Spain announced, under EU pressure, that it will be engaging in an $80 billion austerity package. The austerity program "includes tax hikes and spending cuts."
There are two major problems with Spain's announcement that will most likely doom its effort to avoid a national bailout.
Counterproductive Tax Increases
As has been the case with "austerity" efforts throughout Europe during the crisis, the Spanish "austerity" isn't just a matter of cutting spending. It includes tax increases.
Tax increases have been a fatal flaw in each of these plans.
It goes without saying that reducing spending is painful in any economy. The government spends less money which results in lower government salaries, fewer government jobs, etc. While in the long-term this is absolutely necessary and makes good economic sense, it is painful in the short-term. The size of the economy will shrink.
The reason these plans are "failing" is that each time the government tries to reduce spending, it simultaneously attempts to extract more money from its citizens through higher taxes. This is a double hit to the economy. Higher taxes just when there is less money in the economy is an economic suicide mission.
The proper way to implement austerity is to leave taxes unchanged while reducing spending. That's how families make ends meet, and it's how countries can make ends meet without destroying their economy in the process.
Austerity Too Late
An additional problem is that every European country that has attempted austerity--including Spain--has done so only once it was clear they had an imminent problem. Either their rates started going up in the bond markets or investors and pundits started talking about bailouts.
Once interest rates spike or investors start talking about bailouts, evidence indicates it's too late for that country to fix its economic situation. Emergency "fixes" and attempts at "austerity" may postpone the day of reckoning, but won't avoid it.
Once the world starts talking about bailouts for a country, it seems to be too late to avoid it.
Austerity The Right Way
The right way to implement austerity is to reduce spending to fit within revenues without raising taxes, and to do it before the country is the subject to rising interest rates and talk of bailouts. The best way--indeed the only way--to avoid an economic crisis is to engage in economic behavior that is sound and sustainable. That means engaging in austerity (reduced spending) before the markets demand it. Because once the markets demand it, it's too late.
It's still not too late for the United States. The markets are still focused on Europe. Now is the right time to reduce government spending while not raising taxes--real austerity.
But if we continue to drag our feet and wait for Europe to complete its collapse, the markets will eventually turn their attention to us.
And then it will be too late.
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