The Greek Bailout Deal: Finally Getting the Tax Policy Right

July 14, 2015

The Greek Prime Minister, Alexis Tsipras, agreed to a bailout deal over the weekend. As with previous proposals, the deal included a mixture of spending cuts and tax reforms, but the latest deal shows that the Eurogroup understands the elements that underpin economic growth. Unlike previous proposals, the tax reform component of the deal called for “the streamlining of the VAT system and the broadening of the base to increase revenue.” This is the equivalent of the time-honored, tax-reform slogan, “reduce the rate and broaden the base.”

The tax component of the deal demonstrates an important point rarely discussed in tax reform: one can increase revenues without raising rates. Broadening the base without reducing the tax rate effectively raises revenue without changing marginal incentives on the current base. In other words, broadening the base does not exacerbate the tax burden of those already paying the tax, which can have negative long-run effects.

Moreover, the economically distortionary effects of a narrow base are alleviated when the base is broadened. The reduction in economic biases due to tax incentives allows the economy to focus on comparative advantages rather than political favor. The result is more specialization, increased productivity, and more trade.

The Eurogroup also chose to broaden the base of the VAT, which is a consumption tax, rather than that of an income tax. Consumption taxes are known to have the least distortionary effects on savings and investment, which are key elements of an economic recovery.

In addition, the Eurogroup has asked that ELSTAT, the national statistical service of Greece, be given full legal autonomy. The provision is a protection against the Greek government meddling with official statistics in an attempt to hide the actual health of the economy. The provision ensures transparency to the credit markets and fellow EU member states.

The request for an independent ELSTAT is in response to Syriza reopening a criminal case against Andreas Georgious, the famous whistle blower who headed ELSTAT, last March. Georgiou famously exposed that the Greek deficit in 2012 was twice as much as was previously reported by ELSTAT.

Rarely do I have an opportunity to praise politicians for sensible economic decisions, but here is my opportunity. Good job Eurogroup. You are showing the economic maturity we should all expect from our political representatives.

I hope that the Eurogroup has the fortitude to stay the course; it is the best option if Greece is ever to repay its debts.


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