and refned petroleum I4 Electrcty, gas and water I5 Food, beverages and tobacco I6 Textle and dressng I7 Leather products I8 Wood I9 Paper, publshng and prntng I10 Chemcal ndustry I11 Non-metallc mneral products I12 Metallurgy and metal products I13 Mechancal machnery and equpment I14 Manufacture of electrcal machnery and precson nstruments I15 Manufacture of vehcles and other transport materal I16 Other manufacturng ndustres I17 Constructon I18 Wholesale trade and retal trade I19 Accommodaton and caterng I20 Transport and communcatons I21 Fnancal ntermedaton I22 Real estate actvtes I23 Market Educaton I24 Market Healthcare and Socal servces I25 Other actvtes and assocatve market servces I26 Households whch employ household personnel I27 Publc Admnstraton I28 Non market Educaton I29 Non market healthcare and Socal servces I30 Other actvtes and assocatve non market servces S1: Taxes on products: Extracton of energetc products, etc.: 10.5 %; Food, beverages and tobacco: %. S2: VAT: %. S3: Income tax on households: 7.2 %. S4: S1+S2+S3. 13

14 Table 2. Varaton n consumer prces (In percentage) Sector S1 S2 S3 S4 I1 Agrculture, fshng and aquaculture I2 Extracton of other mnng and quarryng I3 Extracton of energetc products, coke and refned petroleum I4 Electrcty, gas and water I5 Food, beverages and tobacco I6 Textle and dressng I7 Leather products I8 Wood I9 Paper, publshng and prntng I10 Chemcal ndustry, rubber and plastc products I11 Non-metallc mneral products I12 Metallurgy and metal products I13 Mechancal machnery and equpment I14 Manufacture of electrcal machnery and precson nstruments I15 Manufacture of vehcles and other transport materal I16 Other manufacturng ndustres I17 Constructon I18 Wholesale trade and retal trade I19 Accommodaton and caterng I20 Transport and communcatons I21 Fnancal ntermedaton I22 Real estate actvtes I23 Market Educaton I24 Market Healthcare and Socal servces I25 Other actvtes and assocatve market servces I26 Households whch employ household personnel I27 Publc Admnstraton I28 Non market Educaton I29 Non market healthcare and Socal servces I30 Other actvtes and assocatve non market servces Consumpton Prces Index (CPI) S1: Taxes on products: Extracton of energetc products, etc.: 10.5 %; Food, beverages and tobacco: %. S2: VAT: %. S3: Income tax on households: 7.2 %. S4: S1+S2+S3. 14

15 Table 3. Varaton n domestc producton (In percentage) Sector S1 S2 S3 S4 I1 Agrculture, fshng and aquaculture I2 Extracton of other mnng and quarryng I3 Extracton of energetc products, coke and refned petroleum I4 Electrcty, gas and water I5 Food, beverages and tobacco I6 Textle and dressng I7 Leather products I8 Wood I9 Paper, publshng and prntng I10 Chemcal ndustry, rubber and plastc products I11 Non-metallc mneral products I12 Metallurgy and metal products I13 Mechancal machnery and equpment I14 Manufacture of electrcal machnery and precson nstruments I15 Manufacture of vehcles and other transport materal I16 Other manufacturng ndustres I17 Constructon I18 Wholesale trade and retal trade I19 Accommodaton and caterng I20 Transport and communcatons I21 Fnancal ntermedaton I22 Real estate actvtes I23 Market Educaton I24 Market Healthcare and Socal servces I25 Other actvtes and assocatve market servces I26 Households whch employ household personnel I27 Publc Admnstraton I28 Non market Educaton I29 Non market healthcare and Socal servces I30 Other actvtes and assocatve non market servces S1: Taxes on products: Extracton of energetc products, etc.: 10.5 %; Food, beveages and tobacco: %. S2: VAT: %. S3: Income tax on households: 7.2 %. S4: S1+S2+S3. 15

16 Table 4. Publc revenues and expendtures (In percentage of GDP) Base year S1 S2 S3 S4 Total revenues Property ncome Total ncome tax Income tax (households) Income tax (corporate) SSCE SSCH SSCS Current transfers Taxes on producton Taxes on mports VAT Taxes on products Captal Total current expendture Publc consumpton Property ncome Unemployment benefts Other socal benefts Current transfers Subsdes on producton Subsdes on products Publc nvestment Non resdental publc nvestment Agrculture products Machnery and mechancal products Transport equpment Other constructons Other products Resdental publc nvestment Publc surplus S1: Taxes on products: Extracton of energetc products, etc.: 10.5 %; Food, beverages and tobacco: %. S2: VAT: %. S3: Income tax on households: 7.2 %. S4: S1+S2+S3. 16

