Mr Rajoy, the figures don't add up

Spain has set its course and there is turning back" has been Prime Minister Mariano Rajoy's mantra since taking office in January after committing himself to reducing the budget deficit from 8.5 percent of GDP to three percent by 2013 in a bid to avoid an ECB and IMF bailout, as has happened in Greece, Portugal, and Ireland.

The prime minister said on April 13 that it was "not possible" for the EU to rescue Spain: "If we don't meet the deficit targets, they will stop lending to us, and if no one lends to us, they will have to rescue us. Because the government rules out the possibility of a rescue and intervention, that's why we're implementing reforms."

Determined to fulfill the constitutional amendment agreed last year with his predecessor José Luis Rodríguez Zapatero that obliges the government to balance its books well ahead of its 2020 deadline, the prime minister's goal for this year is reduce the deficit to 5.3 percent. He says he can do so without reducing pensions and unemployment benefits or cutting civil service salaries, which collectively make up 40 percent of government spending.

Few, including the Bank of Spain, believe that Rajoy can pull it off without going back on his word.

"It is extremely unlikely that the current budget will enable him to reduce the deficit by 3.2 percentage points of GDP: spending has been cut by just 1.1 percent on last year," says José Ignacio Conde-Ruiz of the economic research group FEDEA. "To reach his goal we will have to make the biggest cuts in modern history, and that can only be done by taking the knife to major items like salaries, pensions, and other welfare benefits. Then there is the question of whether doing so would be a good idea at a time of deep recession."

"Reducing the deficit needs to be done more gradually: austerity in itself is not enough," says Antoni Castells, an economist who advised the previous Catalan regional government. "Spain is being forced by Brussels to push ahead, and anything it says to the contrary will only undermine its credibility further," he adds.

Santiago Lago, a professor of applied economics at the University of Vigo, says the government's revenue estimates are overly optimistic, particularly its controversial one-off tax amnesty for individuals and companies hoarding cash and undeclared assets. "Research into past amnesties of this kind in Spain suggest we should be very cautious," he says.

The Economy Ministry says that its calculations are "cautious and reasonable." Revenue for this year is estimated at 119.2 billion euros, 14.28 percent up on last year, and which includes 12.2 billion in assorted tax hikes."

Meanwhile, the Bank of Spain is also pessimistic about Rajoy's deficit estimates. "The projected course of total revenues in the budget is subject to downside risks," The governor of the Bank of Spain Miguel Ángel Fernández Ordóñez told a parliamentary committee this month. Fernández Ordóñez said revenue estimates should be "prudent" as he confirmed the economy is now suffering its second recession since 2009. The economy will shrink 1.8 percent this year, according to the International Monetary Fund's latest forecast.

The government's plan to raise 2.5 billion euros from a tax amnesty is "particularly uncertain," Fernández Ordóñez told lawmakers in a session to discuss the budget, which was approved by the Cabinet on March 30 and is making its way through Congress.

Spending linked to unemployment benefits may also be more than forecast as the nation suffers the highest jobless rate in the European Union, at almost 24 percent, the governor said. If additional measures are needed, indirect taxes should be increased and temporary tax measures may have to be replaced by permanent ones, he added. Fernández Ordóñez also said the decision by the government not to present the 2012 budget until March 30 had further undermined international confidence.

"The doubts on the deficit goal created enormous worry as well as the presentation of the budget three months into the year, which was probably justified, but the markets didn't see it as justified," he said.

The IMF stirred up new doubts about Spain's current targets this week when it forecast a Spanish shortfall of six percent this year and 5.7 percent in 2013, almost twice the three percent pledged by the Rajoy government for next year.

Pensions: Rajoy's Achilles' heel

Earlier this year, the Social Security department announced that it would probably break even this year. But even if the Social Security's current account does go into the red, it doesn't mean that pensions and unemployment benefit will stop being paid. The system has savings of its own and access to other resources to a total of more than 70 billion euros.

The biggest doubt hanging over the Social Security's accounts is its ability to keep paying out pensions to retired people. Of the some 115 billion euros set aside for pensions, around 102 billion euros goes to contributory pensions, and many economists say that this isn't enough.

"It is an underestimation," says Miguel Ángel García of the CCOO labor union. The Social Security department estimates that this portion will increase 2.9 percent on last year, and around 2.3 percent on top of total spending. According to his calculations, the difference is more likely to be 4.5 percent, in line with the increase in the first months of the year, and taking into account that inflation could reach around 1.5 percent for this year.

