VZCZCXRO7749
RR RUEHAG RUEHDF RUEHIK RUEHLZ RUEHROV
DE RUEHVI #1287/01 2521448
ZNR UUUUU ZZH
R 081448Z SEP 08
FM AMEMBASSY VIENNA
TO RUEHC/SECSTATE WASHDC 0909
INFO RUEATRS/DEPT OF TREASURY WASHDC
RUCPDOC/USDOC WASHDC
RUCNMEM/EU MEMBER STATES

UNCLAS SECTION 01 OF 02 VIENNA 001287 
 
SIPDIS 
 
PASS TREASURY FOR OASIA/ICB/VIMAL ATUKORALA 
TREASURY ALSO FOR OCC/EILEEN SIEGEL 
TREASURY ALSO PASS FEDERAL RESERVE 
 
USDOC PASS TO OITA 
USDOC FOR 4212/MAC/EUR/OWE/PDACHER 
 
PARIS ALSO FOR USOECD 
 
E.O. 12958: N/A 
TAGS: ECON EFIN ELAB EUN AU
SUBJECT: Red Ink Permeates Austrian Campaign, Marking Break with 
Economic Reform Path 
 
REF:  (A) VIENNA 0969; (B) VIENNA 0965; 
      (C) VIENNA 0954; (D) VIENNA 0621 
 
¶1.  SUMMARY: Economists are concerned about pre-election spending 
proposals which combined with a proposed tax cut could drive up 
Austria's budget deficit from near balance to 2.5% of GDP (near the 
Maastricht limit).  Parliament might even enact large spending 
increases before the September 28 elections, seriously limiting the 
next government's policy scope and marking the de facto end to 
serious economic reforms for the time being.  END SUMMARY. 
 
The Outset 
---------- 
 
¶2.  Austria now has its highest inflation rate in fifteen years (ref 
A) and economic growth is projected to weaken to 2.2-2.3% (at best) 
in 2008 and 1.4-1.9% in 2009 (ref C).  Blessed with strong tax 
revenues in 2006 and 2007, the outgoing government spent most of the 
extra income and only reduced the total public sector deficit from 
1.5% of GDP in 2005 to 0.5% in 2007 (at a time when it could well 
have run a surplus).  Unexpected 2008 revenues will be used for 
"anti-inflation" measures, a recent turn of phrase for spending 
programs (including reduced unemployment insurance contributions for 
low-income groups and moving the annual pension increase forward by 
two months to November 1).  Even before the wave of pre-election 
spending, Vice-Chancellor and Finance Minister Wilhelm Molterer 
(OVP) announced that the GoA will be able to cut the federal deficit 
to 0.1% of GDP in 2010 with a small surplus thereafter, signifying 
that the GOA has abandoned the goal of a balanced budget over the 
economic cycle (in line with the EU's Stability and Growth Pact). 
 
¶3.  Relative to other Eurozone economies, Austria made major fiscal 
policy shifts from 2000 to 2006 including pension reform and a 
corporate tax cut.  However, in the past two years, the SPO-OVP 
grand coalition failed to continue the reform agenda in such areas 
as streamlining government and administration, health care reform, 
and other measures to anchor long-term fiscal sustainability. 
 
More Pork than Usual for Election Season 
---------------------------------------- 
 
¶4.  Coming at a time of voter discontent, the election campaign has 
led all major parties to propose ways to soften the impact of 
inflation through tax cuts and new spending. In July, Molterer 
opened pork season by proposing a thirteenth monthly family 
allowance, a higher nursing care allowance and a subsidized "Austria 
ticket" for all public transportation - estimated to cost EUR 550 
million in all.  Social democrats were sympathetic but needed their 
own package for campaign reasons, leading SPO Chairman and Transport 
Minister Werner Faymann to terminate the coalition's parliamentary 
truce and present an SPO spending package: a higher nursing care 
allowance and thirteenth monthly family allowance (by and large 
compatible with the OVP), abolishing university student fees, 
extending from 2010 to 2013 the possibility for early retirement 
without cuts in pension payments (another step back from 2003/4 
pension reforms), and cutting the VAT on food products from 10% to 
5% - estimated total cost of EUR 1.3 billion.  Since then, the 
parties have outbid each other on new spending, with cost estimates 
(including the income tax cut) as follows: 
 