17 Table 5. Aggregate varables Man aggregates and welfare ndex Base year S1 S2 S3 S4 Unemployment rate (%) Employment growth rate Varaton of households net dsposable ncome 411, Varaton Consumer prce ndex Households welfare Nomnal GDP 630, Real GDP 630, Demand sde aggregate varables (In percentage of GDP) Base year S1 S2 S3 S4 Prvate consumpton Total prvate nvestment Non-resdental prvate nvestment Agrculture products Machnery and mechancal products Transport equpment Other constructons Other products Resdental prvate nvestment Publc consumpton Publc nvestment EU current balance ROW current balance S1: Taxes on products: Extracton of energetc products, etc.: 10.5 %; Food, beverages and tobacco: %. S2: VAT: %. S3: Income tax on households: 7.2 %. S4: S1+S2+S3. 17

18 The effects on publc revenues are notceable but small. The percentage of taxes on products over GDP goes up from 4.41 to 4.60 percent. Employng the 2010 GDP fgure, 1,062,591 mllon, the estmated ncrease s 2, mllon, a fgure lower than the Government estmate, 2,317 mllon, presumably obtaned by applyng the new tax rates to the old bases. However, the results n Table 1-3 ndcate that nether prces nor quanttes reman constant after the tax reform. It s worth notcng that the publc defct falls less than the ncrease n taxes on products revenues, because the ratos of several current expendtures tems (unemployment benefts, other socal benefts and current transfers, etc.) over GDP go up. The ncrease n taxes on products rases a bt the unemployment rate (0.27 pp) and lowers employment (0.31 %) and real GDP (0.30 %). In sum, rasng taxes on ol and tobacco has a notceable effect on producton and consumer prces of a few commodtes and neglgble effects on the rest. Producton of sectors drectly affected by the ncrease n tax rates fall whle other sectors output regster ether neglgble changes or even some advances n the case of nvestment orented sectors. The publc defct far falls less than the ncrease n revenues from taxes on products, and there s a negatve although lmted mpact on unemployment, employment and GDP. Effects of an ncrease n VAT rates The effect of a 12.5 % ncrease n all effectve VAT rates reduces domestc and total prces n Table 1, due agan to the fall (0.8 %) of the prce of captal servces. However, consumer prces n Table 2 ncrease n all but a few exempted sectors (Market educaton and Health care, and the three publc servce sectors). In a few cases, the ncrease n consumpton prces exceeds 1 %, although the overall mpact measured by the CPI s 0.56 %. Changes n producton levels depend on three factors: the ncrease n consumer 18

19 prces, the change n households ncome and the effect of the reducton n the publc defct on prvate nvestment. The ncrease n consumer prces and the fall n employment and household ncome reduce domestc producton levels, whle the reducton of the publc defct softens those mpacts n nvestment orented sectors. As Table 3 makes clear the reducton n producton levels s larger n ndustral consumpton orented sectors ( Textles and dressng, Leather products, Other Manufacturng, Electrcty, gas and water, etc.) and n prvate non exempted servces (Wholesale trade, Accommodaton and caterng, etc.) than n nvestment orented sectors ( Non-metallc mneral products, Metallurgy and metal products, Mechancal machnery and equpment, etc.). Under the new VAT rates, the rato of VAT revenues over GDP rases 0.62 pp, VAT revenue goes up 11 % and total revenues ncrease 1.08 %. Multplyng 0.62 by the 2010 GDP, VAT revenues go up by 6, mllon, a fgure that consderably larger than the mllon announced by the Government. 10 Notce that the reducton of the publc defct, 0.29 pp., s less than half the ncrease n VAT revenues due to general equlbrum effects. The VAT reform rases the unemployment rate 0.58 pp and reduces employment and GDP by 0.67 and 0.31 percent, respectvely. The fall n producton levels and employment and the ncrease n consumer prces reduces the GDP shares of other taxes (ncome, socal securty contrbutons and taxes on products other than VAT) and ncreases those of publc expendtures (unemployment and other socal benefts, current transfers and publc nvestment n other constructons). 10 The overshootng may be caused by havng ncreased all effectve VAT rates 12.5 %, the same amount that the nomnal normal VAT rate. Although rulng out tax evason may be an acceptable assumpton n the case of excse taxes, gven the strct control exercsed by the Government over the producton and dstrbuton of ol and tobacco products, t s unrealstc to adopt the same assumpton n the case of the VAT. 19

