CONTENTS

Executive summary..................................................................................................................... 3

1............ Introduction.................................................................................................................. 5

2............ Economic situation and outlook................................................................................... 5

3............ Challenges and assessment of policy agenda............................................................... 6

3.1......... Fiscal policy and taxation............................................................................................. 6

3.2......... Financial sector........................................................................................................... 19

3.3......... Labour market, education and social policies............................................................. 22

3.4......... Structural measures promoting sustainable growth and competitiveness................... 28

3.5......... Modernisation of public administration...................................................................... 36

4............ Conclusions................................................................................................................. 38

Overview table.......................................................................................................................... 40

Annex........................................................................................................................................ 47

Executive summary

Progress on the adjustment of macroeconomic imbalances and advances in the policy reform agenda are helping to rebuild confidence on the Spanish economy. Spain has taken measures to strengthen the financial sector, restore competitiveness and shore up public finances. The private sector is gradually reducing its debt, and the current account balance has turned into a small surplus. Amid recovering confidence, easing financing conditions (although still relatively onerous for smaller borrowers) and reduced economic uncertainty, the economy pulled out of a long recession in the third quarter of 2013 and employment stopped declining at the end of 2013. GDP is expected to grow by 1.1 % this year in the Commission 2014 spring forecast, as exports remain robust and domestic demand stops being a drag on growth.. Employment is expected to progressively gain some traction over 2014 and 2015, prompting a moderate fall in unemployment.

However, the recovery of the Spanish economy is at an early stage and remains fragile. High levels of private and public debt and external liabilities and very high unemployment make the economy vulnerable and constrain future growth prospects. The recovery can be sustained only if it does not result in a halt or reversal of the correction of imbalances and the economic adjustment process. This calls for a continuation of structural and fiscal policies that support an efficient reallocation of resources and macroeconomic stability, hence underpinning sustainable growth and employment going forward.

Overall, Spain has made some progress in addressing the country-specific recommendations of 2013. Fiscal consolidation continued in 2013 and the national reform agenda has advanced significantly, with many important reforms being passed into law, broadly in line with the plans in the 2013 Spanish national reform programme and stability programme. Notably, Spain has adopted reforms on pensions, healthcare, independent fiscal institution, public administration, internal market, financial sector, non-bank financial intermediation, labour market, corporate insolvency, liberalisation of the housing rental market, and to tackle the electricity tariff deficit. The implementation of many of these reforms required follow-up actions and is thus ongoing (in some cases it is still at an early stage), and not devoid of risks, including from the need of joint delivery by various tiers of government in many reforms. Moreover, some key reforms, e.g. regarding professional services and associations, have been delayed.

The 2014 national reform programme confirms the reform agenda, providing further detail on reforms still to be adopted and focusing on implementation. Building on the measures included in the 2012 and 2013 programmes in key areas such as business environment, the labour market and network industries, the 2014 programme aims at deepening the reforms, favouring economic recovery and job creation, and emphasises the need for a swift and full implementation of the measures already adopted. Amongst the key new measures are a far-reaching reform of the tax system, planned to be adopted in the second half of 2014, measures to promote democratic regeneration and fight against corruption, the reform of active labour market policies and to address social issues, and measures to improve access to bank and non-bank financing for small- and medium-sized enterprises. For most of these measures, however, a concrete timeline is missing.

Despite the recent achievements, there are still important challenges to be addressed in several policy areas:

· Public finances: Fiscal consolidation remains a priority to reduce the still high general government deficit (7.1 % of GDP in 2013, of which 0.5 % of GDP related to bank recapitalisations) and put the high general government debt (around 100 % of GDP) on a declining path. While in the stability programme the headline deficit is planned to be brought below 3% in 2016, which is the deadline set in the Council's recommendations in the context of the excessive deficit procedure, the planned fiscal efforts fall short of what recommended by the Council. Moreover, the deficit and debt adjustment paths are subject to downside risks in particular in 2015 and beyond, relating in particular to a somewhat optimistic macroeconomic scenario underpinning the budgetary projections and from the fact that concrete measures to reach the deficit targets from 2015 onwards are not yet sufficiently specified, notably regarding the changes to tax legislation within the framework of the planned tax reform. Spain is enhancing its public finance management, notably with measures taken to underpin the sustainability of the pension system, control healthcare expenditure, reform the public administration and avoid the emergence of new arrears in public administration payments to providers.

· Financial sector: Spain has successfully concluded a euro-area-backed programme to recapitalise its financial institutions. However, the sector still faces challenges and risks that need to be carefully monitored and managed, and it is important to ensure that credit keeps flowing to viable sectors of the economy as the deleveraging of the corporate sector continues, in particular by completing the recent and ongoing measures to widen access to finance for small and medium-sized enterprises. New legislation was adopted in March 2014 to facilitate corporate debt restructuring of viable firms. Nevertheless, there seems to be still scope to reinforce the efficiency of the insolvency framework for both corporate and individuals.

· Labour market, education and training, and social policies: Although slowly declining, unemployment is unbearably high. Moreover, the labour market remains fragmented, with a high share of temporary employment carrying risks for productivity and human capital development. As a result of the deterioration of the labour market and the strain on the capacity of social protection from growing demand, poverty, social exclusion and income inequality are on the rise. Early school leaving is falling, but the use of vocational training is still insufficient and the mismatch between education and labour market needs is a problem. Effective active labour market policies and labour market institutions, as well as flanking reforms in education, training and youth policies are key to reabsorb over time the very high number of unemployed. At the same time, it is also crucial to continue monitoring closely the effects of recent reforms and maintaining wage setting consistent with job creation and international competitiveness. More employment-friendly taxation and greater competition in product and services markets are also necessary to boost employment.

· Product and service markets: Competition in the domestic goods and services sectors would be further improved with the full implementation of ongoing reforms, such as the December law to secure market unity and adoption of the law on professional services, which has been further delayed. The parliamentary approval process for the dis-indexation law is ongoing, and some of its principles have already been implemented with the 2014 budget law. Efforts have been made to foster a more efficient rental housing market and steps have been taken to address the electricity tariff deficit, in particular by reducing the system costs, with the aim of eliminating the deficit as of 2014.

1. Introduction

In May 2013, the Commission proposed a set of country-specific recommendations (CSRs) for economic and structural reform policies for Spain. On the basis of these recommendations, the Council of the European Union adopted nine CSRs in July 2013. These CSRs concerned public finances, taxation, labour market, education and training, social policies, business environment, product and services markets, network industries, public administration and the judicial system. This staff working document (SWD) assesses the state of implementation of these recommendations in Spain.

The SWD assesses policy measures in light of the findings of the Commissionʼs Annual Growth Survey 2014 (AGS)[1] and the third annual Alert Mechanism Report (AMR),[2] which were published in November 2013. The AGS sets out the Commissionʼs proposals for building the necessary common understanding about the priorities for action at national and EU level in 2014. It identifies five priorities to guide Member States to renewed growth: pursuing differentiated, growth-friendly fiscal consolidation; restoring normal lending to the economy; promoting growth and competitiveness for today and tomorrow; tackling unemployment and the social consequences of the crisis; and modernising public administration. The AMR serves as an initial screening device to determine whether macroeconomic imbalances exist or risk emerging in Member States. The AMR found positive signs that macroeconomic imbalances in Europe are being corrected. To ensure that a complete and durable rebalancing is achieved, Spain and 15 other Member States were selected for a review of developments in the accumulation and unwinding of imbalances. These in-depth reviews were published on 5 March 2014 along with a Commission Communication.[3]

Against the background of the 2013 Council Recommendations, the AGS, the AMR and the in-depth review, Spain presented its national reform programme and a stability programme on 30 April 2014. These programmes provide detailed information on progress made since July 2013 and on the plans of the government. The information contained in these programmes provides the basis for the assessment made in this staff working document.

The programmes submitted underwent a consultation process involving regional authorities and relevant stakeholders, such as social partners and representatives of the third sector, in the areas of their competence.

2. Economic situation and outlook

Economic situation

The correction of macroeconomic imbalances has progressed, allowing a return to positive economic growth and a stabilisation in the labour market. A number of policy measures were taken to strengthen the financial sector, restore competitiveness and shore up public finances. The private sector is gradually reducing its debt, and the current account balance has turned into a small surplus. Amid recovering confidence and reduced economic uncertainty, the economy has pulled out of a long recession and employment rates have stopped their decline in the fourth quarter of 2013 (in quarterly terms). A return to positive GDP growth took place as domestic demand became less of a drag on growth amid recovering confidence and gradually easing financing conditions, in particular for larger borrowers. However, large deleveraging needs in the private and public sectors cap medium-term growth prospects and mean that the economy remains vulnerable to shocks. The recovery can be sustained only if it does not result in a halt or reversal of the adjustment process, as the ongoing correction of imbalances still has a long way to go.

Economic outlook

According to the Commission 2014 spring forecast, GDP is expected to grow by 1.1% in 2014. The narrowing contribution from the external sector will be more than offset by the positive contribution from domestic demand, which is expected to gain momentum in the coming quarters. Private-sector investment in equipment is expected to benefit from the improved economic outlook and the relative strength of exports. Conversely, the adjustment of residential investment is set to reach its inflection point only in 2015. The unemployment rate is forecast to fall moderately to 25.5 %,[4] due to both the decline in the labour force and meagre employment growth. Although productivity growth is expected to slow, wage moderation should allow for further improvements in nominal unit labour costs and competitiveness gains.