 PARTY PROPOSED NEW SPENDING 
 ----- --------------------- 
 SPO  EUR 5.0 billion 
 OVP  EUR 3.8 billion 
 FPO  EUR 5.7 billion 
 Greens EUR 7.5 billion 
 BZO   EUR 4.8 billion 
 
Economists Sound the Alarm 
-------------------------- 
 
¶5.  Austria has done well since 2000 by pursuing liberal market 
reforms but remains in transition from a highly regulated economy 
with a large government sector to a flexible "social market" 
economy.  Economists are concerned about the recent spiraling of 
campaign promises -- none of which qualifies as structural reform or 
true growth promotion -- and their negative potential impact on 
Austria's federal budget.  Conservative senior economist Bernhard 
Felderer (head of the Federal Debt Committee) expressed concern that 
the spending promises could push the budget deficit to 1.5% of GDP 
in 2010, including the planned income tax cut even to 2.5% of GDP, 
 
VIENNA 00001287  002 OF 002 
 
 
in which case Austrians have can expect a new wave of austerity 
measures. 
 
Income Tax Cut in Jeopardy, VAT Tax Cut Problematic 
--------------------------------------------- ------ 
 
¶6.  There is broad consensus that Austria should lower and overhaul 
personal income taxes.  Austria's tax quota is high (close to 43% of 
GDP) and the current system is unbalanced:  7.5% of salaried tax 
payers are responsible for 45% of total income tax revenues on wages 
while almost 43% pay no tax.  Since 1990, personal income tax burden 
has fallen as a share of EU GDP (from 10.7% to 10.2%) while rising 
in Austria (from 8.3% to 9.3% of GDP).  Austria has high taxes on 
labor income but low property and corporate taxes and is below the 
EU average for ecological taxes.  Given election-related promises, 
there may be no money left for cutting income tax, in part because 
the outgoing GoA failed to free up budget funds by implementing 
administrative reform and streamlining levels of government (ref 
B). 
 
¶7.  Experts criticize the proposed VAT cut as costly (about EUR 1 
billion), socially unbalanced, the wrong way to fight inflation and 
a measure that can hardly be reversed.  Despite a legal requirement 
on firms to pass on tax cuts, many experts doubt that consumers will 
reap the full benefit of a VAT reduction in the form of lower 
prices, particularly given Austria's extremely high concentration 
among retail grocery chains. 
 
COMMENT:  Resting on Laurels While Reform Fades 
--------------------------------------------- -- 
 
¶8.  Across the spectrum, parties are painting the next government 
into a corner by promising expensive new programs without new 
sources of savings or revenue.  Even if only some of the proposed 
measures are implemented, the budget deficit could rise to 1.5% of 
GDP, which with the planned tax cut would mean a deficit of up to 
2.5% of GDP (or higher in a recession).  Expanding Austria's already 
large welfare state seems like electioneering rather than a coherent 
response to inflation.  Austria's family allowances already total 
3.1% of GDP - considerably above the OECD average of 2.4%.  A bigger 
state will crowd out needed investments in R&D, restructuring, and 
other measures need to keep Austria competitive despite its high 
wages and costs. 
 
¶9.  The end of Austria's economic reform decade is in the air.  The 
bulk of new spending proposals - whether enacted before the election 
or soon afterwards -- would considerably pre-charge the next budget 
and limit the incoming government's economic policy scope. 
Moreover, the campaign has degenerated into a race to "buy votes" at 
the cost of long-term sustainability.  The next GOA will have 
difficulty convincing markets that it can kick-start reform despite 
promising voters the contrary. 
 
GIRARD-DICARLO