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February 11, 2015

Greece's new Prime Minister, Alexis Tsipras, has begun to lay out more detailed proposals to address Greece's economic situation, in which the nation finds itself both unable to pay back the money it has been borrowing to keep its government afloat and to grow its economy. We've excerpted the major initiatives that are within the new Greek government's ability to achieve below:

(Reuters) - Leftist Prime Minister Alexis Tsipras laid out plans on Sunday to dismantle Greece's "cruel" austerity program, ruling out any extension of its international bailout and setting himself on a collision course with his European partners.

In his first major speech to parliament since storming to power last month, Tsipras rattled off a list of moves to reverse reforms imposed by European and International Monetary Fund lenders: from reinstating pension bonuses and cancelling a property tax to ending mass layoffs and raising the mininum wage back to pre-crisis levels....

Greece would achieve balanced budgets but would no longer produce unrealistic primary budget surpluses, he said, a reference to requirements to be in the black excluding debt repayments....

In a bid to show he was serious about avoiding a new upward spiral in public spending, Tsipras announced a series of cuts to make the government leaner by trimming ministerial benefits like cars and selling one of the prime minister's aircraft.

He also outlined plans to crackdown on tax evasion by targeting the rich and pledged public sector contracts would no longer favor oligarchs, a move that is likely to make him popular among the many Greeks fed up of a state they believe serves the wealthy.

Taking each of the items in order.

Reinstating Pension Bonuses

Source: http://www.visitgreece.gr/en/civilisation/christmas_in_greece_a_celebration_for_your_senses

This refers to a popular program in which the Greek government provides an extra payment coinciding with the Christmas holiday to retired individuals with low public (think "Social Security") pension incomes. As such, it represents more red ink to the Greek government's fiscal situation, since the payments would likely not be tied to the country's economic performance.

If it were however, say through Greece's new Finance Minister's proposal to issue government bonds with payments linked to the country's GDP growth, then it becomes a very interesting way to align the interests of Greece's pensioners with economic growth-oriented reforms.

Cancelling a Property Tax

While Greece's tax hikes of recent years have clearly damaged its economy, cutting Greece's recently hike property tax will provide some benefit because of the GDP multiplier effect. A benefit that would be largely lost if Tsipras' government intends to impose a new property tax on large properties in its place.

Meanwhile, Tsipras is missing the opportunity to undo the greater damage that was caused by hiking Greece's Value Added Tax (VAT) in 2011, where reducing and simplifying this tax would provide a more immediate benefit to long suffering Greek consumers.

Greece: Value Added Tax Rate, 2000-2011

Instead, Tsipras' is proposing to selectively cut the VAT on some basic items, while imposing new consumption taxes on perceived "luxury" items and otherwise continuing to enforce Greece's VAT at its higher confiscatory rate, which really seems to be the primary way the Tsipras' government will go after the two-thirds of Greek citizens who underreport their incomes to the government to avoid paying Greece's income taxes.

Perversely, that dynamic is perhaps what incentivizes an increasing number of Greeks to engage in income tax evasion - doing so allows them to be able to afford to buy the things whose prices have been jacked up by Greece's Value Added Tax. There is, after all, a reason why the percentage of Greeks now engaging in tax evasion has increased from the much lower level of tax evasion recorded in 2006.

Oh, by the way, if the example of the U.S. in attempting to tax "luxury" items in the past is any indication, those new taxes will instead cause job losses and hurt GDP growth, erasing the benefits from the proposed cuts in the value added tax rates for selected items.

Ending Mass Layoffs

The mass layoffs Tsipras is pledging to end are those of government workers. As the head of a coalition of radical and leftist political groups, this action is required of Tsipras by his main constituency and likely cannot be avoided, even though government workers are largely responsible for Greece's deteriorating fiscal situation given the parasitic effects of the regulations and other barriers they impose upon genuinely productive economic activity through their widespread corruption.

Like poor pensioners, Tsipras needs to align the interests of government workers with the positive growth of the Greek economy, and to achieve that, Tsipras need to link any bonus payments they might receive as part of their compensation as well as their entire public sector pensions to the nation's current and future GDP growth. Once again, we would suggest that might be achieved through the mechanism of GDP-linked bonds. Otherwise, the action of rebloating Greece's government bureaucracies would be little different from adding large lead weights to the decks of the Titanic.