The macroeconomic scenario underlying the national reform programme and the stability programme appears somewhat optimistic for 2015 and the outer years. For 2014, the GDP growth forecast of 1.2 % is similar to the outlook in the Commission 2014 spring forecast, albeit with a more even growth composition, with contributions of 0.7 pp. of domestic demand and 0.6 pp of net external demand (0.4 and 0.8 respectively in the Commission 2014 spring forecast). For the following years, the authorities forecast economic growth of 1.8 % in 2015, 2.3 % in 2016 and 3.0 % in 2017, compared to growth of 2.1% in 2015 in the Commission 2014 spring forecast. However, the Commission forecast is carried out under the customary no-policy change assumption, which does not factor in the consolidation plans underlying the official macroeconomic scenario. Specifically, the general government deficit projected for 2015 in the stability programme is 4.2% of GDP, against a deficit of 6.1 % of GDP forecast by the Commission. Had the Commission incorporated the fiscal adjustment to reach the 4.2% of GDP deficit, the resulting GDP growth forecast in 2015 would have most likely been below 1.5 %. Moreover, the GDP growth rates for 2016 and 2017 in the stability programme seem optimistic when seen against current estimates of the potential growth rate of the economy and the remaining economic adjustment needs.

3. Challenges and assessment of policy agenda 3.1. Fiscal policy and taxation

Budgetary developments and debt dynamics

The main goal of the medium-term budgetary strategy outlined in the stability programme is to correct the excessive deficit by 2016 and reach the medium-term objective (MTO) in 2017.[5] The stability programme confirms the medium-term objective (MTO) of a balanced budgetary position in structural terms, which is more stringent than what the Stability and Growth Pact requires. The stability programme broadly confirms the fiscal structural reform agenda included in the economic partnership programme presented in October 2013.

Fiscal consolidation continued in 2013, although at a slower pace than in 2012. The general government deficit net of capital transfers to banks (3.8 % of GDP in 2012 and 0.5 % of GDP in 2013), carried out in the framework of the financial sector programme and considered as one-off operations, narrowed to 6.6 % of GDP in 2013, from 6.8 % of GDP in 2012. This marginally exceeds the government and EDP target of 6.5 % of GDP.[6] By level of government, the main consolidation effort was achieved at the regional and local level, although the regions as a whole missed the deficit target of 1.3 % of GDP by slightly more than 0.2 pp., while the local governments over-performed their zero balance target, posting a surplus of 0.4 % of GDP. In contrast, the social security sector balance deteriorated by around 0.2 pp., resulting in a deficit of almost 1.2 % of GDP, which, however, was more than 0.2 pp. better than target. The deviation from the general government target set in the 2014 Draft Budgetary Plan was largely linked to weaker-than-expected current revenues, mainly as a result of lower-than-targeted taxes on income and wealth. On the expenditure side, slippages regarding social transfers in kind, other current expenditure and gross fixed capital formation were more than compensated by lower-than-expected social transfers other than in kind, subsidies and other capital expenditure.

For 2014, the stability programme aims at accelerating the general government deficit reduction to 5.5 % of GDP, over-performing the headline target of 5.8 % set in the 2014 budget and in the June 2013 EDP recommendation. The new more ambitious target largely reflects the positive budgetary impact from a significant upward adjustment of the macroeconomic scenario and labour market developments, which more than offset the slightly worse starting position in 2013. The planned narrowing of the deficit in 2014 would be achieved by a combination of higher revenues and expenditure restraint. The revenue-to- GDP ratio is forecast to increase by 0.8 pp., reflecting more buoyant revenues from both direct and indirect taxes due to the expected higher GDP growth and more tax-rich growth composition as well as to some additional consolidation measures adopted in response to the Commission Opinion on the 2014 Draft Budgetary Plan. The expenditure ratio is projected to fall by 0.4 pp. (excluding bank recapitalisation costs in 2013), reflecting mainly lower spending on compensation of employees, intermediate consumption and unemployment benefits, while the increase in nominal interest expenditure is decelerating thanks to improved market financing conditions. In total, the consolidation in the programme relies on adopted discretionary measures with a budgetary impact estimated by the government at 1.6 % of GDP. In its 2014 spring forecast, the Commission projects a marginally higher deficit of 5.6 % of GDP.

In the stability programme the authorities confirm their commitment to advance with fiscal consolidation over the medium term. The authorities target a headline deficit of 4.2 % of GDP in 2015, 2.8 % of GDP in 2016, and 1.1 % in 2017. The fiscal consolidation plan projects an increasing fiscal effort towards the end of the programme period, back-loading the fiscal adjustment. The current programme targets differ only marginally from those in the previous programme and are set in line with the budgetary plans presented in October 2013. According to the programme, the consolidation would be primarily achieved via expenditure restraint. The expenditure-to-GDP ratio (net of bank recapitalisation costs in 2013) is projected to fall by 4.2 pp. between 2013 and 2017 while the revenue-to-GDP ratio is expected to increase by 1.3 pp. The planned expenditure savings mainly falls in the areas of compensation of employees and social transfers and less in intermediate consumption and other current expenditure. On the revenue side, higher revenue from both direct and indirect taxes, including due to measures in environmental taxation, is expected to more than offset a fall in social security contributions. The central government would reduce its deficit by 3.7 pp. between 2013 and 2017, the regional governments by 1.5 pp., and social security by 1.2 pp. The local government budgets are planned to be in balance from 2014 onwards.

Concrete measures to support the headline deficit targets from 2015 onwards are not yet sufficiently specified, especially regarding the changes to tax legislation within the framework of the planned tax reform (see Box 1). For 2015, the stability programme foresees the headline deficit to narrow by 1.3 pp., with decreasing expenditure contributing 1 pp. and a further 0.3 pp. stemming from higher revenues, primarily higher indirect taxes. The projection is based on consolidation measures with an incremental budgetary impact of only 0.97 % of GDP, of which 0.82 % on the expenditure side and 0.15 % on the revenue side. The programme does not clearly specify to what extent these measures have already been adopted or are to be adopted. However, the fact that the programme foresees a net consolidation effect of revenue measures of 0.15 % of GDP seems to indicate that those temporary revenue measures taken in previous years that were due to expire by the end of 2014 will either be extended, made permanent or replaced by other measures, including (still to be specified) revenue measures at regional level. According to the programme, a gradual reform of the tax system from 2015 onwards will be adopted based on the report of the committee of experts already presented in March, although concrete details on the planned measures and their estimated budgetary impact are not provided. On the expenditure side, the main discretionary measures with an incremental impact in 2015 are the continued freeze in public sector hiring, unspecified savings at regional level and savings under the public and local administration reform. The main consolidation efforts for 2016 presented in the programme concern planned savings at regional level and further savings from the public and local administration reform. For 2017 the programme does not specify any measures to underpin the envisaged further reduction in the deficit.

Risks to the deficit adjustment path presented in the stability programme are tilted to the downside. In particular, while the macroeconomic scenario underpinning the budgetary projections in the programme is broadly plausible for 2014, the budgetary targets for 2015 and beyond rely significantly on the underlying scenario of accelerating GDP growth. There is uncertainty regarding the revenue projections from 2015 onwards, as the source of additional regional revenues and the changes to the tax legislation in the framework of the planned tax reform are not sufficiently specified. The yield of planned savings from the local government reform and at the regional level is still uncertain and subject to significant implementation risks, which could be further heightened by the upcoming elections in 2015. Moreover, maintaining the public sector pay and hiring freeze may prove increasingly difficult the longer it has been in place. Other risks to the budgetary strategy are larger deficits in the social security system if employment growth falls short of expectations. Finally, contingent liabilities linked with asset protection schemes (guarantees) for financial institutions, the electricity tariff deficit and the financial health of toll road companies are significant.

Although Spain plans to meet the headline EDP targets recommended by the Council in June 2013, the planned fiscal efforts falls short of the Council's recommendations. After marginally missing the headline deficit target in 2013 (excluding the costs for bank recapitalisations within the framework of the financial sector programme) the headline deficit target for 2014 (5.5 % of GDP) is more ambitious than the EDP target of 5.8 % of GDP while for 2015 and 2016 the programme targets are set in line with the EDP targets of 4.2 % and 2.8 % of GDP, respectively. However, in terms of the structural balance, the programme foresees an improvement in the (recalculated) structural deficit of 0.7 % of GDP in 2014, 0.2 % of GDP in 2015, 0.5 % of GDP in 2016 and 0.7 % of GDP in 2017. For 2014, the programme assumes deficit increasing one-off measures of 0.2 % of GDP related to the introduction of a temporary flat social security rate on new permanent employment contracts and to the European Court of Justice decision on illegally levied special taxes, 'centimo sanitario', whereas in the Commission 2014 spring forecast only the latter measure is considered as a one-off measure to be excluded from the structural balance. Overall, the annual improvement in the structural balance falls below the structural effort recommended by the Council (see Box 2). For 2017, after the planned correction of the excessive deficit, the programme foresees adequate progress in structural terms, by 0.7 pp., towards achieving the MTO, which based on the (recalculated) structural balance, would not be reached within the programme period.

