essay on portuguese fiscal position

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Portuguese Fiscal Policy Assessment

Abstract: This work tries to do an overview of the Portuguese Fiscal situation ex-post

the 2008 financial crisis. There is a short description of the GDP evolution and how it

affected fiscal revenues and expenditures: revenues decreased with the crisis and then

got up with taxes increasing and expenditures add an upward trend (from 2008-2010,

for 2011 everything is projected). Moreover, we compute four types of fiscal balances

(total, primary, adjusted from GDP and structural) and conclude that all of them incur a

deficit and the huge gap is between the total and primary deficit, showing that the debt

service is becoming heavier.

Course: Macroeconomic Policies

Fall semester 2010

Professor: João Amador

Teacher Assistant: Sharmin Sazedj

Diogo Silva no. 9395

Francisco Palmares no. 9647

Gustavo Direitinho no. 9320

Pedro Casimiro no. 9467



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Introduction

This work consists on a fiscal assessment of an European Monetary Union country. The

country chosen to analyze was Portugal and the time range goes from 2008 to 2011 (2011

is a projection). The fiscal data (including projections) comes from the Stability andGrowth program and Governmental Budget Bill 2011, mainly.

The structure starts with a description of the economic activity (mainly GDP and output

gap), fiscal revenues and outlays (and their components), and the deficit generated

(including adjustments from economic environment and temporary measures, as well as

fiscal policy cyclicality). After determining these flux variables, we compute and examine

the sustainability of the public-debt stock variable. Finally we make a recommendation to

future fiscal policy in order to ensure the sustainability of future generations and to fight

the external pressures of foreign creditors.

Evolution of the Economic Activity

The description of the economic activity is important because it influences fiscal

revenues, expenditures and deficits through the automatic stabilizers mechanism [insofar

that a decrease in GDP (increase in unemployment) leads to less transactions and profits

(thus less fiscal revenues) and higher unemployment benefits (therefore higher costs)] and

all these variables are expressed as percentage of nominal GDP.

Looking at graph 1, in 2009 Portugal faced a recession due to the world financial

crisis, with a decrease in the real GDP of 2,7%. The components that contributed the most

for this descent was the fall of investment and private consumption, with a variation of -

11,1% and -0,8%, respectively. The only component that smoothed the drop of the GDP

was the public expenditure item that registered an increase of 3,5%.

In 2010, the product is expected to rise about 0,7%, driven mostly by the increase in private consumption, investment and net exports. In the following year (2011), GDP is

expected to decrease 1% due to austerity fiscal measures, according to European

Commission’s forecasts.

Regarding the output gap, since 2009, this indicator was negative. Portugal is, since

2009, producing more or less 2% under its potential GDP and this situation is not expected

to change in the next years, which represents a negative situation for the expenditures and

revenues. Please look at graph 2.



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Fiscal Revenues (graph 3)

2009:

-Highest drop ever (12%)

-Total taxes fell by 11%

-Social Contributions fell by 13%

-Other revenues grew by 8%

-

2010:

-Expected to increase by 6,5% (due to June increasing inVAT and Income Taxes)

-Other revenues increased 20%

-Temporary measures corresponded to 1,14% of GDP 1

2011:

-Slight increase (1%)

-Taxes’ revenues are expected to increase by 5,8%

-Social Contributions go up by 2,2%

-Other revenues will face a break of 6,6%

Fiscal Expenditures (graph 4)

2009:

-Increment of 5% (reached 49% of GDP)

-All components of the expenditure increased

-

2010:

-Small increase (1,7%)

-Investment, Personnel Outlays, Social Transferswent up but by a smaller rate

-Interest expenses were the only with anincreasing rate, by 26%

2011:

-Public expenditures will decrease by almost 5%,

according to the Governmental Budget

-Investment, public servant’s wages and social

transfers are the most punished

-Interest payments keep growing (7%)

Portugal’s Fiscal Situation

Our data was gathered from Growth and Stability Program of Portugal on March 2010,

with some updates for 2011 from the European Commission forecasts and Government

Budget Bill 2011.