García's figures are closer to those of Social Security itself, which puts the contributory outgoings at 104.9 billion euros, with inflation running at two percent. With those figures, Rajoy will find it hard to balance the books unless he does something that he criticized Zapatero for while in opposition, which is to freeze pensions, something that would further erode his already fast-waning popularity.

Calculating how much the cost of paying pensions this year will be involves three variables: inflation (pensions are indexed); the increase in the average pension; and the number of pensioners. The Social Security estimates a relatively low increase of 2.9 percent. The government announced a one-percent increase in pensions in its first Cabinet meeting. If inflation hits 1.9 percent by year-end, as most studies suggest, that leaves the government with just nine tenths of a point to play with. It seems not to have taken into account that there was a 1.5-percent increase in the number of pensioners in 2010, followed by a 1.4-percent rise in 2011.

The Economy Ministry says that for this year it expects an increase in the number of pensioners of just one percent, even though the Social Security's own figures estimate an increase of 1.6 percent. The Economy Ministry says nothing about the average increase in pension payments, which the Social Security puts at around 1.7 percent, nor does it take into account the possibility of higher inflation.

There are other causes for concern, for example the money required to pay people who take early retirement now that it is easier for loss-making companies to sack workers.

But Conde-Ruiz of the economic research group FEDEA says that the government need not worry unduly about payments to those forced into early retirement. "Early retirement will decline. It is clear that when the stock market falls or pension plans no longer offer high yields, workers delay retirement. What's more, if your children are without work, you are less likely to think about retiring."

At the same time, the worsening crisis has seen a sharp decline in the amount of money being paid into the Social Security system: at the end of 2011, there was a shortfall of 2.5 billion euros. Things are not looking much better in 2012, with employment set to rise by a further 3.7 percent.

As a result, the government says that there will be a 3.7-percent drop in payments into the Social Security system this year. The starting point is not the 105.3 billion euros collected in 2011, but the 110.4 billion it plans to spend on pensions. The government foresees collecting 106.3 billion this year, despite there being 630,000 fewer people working. If it had based its calculations on spending, the result would have been 101.4 billion euros.

The Secretariat of State for Budgets says that it estimates an increase in contributions of 850 million euros because it predicts a fall of 1.9 billion euros due to a drop in the number of contributors, which will be made up for by the 949 million euros that will come from increasing the contribution rate, along with 1.8 billion euros generated by combating fraud.

"This budget has been calculated as though we were still in September, and not in March, with spending already underway. We got it wrong in 2010," says the former secretary of state for social security in the Zapatero administration, Octavio Granado.

Based on the above figures, the Social Security system looks set for a shortfall of around 6.8 billion euros, around 0.7 percent of GDP; if inflation can be kept at 1.5 percent, and salaries are kept in line with government forecasts, the figure might be lowered to 5.5 billion euros.

Unemployment payments

The Social Security department is also responsible for unemployment benefit payments. In 2010, it paid out a record 32.2 billion euros, a figure that fell last year to 29.6 billion euros. The government says that the figure for this year will be 28.5 billion euros. "The figure reflects a reduction in spending on unemployment that began in 2011," says the Economy Ministry, adding that it is not due to paying out less money to the unemployed.

The figures show that applications for unemployment benefit increased by 18 percent in February this year.

Miguel García of the CCOO labor union believes that outgoings for unemployment benefit payments for this year will match those for 2011 because growing numbers of people's payments will run out in the coming months. Other analysts are more pessimistic, suggesting that the government faces a shortfall of three billion euros.

The tax amnesty

Officially called an "extraordinary regularization process," the government is offering a no-questions-asked amnesty to tax cheats allowing them to launder their money or assets by making a one-off payment of 10 percent. The government says that this will flush out 25 billion euros, and thus bring in tax revenue of 2.5 billion, but has failed to say on what basis it has made its calculations.

"Getting at hidden assets is very difficult, as previous efforts have shown," says the academic Juan José Rubio. Most economists tend to agree that the government's move will probably not generate much cash, based on the experiences of other countries. In 2003, Germany offered a similar tax amnesty, with a 25-percent payment. It estimated that some 100 billion euros would surface; in the end the figure was a fifth of that. In 2010 Italy offered tax cheats fines of between five and seven percent if they reported hidden cash. It raised five billion euros from 104 billion previously undeclared wealth.