In the Commission 2014 spring forecast, the general government deficit is forecast to decrease to 5.6 % of GDP in 2014, over-achieving the EDP target, and to rebound again to 6.1 % of GDP in 2015 (based a no-policy change assumption), above the EDP target. While the improvement in the structural balance for 2013 is 0.2 pp. above the effort in the EDP recommendation, the cumulative change in the structural balance over 2013 and 2014 falls somewhat (0.2 pp.) short of the EDP recommended value. When corrected for revisions in potential output growth and for unexpected revenue windfalls/shortfalls, the cumulative change in the structural balance for 2013-14 falls short by 1.1 pp. of the recommended adjustment (although this figure is inflated by recent changes in the methodology for the estimation of potential output).[7] Over the same period, the fiscal efforts calculated according to the bottom-up methodology, which estimates the size of the additional effort on the basis of the discretionary revenue measures and the expenditure developments under the control of the government between the baseline scenario underpinning the EDP recommendation and the Commission's 2014 spring forecast, fall short by 0.4 pp. compared to the amount of measures estimated as necessary at the time of the EDP recommendation. For 2015, the structural deficit is projected to deteriorate by 1.1 pp. to 3.4 % of GDP based on a no-policy change assumption, in contrast to the programme which projects the structural deficit to improve by 0.2 pp. The no-policy-change assumption in the Commission's forecast implies among others that a sizeable amount of revenue measures of about 1.2 % of GDP, which were announced as temporary before the cut-off date of the forecast, are projected to expire in 2015, which significantly contributes to the deterioration in the deficit.[8]

The general government debt-to-GDP ratio has been on a steep upward path since reaching a low of about 36 % of GDP in 2007. In 2013, it rose further to almost 94 % of GDP. The debt ratio is projected to continue to increase over the programme period, peaking at close to 102 % in 2015, well above the Treaty reference value in all years. This increase in debt is mainly driven by high interest payments and to a lesser extent by the dynamics in the primary deficit, which is expected to turn into a surplus in 2016. According to the programme, the stock-flow adjustment contributes 1.7 pp. in 2014 and one additional percentage point accumulated over 2015-17. The trend in the debt ratio may be more unfavourable than projected in the programme if risks related to the budgetary targets materialise.

The stability programme foresees most of the consolidation over the 2013-17 period to take place on the expenditure side. While this is consistent with keeping tax pressure low, it also calls for reviewing systematically expenditure at all government levels to identify areas where savings could be made and to ensure that these are generated in a growth-friendly way while catering for the needs of the most vulnerable. Key categories of spending have been reviewed recently on occasion of the health, education and public administration reforms, the implementation of which is ongoing. Looking forward, reviews could be extended to areas such as spending on active labour market policies, for instance to re-assess the efficiency and efficacy of current hiring subsidies (see section 3.3). Additional reviews on public administration spending could also take place, especially at sub-central government level.

Box 1. Main measures

After relying on a number of tax increases in 2012-14, such as personal and corporate income taxes, VAT and environmental taxes, the measures presented in the programme are more clearly tilted towards the expenditure side in the latter years of the programme. Notably, the programme relies on a continuation of the hiring freeze, deceleration of social transfers as a result of the pension indexation reform, and continued expenditure restraint at regional and local government level. The reform of local government and other savings at local level are expected to yield increasing savings, reaching 0.6% of GDP over 2015-2016. The table only includes measures that have been specified in sufficient detail. In addition, for the years 2015-2016, the programme also refers to a number of other unspecified measures, in particular on the revenue side.

Main budgetary measures

Revenue || Expenditure

2013

· Income tax and taxes on non-residents (0.2 % of GDP) · Excise taxes and environmental taxes (0.3 % of GDP) · VAT (0.8 % of GDP) · Revenue measures at regional level (0.2 % of GDP) · Social contributions (0.2 % of GDP) || · Christmas bonus reintroduction (-0.5 % of GDP) · Public employment (0.3 % of GDP) · Labour market policies (0.3 % of GDP) · Long-term care (0.1 % of GDP) · Regional measures, excl. public employment measures (0.7 % of GDP) · Local government reform and adjustment plans (0.1 % of GDP) · Other, incl. CORA (0.4 % of GDP)

2014

· Corporate income tax (0.2 % of GDP) · Measures combatting fraud (0.1 % of GDP) · Revenue measures at regional level (0.3 % of GDP) · Environmental taxes (0.1% of GDP) · Social security (0.1% of GDP) · Local government measures (0.1% of GDP) || · Public employment (0.2 % of GDP) · Labour market policies (0.1% of GDP) · Regional measures, excl. public employment measures (0.1 % of GDP) · Local government reform and adjustment plans (0.1 % of GDP) · Social security (0.1 % of GDP)

2015

|| · Public employment (0.1 % of GDP) · Local government reform and adjustment plans (0.4 % of GDP) · Social security (0.1 % of GDP)

2016

|| · Public employment (0.1 % of GDP) · Local government reform and adjustment plans (0.3 % of GDP) · Social security (0.1 % of GDP)

Note: The budgetary impact in the table is the impact reported in the programme, i.e. by the national authorities. A plus sign implies that revenue increases or expenditure decreases as a consequence of this measure.

Macro-structural measures presented in the programme include, among others, measures on labour markets, insolvency procedures, regulation of electricity prices, local governments and to increase competition in railway and air transport (see Section 3.3). The aim of the measures is to improve the working of the labour market in order to reduce the high level of unemployment, sustain the deleveraging in the private sector, and boost competition.

Box 2. Excessive deficit procedure for Spain

Spain is currently subject to the corrective arm of the Stability and Growth Pact. The Council opened the excessive deficit procedure for Spain on 27 April 2009, in accordance with Article 104(6) TEC. On 21 June 2013, the Council issued its most recent recommendation to correct the excessive deficit by 2016 in accordance with Article 126(7) TFEU and Article 3 of Council Regulation (EC) No 1467/97 of 7 July 1997 on speeding up and clarifying the implementation of the excessive deficit procedure.

To this end, the Council recommended that Spain should reach a headline deficit target of 6.5% of GDP in 2013, 5.8% of GDP in 2014, 4.2% of GDP in 2015, and 2.8% of GDP in 2016, which is consistent with an improvement of the structural balance of 1.1%, 0.8%, 0.8%, and 1.2% of GDP in the years 2013-2016 respectively, based on the Commission's 2013 spring forecast extended to 2016. Spain was also recommended to (a) implement the measures adopted in the 2013 budget plans at all levels of government and stand ready to take corrective action in case of deviations from budgetary plans; (b) reinforce the medium-term budgetary strategy with well-specified structural measures for the years 2014-16 that are necessary to achieve the correction of the excessive deficit by 2016; (c) strengthen the effectiveness of the institutional framework by raising further the transparency in implementation of the budgetary stability law as well as by establishing an independent fiscal council to provide analysis, advice and monitor compliance of fiscal policy with national and EU fiscal rules; (d) undertake concrete steps to rein in the increasing structural deficit in the social security system, and (e) give a greater emphasis to the growth friendliness of the consolidation, including by conducting systematic reviews of expenditure and the tax system. In addition, to ensure the success of the fiscal consolidation strategy, the Council highlighted the importance of backing the fiscal consolidation by comprehensive structural reforms, in line with the Council recommendations addressed to Spain in the context of the European Semester and the Macroeconomic Imbalances Procedure.

On 15 November 2013, the Commission concluded that, based on its 2013 Autumn Forecast, for 2013 Spain had taken effective action in compliance with the revised Council recommendation of 21 June 2013, provided that risks to the budgetary targets were dispelled. As regards 2014, the assessment pointed to risks of non-compliance. For 2015 and 2016, the budgetary adjustment still fell far short of the recommendation.

The year following the correction of the excessive deficit, Spain will be subject to the preventive arm of the Pact and should ensure sufficient progress towards its MTO. As the debt ratio in 2016 is projected in the programme at 101.5% of GDP, exceeding the 60% of GDP reference value, during the three years following the correction of the excessive deficit Spain will also be subject to the transitional arrangements as regards compliance with the debt criterion, during which it should ensure sufficient progress towards compliance.

An overview of the current state of excessive deficit procedures is available on: http://ec.europa.eu/economy_finance/economic_governance/sgp/deficit/countries/spain_en.htm.

Fiscal framework

In 2013, the transparency of budget execution improved considerably. This followed the publication of more systematic and higher-frequency regional and local government budgetary data, both in terms of cash and national accounts.[9] In addition, the Ministry of Finance issued detailed and comprehensive evaluation reports of regionsʼ economic and financial plans. It has also requested regions at risk of non-compliance with the 2013 target to adopt corrective measures, and the content of these measures was disclosed for the first time. Specifically, in November 2013, Andalusia, Catalonia, Valencia and Murcia were required to take additional measures in order to reach their 2013 fiscal target. However, the full range of the enforcement mechanisms set out in Spainʼs budget stability organic law for non-compliant regions has not been fully utilised so far. Regional governments failed to meet the 2013 fiscal deficit target of 1.3% of regional GDP by a relatively small margin, but the overall budgetary outcome masks differences among them.

