General State Budgets 2011 N.I.P.O.:

General State Budgets 2011 N.I.P.O.: 601-11-028-0

THE PATH TO FISCAL CONSOLIDATION AND THE FOUNDA- TIONS FOR COMPETITIVENESS I. Introduction Economic policy should focus on two fundamental principles in order to pursue the exit strategy: austerity and reform. Austerity, in an attempt to reach an equilibrium in public accounts, foster confidence in the economy and, eventually, ensure that access to financing, both public and private, is back to normal after two years of instability. As for reform, the aim is to increase our economy s competitiveness and thus to engage in recovery, economic growth and the reduction of unemployment. The Central Government Budget for 2011 reflects several of the necessary building blocks in line with this economic policy. They include adjustments in expenditure to achieve a reduction in the public deficit that is without precedent in our economic history. In this way, Spain has proven its ability to meet its commitments by fulfilling the Stability Programme. Austerity does not impede the Central Government from allocating significant resources towards maintaining social cohesion or investing in priority policies to modernize our production structure. The Budget contains elements that improve the distribution of the tax burden. However, it should be noted that the Central Government redistributes income primarily through public spending, and, therefore, fairness and equity should be evaluated by considering the system as a whole. The structural reforms implemented by the Government constitute the foundations of Spain's economic policy for consolidating the economic recovery, improving our competitiveness, and obtaining a more balanced sustainable growth model in social, eco-

2 GSB 2011 nomic and environmental terms. Both austerity and structural reforms contribute decisively to economic recovery, not only through direct, tangible effects, but also by helping to restore confidence in our economy on the part of economic agents, households and businesses. II. Challenges facing the Spanish economy Spain is beginning to recover The Spanish economy is slowly beginning to recover after experiencing a sharp recession, the effects of which are still patent, especially in the labour market. In fact, unemployment is the Spanish economy's main problem, and its reduction is a priority from both a social and economic standpoint. GDP Growth (%) 6 4 Spain Germany France Euro area 2 0-2 -4-6 2006 2007 2008 2009 2010 Forecast Source: Eurostat and the Spanish Ministry of Economy and Finance 2011 Forecast

GSB 2011 3 Our public deficit must be reduced to 3 per cent of Gross Domestic Product (GDP) by 2013, in compliance with the Stability and Growth Pact. To attain this goal, it is crucial to reduce the general government deficit to 6 per cent by 2011. To this end, economic policy must pursue two complementary objectives: reducing the deficit, in the short term, and increasing our competitiveness, as a medium- and long-term objective. Reducing public deficit is essential... In the short term, the only option is austerity in public finances, specifically an unprecedented reduction in public spending to align it with current public revenues. The economy's still-timid recovery advises against major reform of the tax system. Therefore, the Central Government Budget for 2011 includes tax modifications only to improve the fairness of the system and to encourage changes in the production model, although their effects on tax revenues are not noteworthy. but also improving competitiveness through reforms In the medium and long term, improving the competitiveness of our economy will strengthen the recovery, allowing for job creation and the consolidation of a more balanced growth model. This objective can only be attained through reforms that will transform Spain's production structure. These reforms cannot be postponed, as they will lay the foundations for the next economic growth cycle. Their immediate implementation will have positive effects on expectations in the short term, boosting confidence in our economy, which is a vital component of the recovery. Moreover, they must be accompanied by price and wage moderation in order to provide the needed boost to competitiveness.

4 GSB 2011 III. Fiscal policy trends Following a countercyclical fiscal policy, a firm process of fiscal consolidation is unavoidable... To palliate the immediate effects of flagging economic activity and job destruction, Spain implemented a strongly countercyclical fiscal policy, coordinated with other G20 countries as well as the European Union. As a result, following surpluses from 2005 to 2007, the Government registered a deficit of 11.1 per cent of GDP in 2009. The fiscal consolidation process commenced with the Central Government Budget for 2010. In addition to these measures, an austerity strategy was stemmed from the Immediate Action Plan, which reduced Central Government expenditure by an additional 5 billion euro in 2010, and from the Central Government Expenditure Austerity Plan 2011-2013. The territorial administrations also contributed to this budgetary effort, with the approval of framework agreements for sustainability in public finances. The instability of the sovereign bond markets was greatly exacerbated in the first week of May due to the worsening of Greece's budgetary crisis. To avoid a liquidity crisis, the member States of the European Union created new financial stabilisation instruments which would allow for the mobilisation of up to 750 billion euro, and they reinforced consolidation plans already under way....which was frontloaded with the measures adopted in May 2010... In this context, the Spanish Government passed the Royal Decree-Bill 8/2010, 20 th May, on extraordinary measures to reduce the public deficit, froze 2.4 billion euro of existing budget allocations, and approved the Central Government Expenditure Review Plan 2011-2013. The Fiscal and Financial Policy Board and the Local Administration National Commission approved amendments to framework agreements that reflected the new fiscal con-

