Can Europe Make It?

Trapped in the Eurozone - the deep nature of Spain's economic woes

The logic behind tax avoidance is the lack of trust. If you do not trust your fellow countrymen (and particularly the state) and think they will cheat on their taxes, then there is no point in you paying at all.

Manuel Muriel
2 December 2013
barcenas.jpg

Protests against Luis Barcenas, former treasurer of the Popular Party in Spain. wikimedia commons/Popicinio. Some rights reserved.

A few years ago, when still living in Spain, I requested a quote from a local supplier for a building service. I was puzzled as he put a VAT rate of 8%, instead of the standard rate then of 16%. I was shocked as, being an economist, it seemed that I was not up to date on tax issues. So I called the supplier to clarify the issue who – a bit upset, as he thought I was challenging his price policy – said that “as no one wants to pay a single Euro cent of VAT” he decided that the right rate was to be in the middle; between nothing at the official rate.

This Aristotelian approach to taxation (virtue as the mean between extremes) shows the extent of tax avoidance in the country and the limits of the state to raise taxes and to change people’s customs. Any meaningful fiscal policy can be offset by powerful, even if popular, institutions such as tax avoidance, i.e.: the exclusion of the state from economic exchange. Of course I was not oblivious to practices such “black work”, “accountancy B” and other realities of business in Spain. In 1987, when I started at the University of Seville, the accountancy teacher warned us that there were actually two types of accountancy, i.e.: the legal one and “B” accountancy (the real one). It was rather a criticism to the textbooks that nothing of the matter was said.

Twenty five years later double accountancy is still a matter of fact in Spain, which probably shows the difficulty of the modern state to shape the society. The recent Bárcenas scandal, in reference to the treasurer of the Popular Party (PP) for more than ten years, shows the allegedly common practice of topping up top party officials’ pay with a slush fund. Among the beneficiaries of these payments is said to be PM Mariano Rajoy. The fund would have been fed by bribes paid by construction companies to the party in return for favours from local and regional governments or from the central government itself. 

Although PM Rajoy denied the allegations, he eluded the matter at home until was asked in Berlin when in company of Chancellor Angela Merkel. There he said it was “untrue except for some things”. However, he talked of fighting corruption and said he was going to put his tax return online, which he did. Unsurprisingly, the Spanish tax form does not have any section or box aimed at these revenues.

The logic behind tax avoidance is the lack of trust. If you do not trust your fellow countrymen (and particularly the state) and think they will cheat on their taxes, then there is no point in you paying at all, i.e.: the prisoner dilemma and a Nash inefficient equilibrium. The World Values Survey (2006/7) shows a trust index in Spain of 40.9% –against 61.7% for instance in the UK. The ultimate result seems to be a high structural unemployment. A low social capital –as evidenced by a low trust index– increases transaction costs and hence shrinks the frontier of production. In the semi-autonomous region of Andalusia, where the trust index according to the European Values Study is 24.5% (Tabellini, 2006) the unemployment nears 35%; in EU terms it borders on a failed state. 

The value of a currency – being a fiduciary means – depends on the capacity of its issuer, normally a state, to keep its promises. Before the Euro, peripheral economies in Europe, such as Spain, could adjust the value of their currencies: the monetary policy was actually one of the pillars of their economic policy. This is what Spain did three times after the hangover of post 1992 (Expo92 in Seville and the Olympic games in Barcelona); she was able to regain competitiveness by devaluing the Peseta. 

Now things are very different, the Euro is a Germanic-like currency that performs like a strait-jacket all over the Eurozone and does not leave room for manoeuvre to countries with a different logic. In the Mediterranean countries, the rules of the monetary game are now the German Mark’s but the practices are not.

An iron fist institution such as the Euro has been imposed on countries with very different cultural and historical backgrounds. The single currency is probably too strong for countries with, in many respects, such poor standards. Having lost their monetary sovereignty, no Eurozone member state can now deceive – at home or abroad – with the value of its currency. The Euro will survive but at the cost of a sizable unemployment in the peripheral countries that will only decline via a slow internal devaluation; until they regain their competitiveness. This is what is painfully happening now.

Low trust countries, in which the state tends to be a predatory entity that does not always honour their promises, tend to have weak currencies – as was the case of the Mediterranean countries. They are not the best partners in a monetary union with the core high trust countries of Europe which tended to have strong currencies, as was the case of Germany and still the UK.

The adoption of the single currency by Spain induced a property bubble that after it burst in 2007 has left around 3.4 million empty houses (INE 2013). This probably shows a nation who used to believe that wealth could just be created out of construction and property speculation – making even the need to work, redundant. It is now clear that the property rush was the origin rather than the outcome of the economic bonanza in the last decade. A boom fuelled by cheap money from a strong new currency.

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