20 Effects of an ncrease n households ncome tax rate The ncrease n the personal ncome tax reduces producton prces a bt less than n the VAT smulaton. That s no surprse snce the equlbrum prce of captal servces falls 0.6 % now. In contrast wth the VAT case, however, the reductons n producton prces are translated nto consumer prces and the CPI falls 0.30 %. The reducton of dsposable ncome reduces consumpton and savngs. However, ths effect s to some extent counteracted by the reducton n consumer prces and the reducton n the publc defct. Ths explans the dfferences observed n producton levels wth the VAT prevous smulaton: the fall s consderably smaller n consumpton orented sectors and even there s an ncrease n producton n some nvestment orented sectors. Personal ncome revenues over GDP ncrease 0.52 pp. as a result of the elmnaton of the tax rebate. Multplyng 0.52 by the 2010 GDP, the estmated ncrease n revenues s 5, mllons, a fgure not too far from the mllon advanced by Government offcals General equlbrum effects are agan responsble for other thngs not beng equal. Notce that the reducton n the publc defct (0.32 pp) s also n ths case well below the ncrease n the personal ncome tax share. The fall n producton level and the ncrease n the real wage rases 0.41 percentage ponts the unemployment rate and reduces 0.48 % employment and 0.28 % GDP. On the revenue sde, there s a small fall n the share of VAT revenues and on the expendture sde the share of publc consumpton, unemployment and other socal transfers and current transfers go up. Effects of an ncrease n taxes on products, VAT rates and the personal ncome tax Column S4 n Tables 1-5 ncludes the results obtaned jontly smulatng the three tax reforms just dscussed. Producton prces fall n all sectors except n Extracton of 20

21 energetc products, coke and refned petroleum and Food, beverages and tobacco, the two sectors drectly affected by the ncrease n ol and tobacco tax rates. Notwthstandng the fall n producton prces, consumpton prces of manufactures and not exempted servce products go up drven by the ncrease n VAT rates. The CPI ncreases 0.52 %. Domestc producton levels fall n all sectors, except Mechancal machnery and equpment and Manufacture of electrcal machnery and precson equpment, beng notceable the reducton n Extracton of energetc products, coke and refned petroleum, 7.96 %, and Food, beverages and tobacco, 2.19%. The ncrease n the jont share over GDP of the personal ncome tax, VAT and taxes on products, 1.24 pp, s a bt lower than the sum of the ncreases obtaned for each of them n the ndvdual smulatons, 1.33 pp. Multplyng 1.24 by the 2010 GDP, the estmated ncrease n revenues caused by the smultaneous ncrease n all rates s 13, mllon, a fgure very smlar to the fgure obtaned by addng up the ncreases estmated ex-ante by the Government n the three nstances (13.167). Notce agan that, the reducton n the publc defct estmated n the jont smulaton, 0.66 pp, s almost half the foreseen ncrease n revenues. As ndcated n other smulatons, changes n prces and producton levels explan the fall of other revenue shares and the ncrease of publc consumpton and expendture shares n Table 4. The changes of the man macroeconomc varables n Table 5 sum up the stuaton: The unemployment rate ncreases 1.25 pp and employment and real GDP fall 1.45 and 0.89 percent, respectvely The senstvty of the results has been tested smulatng the tax polces for =0.9 and =1.5. The lower the value of, smaller are the fall n domestc producton, the ncrease n consumpton prces and the fall producton levels. Publc revenues ncrease a bt more and publc expendtures a bt less. However, the change n the publc 21