Spainʼs independent fiscal institution (Autoridad independiente de responsabilidad fiscal or AIREF) was created in law in November 2013, its president appointed in February 2014 and its statutes published on 30 March 2014. AIREF has an initial budget of around EUR 4 million for 2014. While the launch of the independent fiscal institution is welcome, it is coming after the 31 October 2013 deadline set out in EU law to have such monitoring institutions in place and too late for AIREF to be able to assess the 2014 stability programme. In line with the law, the AIREF will have to issue reports and opinions, including endorsing macroeconomic forecasts, and produce studies (resources permitting) upon the request of specific administrative bodies. The independence of the AIREF and its president is protected by several articles of the law, although this could have been further underpinned with regard to its administrative location (currently attached to the Ministry of Finance, instead of, for example, the Spanish Parliament or the Ministry of the Presidency as suggested by the Spanish Council of State).[10]

Measures have been taken to reduce public-sector commercial arrears.[11] Information available shows that Spainʼs public sector has relatively high payment duration (155 days in 2013, well above the EU average of 65 days, with only limited progress over time).[12] In particular, Organic Law 9/2013 on the control of the public sector's commercial debt aims to enforce an average payment period to commercial suppliers of 30 days across all general government levels. This is to be done by periodically publishing payment periods for each administrative body (this obligation had been followed up partially at the cut-off date of this report, as the implementing legislation had not been issued) and by strengthening the powers of the Ministry of Finance to enforce correction mechanisms and impose penalties on non-compliant administrations. These provisions follow the repayment of large public sector arrears deriving from regions and local entitiesʼ commercial debt: EUR 41.8 billion have been paid since 2012 through the three stages of the Suppliersʼ Payment Scheme. The new provisions can create incentives at all government levels to speed up payments to commercial suppliers. However, reducing the payment period of Spain's administrative bodies to an average of 30 days is a challenge, in particular, at sub-central government level.

Long-term sustainability

Amongst the 2013 country-specific recommendations for Spain were the need to improve the long-term sustainability of the pension system and to increase the cost-effectiveness of the health-care sector, while maintaining accessibility for vulnerable groups. The analysis in this SWD leads to the conclusion that Spain has made substantial progress on some aspects, and some progress on others (for the full CSR assessment see the overview table in Section 4).

Spain appears to face high fiscal sustainability risks in the medium-term, primarily related to high level of government debt. Government debt (93.9 % of GDP in 2013 and projected to rise to 103.8 % in 2015 in the Commission's spring 2014 forecast under a no-policy change assumption) is currently well above the 60 % of GDP Treaty threshold. While the debt ratio is projected to fall by 2030, it would remain above 60 %. However, the full implementation of the plans in the stability programme would put debt on a decreasing path and it would fall below the 60 % of GDP reference value by 2030. The medium-term sustainability gap, showing the adjustment effort up to 2020 required in the structural primary balance to bring debt ratios to 60 % of GDP in 2030, is at 2.6 % of GDP, relative to the 2015 primary balance in the Commission 2014 spring forecast. In the long-term, Spain appears to face low fiscal sustainability risks: the long-term sustainability gap, showing the adjustment effort in the structural primary balance needed to ensure that the debt-to-GDP ratio is not on an ever-increasing path, is at 0.3 % of GDP. As a result of the recent pension reforms, the costs of ageing[13] (as a ratio to GDP) are projected to decrease by 1 pp. of GDP over the very long run, almost offsetting the impact of the initial budgetary position on the long-term sustainability. However, the contribution from health care expenditure is relatively large (the projected increase in expenditure is 1.2 pp). There is also a risk that the structural primary balance reverts to lower values observed in the past (e.g. the average for the period 2004-2013). It is therefore appropriate for Spain to reduce government debt and further contain age-related expenditure growth to contribute to the sustainability of public finances in the long term.

An important reform of the pension system was approved on 23 December 2013. Law 23/2013 revising pension indexation and regulating the pension sustainability factor complements the 2011 pension reforms and the measures to reduce access to early and partial retirement that were adopted in March 2013. The law changes the annual indexation of pensions as of 2014, by linking it to the financial balance of the system, with minimum (0.25 % in nominal terms) and maximum (0.5 % in real terms) thresholds. At the end of December, based on the new law, the government adopted a nominal indexation of pensions by 0.25 % for 2014. From 2019, the law also introduces the automatic adjustment of future retirees’ new pensions to take account of changes in life expectancy. The reform will help to contain long-term pressure on pension expenditure. According to the latest projections, public pension expenditure in Spain will decline from 10 % of GDP in 2010 to 9.6 % in 2060, compared with a projected 13.7 % of GDP in 2060 before the reform. However, the sustainability factor formula does not link the statutory retirement age to life expectancy, heightening the challenge of pension adequacy for lower pensions.[14] High levels of inactivity, lengthy unemployment periods and gender disparities in employment and contributory periods may have a negative impact on future benefits. Minimum contribution periods for pensions were adjusted for part-time workers (who are mainly women), following a ruling of the European Court of Justice.

A comprehensive regulatory framework has been developed since 2012 to increase the efficiency and control of health-care expenditure. This includes: reviewing the services covered; introducing co-payments for some services; changing the reference pricing for pharmaceuticals; building a centralised purchasing platform for buying medicines, medical devices or services; developing digital clinical records and electronic prescriptions; and, preparing for the introduction of clinical management where physicians have more responsibility for their budgets in health establishments. A system of pharmaceutical expenditure control in hospitals has also been designed. The measures that have already been implemented have helped to reduce expenditure and to increase cost-effectiveness. While full implementation of the measures adopted continues, the impact of recent reforms will need to be monitored and evaluated to prevent unwarranted effects. As the system moved from a universal health system to a coverage approach, the number of complaints about restrictions on access grew. In addition, an increase in waiting lists has been noted, despite initiatives to guarantee accessibility for vulnerable groups. Measures to improve coordination of health and social services are also being developed to make the healthcare model more efficient in the long-term.

The long-term care system has faced significant challenges. The reduction in central budget contributions to financing the long-term care system has halted the gradual roll-out of the system and reduced the numbers of current and future beneficiaries. Spain is among the Member States with the highest proportion of informal carers, and care needs are likely to increase further due to the ageing population. As institutional care is considerably more expensive than home care, it seems sensible to find strategies to formalise support for informal carers, including by improving the quality of home- and community-based services.

Tax system

In 2013, Spain was recommended to review and reform its tax system in order to raise revenue in a way that is growth-friendly, contributes to employment and improves tax compliance. Overall, the analysis in this SWD leads to the conclusion that Spain has made some progress to design the measures to be taken addressing this recommendation (for the full CSR assessment see the overview table in Section 4). The crisis revealed significant shortcomings in the Spanish tax system, adversely affecting economic efficiency and fiscal performance. The bursting of the construction and housing bubble and the ensuing recession led to a significant erosion of tax bases in Spain. In 2012, the tax-to-GDP ratio in Spain reached 32.5 %, much below the EU-28 average of 39.4 %, and below the national average over the last decade (33.9 %). Thanks to a number of discretionary tax increases and a stabilisation of output, the ratio bottomed out in 2013.

In response to last year's country-specific recommendation to undertake a systematic review of the tax system by March 2014, the government appointed an expert committee last July. On 13 March, it delivered its report (see Box 3), which focuses on simplifying the tax system and increasing its efficiency, inter alia, by lowering the relatively high statutory tax rates while broadening the tax bases, and suggests a revenue-neutral tax shift away from direct taxes towards indirect taxes. However, the committee's report lacks detail on the quantitative impact of specific measures and their effect on income distribution, making their relative importance difficult to assess. Following this report, the NRP undertakes the commitment to present a tax system reform by the second quarter of 2014. Its main objectives will be: modernizing the tax system, addressing its disincentives to employment – reducing the tax wedge - and the low tax revenues, fostering economic development, guaranteeing market unity and tax neutrality and improving competitiveness.

Box 3. Report from the committee of experts on the reform of the Spanish tax system

The general direction of the proposals is to broaden tax bases to allow for a lowering of nominal and marginal tax rates and to move the burden of taxation away from direct taxation towards indirect taxation. The committee, led by Prof. Manuel Lagares, preferred not to enter into a discussion on the optimal level of taxation and thus worked under the assumption of constant overall tax revenues in percent of GDP in the coming years. The experts also recommend actions to combat tax fraud and preserve market unity. These principles have guided the committee to make the following main recommendations:

Personal income tax: Maintain the dual system of a standard base and a savings base, but reduce progressivity in the taxation of the former and reduce the number of tax brackets. Tax the savings base at a single rate close to its current lowest rate. Broaden the tax base by eliminating or reducing exemptions and deductions.

Corporate income tax: Allow a gradual lowering of the nominal tax rate from 30% to 20% by eliminating deductions, so that the effective and legal tax rates converge. Eliminate the differentiation of tax rates according to firm size to improve incentives for firms to grow.

Value added tax: Raise the super-reduced and reduced rates to the general rate of 21% in the long run, but with the following exceptions and provisos: a) Only increase the super-reduced rate if compensatory benefits to those with the lowest incomes are introduced simultaneously; b) only consider bringing tourist services to the general rate if combined with a substantial reduction in social security contributions; c) do not raise the VAT rate for housing to the general rate for the time being, as it would complicate the unwinding of the significant stock of unsold houses in Spain; d) maintain the reduced rate for public transport services, given their positive environmental effects. To reduce fraud, eliminate the special retailers' regime and the simplified VAT regime.

