Spain, under threat of falling victim to the region’s debt crisis, will raise taxes and slash spending to achieve 27 billion euros ($36 billion) in deficit cuts as it tries to trim its budget gap by a third.
The government will cut ministries’ spending by 17 percent, increase corporate levies and raise 2.5 billion euros through a one-time amnesty on tax evasion, Budget Minister Cristobal Montoro said in Madrid. The 2012 spending plan seeks to reduce the budget gap to 5.3 percent of gross domestic product from 8.5 percent in 2011, the largest reduction in at least three decades.
“We are in a critical situation that has forced us to respond with the most austere budget of the Spanish democracy,” Montoro said today in Madrid after a Cabinet meeting that approved the plan.
The yield on Spain’s 10-year bond has risen more than 50 basis points since March 2 when Prime Minister Mariano Rajoy unilaterally raised his deficit goal for 2012 as a deepening economic slump compounded a bigger-than-forecast shortfall last year. The additional austerity announced today may fuel second recession since 2009 that’s left the country with the euro-region’s highest jobless rate at more than 23 percent.
“This is as austere as it gets,” Nicholas Spiro, managing director of Spiro Strategy said in a note. “The big question is, ‘can Spain’s sickly economy endure such harsh austerity?”
The 10-year yield fell 12 basis points to 5.34 percent at 5:45 p.m. in Madrid, leaving the difference with comparable German debt at 355 basis points, down from yesterday’s close of 365, the highest in almost four months.
Under today’s plan the central government will reduce its shortfall to 3.5 percent of GDP from 5.1 percent last year. Spain’s 17 autonomous regions, the town halls and social-security system account for difference between the central government budget gap and the overall deficit goal of 5.3 percent. Montoro said he would enforce budget discipline in the regions, which accounted for much of last year’s slippage, to make sure they meet their 1.5 percent target.
Today’s blueprint seeks to avoid making consumers fund the cuts. The plan won’t raise value-added tax, cut pension payments or reduce civil-servants wages, Deputy Prime Minister Soraya Saenz de Santamaria said.
About two thirds of the deficit reduction announced today by the government is through spending cuts, with tax increases and other revenue measures accounting for the rest.
The government aims to raise 12.3 billion euros in tax revenue, including an additional levy on income announced on Dec. 30. The new measures include 5.35 billion euros from reductions to corporate tax breaks such as rebates linked to financial costs, depreciation, and goodwill of acquired companies.
“The non-property part of corporate Spain is in a good position, so it’s a good idea,” Gilles Moec, co-chief economist at Deutsche Bank AG said in a telephone interview. “The adjustment is more advanced in businesses than in households.”
Investment will fall 20 percent and spending of 1.6 billion euros will be slashed from job-placement policies. Transfers for foreign aid will fall by 594 million euros and spending by the foreign ministry will decline 54 percent.
Rajoy riled European Union partners with his March 2 announcement at a summit in Brussels that he had raised Spain’s deficit target to 5.8 percent of GDP from the 4.4 percent initially pledged. Earlier that day, he had attended a ceremony to sign a treaty aimed at ending the debt crisis by enforcing fiscal discipline. EU allies pushed back and got Spain to agree on March 12 to a 5.3 percent goal.
Rajoy raised the target after his predecessor, Socialist Prime Minister Jose Luis Rodriquez Zapatero, left him with a deficit of 8.5 percent of GDP, dwarfing the 6 percent pledged to the EU.
The reduction that Rajoy is pledging in the overall deficit of 3.2 percentage points of GDP is more than the 2.7 percentage points achieved by Zapatero, in the previous two years, when the economy was performing better than the 1.7 percent contraction forecast for this year.