GSB 2011 5 EFFECT IN 2010 OF THE MAIN MEAUSURES TO CUT PUBLIC EXPENDITURE ADOPTED BY THE CENTRAL GOVERNMENT AND THE COMMITMENTS REACHED WITH THE REGIONAL ADMINISTRATIONS million euro Aut. Measures to reduce expenditure Central Govt. Comm. & Local Admin. Social Security TOTAL Spending freeze decision of 29 January 5,000 5,000 Royal Decree-Act 8/2010 480 2,040 305 2,825 Reduction in remuneration 480 1,765 55 2,300 Partial retirement under Act 40/2007 250 250 Pharmaceutical expenditure 275 275 Spending freeze decision of 20 May 2,425 2,425 Impact of Central Government measures 7,905 2,040 305 10,250 Framework agreements with territorial administrations 1,200 1,200 TOTAL PUBLIC EXPENDITURE REDUCTION MEASURES 7,905 3,240 305 11,450 Source: Spanish Ministry of Economy and Finance solidation process and a commitment to save additional 1.2 billion euro. The measures adopted in the above-mentioned Royal Decree- Bill include a 5 per cent reduction in public sector wages and a freeze on pensions for 2011, which was taken exceptionally and excluded non-contributory and minimum pensions. The Central Government Expenditure Review Plan 2011-2013 will reduce spending by 23,000 million euro. Moreover, it states that any new spending action by the Central Government will be subjected to deficit reduction, and that any increase in revenues in excess of projections will be used to further reduce the deficit. This commitment to fiscal consolidation was once more reinforced in December 2010, through an increase in the excise duty on tobacco. These should allow a reduction of Central Government s deficit by 1.9 points of GDP by 2011, the autonomous communities deficit by 1.1 points, and the

6 GSB 2011 Total public sector deficit (-) and surplus (+) (% of GDP) 4 2.0 1.9 2 1.0 0-0.3-2 -4-6 -8-4.1-6.0-4.4-3.0-10 -12 2004 2005 2006 2007 2008 Source: General Comptroller of the State Administration -11.1-9.3 2009 2010 2011 2012 Forecast Forecast Forecast 2013 Forecast local governments by 0.1 points, not including the effect of settlements in the territorial financing systems. It is thus a balanced distribution of the austerity effort....allowing for compliance with the 6% commitment by 2011 Against this backdrop, the Central Government Budget for PROJECTED FISCAL DEFICIT / SURPLUS 2010-2013 Deficit (-) / surplus (+) (% of GDP) Scope 2010 2011 2012 2013 Central government -6.7-4.8-3.2-2.1 Including effect of settlements with territorial administrations -5.9-2.3 Autonomous Communities -2.4-1.3-1.3-1.1 Including effect of settlements with territorial administrations -3.1-3.3 Local government -0.4-0.3-0.3-0.2 Including effect of settlements with territorial administrations -0.6-0.8 Social Security 0.2 0.4 0.4 0.4 GENERAL GOVERNMENT TOTAL -9.3-6.0-4.4-3.0 Source: Spanish Ministry of Economy and Finance

GSB 2011 7 130 110 Public debt in 2010 (% of GDP) 118.2 90 78.8 83.6 79.1 84.7 70 62.8 50 30 Italy Germany France UK Euro area Source: European Commission and the Spanish Ministry of Economy and Finance Spain 2011 ensures compliance with the stability target approved by the Government, i.e. a deficit of not more than 2.3 per cent of GDP by year-end. All this will fulfil existing commitments with the firm determination of adopting additional measures if necessary. As a result of the deficit, public debt will continue to expand, reaching 62.8 per cent of GDP by 2010 year-end and 68.7 per cent in 2011, i.e. still far below the euro area average, which is expected to be 88.5 per cent of GDP in 2011. IV. Reforms to recover growth Reforms are crucial to economic recovery The reduction of the public deficit must be compatible with policies which seek to resume economic growth. Meeting both challenges requires implementation of structural reforms to consolidate the reorientation of our production model towards a more sustainable pattern.

