Spain’s Prime Minister Pedro Sanchez, center, sits at the table with the new members of the Spanish Cabinet.
PHOTO: MANU FERNANDEZ/ASSOCIATED PRESS
Spain’s economy could suffer if plans by the country’s new coalition government to reverse labor reforms, increase tax, raise the minimum wage and increase inflation-indexed pensions go ahead, economists warn.
“Spain’s government is on a dangerous course,” said Commerzbank’s economist Ralph Solveen.
Spain last week formed its first coalition government since its transition to democracy in 1975. The new coalition unites the Socialist Party (PSOE), led by Prime Minister Pedro Sanchez, and the left-wing party Unidas Podemos.
Mr. Sanchez on Tuesday announced a 0.9% rise in pensions to be applied retroactively from January 1. The rise corresponds with the average estimate of the annual consumer price index. If inflation increases above 0.9%, pensioners would receive a single payment with the difference, Mr. Sanchez said.
This policy is expected to cost the country money and increase debt, especially as life expectancy at birth in Spain is 83 years, three years higher than the Economic Cooperation and Development (OECD) average of 80 years, according to the organization’s Better Life Index.
“The UN forecasts Spain will reach the highest life expectancy globally over the next two decades, while it will have one of the lowest birth rates, so the public pensions deficit will only grow without further reform,” said Antonio Garcia Pascual, Johns Hopkins University visiting scholar and former chief European economist for Barclays.
Tackling the major demographic challenge of an ageing population is not an easy task for any government. In France, citizens have been hitting the streets since December against President Macron’s pension reform.
But measures proposing a higher retirement age, higher taxes or forcing citizens to take out private pensions are necessary even if they are unpopular, said Mr. Garcia.
“Without a combination of these measures, the deficit will only widen.”
Meanwhile, the new government’s plans to reverse some elements of labor market reforms adopted in 2012 could reduce inward investment into Spain.
The 2012 reforms made the labor market more flexible and contributed to pronounced improvements in Spain’s price competitiveness, said Commerzbank’s Mr. Solveen.
“With the planned reversal of the labor market reforms, Spain’s new government is jeopardizing the country’s price competitiveness and thus the attractiveness of Spain as an investment location,” he said.
It remains unclear which labor reforms will be reversed, but after announcing the increase in pensions, Mr. Sanchez said his coalition had a “firm” intention to raise the minimum wage by 60% over the next four years.
This plan could reverse steep improvements in Spain’s labor market in recent years. Spain’s unemployment rate stood at 13.9% in the third quarter of last year, according to the Ministry of Labour. While still high, this is well below the 27% rate reached in 2013 in the aftermath of the global financial crisis.
Improvements in the job market had already started to tail off last year, CaixaBank’s economist Josep Mestres said. The pace of job creation fell more sharply than expected in 2019 following a run of four years with increases of around half a million workers per year, and in 2020 it is expected to moderate further, he said.
Mr. Garcia at Johns Hopkins University said the key will be whether the government considers a different scale of minimum wages by age and experience.
“Raising further the minimum wage for all workers is something that would disproportionately hurt young workers,” he said. This could be a disincentive for businesses that might want to hire them.
The youth unemployment rate in Spain was 32.10% in the third quarter, the highest rate in the eurozone, according to Eurostat.
The government’s proposed expansion of social benefits is planned to be financed in part by higher taxes. According to the government program, the tax rate for private households with incomes above 130,000 euros will be raised by 2 percentage points and for those with income above EUR300,000 by 4 percentage points.
Tax on large companies would be increased to a minimum rate of 15%, rising to 18% for financial and energy companies. For smaller companies, the tax rate would fall from 25% to 23%.
“Ideally, an EU coordinated response against too-low corporate income taxes is the preferred solution,” Mr. Garcia said, adding that a unilateral move by Spain towards higher corporate taxes while neighbors stay put could tilt investments towards other member states.
Even with a rise in taxes for high earners, the government’s plans could put a burden on government finances, jeopardizing the planned reduction in the budget deficit agreed with the European Union.
“The announced measures, if approved, are going to negatively impact budget spending and we thus expect a budget deficit of around 2.4% for 2020,” said Eirini Tsekeridou, fixed income researcher for Julius Baer.
But Mr. Garcia said Brussels “might be more lenient” with Spain this year if higher public expenditure targets areas that help improve productivity and reduce inequality while “credibly addressing the demographic challenge over the medium term.”
Economists will be waiting to see which of these plans are implemented. The Spanish parliament remains fragmented, making it difficult for the government to pass reforms.
Write to Maria Martinez at maria.martinez@wsj.com