A Catalan Treasury would be in Spain’s best interest

For some time now, the state of Catalonia’s public finances has not been something to be proud of. Rating agencies have continued to downgrade Catalan debt, which they dropped to junk bond level some time ago. This would be a cause for concern, should the Catalan government intend to issue new bonds to bridge the permanent gap between income and spending. But it is a moot point, since Catalonia’s Generalitat is not allowed to access the open debt market.

As with any other economic agent, the Generalitat must borrow when spending exceeds income. Since it cannot resort to the finance market directly, it borrows from Spain’s central government. The loans come via Spain’s Regional Liquidity Fund (FLA, in Spanish). This creates a situation plagued with dubious, absurd incentives that I would like to discuss briefly.

Spain’s regional funding system provides most of the Generalitat’s steady income. The system means that Madrid collect’s the lion’s share of all tax revenue and, by means of a complex, opaque formula, every regional government is then handed its share. Every time the system is due a makeover, the formula gets modified as well. One such reform was due in 2013, but Spain’s Finance minister, Cristóbal Montoro, refused to pursue it, thus effectively breaking the law.

In Catalonia —as well as in Valencia and other regions— we are certain that this system is exceedingly unfair. There are objective reasons to denounce it, but allow me not to dwell on them in this article. The fact remains that the Catalan government receives an arbitrary transfer of funds as part of its budgeted income and this is what it must build its policies on.

Despite its efforts to cut expenses, the Generalitat still can’t make ends meet and it is unable to reduce the existing deficit. Ultimately, this deficit is financed by Spain’s central government through the FLA. In other words, the Generalitat has two sources of income: the central government (via the ordinary transfer of funds) and the central government (via the FLA). What is the difference between them? From an accounting point of view, they are like night and day: the former is regular income, while the latter is an interest-bearing loan, which accrues and must be repaid.

Politically speaking, though, the difference is minimal. Who ever said that FLA loans will eventually be paid back? Some have already argued that they should be condoned for all regions, as many of them would struggle to meet the payments. How could the central government possibly insist that these loans be repaid, with any credibility? The only way would be to refuse to bail out the first region to default on its payments. But we all know that the central government is the only source of income for Spain’s regions. In other words, if a region doesn’t pay, it must be because Madrid cannot or will not fund them. When Spain’s Finance and Economy ministers boast that they won’t allow anyone to default it is because they realise that this would inevitably cast major doubts on the financing capacity of Spain’s central government.

Therefore, if no region will ever be allowed to default, then there is little difference between FLA loans and ordinary funding. Actually, the FLA has become merely another financial hurdle in a system that has reached such a degree of irrationality that it blurs the difference between income and deficit. Because the funding system is unfair, Catalonia passes unrealistic budgets —which include revenue that we are supposedly entitled to— that the government fails to comply with by the end of the year. And then the deficit incurred means that Catalonia must borrow from the FLA. This annoys the Spanish government, which threatens and monitors all expenses, but ultimately  it pays (albeit with great fanfare, as with the recent meeting between minister Montoro, Catalan PP leader Albiol and Catalonia’s finance minister Oriol Junqueras). In terms of fiscal co-responsibility, it is highly embarrassing.

Given how distrustful Madrid and the regions are of one another —and in the absence of fiscal responsibility—, it is no wonder that the deficit caps are systematically ignored. We require a system with the utmost clarity and solid budgetary restrictions in order to bring incentives back. A system where the powers conferred are well defined, with a separate finance method for each administration. For instance, a system like in the US, where every State has its own Treasury and tax-payers fill in two separate tax forms, one for the federal government and another for the State. If Mr Montoro wishes to spare himself the yearly palaver about Catalonia’s deficit, he should be the first to demand a separate Catalan Treasury that actually works.

But that is out of the question, because it might hinder Madrid’s central powers. It would appear, then, that nationalism is a hurdle for efficient economic solutions. Sound familiar?