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I-CONnect Symposium on “The Euro-Crisis Ten Years Later: A Constitutional Appraisal”–Part IV–Stemming the Tide During the Crisis in Spain: Fiscal Rules and Regional Finances

[Editor’s Note: This is the fourth and final entry in our symposium on the “The Euro-Crisis Ten Years Later: A Constitutional Appraisal.” The introduction to the symposium is available here, Part I is available here, Part II is available here, and Part III is available here.]

–Violeta Ruiz Almendral, Universidad Carlos III de Madrid

The debt and deficit exploded in Spain as a consequence of the 2007-2008 crisis, leading to the first ‘excessive deficit procedure’ against Spain in 2009, which is still open.

One of the first direct consequences of the financial crisis was the halting of the construction economy, a sector that in 2007 had represented about 13 % of Spain’s Gross Domestic Product, which is of course way too big for any economy. When the construction bubble finally popped, partly due to the financial crisis and the ensuing freeze of credit to finance further construction activities, unemployment rates soared, reaching 27 per cent in 2013. Current unemployment is still close to 15 per cent. Tax revenues followed shortly, and also plummeted. In a way, Spain had also suffered from a tax bubble, with revenues soaring too in the boom years of 2006-2007. In fact, if we analyze tax revenues for the past 10 years, the 2007-2008 years were an anomaly and the tax revenues a small bubble. This was problematic because to a certain extent such high revenues also justified higher spending, including the establishment of new entitlements.

August 2011 was a critical month for the Spanish economy. Interest rates for 10-year bond yields were near 7 per cent. Barely a month earlier, on 20 July 2011, the Spanish Constitutional Court had declared that the internal stability pact – a set of Stability laws approved in 2001 and reformed in 2006 – was compatible with the Constitution and, specifically, did not imply unlawful restrictions on the financial autonomy of Autonomous Communities (Ruling 134/2011). This Court’s ruling, together with the unsustainability of the Spanish public debt, paved the way to strengthen budgetary discipline in Spain.

On September 27, 2011, Article 135 of the Spanish Constitution was amended for the purpose of introducing deficit and debt rules. The new article 135 partly followed the German reform. The revised article builds on the existing «internal stability pact» and its provisions are further developed in Organic Law 2/2012, Law on Budgetary Stability and Financial Sustainability, a law that has already been amended five times, among other reasons, in order to further control indebtment of regions. Like other countries, such as Italy, Slovakia, Germany and Slovenia, Spain was one of the early adopters of a constitutional balanced budget clause, for well-known specific reasons, which is the substantial increase of the bond yields in the summer of 2011.

Fiscal rules are considered necessary in a monetary union, among other reasons to minimize ‘moral hazard’, which arises when governments may feel protected by the rest of the Union and incur higher debts than they otherwise would. However, this rationale may also be a reason not to limit beforehand all room for manoeuvre. In this regard, it has been rightly argued that the more limited and myopic the rules, the less leeway Member States will have to develop their own cooperation mechanisms. That, in turn, may actually decrease the effectiveness of the rules from the beginning, as they will be perceived as something external and there will be less of an incentive to develop own rules to achieve fiscal consolidation.

Also, establishing some form of fiscal constraints or budgetary discipline rules for subnational governments will be needed, especially if the market-pressure mechanisms (i.e., more expensive financing as a mechanism to borrow less) do not work. One of the situations where they may not work is when there is a reasonable expectation that the center will bail out Communities, as has happened in Spain. From this perspective, merely stating, in a law or agreement, that there will be no bail outs does not suffice: there needs to be a history of no bailouts.

Ideally, internal fiscal rules should also allow for cyclical flexibility, but because it is difficult to accurately determine local cycles, a rainy day fund may be more effective. In any event, fiscal rules will not foster fiscal discipline in the absence of real political commitment, or when the system of intergovernmental relations or of subnational financing is inefficient.

