Tuesday, June 28, 2011

Why Doesn't Greece Just Default?

Courtesy of ZeroHedge, here are some of the austerity measures that will be coming up for a vote tomorrow in Greece (originally compiled by the BBC) with a focus on the taxation portion:

  • Taxes will increase by 2.32bn euros this year, with additional taxes of 3.38bn euros in 2012, 152m euros in 2013 and 699m euros in 2014.
  • A solidarity levy of between 1% and 5% of income will be levied on households to raise 1.38bn euros.
  • The tax-free threshold for income tax will be lowered from 12,000 to 8,000 euros.
  • There will be higher property taxes
  • VAT rates are to rise: the 19% rate will increase to 23%, 11% becomes 13%, and 5.5% will increase to 6.5%.
  • The VAT rate for restaurants and bars will rise to 23% from 13%.
  • Luxury levies will be introduced on yachts, pools and cars.
  • Some tax exemptions will be scrapped
  • Excise taxes on fuel, cigarettes and alcohol will rise by one third.
  • Special levies on profitable firms, high-value properties and people with high incomes will be introduced.
This kind of reads like "how to crash an economy in 10 easy steps".  Greece is currently in the midst of a deep recession/depression with GDP falling about 5.5% this year and while people are already having a tough time paying the bills you are going to make it even harder by increasing taxes on both your income AND your purchases (through the VAT)?  Also, people who are pretty much living under the poverty line will be required to start paying income taxes, thanks to a reduction of the tax free threshold from 12,000 to 8,000 Euros. 

So from Greece's point of view, why aren't they simply defaulting and going to the Drachma.  I know why the international community wants them to not default and stay with the Euro.  Greece defaulting would cause an international financial crisis similar to or even bigger than Lehman.  It wasn't that long ago that Greek debt was considered to be just about as safe as German debt, thanks to its inclusion in the Euro, and so you have Greek debt just about everywhere, as well as that of key banks.  But at this point, what does Greece get out of it?  The low interest rates that Greece enjoyed following inclusion in the Euro are gone, nobody but the EU/ECB is lending to them right now anyway.  And this austerity budget will make sure that the Greek economy does not recover for a long, long time.  Between wage cuts and across-the-board tax increases nobody will have a spare dime to spend on anything but necessities.  And that massive increase in the VAT rate on restaurants and bars will make it that much more expensive for tourists to go to Greece and maybe they will go somewhere else, like Turkey, which has similar scenery but is cheaper.

If Greece decides to default and return to their old currency, things won't be rosy but my guess is that they will recover faster than if they take another hit of heroin from the EU.  Yes, they will be cut off from extrernal funding sources for years but they will be in charge of their own monetary policy for a change.  They will likely start printing more drachmas as a way to both boost the economy and pay debts and then the Drachma will fall in value rather quickly.  This will cause massive inflation of any imported goods but on the positive side it will make all Greek products relatively cheap.  This will help to boost both tourism from abroad as well as the purchase of Greek products (think about it, thanks to both having the same currency, Greek products are about as expensive as German ones, which one would you rather buy?).  You might also see some more foreign direct investment as Greek labor just got much cheaper than the rest of Europe.

It seems like the choice for Greece is either a) continue in this economic death spiral, mainly for the benefit of non-Greeks or b) take a quick hit and all its immediate consequences but build the groundwork for an economic recovery.  Neither choice is ideal, but after years over fiscal mismanagement they are the only choices that seem to be available and it seems like default and an exit from the Euro is the better choice for Greece.

No comments:

Post a Comment