Excise duties and environmental taxes: Periodically revise excise duties on alcohol and tobacco to maintain their weight on the consumer price and to gradually bring them in line with those in the rest of Europe. In environmental taxation, tax separately the carbon dioxide and energy content of products to ensure the neutrality of the tax system between various energy sources. To this effect, bring the tax on diesel fuel into line with that on petrol and change the rate and eliminate exemptions from the coal tax. Replace the tax on the invoiced amount of electricity sales with one based on kW/h consumed to encourage energy efficiency. Eliminate certain allegedly environmental taxes at regional level that hamper market functioning or simply do not achieve their purpose and replace them with national level taxes.

Social contributions: Eliminate non-discriminatory rebates in favour of more targeted rebates directed at particularly underprivileged groups that cannot be reached by other more efficient means.

Combating tax fraud: Implement the recommended reductions in tax rates to reduce incentives for fraud. Provide sufficient resources to tax authorities to enable them to fight fraud, notably through large-scale and coordinated processing of information.

Decentralised taxation: Given the relatively high level of decentralisation of revenue in Spain, the report puts forward key principles to avoid that decentralisation hamper the unity of the internal Spanish market and economic neutrality. To this end, a mechanism of ex ante coordination for regional governments' taxation is also proposed.

There remains scope to increase consumption taxes and improve their efficiency by broadening the VAT base. In 2012, VAT rates were raised and the base of the reduced rate was narrowed. However, in January 2014, it was decided that imports and certain transactions regarding art, antiques and collectibles should be moved from the standard to the reduced rate. Excise taxes (levied at lump-sum rates) on alcohol and alcoholic drinks were increased, as of June 2013, by approximately 10 %, although this does not apply to beer or wine. Tobacco excise duties were also increased. Despite these increases, overall progress appears limited. The NRP does not foresee further measures to broaden the standard VAT rate base. Certain measures taken to foster entrepreneurial activity (such as the VAT special cash accounting scheme) are announced to remain in place.

Revenues from environmental taxes, expressed as a percentage of GDP, remained among the lowest in the EU in 2012, with low revenues from energy and transport fuel taxes. Following the package of taxes that entered into force on 1 January 2013, further progress includes a new tax on fluorinated greenhouse gases, applicable from 1 January 2014 and which according to the NRP should yield 400 million euros in 2014. No progress, however, seems to have been done on fuel taxes, expressly mentioned in the 2013 country-specific recommendations, and where there is scope to address the preferential treatment of diesel compared with petrol. The expert committee’s report contains a number of proposals in this area which aim to rationalise and increase the weight of excise duties and environmental taxation. The NRP refers to further studies to increase environmental taxation while minimising the impact on competitiveness. The NRP also refers to certain progress made in this area at regional level, since several regions have created new environmental taxes or have increased the rates of existing environmental taxes.

Limited progress has been made on reducing high tax expenditure in direct taxation, as proposed in the 2013 CSR. There is scope to downscale tax expenditures by assessing their effectiveness and likelihood of achieving their goals. Despite the restriction in some deductions – depreciation rates, value depreciation of shares and financial goodwill, loss offsetting, recent trends show that new discretionary measures were created or extended. Altogether, tax expenditures set out in the 2014 budget amounted to around 2 % of GDP. In this respect, the expert committee also recommended eliminating exemptions and deductions, while lowering headline tax rates.

In line with the 2013 CSRs, new measures to address the debt bias in corporate taxation were introduced, but with likely only indirect effects. The measures adopted in 2013 include deductions for reinvested profits and for shares acquired in newly set up companies. However, these measures may only indirectly limit the debt bias and their effectiveness will have to be monitored over time, also as there are . It is difficult at this stage to ascertain whether and to what extent the measures adopted since 2012 might have contributed to the ongoing deleveraging in the corporate sector

Property taxation is still to a large extent transaction-based. Although revenues from recurrent property taxes increased in 2012 to 1.2 % of GDP, property transaction taxes still account for a large proportion of property taxation. To ensure a more stable tax base and in order not to hamper labour market mobility, property taxation could be further shifted towards recurrent taxes, as the NRP proposes to analyse further.

A shift from taxes on labour to mainly indirect taxes could play a role in addressing Spain's unemployment challenges, although it is not a panacea as other structural factors mostly explain the labour market outcome.[15] Spanish labour tax rates are not high in comparison with other EU countries: the implicit tax rate on labour (33.5 %) and the proportion of an individual total wage paid as tax (37 %) are below the EU average. The announcement of the NRP to increase the exemption of labour income earners with income below EUR 12.000 should contribute to reduce the tax wedge of the low-skilled. While employees' social security contributions are relatively low, employers contributions are relatively high (8.4 % of GDP in 2012, accounting for 25.8 % of total taxation — the fourth highest value in the EU — and 70 % of the total contributions). Focusing cuts on employer's social security contributions (in particular for low-wage earners) may thus have a more immediate impact on employment than reducing the personal income tax rate. In 2013, Spain introduced reductions in social security contributions for hiring young people and in February 2014, the government also introduced a temporary low flat-rate social security contribution for new permanent contracts, in order to support employment and improve incentives to leave the informal sector (see also section 3.3 on the labour market). This measure increases incentives to hire permanent staff during the period of validity (until the end of 2014). There is a risk, however, that it may carry a non-negligible fiscal cost relative to its impact on net employment creation.

In the fight against fraud, Spain has made efforts to tackle aggressive tax planning and organized crime, control electronic commerce and online gambling and extend its network of international agreements to exchange information relevant for tax assessments. The returns from auditing and control activities and the improvement of the tax assessment yield about EUR 11 billion according to the NRP. The new reporting obligations regarding assets held abroad affected 131 000 taxpayers, who reported assets valued at EUR 87 billion. In 2014 a special plan to combat grey economy has been launched, which will provide for an increase of the staff's working hours to run e-audits. Spain also launched a project with private companies to study potential improvements in managing the benefits system. Still, the Spanish tax administration neither estimates nor monitors the tax gap. As the ceiling for cash payments – EUR 2 500 – is higher than in other Member States with similar challenges, [16] there seems to be scope to expand the use of electronic payments - a useful measure to reduce the underground economy. The implementation of the 2012-2014 national plan against irregular work and social security fraud continued, including strengthened monitoring and checks to combat sham companies, irregular employment and social security fraud, and undue benefit collection.[17] The intensification of social security checks resulted in a reported 30.6 % increase in identified infringements by employers who employed recipients of unemployment benefits or provided access to such benefits without cause, and a 28.9 % increase in identifying the illegal combination of unemployment benefit receipt and work.[18] As recommended by the experts' committee, Spain could also usefully consider – among other measures – expanding the use of data matching to detect tax evasion and fraud.[19]

Box 4: Conclusions from the March 2014 in-depth review on Spain

The third in-depth review (IDR) on Spain under the Macroeconomic Imbalances Procedure was published on 5 March 2014. [20] On the basis of the IDR, the Commission has concluded that Spain is experiencing macroeconomic imbalances which require specific monitoring and decisive policy action. In several aspects, the adjustment of the imbalances identified last year as excessive has clearly progressed and the return to positive growth has reduced risks. However, the magnitude and inter-related nature of the imbalances, in particular high domestic and external debt levels, mean that risks are still present. The main conclusions of the IDR, many elements of which are taken up and further developed in this staff working document, can be summarised as follows:

- The adjustment has been supported by decisive policy actions at the EU level and at national level. In particular, the recapitalisation and restructuring of weaker banks has dispelled systemic concerns about the financial sector and allowed a smooth conclusion to the financial assistance programme at the beginning of 2014. The current account has turned into surplus, as a result of import compression and strong exports, supported by competiveness gains. The housing market has nearly stabilised. The pace of job losses appears to be coming to an end. The comprehensive agenda of structural reforms outlined in the 2013 national reform programme has been mostly completed, and attention is shifting to a challenging implementation phase. These positive developments have led to a strong return of confidence, shown by the fall in market risk premiums, the return of foreign capital inflows and the rise in business and consumer confidence.

- However, the adjustment is far from complete and vulnerabilities persist: the very high stock of private and public debt, both domestic and external, continues to pose risks for growth and financial stability; unemployment remains at alarming levels; maintaining the re-orientation of the system of production towards exporting sectors and recovery in international competitiveness is key to reducing the very large stock of external liabilities; the adjustment of private-sector balance sheets is advancing, although at a limited pace due to high unemployment and falling incomes, while non-financial corporations have reduced debt at a somewhat more sustained pace.

The IDR also discusses the policy challenges stemming from these imbalances and the possible ways to address these. A notable challenge will be ensuring that deleveraging goes hand-in-hand with positive credit flows to financially healthy borrowers, including by removing hindrances to the functioning of the product and financial markets and efficient insolvency procedures. Building on recent reforms to internal flexibility and wage setting, additional reforms could be envisaged to the labour market. Future reform of the tax system, still to be developed, could help make the tax system more growth-friendly and make tax revenues less volatile. Finally, significant revenue shortfalls, higher social expenditure and the costs of bank recapitalisation have led to substantial pressure on government deficits and a steep rise in government debt. Sustained fiscal efforts will be required to ensure a reduction in government debt in the medium term.

3.2. Financial sector

Spain has successfully concluded the financial sector programme for the recapitalisation of its financial institutions. The 2013 CSR on implementing the financial sector programme in Spain has been fully addressed, and the conditionality included in the Memorandum of Understanding has been met, as confirmed by the final programme review in December 2013.[21] The programme contributed to improving the solvency and liquidity position of Spanish banks and to a strengthening of financial sector governance and regulatory and supervisory procedures. In particular, European Banking Authority core tier 1 ("capital principal") reached 11.5 % at the end of 2013. In addition, banks are shifting towards more stable funding sources like retail deposits, and thus reducing their reliance on the Eurosystem and on wholesale markets.

