The decision by Portugal’s constitutional court to rule out some proposed pay and benefit budgetary cuts was contradictory. But in the long run it may have done the government a favour, as it searches for new options to meet the terms of its EU bailout

The fate of the Portuguese bailout programme may have been decided on April 5, by the Portuguese constitutional court, when its members (as civil servants) basically voted on the suspension of their own 13th and 14th salary payments (Christmas and holiday subsidies, as these are known in Portugal).

What has been puzzling constitutional lawyers in Portugal, however, is the fact that the same court did not reject an ‘extraordinary solidarity contribution’, which implies progressive haircuts on pensions above €1,350 (up to 40% for the highest pension bracket).

The justification cited by the constitutional court for approving this measure was its temporary character, which was ‘justified by a situation of economic and financial distress’, and the fact that it was progressive.

The proposed suspension of the 13th and 14th salary payments is also a temporary measure and arguably also justifiable by financial distress, although it is not progressive. In this case it has been argued that the grounds for the rejection lie in an interpretation of the constitution that rejects unequal treatment between the private and the public sectors (this would be a clear conflict of interest in any board meeting).

This decision by the constitutional court came as a blow to the Portuguese government, delivered on the eve of the informal Ecofin meetings in Dublin (April 12 and 13), where EU finance ministers were slated to discuss the deteriorating economic situation of the country and a request for an extension of the schedule for loan repayment, which is seen as crucial for Portugal.

What are the next steps? Well, Portugal, where the implicit tax rate on capital is now significantly above that of the EU average, could be already close to the descending part of the Laffer curve on this tax category, which means that raising capital tax rates further is unlikely to have a significant effect on, and could even lower, tax revenues.

Its VAT tax rates are among the highest in Europe, with the normal rate set at 23%, and labour taxation has proved to be relatively difficult to increase in Portugal.The government recognises this and has already pledged not to substitute expenditure cuts for higher taxes.

This implies that it will have to come up with alternative cuts in expenditure amounting to roughly €1.3 billion (representing about 0.8% of GDP). The amount of savings required may not be very large, but the options are extremely limited: cuts in health, social benefits, education and state owned companies.

Excluding the cuts in social benefits, which are likely to affect the most vulnerable (so much for the equality praised by the constitutional court), the others are areas typically characterised by poor budgetary execution. Hence, it will not be easy to convince the Troika that planned expenditure cuts in these areas will deliver.

One remaining option is a further reduction in the number of public sector employees in combination with an increase in public sector working hours which, at 35 hours a week, constitute one of the lowest workloads in Europe. This option is likely to be very welcome to the IMF, and in fact was suggested in its latest Article IV consultation.

The cuts cannot come through retirement schemes, since these only shift the expenditure from payrolls to pensions; rather, they must come from an effective reduction in the number of workers in areas where current employment levels are found to be excessive.

These measures will have the best long-term implications both in terms of fiscal sustainability and of labour productivity, and may finally allow the country to resume the catching-up process that has been stalled since the start of EMU.

Depending on the response of the government, the Portuguese constitutional court may have decided the fate of Portugal for the better.

Leonor Coutinho is a senior scientist at the University of Cyprus and senior researcher at Europrism Research. This post first appeared as a CEPS Commentary on the Centre for European Policy Studies website