The government announced the tax amnesty at the last moment, also offering businesses with money stashed offshore the same opportunity, with a one-off payment of eight percent that the government believes will add an additional 750 million to its coffers.

"I don't understand how the government reached the figure of 25 billion euros because it isn't based on any other amnesty," says Luis del Amo. The Economy Ministry admits that it is difficult to make estimates based on what goes on in the black economy, and points to the experience of other countries that have declared similar amnesties. Last week the government announced that it had another plan to combat tax fraud that it says will raise more than eight billion.

How to raise 47 billion from VAT without a hike

Finance Minister Cristóbal Montoro has so far put off raising the value-added tax rate. But the government's forecasts of raising more than 47 billion euros in VAT this year, 3.3 percent less than the previous year, are looking increasingly shaky as the economy slumps yet further into recession.

Last year saw a 0.4-percent increase in VAT takings due to the hike in the rate in 2010 from 16 percent to 18 percent, along with 0.7-percent GDP growth that year. But this year a fall of 1.7 percent is forecast. Consumption is in sharp decline, and is forecast to shrink by 3.1 percent. Rajoy's estimate is that he will have 2.3 billion euros in VAT revenue this year. Rubio believes that the prime minister is being overly optimistic: "With the job market worsening, and consumption and house purchases down, that VAT calculation makes no sense," he says.

Will corporate tax generate revenue?

The government hopes to bring in 19.5 billion euros from corporate tax, almost three billion more than last year. Where will the money come from? Corporate tax reform has limited deductions on expenses and imposed other measures that the government says will squeeze an extra 5.3 billion euros out of businesses. Del Amo says that the government's calculations in this regard are probably realistic.

Revenue from corporate tax rose in 2011 by 2.5 percent, or 413 million euros, after a three-year decline following changes to the law.

The government has factored in a drop, but things are much worse than in 2011, so given the circumstances, the estimate is probably too high," says Juan José Rubio. He also warns that provisions to strengthen the banks' capital requirements will cost around 50 billion euros, meaning that "they won't be paying any tax."

And then there is the regional question...

Spain's regional governments have incurred the ire of Brussels, as well as the international financial markets for failing to meet their spending limits last year. And the 17 semi-autonomous governments remain a great imponderable when trying to put a figure on spending for this year.

Before looking at their accounts, the European Commission wants to know why the regions overspent last year. The government's Fiscal Policy Council meets with regional finance chiefs in May, and will be looking to reach agreement and a commitment to stay within budget for this year.

Juan Rubio-Ramírez of Duke University asks why the government is to reduce transfers from the central government to the regions by 61 percent, "when the regions' own budgets foresee only a 12 percent fall in capital revenue."

State investment in the regions is being cut by a quarter and money for employment, health and education will be cut by almost 45 percent. The regions face some tough decisions, and will find it hard to decide where to make cuts: 60 percent of what they spend goes on health, education and social services.

Professor Antoni Castells, a former economy chief in the Catalan government, says that blaming the regions for the size of the deficit is "unfair and disproportionate and is simply about playing party politics."

The Economy Ministry points out that it is "essential to remember that any agreement on spending has to take into account that more than half of public spending is managed by regional governments." It adds that measures such as raising income tax will help local authorities. Rajoy has also said that regional governments that do not stick to their budget guidelines will have their finances taken over by Madrid.

The cost of borrowing

Spain will spend some 28.8 billion euros this year on interest payments to maintain its debt, equivalent to around 2.75 percent of GDP, and 5.3 percent more than last year. José Luis Martínez Campuzano, a strategist at Citi, argues that "this is a reasonable increase, and one that will not likely change, given that the estimates were based on the average bond maturity rate for 2012," which is 3.47 percent.

Yet doubts persist about the volatility of the markets and the short-term costs of borrowing. When the government approved the budget, the spread Spain was paying on 10-year bonds over the German equivalent was 3.5 percent. But recent weeks have pushed it as high as 4.3 percent, with yields close to six percent. When rates go up in the secondary market this pushes yields higher at debt tenders. The impact of this is not fully felt until the following years in terms of paper with a maturity of over 12 months but has a direct effect on short-dated bills.

"This is a wartime budget," is how Foreign Minister José Manuel García-Margallo has described the deepest spending cuts in Spain's recent history: 27.3 billion euros. The question now is whether the government has got its numbers right, because if not, we will be looking at even deeper cuts next year.