Thursday, May 13, 2010

Spain Chooses Sounder Austerity Measures Than Portugal

In exchange for the rescue package announced last Sunday, both Spain and Portugal committed to making further austerity measures.

Now the details have been released. The difference is that while both countries chooses to both raise taxes and reduce spending, Spain primarily relies upon reductions in government spending increases, while Portugal relies primarily upon tax increases. The Portuguese Prime Minister Jose Socrates argued that the emphasis on tax increases instead of spending cuts. this mix would have "the smallest recessionary impact possible".

But tax increases do not have a smaller recessionary impact. Quite to the contrary. Spending cuts and tax increases have the same demand side effects, but tax increases also have a negative supply side effect by worsening incentives, meaning that tax increases are a much worse option.

Perhaps Socrates hopes that tax increases will invoke less Greek-style strikes and protests from labor unions and other Marxist groups, but a representative for the Portuguese Communist Party has said that they will still launch protests.

It seems that the Iberian Peninsula divide on economic policy wisdom persists.