The cost of public deficit in Spain: Increasing tax rates and reducing public spending

Abstract

Background: In the last seven years, the Spanish economy has been struggling to reduce the ratio of public deficit-gdp from 11.1 percent in 2009 to 3 percent. This value is a commitment recorded in the Stability and Growth Pact signed by eu members and it has been determining the economic policies implemented by the Spanish Government since 2010. The aim of the paper is to evaluate the costs of a decline in 1.5 pp the ratio of public deficit-gdp on the main macroeconomic variables with alternative fiscal policies. Methodology: The model used is a static disaggregated Computable General Equilibrium model that includes all the elements needed to evaluate the short run effects of fiscal policies aimed to reduce public deficit. This model captures the circular flow of income and accounts for households corporations, government and the foreign sector. Results: The results suggest that the decline of public spending on investment, public administrations and social services has less harmful effects on the economy than the increase of vat and personal income tax rates. Conclusions: Despite these results, it is important to take into account that the long run effects of declining public investment and social services are not included in the model.