Budget 2019: More taxes, less fiscal responsibility

Did you know that the 2019 Budget of Portugal has a higher deficit than that of Portugal, which was in a fiscal crisis a few years ago? The 2019 Budget was officially published on the website of the Ministry of Finance this Monday and unfortunately, once again the government focuses on higher spending without structural reforms, as well as higher taxes, without savings for the crisis. In addition, for some inexplicable reason, GDP growth is expected to accelerate in 2019, given that the tilt of its fiscal policy is rather pushing growth in the opposite direction.

Another surplus, another deficit – why?

The government is targeting a deficit of 0.5% of GDP for 2019, even though it has been running a record-breaking surplus for the third year in a row (it had already reached 2 billion leva by the end of the first half of the year). Unfortunately, at this point, running a deficit in the face of record-high surpluses is not even an unpleasant surprise, but a vicious habit that will sooner or later have an extremely negative impact on fiscal stability. Fundamental economic wisdom says that when you have unexpected surpluses, you should save, not do everything possible to spend them. Save, because what surprises you pleasantly today may surprise you unpleasantly tomorrow. Record tax collection is coming to an end.

In all likelihood, the current economic cycle has already passed its peak at the global and local levels. The first indications that this has happened are present in developing economies such as Turkey and Argentina, which fell into severe crises this year. Bulgaria should not remain in a position where the state treasury does not provide any buffers against a sharp decline in tax revenues and a subsequent jump in the size of the deficit, which would be a consequence of a recession or even a more noticeable slowdown in GDP growth.

The next crisis won't wait for us to balance our budget

Over the past few years, the government has had the incredible opportunity to virtually immunize the state treasury against a crisis scenario, thanks to record surpluses year after year. These surpluses (or at least a significant part of them) can be saved in a "rainy day" fund, as, for example, the Irish government does, which has not even accumulated a budget surplus in recent years!

But instead, our government is doing the opposite. Expenditures are rising, and the significant increase is not even in investment spending, which could perhaps increase the productivity of the economy. The government is focusing on current personnel costs – salaries and pensions. This is extremely dangerous because current spending is the most difficult to cut at a later stage, even in periods of severe economic crisis. This is due to the enormous pressure from certain lobby groups (particularly in the public sector). Therefore, when current spending is raised during periods of record high tax revenues, it significantly increases the risk of falling into a fiscal crisis when the economic cycle turns and revenues fall.

We are betting on a higher deficit than countries that were recently in fiscal crisis

And speaking of fiscal crises, did you know that the Bulgarian Budget 2019 includes a higher deficit than that of Portugal? That's right. The Bulgarian government is planning a higher budget deficit than that of a country that was in fiscal crisis 4 years ago after achieving a record deficit of 11.2% of GDP in 2010. At the beginning of the mandate, the first GERB cabinet had Bulgaria as a fiscal champion, while Portugal was on the verge of fiscal disaster. Now, during the third GERB cabinet, the Portuguese government expects a lower budget deficit. This is an extremely worrying development, which very clearly reveals the degradation of the quality of fiscal policy in the country over the past few years.

Of course, it should be noted here that in view of the fact that the fiscal has been accumulating surpluses for several years in a row, the projected deficit is not actually a real deficit. The money is there to eliminate the entire deficit, the government simply does not want to officially recognize it. Why? Because projecting a deficit gives more freedom to the rulers to literally do whatever they want. When the state treasury accumulates an "unforeseen" surplus, it can be spent by the government in any way it chooses, without the need for parliamentary approval.

After all, when it comes to billions of leva in the hands of the government, which it can spend as it pleases without consulting anyone, is it surprising that imaginary deficits are being set up year after year? It is not surprising, but such spending is dangerous, absorbing financial resources that could be used for savings, not to mention that it is also extremely opaque.

Is the GDP growth forecast for 2019 unrealistic?

All these fiscal horrors are set against the backdrop of a macroeconomic forecast that, specifically with regard to GDP, seems to be more optimistic than justified. Given the fact that GDP growth is expected to weaken this year (due to the slowdown in growth in the first half of the year), there is no reason to believe that there will be a reversal of this trend next year, even minimally (by only 0.1 pp). For comparison, the IMF predicts that growth in our country next year will slow to 3.1%, which seems like a much more realistic scenario. With regard to our government's forecast, the question cannot help but arise: what would be the circumstances that would lead to the (slight) acceleration in the pace of GDP growth that it expects?

They can hardly be global. The economic climate in 2019 will be quite uncertain, especially for the European Union. Brexit should happen then, which certainly would not have a stimulating effect on economic activity in the union, but on the contrary - since it is expected to reach its climax, the "Brexit" factor will make investors more cautious than ever. There will be no direct effect on Bulgaria, of course, but the indirect effect is guaranteed since we are an EU member state. In addition, the European Central Bank is expected to finally raise its interest rates in the second half of 2019. Given how much effort through monetary stimulus the ECB needed to push the average level of GDP growth in the Eurozone to just 2.5%, business will be particularly worried about the potential increase in interest rates, even if it is minimal. Another factor that pushes growth down.

On a global level, the situation is actually even worse. This year, emerging markets such as Turkey and Argentina fell into severe crises, which in turn were to a greater or lesser extent (in the case of Turkey, quite a large one) caused by the regular increase in interest rates by the US central bank - the Fed. Its increasingly restrictive monetary policy is causing a massive withdrawal of liquidity from global financial markets, and subsequently - a withdrawal of investments from emerging economies. Where, then, is this increase in GDP growth in Bulgaria expected to come from?

An internal growth engine with a higher tax burden?

Apparently, the government expects the generator of this growth to be internal. Which is an extremely unrealistic expectation, given the fact that the government is not taking any measures to stimulate such growth. Quite the opposite – for the third consecutive year we are witnessing an increase in the social security burden, this time in line with the increase in the maximum social security income. Last year, there were minimum social security thresholds and the amount of social security contributions. The year before, the amount of social security contributions was also raised. And this is happening in a period in which there is no economic crisis, there is record high tax collection (including social security contributions) and record high budget surpluses year after year.

Where is this higher growth expected to come from when the government increases the tax burden on labor? Especially when it comes to high-paid labor, which is the specific victim of the increase in the maximum social security income? This is the labor that brings the highest added value to the Bulgarian economy and, accordingly, a very significant contribution to GDP growth. When investments in this type of labor are de-stimulated due to an increase in the social security burden, its contribution to GDP growth will certainly be lower than it would otherwise be.

Recently, the Institute for Market Economics recalled that over the past 10 years there have been at least 25 increases in current taxes or the introduction of new ones. Yes, these are not the direct taxes on income and VAT, whose "stability" the government likes to boast about so much. But "smaller" indirect taxes are also of particular importance. And specifically when it comes to the cost of labor, the so-called "social security" taxes (which are practically taxes because they perform a purely redistributive function) are of particular importance. And over the past decade they have been on a strong upward trend. And yet, the financial conditions of the public healthcare and pension system remain critical. Why? Because the government refuses to push through the necessary structural reforms!

Conclusion

With record surpluses accumulating in the treasury over the past few years, the last two GERB governments (with the RB and OP before 2017 and with the OP since then) had the opportunity to ensure the country’s long-term fiscal stability. By creating fiscal buffers and paying down debt faster, the last two cabinets could have ensured that Bulgaria would be the fiscal star of the EU during the next crisis. Instead, however, they chose to do the exact opposite – by spending every single surplus opaquely, indiscriminately raising current spending in unreformed sectors, and stifling growth through constant increases in the tax burden.

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