22 surplus s just 0.07 pp, or mllon usng the 2010 GDP. Changes n the unemployment rate, employment and GDP growth rate are also small. 4. Conclusons Ths artcle has presented the effects of smulatng three permanent tax rate ncreases mplemented by the Spansh Government n the second semester of 2009 and 2010 to reduce the publc defct that reached an all tmes record (11.1 % of GDP) n Taxes on ol products and tobacco were ncreased n June 2009; the normal and reduced VAT rates were ncreased n July 2010 and a 400 EUR deducton was elmnated n 2010, rasng the effectve personal ncome tax rate. The results obtaned n each smulaton ndcate that the three polces ncrease revenues n amounts not far from those foreseen by the Government, but the reducton acheved n the publc defct s consderably smaller than one mght have advanced n vew of the ncrease n revenues. The reason beng that the polces mplemented change prces and quanttes, modfy tax bases and revenues, and ncrease government expendtures and transfers. In the three scenaros, the unemployment rate goes up and aggregate employment and GDP fall. Those changes are qute sgnfcant when the three polces are jontly smulated. As expected, the GDP shares of taxes on products other than VAT, VAT and personal ncome go up, although a bt less than n the ndvdual smulatons. The total ncrease n revenues (1.4 pp) s also lne wth the fgures expected by the Government, but the reducton acheved n the publc defct (0.7 pp) s only half that fgure. Consderng that the observed rato of the publc defct to GDP fell just 1.8 pp n 2010 (from 11.1 to 9.3 percent), the result of the jont smulaton suggest that the task rate hkes mplemented n account for only 38.9 % of the reducton n the publc defct n

23 The man polcy mplcaton that can be extracted from the tax smulatons dscussed s that further substantal spendng cuts and tax ncreases wll be requred n the next few years to brng down the rato of the publc defct over GDP to 6 % n 2011, 4.5 % n 2012 and 3 % n 2013, as accorded wth EU authortes. On the expendture sde, the Spansh government may contnue cuttng down educaton and health programs, or face the need to reform the unemployment beneft system that has channeled more than mllon to the unemployed n , a generous system that may be behnd the anomalous ncrease of the offcal unemployment rate n Span that rose from 8.01 % n the thrd quarter of 2007 to % n the second semester of On the revenue sde, the government needs to ncrease the effcency of the fscal system hghly dependent on labor ncome taxes and VAT revenues from real estate transactons and automoble sales n the boom years ( ). Automatc stablzers may explan that fscal revenues fall more than nomnal GDP n recesson tmes, but not to the extent observed n Span. Notce that although the Government rased substantally taxes on products, VAT and personal ncome taxes n , the revenues of all publc admnstratons n 2010 were stll 53,311 mllon nferor to those n Snce nomnal GDP was almost the same (1,062,591 mllon n 2010 and 1,053,057 mllon n 2007), and the labor ncome share fell 2 pp. n the nterm, t s hard to escape to the concluson that non-labor ncome s not adequately taxed and there s wdespread VAT fraud n many sectors. A profound reform s needed to ncrease the revenue effcency of the Spansh fscal system whose lmtatons have been exposed by the Great Recesson. 23

24 References Andrés, J., Dolado, J.J., Molnas, C., Sebastán, M., and Zabalza, A. (1988), The nfluence of demand and captal constrans on Spansh unemployment, Documento de Trabajo SGPE-D-8805, Mnstero de Economía, Madrd. Barrell, R. and Weale, M. (2009), The economcs of a reducton n VAT, Fscal Studes 30, Blake, A. (2000), The economc effects of toursm n Span, Dscusson Paper 2000/2 Toursm and Travel Research Insttute, Unversty of Nottngham. Blundell, R. (2009), Assessng the temporary VAT cut polcy n the UK, Fscal Studes 30, Conesa, J. C., Díaz-Gménez, J., Díaz-Saavedra, J., and Pjoan-Mas, J. (2010), La subda del mpuesto sobre el valor añaddo en España: Demasado cara y demasado pronto, Workng paper FEDEA Crossley, T.F., Low, H., and Wakefeld, M. (2009), The Economcs of a Temporary VAT cut, Fscal Studes 30, Fernandez de Córdoba, G. and Torres, J.L. (2010), El aumento del IVA en España: una cuantfcacón antcpada de sus efectos, Revsta de Economía Aplcada 53, García-Manar, I. and Montuenga-Gómez, V. (2005), The Spansh wage curve: , Regonal Studes 37, INE (2009), Cuentas Naconales. Marco Input-Output. Resultados Madrd: Insttuto Naconal de Estadístca. INE (2010) Cuentas Trmestrales. Madrd: Insttuto Naconal de Estadístca. Montuenga, V., García, I., and Fernández, M. (2003), Wage flexblty: Evdence from fve EU countres base on the wage curve, Economc Letters 78, Sanz-de-Galdeano, A. and Turunen, J. (2006), The euro area wage curve, Economc Letters 92,

25 Correspondng author: María Teresa Álvarez-Martínez Rutgers, The State Unversty of New Jersey 33 Lvngston Avenue, Room 493 New Brunswck, NJ p f