Link between the aggregates (in our sample):-Correlation between fiscal revenues and outlays is positive (0,278)

-Correlation between fiscal revenues (absolute values) and real GDP growth (0,8328)-Correlation between fiscal expenditures (absolute values) and real GDP growth (-0,4824) – Fiscal Policy is counter-cyclical

Total Fiscal Balance (the joint result of revenues and expenditures) – graph 5:

-In our sample, the government always incurred in a deficit (negative fiscal balance), although the decreasing from

2009 to 2011. The deficits registered have always out ruled the maximum of 3% of GDP (fulfilling EC’s rules).

-The pressure of external creditors imposed Portuguese Government to drastically reduce the deficit. The interest

payments of government debt are the only factor that keeps an increasing movement.

-2009: Highest value for the fiscal deficit (revenues fell by 12% and expenditures rose by 5%) – 9,4% of GDP. Major

reasoning: -Drop in output subsequent to the financial crisis, much weight on revenues’ drop.

-2010: Fiscal deficit reached 7,56%. Major reasoning: -Economic recovery and Revenues increasing (measures from

the Stability and Growth Program in March – augment of 1% on VAT, Income Taxes, privatizations and other

extraordinary measures, like the Retirement funds transfer from Portugal Telecom to the State)

-2011: The deficit holds its reducing path, now to 4,83% of GDP. Major reasoning: Not only taxes will go up (like 2%

on VAT) – approximately 1% of GDP - but also expenditures are reduced – approximately 2% of GDP, due to the

weak financing conditions of the Portuguese Economy (from State and banks to households). A negative factor coming

from these measures is the expected reduction on GDP by 1%.

1 – Transfer of Portugal Telecom’s Funds Retirement to State’s accounts

Confirming the Automatic Stabilizers dynamics!



4

Evolution of the four fiscal balances

There are four types of fiscal balances. We made the division to observe the impact of

interests, economic evolutions and temporary policies on fiscal balance and reach fiscal

balance that reflects more the structural / basis policies of the government. All deficits are positively correlated because the revenues account is in all of them:

-Total fiscal balance. Simply the difference between fiscal revenues and public

expenditures (if it is negative we have a deficit, if it is positive we have a surplus) – graph

5 (already described on the previous scheme);

-Primary fiscal balance, computed as the difference between fiscal revenues and public

outlays excluding interest expenditures – graph 5. We noticed that in 2008 the balance was

positive (no interest payments would make the total balance positive), for 2009 the

evolution is similar to total fiscal balance, from 2010 onwards the primary balance

enhances while the total balance worsens – this is the effect of an interest rate increasing

on government bonds.

-Cyclically adjusted fiscal balance, equaling the primary fiscal balance minus the effects

of economic developments (GDP variation) on public finance. To calculate the latter, we

used the 0.5 elasticity of public expenditures to GDP (ξ) suggested by the European

Commission and the output gap (extracted from Bank of Portugal’s annual report) – graph

5.

Cyclically adjusted fiscal balance = Primary Balance *[ -(ξ*Output gap)]

The elasticity factor can be seen as the sensibility of fiscal balance to output deviations

(unemployment deviations). The sign is always positive, a 1% increase in the output gap

(real GDP grows more than potential) causes the fiscal balance to go up, ceteris paribus.

The huge change in the output gap (recession) is responsible for the worsening of 4% of

GDP on the total fiscal balance. It behaves from then on negatively without any more

relevance, i.e. the output gap is negative thus the automatic stabilizers put a downward

pressure on total fiscal balance.

-Cyclically adjusted fiscal balance, adjusted for temporary measures (structural

balance). Temporary measures are extraordinary actions whose effects concern just one

period of time (graph 6). This indicator can be seen on graph 5 and tells us what would be

the fiscal balance without the extraordinary cash inflows.



