Nova workboard

a blog from young economists at Nova SBE

Why is it so difficult to predict a right public account evolution?

The economic adjustment programme negociated in May 2011 between Portuguese Authorities and members from “troika” had as underlying  objective  implement structural reforms in order to reduce the deficit and public debt as well as improve the competitiveness of the portuguese economy . It was established, under this programme, some deficits targets from 2011 to 2014. However, the portuguese authorities,  right from the start of the programme, has constantly revised up  those targets, which has induced them to ask for new concessions whenever “troika” has come to Portugal to make its regular examinations about the state of the portuguese economy. One of the major reasons for these inaccurate estimates has been the choice of the appropriate fiscal multiplier. Economically speaking, by fiscal multiplier I mean how much economic activity contracts due to a marginal increase in austerity. An inappropriate fiscal multipier implies wrong estimates about the actual negative effects of austerity measures on economic activity,  and such estimates in turn reflect the idea that  the way people change their behaviour facing higher  taxes is somewhat different from the perspective underlying  to the construction of the fiscal multiplier. According to the recent studies released by the most important institutions (IMF,EU), the actual fiscal multipliers were higher than the ones assumed by forecasters. However, we have to recognize how hard is to get an accurate value of this multiplier as it has to take into account several, complex factors such as the future expectations of private agents, the future expectation about the  economic situation of other countries, credit access,  and so on. Moreover, different institutions come up with different fiscal multipliers since the method used varies in a signifcant manner. Thus, its really complicated to say which fiscal multiplier is the most appropriate, however given the huge differences between the forescats made in the middle of 2011 about the future economic activity and the real ones, its plausible to state that the original fiscal multipliers weren´t the best at all.

Although the Portuguese Government has been struggle to meet their fiscal obligations , it seems  inappropriate a new increase in tax rates after we taking into account some important economic concepts. Firstly, the tax rates in the most products  has increased over the last 2 years as a way to cover the larger than expected annual deficits, and given the current level of high unemployment, reduced purchaising power of private agents, and most importantly, the extremely low levels of investment, an increase in tax rates would only exacerbate the fragile economic conditions without increasing the fiscal revenue collected by the Government. Economically speaking, we have probably reached the turning point in the Laffer curve ( a function which relates tax rates and taxes revenues) where an additional increase in tax rates would only decrease the tax renevue. On the other hand,  an increase in tax rates would broaden the deadweight loss of the tax, that is, the social inefficency derived from lost of trades which in the absence of taxes would be made

Alexandre Marques Correia da Silva   Student Number : 630


Author: studentnovasbe

Master student in Nova Sbe

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