Europeans have so many nations in financial trouble that they came up with an acronym, PIIGS, to keep track of the worst: Portugal, Ireland, Italy, Greece and Spain. Now a sixth nation, Cyprus, is about to join this less-than-illustrious group.
European leaders meet in Brussels this week to determine whether Cyprus will get a bailout from the European Commission, the European Central Bank and the International Monetary Fund. Saving the government of this tiny island nation will only cost $23 billion, about the size of Cyprus' gross domestic product.
Should the deal go through, the public debt of Cyprus will hit a staggering 150 percent of its gross domestic product. The alternative is that the nation would begin defaulting on its debt, which starts coming due in June. As Cyprus is deep into recession, and international depositors and investors have begun to pull their funds out of the nation, it's likely the government will take a deal that's likely to make things worse.
The biggest problem with taking money from Eurocrats is they always insist on tax increases as a condition for the bailout. This step would be particularly damaging to Cyprus, which has structured itself to be a prime offshore destination for bank deposits. One proposal would tax the interest earned on deposits by as much as 10 percent, even though Cypriot President Nicos Anastasiades is doing his best to resist that terrible idea.
An increase in the corporate tax rate from its current level of 10 percent would be less damaging since the rates in Cyprus are already much lower than those on the Continent. The new proposed rate of 12.5 percent is still far below the average of 22.5 percent for the rest of the European Union. As deplorable as a tax-rate increase would be, the recognition of the importance of predictability in policy is a plus. Nobel laureate Christopher A. Pissarides, an adviser to Mr. Anastasiades, emphasizes the need to keep the new rate stable, to enable businesses to plan without being subject to uncertain policy, which is making trouble throughout the EU.
Cyprus, like its profligate European peers, is in trouble because of its excessive and unsustainable addiction to government spending. This has created an onerous debt burden. The International Monetary Fund will push Cyprus into adopting a "fiscal adjustment" that relies heavily on raising taxes, even though such proposals have a remarkable record of failure. Higher taxes rarely provide the incentive to cut spending, and, in fact, a surplus of revenue usually pushes the politicians to spend more. The result is faux austerity -- where the private sector is forced into austerity through higher taxes to feed the government's spending addiction. Liberals then proclaim that "austerity" (by which they mean spending cuts) does not work.
If Cyprus is serious about escaping its debt trap, it shouldn't take the devil's bargain of borrowing ever-larger amounts from European central bankers. The only cure for a spending addiction is to stop spending.
The Washington Times
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