Greek Tax Incentives

Historically, one of the key hallmarks of a successful state is the ability to impose and collect taxes. From ancient Egyptian times, to the Roman era and more recently to the Ottoman and American empires, tax collecting is not just a money raising activity but delimits the scope of the state’s power and its effectiveness. Sometimes it goes even further as a means of defining citizenship or nationhood. It comes therefore as no surprise that a sure sign of a failed society or a state is its inefficiency and negligence to collect taxes.

In this respect, the demands of the IMF on the Greek government to improve their tax collecting efficiency goes beyond a pure technocratic measure. It is akin to a call to rebuild a state and a society that lays in (Greek) ruins.

Before attempting to provide explanations of the mechanisms that are responsible for this mess it is instructive to illuminate the mess.

In essence, the Greek tax laws are very complicated. On average 5 tax laws are passed every year (17 so far in 2010) with tax officers unable to keep abreast of the most recent whims of their ministerial masters. While in the late 80’s tax arrears totaled €200mln in 2010 that figure is a staggering €33bln. The information technology revolution seems to have escaped the attention of the modern Greek state where paper filing is still king. Sporadic attempts to introduce computers only resulted in a proliferation of different systems and databases that do not communicate with each other. As a result the cost of collecting taxes is 2-3 times the European average. Corruption among tax officers is rife and has never been dealt with effectively. Tax evasion cases take on average 7-10years to be resolved in Greek courts by which time a tax amnesty is bound to happen. There is one tax amnesty almost every 3 years, which by amazing coincidence correlates highly with election time (the latest in Nov 2010, is the 10th since 1985). Thus, one can argue that it is almost a state policy not to collect taxes. In fact most economists would describe the Greeks as acting rationally within their own economic habitat. Volunteering to pay taxes is not a human trait. Some say it is a God given right to avoid paying taxes.

On the surface, one is puzzled by the inability of the Greek government and the political establishment to raise tax revenue as this is the lifeblood of the state and the essential nutrition of the bureaucracy and the political elite. A clue is given by the exponential growth of tax arrears in the years 1995-2010. Governments have a big incentive to develop the economy and the tax collecting effectiveness, because, this is how they survive and exercise their power.
Against this incentive, a Government needs to balance the unpopularity of the taxes they are imposing and in modern democracies this costs votes. Thus a healthy equilibrium is reached and we have a functional state.

This equilibrium of incentives was violated in Greece and in other peripheral countries, first in the 90‘s by the extension of European subsidies with no strings attached (a cost free cow to be milked) and secondly by the entry into the Euro system and the availability of borrowing at very low rates. Politicians did not have to make hard financial and political choices. They used the subsidies in order to get re-elected and the cheap borrowing to cover any shortcomings. Economic productivity was decimated as traditional industries fell prey to the rising globalization and was replaced by borrowing. GDP growth came from consumption which was fueled by even more cheap borrowing. Why bother with fixing the tax system when you can borrow at low rates with the implicit European guarantee? The spread to the Bund which now stands at roughly 900 basis points was at 10 basis point in 2002 and was close to 70-100 for most of the time. One can mitigate his unpopularity by yet one more tax amnesty. It is possible to delay dealing with hot potatoes until the opposition is in power and then to sabotage any attempts to fix things in order to get re-elected once more. Politicians became debt junkies.

Moral hazard and the disequilibrium of incentives is a very powerful force. It is like compound interest. It acts on a long timescale and it passes undetectable on a daily basis. Slowly, the voices of reason and common sense started fading away. Politicians who advocated restrain and prudence became political eccentricities and increasingly unelectable. Populism rose and an arms race of nepotism and exuberant political pledges took over.

The roots of what has happened in Greece are in completely analogous to the situation in Arab states that discovered oil or to African states with mineral deposits. In all cases the shift of economic incentives for the ruling party/government acted as a retarding force for the economy and created dysfunctional and failed states. In the Arab world, oil supported totalitarian regimes and in Africa contributed to economic misery, civil wars and gun democracy.

The European bail out of Greece and perhaps of other peripheral states, is dealing with the symptoms of the crisis and not with the root causes. None of the moral hazards or the imbalances of political incentives is dealt with in a European level. Once the IMF finishes its work and leaves, the irresponsible behavior will resume in Greece and in other European member states. By that time a more coherent bail out package would exist and a transfer of creditworthiness can resume from the rich north to the south either through a European Bond or some other mechanism. This is not what European citizens want. The current crisis is an opportunity to reset the core European foundations on a more concrete and moral footing ready to meet the challenges of the future. In this respect the current crisis could do us a great service only if we draw the right conclusions and act on them.

To Default or Not to Default

In a recent debate about the Greek debt and the Greek government's Don Quixotic efforts to reduce it, a very rare consensus was achieved. Both the government who implements the directives of the triumvirate (ECB, IMF, EU) and the opposition who vehemently opposes the austerity measures, agreed in anathematising the event of restructuring or default of the Greek debt. Despite the fact of the mathematical inevitability of restructuring and default both agreed that the debt can be sustained and/or repaid in full. They argue that it could be done if Greece had a 6% primary surplus, or growth of more than 4% for the rest of eternity. Armchair generals could not come up with a better scenario. But maybe they are right! Maybe Greece can pull 350bln rabbits out of the conjurers hat and repay the debt. Any real Greek tragedy must have a Deus ex Machina to finish the plot. Or maybe, the Germans or other good willing Europeans can forgive the Greek debt binge.
The Greeks may not be wrong in this one. The word "fail" is not something that Europeans like. Failure is not part of the European way of doing business or part of Europe's cultural heritage. While in the United States of America failure is seen as a necessary trial and the only way to gain experience and wisdom, in Europe, failure is a miasma, a taboo a total no-no. Failure is not an option in a similar way "Resistance to EU policies is futile". When failure comes, it is either swept under the carpet or is dressed as a "moral success" and achievement of some higher yet unforeseen good.

The arguments they employ against default are typical of a drama queen. First, they argue that default of a country would lead the country out of the EU, next, that the Euro would collapse as more peripheral countries (another derogatory name for PIGS) would follow. It naturally follows that the EU would disintegrate, the German dream of European conquest would be achieved and/or the Americans would see their influenced in Europe reestablished. The gloom and terror that follows easily competes with the best traditions of the Christian Hell and countries that leave the EU would be placed in a sort of European limbo. And all because a small and, lets admit it, an insignificant country like Greece or Ireland cannot meet their debt obligations. Why European politicians are so afraid to face real life? Would a 350bln default trigger the collapse of our societies as we know them? When Lehman collapsed more than 650bln were wiped clean and despite the pain and suffering of the bond holders most of them seem to be doing ok 2 years later. What is missing from Europe is more defaults that would put an end to the accelerating moral hazard and less socialisation of losses.

The attention span of most politicians is very short, until the next election. Naturally they don't want to be known in history as the bankruptcy leaders but as the saviors. The Greek prime minister Mr G. Papandreou got one better, in a televised interview he proclaimed that he will "save Greece" and he does not care about "not being re-elected ever again". Quite obviously, one is obliged to ask the negation of his statement; was he striving to bankrupt Greece in the process of being re-elected all these years? Many would agree with the later statement even if they have faith in the current intentions of the Greek PM.

Lets get one line of reasoning out of the way. Countries do not liquidate on bankruptcy, like corporates do, they Restructure their debt and continue to exist (happily or not) thereafter. Thus the real question is not whether Greece or Ireland can repay their debt obligations but what is the price for doing so. If these countries embark on an all out strategy to repay their debt in full they may find their societies in a far worse predicament 20 or 30 years from now.