A lesson not learned

Today Spain raises its VAT from 18 to 21 percent in an effort to increase government revenues and decrease the budget deficit. If history has taught us anything it's that all previous increases failed miserably in achieving the desired result.

Seventy-three years ago today, German troops invaded Poland and plunged the continent into the darkest five years anyone had ever experienced. In Europe alone the total number of casualties (civilian and military) was well over 15 million.

Today Spain is being plunged into darkness with the value added tax being raised from 18 to 21%, its highest level ever. The centrist Partido Popular (PP) government of Mariano Rajoy insists that extreme measures are necessary in order to reduce the budget deficit and foreign debt. While this may true, the real reason has more to do with credibility, or as I like to call it, creditability - the ability to pay back your loan commitments and thus secure further funding. At this stage of the game the blunders in fiscal mismanagement are so compounded that world financial markets have serious misgivings about Spain's ability to meet its monetary obligations. In other words, while Spain is making all the right moves in the eyes of Germany and the European Central Bank (ECB), the rest of the world believes these measures are too little, too late. The result is a risk premium hovering the 6 percent mark, extremely high for a developed country especially when you consider Germany's risk premium is zero.

So the question has to be, if Spain is complying with all the fiscal controls demanded of them, why is there such lingering doubt in financial markets?

Spain's current sitution

The graphic on the left pretty much explains it all. Currently (2012), unemploy-ment stands at 25% with over 5 million people without jobs. Of these, over 2 million have been out of a job for over two years. And there are over 1.5 million households with no income whatsoever. In a country of only 40 million people, this is tantamount to total social and economic collapse.

Furthermore, this Microsoft report from 2011 finds that 99.88% of the registered companies in Spain are SMBs, which is to say, companies with less than 250 employees and with annual revenues below 50 million euros. However, in Spain, 96% of the registered companies have annual revenues below 2 million euros; 53.9% have no registered employees. This means that the majority of companies are "mom and pop" stores: the butcher, the pharmacist, the cobbler, the auto mechanic, etc.

In other words, these companies do not have extensive financial resources and are living at the edge of their monetary capabilities because the products and services they offer are price volatile and subject to the laws of supply and demand.

Therefore, as financial analysts see it, the increase in VAT and other prime commodities will most likely decrease overall revenues. Some analysts estimate government projections will be off by 2 billion euros due to an overall decrease in consumer spending.

As if to prove the analysts right, the latest consumer reports from the National Statistics Institute (INE) state that retail sales decreased by 6.5% in July.

What's even more amazing is that this is not the first time the VAT has been increased. Two years ago, under the administration of socialist president Jose Luis Rodriguez Zapatero, the opposition Partido Popular launched a massive information campaign against Zapatero's increased VAT (from 16 to 18%) initiative. The campaign cited how previous attempts at raising the VAT ended in economic disaster for the administration of Felipe Gonzalez back in 1993 and eventually led to his defeat in the 1996 elections.

So, if the strategy of raising the VAT did not achieve the desired results in 1993 and again in 2010, why is it now deemed the correct response and being forced on the people yet again? The PP has even gone to great lengths to remove all vestiges of their previous "No más IVA" (No to higher VAT) campaign from the Internet but social networking sites have kept photographic records of the PP's top echelon working the streets to get people to sign the petition.

One possible explanation
This time around Rajoy's austerity measures will have no more of a positive effect than in previous attempts. If Rajoy has paid attention to history he can expect unemployment and business closures to rise.

However, one would think that the logic is sound: if government needs money, raise taxes; if it needs to reduce expenses, cut social programs and services. Or is it sound reasoning? Judging from Spain's track record it would seem not, and yet the same strategy is being employed over and over again. Clearly, raising taxes and cutting social programs is not the answer. It hasn't worked in the past, it won't work now. Therefore, the problem lies elsewhere. These problems are deeply rooted in a flawed state system of autonomous regions and a failed business model of an economy solely dependent on real estate speculation and development. A simplistic approach to a complex problem is, at best, a band aid solution.

I won't go into the problems here because it would take more than a blog to explain and would cover several pages of macroeconomic data, the analysis of conflicting cultural attitudes and a historical approach at attempting to explain the lack of national unity. I can however say that the negative figures presented in the graphic above will only be exacerbated.

In the end, Germany may be appeased by the measures Rajoy is implementing. Their loans will be repaid, they'll make money and will continue to be Europe's economic powerhouse. But at what cost to Germany and to Spain itself?

When the dust from this economic fallout finally settles in Spain, how much will have been destroyed in terms of production, employment and wealth? This time around, how many casualties will this European crisis claim?

Those who don't remember the past are condemned to repeat it.