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Budget Day: a repetition of moves

Economic Report

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Over the past few years the wide variety of headgear – whether making or refraining from political statements – has seemed to have a permanent hold on the headlines on Budget Day. As in the preceding years, the Speech from the Throne has few surprises in store for us this year and will once again be drenched in the rhetoric of austerity. Because getting the government’s accounts in order appears to be the only yardstick by which the government assesses the economic situation of the Netherlands. 

Fixation on the 3% deficit threshold…

The remedy for the present economic problems appears to be politically simple: even more austerity measures. Deficit-reducing measures in the years 2011 up to the end of 2014 cumulatively total € 38 billion ex ante (figure 1). At the end of the present government’s term of office in 2017 this will have reached € 54 billion ex ante, which represents an average of almost € 8 billion a year (around 1.3% of GDP). 

Figure 1: Aren’t we thrifty 

Figure 1: Aren’t we thrifty

Source: CPB, Rabobank

Despite its austerity drives, the Netherlands is not managing to push back the budget deficit to below the deficit threshold of 3% of GDP agreed in Europe. While the European Commission requires the budget deficit to be reduced to 2.8% of GDP next year, the 2014 Budget Memorandum indicates an expected decrease of the deficit from 4.1% of GDP in 2012 to 3.2% of GDP in 2013 and 3.3% of GDP in 2014. This estimate includes the 6 billion package put together in response to the recommendations for 2014 issued earlier this year by the Council of the European Union (European Commission, 2013) [1].

A major part of the budgetary gains from these austerity measures will be lost, however, because this policy stifles economic growth. Figure 2 depicts the correlation between economic growth and the EMU balance in the past three decades. Economic activity is currently expected to contract by an average of 0.3% a year in the period 2011-2014. This means that the cumulative growth is over 1.5%-age points lower per year than was expected when the first Rutte government came into office (CPB, 2010a; CPB, 2013). This is not all that surprising exactly because budgetary remedies seeking to improve balances in the near term usually lead to intrinsically higher expenditure. This pressures near-term economic growth and makes no contribution whatsoever to the economy’s growth potential. As a consequence of the additional austerity challenge in 2014 CPB forecasts economic growth to be 0.25%-age points lower next year at 0.5%. In fact, we expect that the effects of the stepped up austerity measures on economic growth in the coming year may well be far more substantial. Owing to the special circumstances – households that are strapped for cash, the gradual tapering of the policy of monetary easing and simultaneous austerity cuts in Europe – it appears that the economic effects of the cuts will be roughly double compared to ‘normal’ times (Stegeman and Kamalodin, 2013 [2]. CPB in fact refers to this as well, albeit as a risk scenario (CPB, 2013; Legierse, 2013).

Figure 2:  The Dutch government budget is sensitive to cyclical economic developments 

Figure 2: The Dutch government budget is sensitive to cyclical economic developments

Source: CPB

At the same time, perpetual downward adjustments of (forecast) economic growth lead to lower potential growth than expected and below-par government revenues [3]. That is why the government may prove, in retrospect, to have undertaken more onerous budgetary efforts than necessary, as has been the case in the Netherlands for the period 2010-2013. Adjusted for the lower potential growth and government revenues the average annual policy effort during this period proved to be 1.1% of GDP. This was higher than the average annual effort set by the Council of the European Union of ¾% of GDP. That is why a one-year extension for reducing the budget deficit in 2013 was justified according to the European Commission and can already be pencilled in as likely to be repeated next year as well. For the proposed policy measures are insufficiently geared to the long term and there is a significant risk that the economic situation will deteriorate even more next year. It is therefore quite likely that the government will have to put together another supplementary austerity package next year, if the 3% budget deficit threshold appears set to be exceeded once more in 2015. Partly due to stringent efforts to meet the 3% threshold, austerity policies focus increasingly on balance management for the near term and are accordingly primarily based on increases in tax and social security contributions and on freezing (semi)public sector salaries. As a result, no lasting solution in terms of budgetary policy is in the offing and our policymakers are again in danger of being overtaken by events (Piljic and Stegeman, 2013).

Footnotes

[1] The European Commission uses the cyclically adjusted budget balance as an indicator for budgetary policy. This is the actual budget balance adjusted for cyclical economic developments. The additional austerity package of € 6 billion represents an improvement of the cyclically adjusted budget deficit by 1% of GDP. This is made up of the sum of the average annual improvement of 0.75% of GDP and an extra structural effort of 0.3% of GDP to offset the predicted deterioration of the structural budget balance in 2014. The European Commission will publish an updated estimate in November and subsequently review the adequacy of the measures taken by the Netherlands following the recommendations issued by the Council on 29 May 2013.