8 GSB 2011 Labour reform is essential to diminish labour market imbalances The first reform targets the labour market. High unemployment (20.1 per cent 2010Q2) confirmed the emergency of reform, with a view not only to stimulating employment in parallel with the incipient economic recovery but also to reducing the split in the labour force between workers with temporary and permanent contracts, promoting stable employment, and enabling companies to adjust to increasingly demanding globalisation conditions, thereby minimising job destruction. These changes combine the right to decent work for the unemployed with a guarantee to maintain the rights of workers. The new labour market framework created under Bill 35/2010, 17 th September, will allow for the creation of better quality jobs and stimulate an increase in productivity, creating a new growth model based on more qualified human capital. The FROB and the reform of the Savings Bank Bill promote the restructuring of the financial sector Thanks to the Government's expeditious intervention and the Spanish financial system's solid foundations under the supervision of the Bank of Spain, Spanish financial institutions weathered the financial turbulence. After helping alleviate liquidity problems, the Government tackled solvency issues by creating the Fund for Orderly Bank Restructuring (FROB), which galvanized the restructuring of the financial sector. Solvency problems are attributable to the financial crisis and the credit constraint and to exposure to the real estate sector. Another mainstay of restructuring is the reform of the Bill on Savings Bank Governing Bodies (LORCA) with Royal Decree- Bill 11/2010, 9 th July, through which Spain established a stable legal framework that ensures the independence and transparency of savings bank ( Cajas ) governing bodies. Moreover, the

GSB 2011 9 new Bill allows for the issuance of "participation shares" with voting rights and provides new legal avenues that make access to capital markets easier for savings banks. Under the new Bill saving banks will enjoy access to funding in the same terms as banks. The Spanish government's initiatives have not had any costs for taxpayers, in contrast with other countries, which have had to take costly measures, such as injecting capital or nationalising their main institutions. The stress tests confirmed financial sector solvency The most recent measure taken to resolve doubts about the solvency of Spain's financial system was the publication of the stress test results. The tests, which were performed throughout the euro area, verified the overall good health of Spain's financial institutions and identified those that would potentially need additional capital in an extremely adverse context. Sustainability of pensions is a medium-term goal Despite the current strength of the Social Security system, challenges stemming from the progressive population ageing now require measures to ensure future pensions and clear doubts about the medium and long-term sustainability of the system and of public finances. To this end, the Government proposed the necessary modifications to the due Parliamentary Commission (The Toledo Pact ) to ensure the future of the pension system, specifically, raising the legal retirement age from 65 to 67. Moreover, new ways to strengthen the linkage between contributions during the working life and pension benefits must be analysed in order to consider the sustainability and fairness of the Social Security System. New measures to promote investment and job creation In order to continue with and reinforce the policy to boost the Spanish economy s growth and competitiveness, the Govern-

10 GSB 2011 ment passed the Royal Decree- Bill 13/2010, 3 rd December, on actions in the fiscal, labour and liberalization fields to promote investment and job creation. This Royal Decree-Bill implements measures to support business activity, focused on small and medium-sized enterprises. It introduces several tax benefits, such as the increase in the threshold to apply the special regime in the corporate income tax, from 8 to 10 million euro, and in the level of the tax base that benefits from the reduced rate of 25 per cent. It also includes several measures to speed up the creation of new companies by reducing administrative burden and costs. Furthermore, it establishes stamp duty tax exemptions in case of company formation, capital raising or moving to Spain of head offices from countries outside the European Union. Finally, it looks for the modernization and liberalisation, and thus for greater efficiency, of the airport and lottery sectors, through the possibility of their partial privatisation. V. Key features of the Central Government Budget for 2011: Fiscal consolidation Spain's fiscal policy is currently focused primarily on attaining sustainability in public finances. The 2011 Budget continues the process of expenditure reduction, although it also makes some settings to the tax structure. Rather than enhancing revenues, these adjustments pursue more fairness and equity and stimulate a transformation in the production model. Personal income tax rates are increased for highincome taxpayers. The marginal rate of the Central Government component of personal income tax has been increased by 1 percentage point for taxpayers with net taxable income of 120,000 euro or higher, and by an additional percentage point for incomes over 175,000 euro (i.e. to 23.5 per cent). Additionally, the 40 per cent tax reduction for income obtained

