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Another victory for tax cuts

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When last I wrote on Greece, in 2012, there had just been elections that resulted in a change of power from the Panhellenic Socialist Movement - which had negotiated a government bailout and austerity package responsible for cutting the size of the Greek economy by one quarter - to New Democracy, which advocated a policy of growth through tax cuts.

Subsequent to the election, New Democracy was not immediately able to implement tax cuts, due to the focus on additional austerity measures - that is, budget cuts and tax increases - from the European Union. However, New Democracy was able to ensure that the additional austerity measures consisted of budget cuts, and not tax increases.

Without additional tax increases further dragging down the economy, and with very large government budget cuts, the Greek government posted a "primary budget surplus" - basically a surplus before interest payments - the next year, a year earlier than expected. With this success under its belt, New Democracy was able to negotiate a reduction in the Value Added Tax for hotels and restaurants from 23% to 13%.

The reduction in the VAT was equivalent to a price reduction of 8% across the board for hotels and restaurants. With Greece suddenly a much less expensive place to vacation, tourism surged. This resulted in a turnaround in Greece's economy, which in 2014 is now on track to become one of the fastest growing economies in the eurozone. This is the economy that, four years ago, was thought to be causing the entire eurozone to collapse.

This near miraculous turnaround shows, yet again, that cuts in government spending do not prevent economic growth, and that cuts in tax rates promote that growth. Hopefully policy makers everywhere are paying attention: if you want your economy to grow, cut government spending and cut tax rates.

I also hope the voters in Greece are paying attention to who brought off this miracle, for their own good.

Previous article on 2012 Greek elections:
http://psychohist.livejournal.com/67874.html

Article on 2013 tax cuts:
http://www.euractiv.com/euro-finance/greece-troika-surreal-battle-analysis-529732

Article on 2014 economic growth:
http://www.wsj.com/articles/greek-economy-grows-for-first-time-in-six-years-1415962022?cb=logged0.1922751464881003
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On January 28th, 2015 07:13 am (UTC), (Anonymous) commented:
What About Unemployment
Five years ago the unemployment rate was about 12%. Now it's at a whopping 26%. That's progress?

The country's net debt doesn't reflect an improving situation either. Net debt was around 130% of GDP in 2010 according to the IMF - now it's around 170%.
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On January 28th, 2015 03:27 pm (UTC), psychohist replied:
Re: What About Unemployment
All of the increase in unemployment and most of the increase in net debt occurred before New Democracy gained power in 2012. Before 2012, the policy, from PASOK, was straight austerity, rather than being supply side stimulation - taxes rates were being increased rather than decreased, with milder spending cuts - which was not working.

The fact that there has been no further increase in the unemployment rate is another sign that New Democracy's policies are working. Debt is slightly higher because it took a year, until 2013, to get to a primary surplus.

If New Democracy were still in power, debt as a percentage of GDP would now start falling as GDP grew. Unfortunately, the Greek voters were not sufficiently patient, so we'll probably now see a return to some version of policies that don't work.
On January 29th, 2015 12:36 am (UTC), Daniel Tobias replied:
Re: What About Unemployment
When New Democracy took power in mid-2012, the unemployment rate was below 25%; it is now 25.8%. You can say New Democracy's policies haven't increased unemployment much, but it hasn't helped either.

Another issue is falling wages, which have dropped by around 20% while New Democracy was in power.

So tax cuts haven't led to significant hiring, and it hasn't increased wages either. We also know it hasn't led to a decrease in net debt as a percentage of GDP. So what has tax cuts controntributed? You say it led to a surge in tourism that boosted economic growth. Let's look into that a bit deeper.

The reduction in the value added tax for hotels and restaurants began in August 2013. Soon after, Greece actually saw economic activity worsen; GDP growth dropped from negative 2.6% to negative 3.1% in the fourth quarter of 2013. Greece didn't see positive GDP growth until the middle of 2014, long after the VAT cut went into effect.

A better explanation for the movements in Greece's GDP growth rate can be explained by movements in the Euro. If you look at a chart of the Euro from 2012-2014 and a chart of GDP growth, they seem to be inverted. At the end of 2013, when GDP growth dropped a bit, it coincided with an increase in the Euro. And through the first three quarters of 2014, the price of the Euro decreased, while Greece's GDP growth increased. This makes sense. As the price of Euros drops so does the cost of traveling to Greece and purchasing Greek exports.

Why is Greece's GDP growth impacted more by a cheaper Euro than other European countries? Well, it's not. In terms of 2014 GDP growth, Greece ranks in the bottom half of Eurozone countries. And its 2015 forecasted growth rate ranks in the middle of the pack.
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On February 6th, 2015 02:59 am (UTC), psychohist replied:
Re: What About Unemployment
You are mistaken about the unemployment rate; the 25.8% figure is from October, and is the figure is significantly lower now. The following graph demonstrates just how consistently unemployment has fallen in the past year, since the tax cuts:



Greece grew at about 2% for the year 2014; contrary to your assertion that this was below average for the Euro zone, this in fact was double the Euro zone average of about 1%. Year over year figures as of 2014Q3 here:
http://www.tradingeconomics.com/greece/gdp-growth-annual
http://www.tradingeconomics.com/euro-area/gdp-growth-annual

Greece had a banner tourism year in 2013 as a result of the hotel and restaurant tax cut. It did take a while for this benefit to spread to the rest of the economy. However, the lesson is clear: in a situation like Greece's, tax cuts work.

Edited at 2015-02-06 03:09 am (UTC)
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