[2] CPB estimates the multiplier for public spending after 1 year at around 0.9 and for taxes at around 0.4 (CPB, 2010b). The fiscal multiplier is more likely to be well over 1 next year as well

[3] In addition the composition of this growth, which is driven mainly by exports, will lead to lower tax revenues than would more broadly supported economic growth

…leads mainly to increases in tax and social security contributions…

Accordingly it comes as no surprise to see a preponderance of measures targeting tax and social security contributions in the proposed policy. Figure 3 shows how the burden of taxation and social security contributions at the micro-level for households and businesses rises during the period 1995-2014 whenever the budget deficit does [4]. In line with this trend, the combined tax and social security contributions burden is set to reach 40% of GDP next year for the first time since 1999. Since 1995, policy-driven tax burden has increased by almost € 26 billion in total. The bulk of this increase is almost wholly concentrated in the past four years (figure 3). Government revenues are maintained by passing on the bill to households and businesses.

Figure 3: Pressure of the burden of taxation and social security contributions at the micro-level rises with budget deficits 

Figure 3: Pressure of the burden of taxation and social security contributions at the micro-level rises with budget deficits

Source: CPB

At the same time the policy measures are aimed at slowing the increase in government spending. Figure 4 shows the effect of the policy measures of the Rutte I and II governments and the 2013 Budget Agreement on government spending levels. The reduction of spending on public administration and international cooperation is particularly notable. Spending on social security is curtailed by measures in the 2013 Budget Agreement, including an accelerated increase of the state pension age to 68.5 years in 2040. The braking distance of that type of spending measure is however always longer than for subsidy or budgetary items in the budget. Rising healthcare spending however represents a major risk for the sustainability of public finances. This is not just because increases in healthcare spending are perpetually underestimated, but also because politics continually fails to take measures that successfully counter those increases. On balance, spending up to the end of 2017 is limited by € 30 billion by the various agreements in place.

Figure 4: Healthcare spending requires the greatest care

Figure 4: Healthcare spending requires the greatest care

Source: CPB, Rabobank

Footnote

[4] The burden of taxation and social security contributions at the micro-level (as from 2012 this indicator is referred to as the development of policy-driven tax burden) is a better indicator of changes in the burden actually weighing on businesses and households. The combined tax and social security contributions burden (i.e. macro tax burden) changes not just as a consequence of policy measures, but can also change if the development of the tax basis differs from that of GDP. As a result, the development of the wage bill can trail behind that of GDP. This is known as an endogenous change.

… that depress domestic demand …

Responding to unforeseen setbacks with short-term cuts and increases in taxes and social security contributions further exacerbates the erosion of domestic demand in the Netherlands. For instance, the total burden for family households in 2014 will be upped by € 5 ¾ billion as a result of the government’s proposed policy. In addition to those increases, households’ disposable income will also be depressed by the fall in real contractual wages, which is expected to continue in 2014 for the fifth year in succession. It is therefore not very surprising that total consumer spending has virtually stagnated since as long ago as 2007 (figure 5). At the same time fixed expenditure, which accounts for a quarter of total consumer spending, rose over 10% in that same period. This was largely absorbed by a decrease in spending on durable consumer goods, which fell by over 20%. But not only are people in the Netherlands spending a growing portion of their disposable income on fixed expenditure, the individual savings rate will remain negative in 2014 for the 12th consecutive year. This is attributable to liquidity problems suffered by households in the Netherlands. Neither pension capital nor capital tied up in property is readily convertible into cash. This effect is set to be exacerbated in the years ahead, as households in the Netherlands will be required to repay an incremental portion of their mortgage debt. If households’ real disposable income falls owing to increases in taxes and social security contributions, rising unemployment and low or even negative real wage growth, the repayment of households’ debt will severely hamper economic growth as they will have no other option except to consume less (Rabobank, 2012)

Figure 5:  Consumer spending is stagnating 

Figure 5: Consumer spending is stagnating

Source: CPB

A fall in real disposable income will trim an average of ½% off purchasing power for all income groups in 2014. Average purchasing power has fallen 4% since 2008. Overall, this depressing slide of purchasing power gives households scant opportunity to concentrate on a matter that is a far greater problem than the level of public debt: reducing households’ private debt. They have not yet been able to address that.

…and cloud the view on diligent budget policy

The budget policy has increasingly focused on the short term in the past few years, at the expense of longer-term policy. This does not do justice to the economic challenges facing the Netherlands. The real problem of the Dutch economy is not the budget deficit of this and/or next year. The real problem for the Netherlands is the erosion of domestic demand, caused mainly by households’ sharp loss of income, which is exacerbated by the way in which the government responds to unforeseen setbacks by short-term austerity measures and increases in taxes and social security contributions. That the latter will ultimately constrain the Dutch economy’s growth potential is a known fact. The pursuit of a credible long-term policy is being impeded at present by a short-termism that produces few benefits but more uncertainty, growing unemployment and erroneous measures. If the government continues on this path the outcome of the debate on the budget for 2015 will not be hard to predict. Another supplementary austerity package

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