However, the financial sector still faces with significant challenges and risks that need to be carefully monitored and managed. Despite recent improvements, the broader economic environment has continued to weigh on the banking sector. The profitability of the banking sector will be subject to pressures stemming from asset quality developments and lower volumes of intermediation. In particular, high unemployment and the ongoing housing market adjustment have continued to put strains on asset quality. Non-performing loans have been on an upward trend until December 2013, when they reached 13.6 % of total loans, but have since then mildly declined to 13.4 % in March 2014.[22] The coverage ratio of non-performing loans is comfortable. Credit contraction has been the main channel of private-sector deleveraging, with bank lending on a declining path since 2007. Recent data shows some deceleration in this contraction and new credit to non-financial companies has started growing again.

Spain is expected to ensure the full implementation of the policy measures initiated under the Memorandum of Understanding and to make further progress in stabilising the banking sector. These include, in particular, completing the reform of the saving banks sector, implementing measures to improve non-bank financial intermediation, completing banksʼ restructuring plans and continued monitoring of Sarebʼs activity.[23]

It is important to ensure that credit continues to flow to viable sectors of the economy, as the deleveraging of the corporate sector continues. In spite of the improvements in the liquidity and financing of the financial sector, credit conditions for smaller borrowers are being eased only slowly and remain relatively onerous (although the latest data, such as the Bank Lending Survey for the first quarter of 2014 and the April 2014 ECB survey of SME, show a more marked relaxation of lending conditions for SMEs). Going forward, banks faced with a historically high level of non-performing loans may have become structurally more prudent in their lending and SMEs may be disproportionally affected by the ongoing bank restructuring, through weakened or broken long-term lender/borrower relations. Specifically, inadequate access to finance for fast-growing firms operating in innovative and knowledge-intensive sectors may hamper the creation and development of start-ups and technology-based SMEs, both critical for spurring long-term growth.

Spain has taken policy actions to ease SMEs access to finance. Access to non-bank finance is being improved, with the development of alternative capital and debt markets and venture capital. The first tender for allocating investment commitments in the venture and development capital funds of ICO[24] Fondo Global was awarded and three other tenders are planned for 2014. The alternative bond market for SMEs (MARF)[25] has become operational and the first issuance on this market took place in December 2013, while several others are in the pipeline. The volume of the ICO's on-lending programme for SMEs via commercial banks has increased significantly, to EUR 13.8 billion in 2013, and its funding rates to banks continued to decline, supported by funding deals with KfW and the European Investment Bank. A broad-based legislative package, which is currently being finalised, aims to facilitate access to finance for SMEs and other non-financial corporations by, inter alia, improving (i) access to financial information (banks are required to give prior notice and disclose their internal creditworthiness assessment of a company before restricting or cancelling its access to financing); (ii) the CERSA (Compañía española de reafianzamiento, S.A.) regime of mutual guarantees; (iii) the arrangements for securitisation; and (iv) the two-way transit between the traditional and the alternative stock markets. Further policy actions could be considered to improve the efficiency of the existing instruments and the allocation of the available resources, taking into account the possibilities offered by increased used of the European structural and investment funds to set up revolving funds. Facilitating companies' access to debt and equity markets and developing venture capital instruments should broaden the set of financial instruments available to Spanish companies in the long run.

The corporate insolvency framework was reviewed in September 2013 and March 2014, but it is too early to assess the impact of these revisions. Inefficiencies in personal and corporate insolvency procedures may delay private-sector deleveraging and the re-allocation of resources by impeding swift recognition and work-out of unsustainable private debt or by unnecessarily pushing viable firms into liquidation. Law 14/2013 on entrepreneurship has addressed some of the apparent shortcomings of the insolvency framework for corporations, by introducing a new debt refinancing procedure with the possibility of a partial debt discharge. The law has also created a limited liability company ‘in formationʼ with lower capital requirements and narrowed personal liability of limited liability entrepreneurs. Increasing the efficiency of the pre-insolvency regime was the main focus of Royal Decree-Law 4/2014 of 7 March 2014, which facilitates further negotiation of refinancing agreements to accelerate the deleveraging process. It will be important to monitor the actual take-up of these broader options to gauge their effectiveness, including monitoring their effect on companies of different size. However, provisions giving second chance to entrepreneurs have not yet been fully developed in Spain, as debt discharges are not automatically applied after a certain period of time.[26] Both the pre-insolvency and insolvency proceedings available seem to offer insufficient incentives to their use by SMEs, as they often exclude some categories of creditors, or limit available options under restructuring plans.

Dealing with the legacy debt of overly indebted individuals could be facilitated by developing a permanent framework for personal insolvency, with due regard for the stability of the financial sector. Some gradual reforms have been introduced to reduce debt-related distress for residential mortgage debtors, but their scope still seems to be insufficient. The current legal framework does not generally allow for the possibility of debt discharge for financially responsible personal debtors. In May 2013, the Spanish Parliament adopted Law 1/2013 on strengthening protections for mortgage debtors, on debt restructuring and on social housing. The law builds on legal acts adopted in 2012, and has tightened conditions for launching foreclosures.[27] These emergency provisions tried to strike a balance between providing relief to over-indebted insolvent households and preserving financial stability. However, according to the available data, their take-up has been limited. A careful evaluation of the effectiveness of these temporary measures (including partial debt discharge) and measures to strengthen consumer protection (i.e. cap on the penalty interest rate) could help defining a medium- and long-term institutional and regulatory framework with due concern for balanced creditor/borrower rights, the stability of the financial sector and overall economic efficiency.

3.3. Labour market[28], education and social policies

Challenges regarding labour market, education and training, social inclusion and poverty remain considerable, notwithstanding the significant reforms, particularly in the labour market. Almost 200 000 jobs were lost only in 2013; overall, 3.6 million have been lost since the crisis began. Following the incipient economic recovery and the unfolding effect of the reforms and measures put in place, the labour market is showing signs of stabilisation since the end of last year. The employment rate stopped its decline in the fourth quarter of 2013, and employment is expected to grow in 2014. Unemployment has been decreasing, initially due to a declining labour force, and is projected to continue falling in 2014. Nevertheless, the legacy of long-standing institutional failures in the labour market and of the financial crisis still weighs heavily on employment and social indicators: the employment rate remains well below the national target of 74 % by 2020, and unemployment remains high, particularly for the young people, the low-skilled and migrants. A large proportion of the unemployed has been jobless for more than a year, and is at risk of exclusion from the labour force, particularly those who are over 50. Gender[29] and regional differences in employment persist, further aggravated by a certain lack of adequate and affordable childcare facilities and insufficient geographical mobility. In 2013, wage moderation has come about as a result of the large slack in the labour market, the 2012-2014 inter-confederal agreement, public-sector wage cuts and changes in firms' internal flexibility. The rate of young people not in employment, education or training has remained high in 2013, at 18.6% for people under 25 years, and further increased to 29.5% for those aged between 25 and 29. Early leaving from education and training, although decreasing, remains very high. Vocational education and training and apprenticeship schemes, although rapidly expanding, are still insufficiently used.[30] Tertiary attainment rates remain constant. Finally, in 2012, Spain saw a further increase in the proportion of the population at risk of poverty or social exclusion, as well as the third largest fall in household disposable income in the EU, while income dispersion continued to increase, to one of the highest in the EU.

In 2013, Spain received country-specific recommendations concerning the labour market, education and training and social inclusion. The analysis in this SWD leads to the conclusion that Spain has made some progress on measures taken to address the recommendations on labour market and education and training, and on social inclusion. (For the full country-specific recommendations assessment, see the overview table in Section 4). The significance and urgency of the challenges in these fields makes it necessary to go further, in particular by fostering job creation, reducing labour market segmentation, enhancing the matching of education and training with labour market demands, reducing early school leaving, increasing participation in vocational education and training, tackling rising poverty and inequalities, and improving the coordination of institutions and policies in these fields.

Labour market

Recent labour market improvements are likely to be partly the result of labour market reforms. Evaluations of the 2012 comprehensive labour market reform conclude that this reform and the social partners' commitment to wage moderation from 2012 to 2014 have helped limit job losses.[31] The main mechanisms have been greater internal flexibility in companies, as the reforms prioritise collective bargaining agreements at company level over sectoral and regional level and increase possibilities for companies to opt out of a collective agreement, as well as wage moderation. The reform has also reduced the compensation costs for unfair dismissal and helped to lower the number of dismissals challenged in court. Other aspects of the reform, like the development of an individual right to training, are still under development.