GSB 2011 11 over a period of several years is now capped at 300,000 euro. Taxation of income from investment companies with variable share capital (SI- CAVs) cannot be deferred Measures have also been adopted to avoid deferral of personal and corporate income tax by shareholders of SICAV (Spanish collective investment scheme). The measures aimed at moving towards a new production model include notably steps to rationalise housing policy, which seek to avoid real estate bubbles, and support for small and medium-sized enterprises. Small companies which cease to qualify as such due to their growth will continue to enjoy the special tax benefits for the following three years. The tax deduction for home purchases will be maintained only for taxpayers with a taxable base of less than 24,107.20 euro. Also, home rental qualifies for an equivalent tax deduction, and the tax benefits for owners of rented homes has been improved by increasing the tax reduction from 50 per cent to 60 per cent. Non-financial revenues will continue to rise in 2011 Non-financial revenues, before deducting the territorial administrations' share of personal income tax, VAT and excise taxes, will amount to 178.9 billion euro in 2011, 5.7 per cent more than the projected figure for 2010. Therefore, these revenues will continue to rise in 2011 due to the economic recovery and the positive impact on revenues of some of the measures adopted in the 2010 Budget, in May 2010, and in the 2011 Budget. The Central Government's nonfinancial revenues, net of the territorial administrations' share of taxes, will amount to 106 billion euro in 2011, 12.8 per cent less than the figure expected for 2010. This change is explained by the full entry into force of the new financing system of the common regime

12 GSB 2011 Autonomous Communities and the Autonomous Cities. The territorial administrations' share of Central Government tax revenue will amount to 72.9 billion euro, a 52.8 per cent increase. Reducing public expenditure The austerity measures envisaged in the Central Government Expenditure Review Plan 2011-2013 will impact expenditure, enabling the Central Government to attain its deficit target for 2011: 2.3 per cent of GDP, or 24.4 billion euro. Additionally, considering projected Central Government non-financial revenues and the adjustments to the national accounts, non-financial expenditure is capped at 150.1 billion euro. This expenditure limit is 18.9 per cent lower than in the 2010 Central Government Budget. The full entry into force of the Autonomous Community financing system means that the expenditure ceiling for 2011 is not fully comparable with that for 2010. For a uniform comparison, it is necessary to deduct the funds for the territorial administrations. After that adjustment, non-financial expenditure amounts to 122 billion euro, a 7.9 per cent decrease with respect to the 2010 Budget. Ministries account for the greatest austerity efforts The reduction of the expenditure ceiling reflects the budgetary efforts being made this year. This effort will be greater in the ministerial departments, where spending will be cut by 15.6 per cent (excluding mandatory items such as interest payments, contributions to the EU, pensions and the contingency fund, among others). This reduction will liberate funds to enable the government deficit to be reduced and cover unemployment benefit payments and higher interest expenses.

GSB 2011 13 All but financial expenses will be reduced in 2011 Central government salaries will be frozen with respect to 2010, after the average 5 per cent cut. This move, plus the restrictions on government hiring in previous years, will lead to a 5.2 per cent reduction in personnel expenditure. Additionally, the public sector hiring plan for 2011 has been cut to an overall 10 per cent replacement rate, without exceptions. Chapters BREAKDOWN OF NON-FINANCIAL EXPENDITURE These factors, coupled with the projected increase in expenditure on government employee pension benefits, will lead to a 2.1 per cent decline in personnel expenses with respect to the 2010 Budget. Current goods and services expenditure, excluding that related to elections, has been cut by 6.7 per cent with respect to the 2010 Budget. Financial expenses have been increased by 18.1 per cent with respect to the 2010 Budget as a result of the increased volume of government debt. Current transfers have been reduced by 27.7 per cent, and capital transfers by 35.2 per cent. This is due to three factors: a consolidation of the freeze on certain items approved in 2010, a reduction in Initial Budget 2010 Initial Budget 2011 Change 2011-2010 (M ) million euro Change 2011-2010 "(%) 1. NON-FINANCIAL EXPENDITURE BUDGET 185,036 150,056-34,980-18.9 2. Financing of Territorial Administrations 52,594 28,034-24,560-46.7 3. EXPENDITURE BUDGET EXCLUDING TERRITORIAL ADMIN. FINANCE SYSTEMS (1-2) 132,442 122,022-10,419-7.9 4. Other obligatory ex penses (interest pay ment, EU, civ il serv ice pensioners, contingency fund) 49,605 52,447 2,843 5.7 5. Other non-ministerial ex penses (Household of H.M. the King, constitutional bodies, interterritorial compensation fund, and Section 32) 4,379 3,326-1,053-24.0 6. EXPENDITURE AVAILABLE FOR MINISTRIES (3-4-5) 78,458 66,249-12,209-15.6