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For 2008, without the temporary measures, fiscal balance would be near zero instead of

positive. For 2009 they were zero. The reduction on the deficit for 2010 had very helpful

temporary measures, specifically the transfer of Portugal Telecom’s Retirement Funds to

the state. Otherwise, the recovery of the fiscal balance would be slower (as the structural

balance shows).

This shows the difficult for the State to contain expenditures, dragged by the post 25th of

April upward expenditure trend, graph 7. Even worse, because Public investment is

decreasing (graph 4), this waste of resources is allocated to consumption and interests

(vicious cycle).

Dynamics of Public debt

The definition of a deficit (flux variable) is how much is added to the public debt (stock

variable) from one period to another. So the public debt must have been increasing.

The important point here is that it reached levels above 60%, going against the rules of the

European Commission. The special fighting measures invoked by the 2008 financial crisis

put Portugal on a dangerous side of indebted countries.

From this sentence follows the issue of public debt sustainability. Using the equation given

on Dornbusch and Fischer Macroeconomics’ book 2, the variation of the debt must be equal

to zero to ensure sustainability, so deficit on 2011 must equal zero. The results obtained are

on graph 8. It should be interpreted as the government’s amount of savings required to

ensure that debt doesn’t increase, given the conditions of the economy: inflation, interests

and GDP growth.

To be more rigorous with our work, we computed the government’s amount of savings

needed in order to comply the 60% maximum imposed by European Institutions on public

debt – GDP ratio. The results are scary and can be viewed at graph 9.

The values are impossible to perform. Even for the debt to be constant they are really hard.

2 - )* yr b x or, according to EC’s rules (b = 60%),)1)(1(

)](*[

y

b yib x , b=debt-GDP, x=primary balance



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An ordinary median Portuguese habitant must save 4306€ and give it to the State to fulfil

the EC rule, corresponding this amount to 26,55% of his/her wealth (for 2010). For 2011,

the value get worse and rise up to 5656,51 €, 33,04% of GDP per head.

Recommendations

Given our analysis and the current upward pressure for sovereign bonds’ interest on the

financial markets, the Portuguese state is forced to save more, containing the growing debt.

To achieve this goal, in the short-run, the government can follow two different paths:

-Reduce Expenditures: Comparing to Europe, Portugal had follow the same pattern of its

European counterparts until 2009. In 2010, the average expenditures of European countries

fell sharply in opposition to the Portuguese one that had maintained its increasing pattern

(graph 10). In 2010, European public outlays are expected to equal Portugal’s.

-Raise public revenues: The average of their European tax revenues (graph 11) have fallen

in the time period considered, while the Portuguese ones fell sharply (2009) and rose

(2010). The fact of the Portuguese tax burden being bellow the EU average may lead

people to believe that Portuguese tax burden can converge to the EU average. However, we

have to take in to account that a rise in tax burden could worse GDP growth. Furthermore,

EU burden is higher but the quality of its public services is also higher. Please look at

graph 12.

In the medium-run government can adopt structural policies, fighting the problem via

economic growth: The Portuguese state should adopt some structural reforms, such as in

labor market, attracting more investors (less bureaucracy), making the country more

competitive. Basically, enable GDP to grow, which in turn would help fixing public debt

sustainability.

To conclude the state must distinguish two types of approaches, one for short-run time

period, in which is imperative to reduce government expenditures or in a last resort case

increase even more the tax burden to accomplish EU norms (Deficit=3% of GDP). And

another approach for the long run scenario, undertake structural measures with the single

objective of increasing GDP growth rate (certainly an issue for another future work).