High labour market segmentation is still a key characteristic of the Spanish labour market. Against the background of an uncertain economic outlook, the proportion of employees with fixed-term contracts in 2013 stood at 23.4 % (among the highest in the EU), and 84.9 % of the temporary jobs had a duration of less than 3 months. This, coupled with low levels of transition to stable jobs, raises concerns about, i.a., productivity, deterioration of job quality and low levels of training on the job, especially for young people and low-skilled workers.[32] The duration of probation periods is typically shorter than in some other EU Member States,[33] with the exception of people hired under the open-ended contract in support of small and medium enterprises introduced in 2012, which has a one-year probation period. Use of this type of contract is increasing, although at a slow pace. The simplification of contract templates, introduced in January 2014,[34] might further increase transparency of information on hiring options for employers. Yet, this administrative simplification is not accompanied by a streamlining of the high number of current contractual arrangements (currently 42). The gap in contract termination costs between permanent and temporary contracts remains above EU and OECD averages, although it is narrowing following the changes introduced by the 2012 reform and the gradual increases for fixed-term contracts introduced in 2010.[35]

A number of new measures have been adopted since the 2012 reform, without introducing major amendments to labour market regulation. In August 2013, Royal Decree-Law 11/2013 further clarified the collective dismissal procedure, made some modifications to the requirements for accessing unemployment benefits, and established a framework for cooperation between public employment services and private placement agencies. In December 2013, Royal Decree-Law 16/2013 introduced new measures and extended hiring incentives to facilitate stable part-time employment. The measure is driven by the relatively low number of part-time workers in Spain (16 % of total employment in 2013 versus the EU average of 19.9 %). However, a significant proportion of part-time employment in Spain is classed as involuntary (60.9 % in Spain versus 27.6 % in the EU). The same Royal Decree-Law introduced new rules concerning in-kind benefits for the calculation of employers' contributions to social security, which, eventually, might increase pension contribution bases but also have a small effect on labour costs. Another relevant measure, likely to have an effect on self-employment growth rates, is the extension of social security contributions rebates designed for young workers to newly self-employed people, included in the law on entrepreneurship passed last September. A new scheme for social security contributions was introduced at the end of February 2014, according to which a lump-sum contribution of EUR 100 per month is made for each new permanent contract signed before the end of 2014 and leading to net permanent employment creation over two years (with special provisions for companies of fewer than ten employees and part-time contracts). It would be expected to mostly have an impact on the choice of contracts, particularly for medium to high earners, as labour costs savings rise with income levels when such a lump-sum contribution is applied. In addition, a further streamlining of hiring subsidies under one piece of legislation has been also announced by the government. Lastly, reducing the gender differences in employment is one of the main objectives of the 2014-16 strategic plan for equal opportunities adopted on 7 March 2014. Swift implementation and close monitoring of the effectiveness and budgetary impact of these new measures will be necessary.

The geographical and skills mismatch between labour demand and supply, aggravated by the ongoing transformation of the Spanish economy, calls for the intensification of active labour market policies, the improvement of public employment services and further extension of vocational education and training. In line with the 2013 country-specific recommendations, national annual employment plans (Plan Anual de Politica de Empleo – PAPE) were adopted in August 2013 and the first semester of 2014. The employment plans confirm the new results-based system to allocate funds to the Autonomous Regions for the development of employment policies,[36] and are likely to help improve coordination and information sharing among regional and national public employment services. However, the division of responsibilities regarding active labour market policies between the central government and the Autonomous Regions means that the move to the new model is likely to be gradual and to face implementation risks. The assessment against the 2013 performance indicators, finalised in spring 2014, is expected to contribute to the further fine-tuning of this framework, including strengthening the incentives (in 2015, it is planned to distribute 60% of the funds to the Autonomous Regions according to the results obtained), simplifying the system of indicators and eliminating potential overlaps between national and regional public employment services. The transition to an evaluation and outcome-oriented system will be corroborated in the forthcoming 2014-16 activation strategy, likely to be adopted by mid-2014. The new strategy will frame all the policy interventions and measures regarding active labour market policies and public employment services. Its strategic objectives are detailed in the 2014 national reform programme: improving youth employability and implementation of the Youth Guarantee, improving employability of older workers and long-term unemployed, stepping up the quality of occupational training, reinforcing the links between passive and active labour market policies and supporting entrepreneurship. The government is working on the several legislative instruments that will be required to implement the activation strategy, most notably a common catalogue of employment services, which, inter alia, will detail the minimum services to be provided by the public employment service. Also, measures to better link active and passive labour market policies, including improving incentives to work, are being developed. The national reform programme details also the future reform of the continuous professional training model for workers, currently under negotiation with the social partners, which will be developed based on the principles of transparency and open competition, and will be subject to a systematic evaluation of results.

The swift implementation of the 2013-16 youth employment and entrepreneurship strategy, adopted in March 2013, should facilitate the entry of young workers into the labour market. Pending the first annual evaluation of the strategy, expected in summer 2014, preliminary national data point to widespread use of short-term measures, such as employment hiring incentives and social security rebates for hiring young workers.[37] The national Youth Guarantee Implementation Plan, submitted to the Commission in December 2013, builds on the youth entrepreneurship and employment Strategy (see Box 5).

Box 5: The delivery of a Youth Guarantee in Spain[38]

The most important challenges to deliver a Youth Guarantee (YG) in Spain are: [39]

- Risk that not all young people under the age of 25 years who are unemployed or who have left formal education are considered as target population.

- Non-availability of comprehensive ex-ante evaluation of the effectiveness and adequacy of the proposed short-term trainings, hiring subsidies and social security reductions to facilitate the sustainable labour market integration of young people.

- Lack of sufficient resources in the Public Employment Services, foreseen as the main entry point for the YG initial assistance, to provide adequate personalised guidance and individual action planning based on the profiles established initially.

- Unclear outreach mechanisms for non-registered unemployed or inactive youngsters.

- Need for better targeting of the regional disparities and needs,[40] continuous monitoring and effective coordination between the central authorities and the autonomous regions that will be among the main responsible for the implementation of the YG.

- Lack of complementary national funding, which could undermine the implementation of the Youth Guarantee in the short- and long-term.

Modernisation and strengthening measures for public employment services seem to be lagging behind, which could hinder the successful implementation of the new active labour market policies framework and the Youth Guarantee. Work continues on a single job portal, which is expected to bring together all national and regional public employment services information for jobseekers and employers. Framework agreements for cooperation between the public employment services and private placement agencies were signed with 14 out of 17 regions[41] and a total of 81 private agencies have been finally selected. Implementation is now underway. However, no specific measures have been taken so far to modernise and strengthen the capacity of the public employment services themselves, allowing them to provide effective, individualised counselling and job search assistance to those looking for jobs. The 2014 national reform programme provides detail of the deployment of an inter-regional best practice exchange programme on employment services. The strengthening of public employment services is also key for the modernisation of national European Jobs Network (EURES) services, which can play a significant role in cross-border recruitment, matching and placement.

Education and training

The 2013 organic law reforming education and training (LOMCE), adopted last November, aims to improve the quality of the Spanish education system and its links with the labour market. The law aims to address three main challenges: (i) the high early school leaving rate (which has wide regional differences); (ii) the insufficient use of vocational education and training; and (iii) the need to improve educational outcomes.[42] New provisions are expected, if effectively implemented, to lead to tangible results on lowering early school leaving. These provisions include compulsory evaluation of studentsʼ performance after completing primary and secondary education and the adaptation of curricula (aimed at improving performance rates), increased flexibility in the certification path, and a new two-year vocational training module that upgrades the PCPI (Programa de cualificación profesional inicial – Initial professional qualification programme), and allows students to obtain initial professional qualifications paired with basic skills by providing an alternative path to the compulsory education diploma. However, the absence of any provision to continue the actions developed by the PROA (Programa de refuerzo, orientación y apoyo – Support and guidance programme) programme to address early leaving is a matter of concern. The LOMCE will enter into force gradually, between the 2014/15 and 2016/17 academic years, although there are implementation risks at regional level, mainly due to the lack of agreement between the Autonomous regions and the State on its funding and implementation of particular provisions.

Some progress was made on implementing the dual vocational education and training system, but links between education and labour market policies could be further improved. Over the past year, Spain has further developed various modalities of dual vocational education and training by strengthening work-based learning. Use of paid internships and of training and apprenticeship contracts is progressing, but requires further monitoring to evaluate its effectiveness as an adequate labour market integration tool. All Autonomous Regions are implementing dual vocational education and training in one of the proposed modalities, with more than 9 500 students, 375 learning centres and 1 500 companies involved. However, the involvement of the business community is low: firms have little training capacity, largely due to the lack of tutors, which leads to a limited availability of traineeships, and the use of dual vocational education and training is clearly geared to tertiary level (72 % of the total current programmes), and private sector adherence is still low at basic level. In addition, the implementation of different dual models across regions and the differences between the Ministry of Education and the Ministry of Labour certifications can lead to compatibility issues. To combat this, strengthening the national qualification system could be a key tool to ensure coherence and comparability at national level.

Tertiary educational attainment continues to be relatively high, but the high unemployment and underemployment of university graduates remains a concern. At 14 % in 2012, graduate unemployment in Spain is well above the EU average (5.6 %). Under-employment, which seems to have a strong structural component,[43] remains the biggest challenge for this group. Consideration could be given to creating a comprehensive national strategy to improve the efficiency of tertiary education and its capacity to adapt to labour market needs. This strategy could help address skills mismatches, promote company-based internships, address potential overlaps at regional level and restructure, anticipate and reorient training and education to better meet future demand, including for green jobs.