Raising the Minimum Wage to Pre-Crisis Levels

Unless the new Greek government's is capable of executing a plan to initiate a period of hyperinflation in the Greek economy, this is perhaps the most economically harmful proposal put forward by Tsipras. To understand what that means for Greece, the chart below shows the minimum wages that apply in Greece and all the nations in close geographical proximity to Greece.


In one fell swoop, Tsipras' proposed 28% increase in Greece's minimum wage would reestablish its former position of having the highest minimum wage in the eastern Mediterranean. If the recent experience of the U.S. in hiking its minimum wage during a period of recession is any indication, Greeks, and particularly young Greeks, should expect significant job losses as a consequence of the action in the absence of considerable real economic growth or inflation to offset its negative impact.

There's one other factor to keep in mind. The U.S. economy only experienced its strongest economic growth of the past decade as it suddenly began generating significantly more jobs at the very lowest end of the income spectrum in the second half of 2014, which could have been even greater if not for the local minimum wage hikes that were imposed in its largest population state.

For a nation that desperately needs to grow its GDP, imposing an arbitrary policy that only makes it harder for the least skilled, least educated and least experienced portion of its population to earn the incomes they are capable of earning must be considered a self-inflicted wound. Likewise, for a nation that desperately needs to reduce its spending on social welfare programs, imposing an arbitrary policy that would actually increase the amount of social assistance spending required of it to compensate for its heavy hand in denying people from being permitted to work at whatever wage level at which they might voluntarily agree to work is beyond stupid.

Balanced Budgets, But No Primary Budget Surplus

A primary budget surplus is one in which the government collects enough revenue to pay for all its outlays, not including any net interest payments on its debt. For a nation with a large amount of outstanding debt relative to its GDP, running a primary budget surplus is necessary to reduce its debt burden.

What Tsipras is saying here is that Greece cannot afford to do this, and for a country that is effectively bankrupt, he's right.

Whether Tsipras can do so depends upon whether and how much relief he can secure from Greece's main creditors in Europe. But if Greece ultimately defaults on its debt payments in the absence of a such a deal, then his government will be forced into running a primary budget surplus, whether he wants to or not.

To do that however would require cutting government spending to levels last seen in 2005 given the country's current tax laws and GDP per capita:

Greece Government Spending and Tax Revenue per Capita vs GDP per Capita, 2000-2013

Very do-able, particularly if the amount of government spending above revenue at the country's current GDP per capita is going to pay off Greece's creditors.

Cracking Down on Tax Evaders

Look at that last chart again, particularly the trajectory of government revenues (taxation). Does it look like the Greek government really has a problem in collecting higher amounts of taxes from its citizens given its GDP per capita? Or does it have a problem in setting its expectations for tax collections too high to support the amount of spending promised by its politicians with respect to the amount of taxes that it can actually collect?

Otherwise, we suspect that Tsipras' government most visible actions will be to prosecute high profile tax evaders, particularly if they're wealthy, which will help distract how its actually going to go about making the vast majority of Greece's tax evaders pay - through Greece's Value Added Tax.

Trimming Government Ministerial Benefits and Selling Government Property

Hear, hear. Tsipras shouldn't stop with just the ministers' benefits - Greece's bureaucrats have excessively generous benefits that can be cut, or better, reformed to be both proportionate to what someone in Greece's private sector earns and affordable as well. That's especially important because it would free up money that Tsipras proposes to spend by bringing back so many previously dismissed bureaucrats onto the public payroll/dole. We would suggest implementing a defined contribution pension plan, where GDP-linked government bonds are the only investment option for all public sector employee pensions, with a one-time 75% haircut on any defined benefit pensions they have as reparations for the economic destruction wrought by their corrupt acts.

Meanwhile, selling unneeded or low-use assets held or owned by the Greek government is an exceptionally good idea. Tsipras shouldn't stop with just the PM's jet, but should extend the sale to assets wastefully employed by lower level bureaucrats in his government.

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