From a purely budgetary perspective, it may be argued that Spain functions as a Federation, since Communities manage about 50 per cent of public spending.  The flip side is that Communities often do not exercise their tax autonomy accordingly. There have been a series of reforms in order to increase fiscal responsibility, and decrease vertical fiscal imbalance. To that end, the system was substantially transformed in 1997, when some taxes formerly managed by the Centre were turned into ‘shared taxes’, enabling Communities to establish their own rates and deductions for some important taxes, including the Personal income tax. This, however, did not substantially increase fiscal responsibility. The financing system of Autonomous communities was redesigned in 2009, but issues concerning the debt and deficit were largely left out.

The current EU legal system says little about internal powers. It is naturally (formally) left to Member States. The very design of the system is, however, hardly compatible with a decentralized system, which is partly why the evidence shows progressive centralization (as the Italian, Spanish or Portuguese cases show), following the German model, which is highly centralized for a decentralized state, taking into account the legal framework to force Länder to comply with the debt and deficit brakes. The “Germanization of the governance of the euro” has other consequences; the impact on fiscal federalism is currently being felt, but it is probably too soon (again) to fully assess the impact.

It was clear, in any event, that given its decentralization level, Spain needed some kind of fiscal rule to distribute debt and deficit among the central government, the communities and the municipalities. Spain’s internal pact was implemented as early as 2001, but it has not been able to avoid fiscal gimmickry schemes. At the same time, in the aftermath of the crisis, there have been substantial, across the board budget cuts in the provision of Health and Education services, which amount to about 70 per cent of Communities’ budget. The system has been substantially centralized, as Communities do not have much say in the way budgetary rules are applied to them. The system of intergovernmental relations envisaged in the Organic Law 8/1980 on the financing of Autonomous Communities (LOFCA) and institutionalized in the “Consejo Fiscal de Política Fiscal y Financiera” (CPFF) is in practice a way to convey Communities decisions made by the center. The CPFF has a very limited role in the internal fiscal pact that, according to some, is in breach of Article 135 of the Constitution, which called for a larger role for the CPFF or any other similar institution.

In 2001 these laws were highly contested and were challenged before the Constitutional Court. About ten years later, the Court decided on these issues in its Ruling of 20 July 2011 (STC 134/2011), declaring the acts constitutional. The Constitutional reform was approved only 2 months after that ruling. Further opinions by the Court confirmed that when controlling the constitutionality of the reform (Opinion 157/2011, 18 October; Rulings 187, 188 and 189, 23 November; 195, 196, 197, 198 and 199, 13 December; and 203/2011, 14 December). The current legal framework has also been reviewed and considered constitutional (Opinion 215/2014).

In 2011, many Communities had in fact increased spending and faced soaring deficit and debt accumulation. So then they had to decrease public spending at a very fast pace, once their budgets started to feel the drastic reductions in tax revenues. Because some Communities could no longer finance themselves in the market, in 2011 the Central Government set up two “bail-out” mechanisms: the ‘Regional Liquidity Mechanism’ and the so-called “payment for suppliers’ mechanism”. This has helped them finance current payments but it has implied a greater increase in their debt. In practice this mechanism entails the central Government lending money to Communities and assuming the risk. However, this lending comes with strings attached, so that Communities receiving extra funds will be monitored more closely.

To sum all up, the 2011-2015 reforms have substantially altered the previous legal framework: (i) there is strong system in place to supervise the debt and deficit; (ii) there is a new fiscal authority (Autoridad Independiente de Responsabilidad Fiscal –AIREF), created in November 2013 which should ensure better control of public finances; and iii) there have been some austerity measures that have been highly contested.

The most important problem now is that our level of public debt is close to 100 per cent of GDP. The still low growth, combined with high unemployment and ageing of the population, makes this situation hard do sustain. The only solution for this is economic growth, in the absence of which there is no legal framework that can solve these issues.

Suggested Citation: Violeta Ruiz Almendral, I-CONnect Symposium on “The Euro-Crisis Ten Years Later: A Constitutional Appraisal”–Part IV–Stemming the Tide During the Crisis in Spain: Fiscal Rules and Regional Finances, Int’l J. Const. L. Blog, Feb. 23, 2019, at:“the-euro-crisis-ten-years-later:-a-constitutional-appraisal”–part-iv–stemming-the-tide-during-the-crisis-in-spain:-fiscal-rules-and-regional-finances

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Published on February 23, 2019
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