So far, limited progress has been made on reinforcing the effectiveness of re-skilling training programmes for older and low-skilled workers, but the government and the regions are working on a common framework for the future lifelong learning plan. The draft plan (expected to be finalised in 2014) is intended to identify common issues and best practice across the Autonomous Regions, in line with a single lifelong learning framework at national level. Some positive steps were taken in regulating e-learning professional certificates and updating the national catalogue of professional certificates. The 2012 labour market reform also envisaged the widening of supply for occupational and continuous training courses and the creation of a new training account for each individual worker, but implementation of those measures has not yet been completed.

Social policies

The prolonged crisis has had a heavy impact on the number of people at risk of poverty or social exclusion,[44] which reached 28.2 % of the Spanish population in 2012.[45] The deterioration of the labour market and the sharp escalation in the number of households with low work intensity[46] have led to a rise in the rates of people at risk of poverty or social exclusion amongst the working-age population and large increases in poverty amongst both unemployed and employed people, with in-work poverty rates reaching the third-highest level in the EU (12.3 %) in 2012, mainly as a result of lower household work-intensity. Poverty levels among children (29.9 % amongst children aged up to 17) and young adults (28.4 % amongst people aged 18-24) were also very high. Various groups at particular risk, such as people with migrant background,[47] those with disabilities and Roma people, suffer disproportionately from poverty and/or social exclusion (and in most cases, this is further aggravated for women). Disparities more generally between these groups and the rest of the population have also increased over time.

The social protection system faced difficulties in responding to growing social needs. Within the EU, Spain is one of the Member States where social protection has had the least impact on reducing poverty, in particular child poverty.[48] Social assistance and benefits suffered from low coverage and effectiveness (with high levels of non-coverage rate for poor people with jobs),[49] with limited redistributive effects across different groups at risk. In addition, limited coordination between employment and social services (including those at regional and local levels) hampered the effectiveness of active labour market policies for those further away from the labour market. A complex administrative process for accessing minimum income schemes also hinders the smooth transition between social assistance and reintegration into the labour market. Access to long-term care and early childhood education and care was also limited.

Newly adopted measures aim to address growing inequalities. These measures pay particular attention to the needs of disadvantaged population groups, but need to be promptly implemented and complemented by further actions. Approval of the second strategic plan for childhood and adolescence (PENIA II) and the 2013-16 national action plan on social inclusion represented steps forward, but these plans still need to be complemented, at least, by the comprehensive plan for family support (PIAF), announced by the government. These plans, combined with the 2013 annual employment plan, also provided a relevant policy framework for promoting active inclusion, although they include a quite limited number of new measures. The 2014 national reform programme refers also to concrete plans to promote the social inclusion and labour market integration of other specific vulnerable groups, like people with disabilities or people dependent on drugs. The programme for professional requalification (PREPARA programme) also played an important role both in terms of activation and providing a last-resort safety net, yet the results show the need to improve its capacity for labour market reintegration .[50] Lastly, the national reform programme recalls the mainstreaming of social issues in other policy areas, such as energy (with specific clauses for small vulnerable energy consumers) and social housing (see section 3.4).

3.4. Structural measures promoting sustainable growth and competitiveness

Progress on structural reforms promoting growth and competitiveness continues, although this has been uneven across policy measures. Removing obstacles to competition in product and services markets and barriers to the growth of firms is crucial to encourage productivity and employment creation and to foster the reallocation of resources towards more productive and sustainable sectors, including the tradable sector. Removing these obstacles may result in significant growth (see Box 6).

In 2013, Spain received a country-specific recommendation concerning product and services markets, the business environment and network industries. The analysis in this SWD leads to the conclusion that Spain has made some progress on measures taken to address these recommendations. Several reforms have progressed broadly in line with the plans in the 2013 national reform programme and with the 2013 country-specific recommendations. However, some key measures, such as the reform of professional services and associations, continue to be delayed and implementation of other reforms remains at an early stage. Some progress has been made in the network industries, where the authorities took steps to address the electricity tariff deficit, and are studying ways to minimise the contingent liability for public finances stemming from unprofitable transport infrastructure. Given the wide scope to improve regulation and competition in product and services markets and network industries, it is crucial that the independence and autonomy of the competition authority and sectoral regulator is preserved.

Box 6: Potential impact of structural reforms on growth – a benchmarking exercise

Structural reforms are crucial for boosting growth. It is therefore important to know the potential benefits of these reforms. Benefits of structural reforms can be assessed with the help of economic models. The Commission uses its QUEST model to determine how structural reforms in a given Member State would affect growth if the Member State narrowed its gap vis-à-vis the average of the three best EU performers on key indicators such as the degree of competition in the economy, skills of the workforce or labour market participation. Improvements on these indicators could raise Spain's GDP by about 6% in a 10-year period. Some reforms could have an effect even within a relatively short time horizon. The model simulations corroborate the analysis of Sections 3.3 and 3.4, according to which the largest gains would likely stem from reducing regulatory fragmentation, improving the average skill level of the working age population and increasing participation rates among women. Skill-enhancing measures could have a major impact on GDP, but only in the very long term. Over a 50-year horizon, such measures could raise GDP by about 7.8% (see note).

Table: Structural indicators, targets and potential GDP effects [51]

Source: Commission services. Note: Simulations assume that all Member States undertake reforms which close their structural gaps by half. The table shows the contribution of each reform to total GDP after five and ten years. If the country is above the benchmark for a given indicator, we do not simulate the impact of reform measures in that area; however, the Member State in question can still benefit from measures taken by other Member States.[52] *The long-run effect of increasing the share of high-skilled population would be 0.5% of GDP and of decreasing the share of low-skilled would be 7.3%. **EU average is set as the benchmark.

Products and services markets

The law on the guarantee of market unity, which aims to address regulatory fragmentation in Spain internal market, came into force on 11 December 2013. Its goal is to make it easier for operators to take advantage of economies of scale and scope in the market by providing unrestricted access to economic activities and the right to perform and expand these throughout Spain. Full implementation of the law is of utmost importance. To that end, effective coordination and cooperation among the different levels of government is critical, in particular when it comes to enforcing provisions on supervising economic operators and amending sector specific legislation to remove inconsistencies.[53] The law also sets out procedures to monitor the application of its provisions. These includes a catalogue of good and bad practices which may affect market unity (to be produced by the newly created secretariat of the Council for Market Unity), the planned dissemination of regulatory quality indicators, the new powers given to Spain's Competition Commission to file administrative appeals with regard to situations contrary to the law and, more generally, the outcome of the sectoral conferences where regional and central government representatives discuss and agree legislative amendments. In addition to measuring progress in implementing the law, these procedures would provide very valuable information, should further legislative action be required in the interest of freedom of establishment and movement and the simplification of burdens.

The draft law on dis-indexation, submitted for parliamentary approval in December 2013, aims to discontinue current indexation schemes on fees and public sector contracts. It prohibits automatic and periodic updating of prices based on general price indices. However, it permits periodic and non-periodic updates of those values on an exceptional basis, based on changes to specific costs. The draft law also provides for new indexation mechanisms to be applied on a voluntary basis on privately agreed prices, such as housing rents, which would yield lower price increases than indexation based on the consumer price index. Indexation schemes for collective bargaining, financial sector instruments and pensions are excluded from the scope of this reform, as some of them have their own dedicated legal instruments (e.g. pensions). The law needs to be accompanied by secondary legislation, however, to set out the details on periodic and non-periodic indexation. Nevertheless, the principles of the law have already come into effect on public sector contracts with the 2014 budget law.

The adoption of the law on professional services continues to be delayed, as it faces resistance from interest groups. In addition to the job creation potential, reforming professional services would lift the competitiveness of the overall economy, given that they are an input for other sectors. Although work started in the previous legislature, it was only in August 2013 that the first draft law (anteproyecto de ley) was approved by the government. The draft aims to set out the professions requiring registration with a professional organisation. It reviews the rules on membership fees, transparency and the accountability of professional bodies. It also safeguards the principle of market unity in the access to and exercise of professional services. The long-term impact of the reform was originally estimated by the government at 0.7 % of additional potential GDP and lower inflation of 0.24 % relative to the baseline. A bold approach in the various areas addressed by the proposal is needed for the reform to have these effects.

Barriers to competition in the postal services sector remain. Although there are several postal operators competing in the Spanish market, the universal service provider Correos still holds close to 90 % of the postal market for letters. Access to the postal network for alternative operators is hindered by the Spanish postal systemʼs use of discriminatory prices for some operators.

Recent measures to improve the business environment aim to support company creation and growth and to reduce administrative burdens. The law on entrepreneurship, adopted in September 2013, includes measures to support the internationalisation of businesses, reduce the cost and time of creation of private limited companies, simplify administrative burdens, promote SME participation in public tenders and allow partial debt discharge in the event of corporate insolvency. The law on environmental assessment, adopted in December 2013, aims to speed up licensing for environmental programmes, plans and projects. There has been further simplification in the requirements for opening small-scale retail outlets, removing the need for municipal permits for the premises or operation of small shops and, linked to this, the "Emprende en Tres" initiative to facilitate business licensing. These measures are steps in the right direction. They can however, be complemented by further action. To illustrate, there is need to issue implementing legislation so that private limited companies can be created through one stop shops within the shorter deadlines set out in the September 2013 entrepreneurship law. There is a case for continuous review of regulatory barriers to company growth given Spain's gap compared with other euro area countries on company size. This includes evaluating lock-in effects originating from corporate income tax, as suggested recently by the committee of experts on tax reform. Lastly, good cooperation with the regions is needed f