14 GSB 2011 transfers to the autonomous communities as a result of the full application of the new finance system, and the nonrenewal of the Central Government Fund for Employment and Local Sustainability. Real investments are 38.1 per cent lower than in the 2010 Budget as a result of the decline in infrastructure investments. VI. Main actions Spending on R&D and innovation, education, and infrastructure, together with the structural reforms described above, are still among the Government's priorities since they are considered essential for enhancing our economy's growth potential. The Government also maintains its commitment to social spending, particularly unemployment benefits. 7.5 billion euro for R&D and innovation Spain maintains its goal of contributing to more balanced long-term growth through science and technology policy. For that reason, in the current context of public spending cuts, a total of 7.5 billion euro have been allocated by the Central 70 60 R&D expenditure growth, 2004-2008 (%) 64.3 50 40 30 20 10 21.9 19.4 10.5 14.4 22.5 0 Italy Germany France UK Euro Area Spain Source: Eurostat

GSB 2011 15 Government for R&D and innovation. The priority attached to this policy is also evident in the steady increase in this investment in previous years' budgets. In 2008, the last year for which figures are available, expenditure on R&D both public and private amounted to 1.4 per cent of GDP, having increased by 64.3 per cent since 2004. Additionally, the total allocation to the Ministry of Science and Innovation has been cut by just 0.8 per cent. This small reduction makes it possible to maintain funding for projects, grants and contracts at universities and research centres, as well as tax credits for companies, practically at the same levels as in 2010. Despite the sharp cut in the budget for infrastructure policy, investment is still considerable efficient. However, a proper assessment of this policy cannot ignore the major budget efforts being made in this area. This policy, which includes investment in infrastructure and transport, water policy and coastline protection, has been assigned a budget of 17.4 billion euro at Central Government level in 2011. The Extraordinary Infrastructure Plan will enable investment to be maintained The Extraordinary Infrastructure Plan facilitates joint initiatives by the public and private sectors to revitalise the economy and jobs. The investments will be financed by publicprivate partnerships, enabling infrastructure to be financed over its lifetime. Study grants and aid amount to over 1.4 billion euro in 2011 Infrastructure policy will also be shaped in 2011 by the goal of reducing the government deficit, which requires investment to be more effective and Although this area has been devolved to the autonomous communities, education policy will continue to have a sizeable allocation in 2011: 2.8 billion

16 GSB 2011 euro. Initiatives such as the Educa3 Plan, Escuela 2.0 Plan and the International Campus of Excellence programmes are being maintained in 2011. The budget for study grants is 1.4 billion euro in 2011, 2.6 per cent more than in 2010. This increase is aimed basically at expanding the salary-grants programme. The allocation for unemployment benefits amounts to 30.1 billion euro As a result of the impact of the economic crisis on the labour market, a total of 30.1 billion euro has been allocated for unemployment benefits in 2011, slightly less than in 2010. The Central Government is contributing 15,786.31 million euro to financing the National Employment Service. The 2011 Budget allocates a significant amount, 7,329.10 million euro, to active employment policies. Notable among these policies are the social security contribution rebates for hiring, which have been restructured to define the target groups more selectively. Minimum pensions have been raised by 1 per cent Pension policy has been allocated 112.2 billion euro in 2011, 3.6 per cent more than in 2010. In 2011, only the minimum pensions, noncontributory pensions and certain other pensions have been increased, by 1 per cent. The system for persons requiring long-term care continues to expand Support for citizens requiring assistance in performing the basic tasks of everyday living continues to be a priority for the Government. A total of 1.5 billion euro have been earmarked for this purpose, in addition to the budget allocation in the Basque Country and Navarra. 5.4 billion euro for citizen protection The protection and defence of citizens' fundamental rights and liberties is a key role of the State. The budget allocation for

GSB 2011 17 this purpose amounts to 5.4 billion euro in 2011. The allocation for official development assistance (ODA) is 4.4 billion euro In the current context of budgetary austerity, the goal that official development assistance (ODA) amount to 0.7 per cent of Gross National Income (GNI) has been postponed to 2015. In 2011, Spain has earmarked 4.4 billion euro for official development assistance. Particularly important items in this area are humanitarian aid and ongoing programmes with partner countries. The Development Promotion Fund, a new financial instrument for Spanish aid which focuses exclusively on combating poverty, will be implemented in 2011.

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