I CAN HAZ THAT MONEY U IZ HOLDIN BEHIND UR BACK?

The other day the economic historian and frequent reader, Alex, pointed out in his blog that Greece will never achieve any sort of sustainable fiscal adjustment unless it can tackle the informal economy. Another regular reader, Andreas, pointed out that increasing our tax take by 3.3% of GDP against the proposed 13.7% and trying to make up the shortfall by cutting spending a little bit further was madness.

Clearly, it’s past time I started talking about tax revenue. Let me put my cards on the table: I believe in a small state in terms both fiscal and regulatory. I’d be happy for the country to default and for much of the public spending in Greece (not to mention the UK, where I pay my taxes) to just wither on the vine. 

However, in our present state Greece isn’t going to be allowed to default until European banks can recapitalise.This means we need to control the deficit just well enough to convince the markets we can run a sustainable state so that we can have our sovereignty back - and then default. In the meantime, Greece also has to keep up much of the spending we currently do or risk serious social unrest, which will send us back to square one. Only if we can pull all of this off over the next four years do we have a serious chance of ever being a serious country again.  

To do all of that we need to get our hands now on what mad Keynesian attack dogs call the missing billions. So let’s prepare an amateur’s estimate of our tax ‘lag’ – the extra tax a country identical to Greece would collect with reasonable levels of success raising funds. It would give the layman an idea of where to look for those elusive extra funds.

This takes a bit of triangulation. First, you need the implied tax rates on capital, labour and consumption (the ratio of transactions to tax rendered). You can get all of these from Eurostat.  You can’t get the capital figures after 2006, but that’s fine because 2006 is the last year the Greek economy performed decently; at least no one can accuse you of a negative bias. Now the big question is which country you want to use a comparator. Ideally you would want a country of similar size and a similar tax system but finding genuinely good comparators is very difficult. If you must try, Portugal compares reasonably well. But I’ve gone for the Eurozone as a whole, which makes the data much less volatile.

Then you need the volume of transactions. You can get consumption from ELSTAT (as it is now known), and capital and labour compensation from EUKLEMS.

Here’s what comes out if you try that: we could have raised EUR22.4bn more in 2006 – well before our tax collection mechanisms collapsed. That’s 10.8% of GDP. Wow! Imagine if we could have got our hands on that kind of money. Why, we’d... have spent it on bullshit like all the other untold billions. But let’s suspend our cynicism and consider Alex’s question: whether this kind of adjustment could put Greece back on the path to fiscal sustainability (and thus buy us our sovereignty back).

The IMF’s long-term projections suggest that it is, just barely, enough, if your definition of sustainability is getting debt down to 60% of GDP by 2060. Frankly I think the markets would turn fractal cartwheels of delight if this prospect were to come into sight for Greece. Anyway, the IMF’s figures say that, as of 2009, Greece required almost exactly that kind of adjustment to get on the ‘60 by 60’ trajectory.

So it sounds like a good plan. Where do we get the missing 22.4bn? Well, just under half of that needs to come from taxing businesses (or capital), which basically get away with paying half what they would elsewhere in the Eurozone. Another 8bn or so needs to come from consumption, as in VAT. Presumably the problem is not the rate or scope of VAT – it’s the fact that so few businesses turn it over to the taxman. Only one seventh of our missing funds can realistically come from taxing labour – our employees don’t really make that much and they can’t hide what they make. Tax avoidance by the self-employed would come under capital, btw. 

Apparently some 4bn of the capital and labour tax lag is down to individuals avoiding tax. That’s a good third of the total.

Stay tuned for a series of posts on how to increase the tax take from capital and consumption. If you can think of something, please leave a comment and I'll dig up some figures.