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References:

Stability and Growth Program of Portugal, March 2010 -

http://www.portugal.gov.pt/pt/GC18/Documentos/MFAP/PEC2010_2013.pdf

General Governmental Budget Bill for 2011 (useful to make updates for 2011) -

http://www.min-financas.pt/inf_economica/OE2011/Rel-2011.pdf ; http://www.min-

financas.pt/discursos/Apres_OE2011.pdf

Bank of Portugal’s Autumn Bulletin 2010 - http://www.bportugal.pt/pt-

PT/EstudosEconomicos/Publicacoes/BoletimEconomico/Publicacoes/bol_outono10_p.pdf

European Commission, Economic and Financial Affairs division -

http://ec.europa.eu/economy_finance/sgp/convergence/programmes/index_en.htm

Dornbusch, Rudiger, Fischer, Stanley, Startz, Richard, Macroeconomics, 10th Edition.

www.pordata.pt

www.publico.pt

www.ecb.int



http://www.min-financas.pt/inf_economica/OE2011/Rel-2011.pdf


http://www.min-financas.pt/discursos/Apres_OE2011.pdf



http://www.bportugal.pt/pt-PT/EstudosEconomicos/Publicacoes/BoletimEconomico/Publicacoes/bol_outono10_p.pdf





http://www.pordata.pt/


http://www.publico.pt/


http://www.ecb.int/

http://www.ecb.int/

http://www.ecb.int/












8

-5.0%

-4.0%

-3.0%

-2.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

2008 2009 2010 2011

Real GDP

(homologous

variation)

Nominal GDP

(homologous

variation)

-3.00%

-2.50%

-2.00%

-1.50%

-1.00%

-0.50%

0.00%

0.50%

2008 2009 2010 2011

Output Gap

Output Gap

-15.00%

-10.00%

-5.00%

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

2009 2010 2011

Social Contributions

Other revenues

Total taxes

Total revenues

Annexes:

Graph 1:

Graph 2:

Graph 3 (Evolution):

Source:

SGP 2010,Governmen

tal Budget

2011

Source:

SGP 2010,

Governmen

tal Budget

2011

Source:

Annual

Report

of Bank

of

Portugal



9

-40.00%

-20.00%

0.00%

20.00%

40.00%

60.00%

80.00%

2009 2010 2011

Social Transfers

Interest payments

Subsidies

Investment

Other outlays

Total expenditure

-10.00%

-8.00%

-6.00%

-4.00%

-2.00%

0.00%

2.00%

2008 2009 2010 2011

Total fiscal balance

Primary fiscal balance

Cyclically adjusted fiscal

balance

Cyclically adjusted fiscal

balance, adjusted fortemporary measures

Graph 4 (Evolution):

Graph 5:

Source:

SGP 2010,

Governmen

tal Budget

2011

Source:

SGP 2010,

Governmen

tal Budget

2011



10

0.00%

0.20%

0.40%

0.60%

0.80%

1.00%

1.20%

1.40%

2008 2009 2010 2011

Temporary measures (% GDP)

Temporary measures (%

GDP)

0.000%

1.000%

2.000%

3.000%

4.000%

5.000%

2008 2009 2010 2011

Sustainability of public debt

Sustainability of

public debt

Graph 6:

Graph 7:

Graph 8:

Source: Banco de Portugal (http://pedroarrojagrupofinanceiro.blogspot.com/2009/01/despesa.html)

Source:

SGP 2010,

Bulletin of

Bank of

Portugal

Source:

Annual

Report of

Bank of

Portugal



11

43.00%

44.00%

45.00%

46.00%

47.00%

48.00%

49.00%

50.00%

51.00%

52.00%

2008 2009 2010

Despesa Total (%

PIB)

Government

expenditure EU-15

(% of GDP)

37.00%

38.00%

39.00%

40.00%

41.00%

42.00%

43.00%

44.00%

45.00%

46.00%

2008 2009 2010

Receita Total

Government

revenue EU - 15

(%GDP)

0

0.05

0.1

0.15

0.2

0.25

0.3

0.35

2008 2009 2010 2011

Sustainability of public debt (60% GDP)

Sustainability of public

debt (60% GDP)

Graph

9:

Graph 10:

Graph 11:

Source: Eurodata

(through Pordata website)

Source: Eurodata

(through Pordata website)

Source:

SGP 2010,

Bulletin of

Bank of

Portugal



12

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

35.00%

40.00%

45.00%

2008 2009 2010

Tax Burden

PT

Graph 12:

Source: Eurodata (through Pordata website)

essay on portuguese fiscal position

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