Monday, September 24, 2012

Portugal caves on hiking workers social security taxes

Portugal highlights just how pervasive the Pension Fund Death Spiral is in the global economy.  In the case of Portugal, the pension fund spiraling down is social security.

The reason that social security is spiraling down is a combination of lack of investment return in an artificially low interest rate environment and money that could be used to support social security is instead being used to support excess debt in the financial system.

Please recall that in the private sector, the lack of earnings on pension fund assets causes the private sector to deprive the real economy of growth by diverting money that could be used by firms for investment in growth into covering the shortfall in pension earnings.

Since the firms aren't investing, they are not hiring.

Without hiring, payments into social security are less than they would be if the economy was growing.

This problem is exacerbated by the simple fact that the Portuguese government is using its limited access to funds to support excess debt in the financial system.  Since the money is being used to support excess debt, it is not available to cover the shortfall in social security taxes.

I know it sounds simplistic, but there really is an easy way out of this problem.  The solution, also known as the Swedish model for handling a bank solvency led financial crisis, is to require the banks to recognize all the losses on the excess debt in the financial system.

As shown by Iceland, making the banks recognize losses today equivalent to what they will recognize if they go through the long process of default, bankruptcy, and foreclosure saves the real economy.  In the case of Iceland, not only is their economy growing, but they were able to expand social benefits.

Please note, with the losses out of the financial system, there is no need for the artificially low interest rates.  This ends the Pension Fund Death Spiral.

As reported by the Guardian,

It's official, Portugal has caved in on its plans to hit workers with a hike in their social security payments. 
As expected (see 8.23am), the Lisbon government has pulled a U-turn on the austerity measures. 
Speaking a little while ago, the prime minister, Pedro Passos Coelho, said new tax measures would be proposed. The original plan to raise employee social security payments from 11% of their salary to 18% is abandoned. 
The decision is a victory for the hundreds of thousands of people who took to the streets nine days ago in massive protests against the plan. 
Passos Coelho warned that Portugal needs to find the money from another source, otherwise its €78bn bailout could be at risk. 
He added that he will continue negotiating with unions and business confederations over news ways to raise the funds, which could include separate income tax rises or changes to "capital tax measures".
This raises the question of why is Portugal taking the bailout.

Its banking system is designed not to need to be bailed out and to be able to function even after absorbing all of the losses on the excess debt in the financial system.

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