Europe getting the finger(s)?

“We are looking for a slowdown in euro-land — we think the economy is grinding to a halt,” says Carl Weinberg, chief economist at High Frequency Economics. “It is suffering under the five fingers of death. Let’s look at how to kill an economy: raise taxes and raise interest rates.”

Weinberg’s other “fingers of death” for euro-land include the high price of the euro, which ultimately makes Eurozone exports more expensive around the globe (and is bad for the trade balance), a slowdown in the U.S. economy, and enlargement of the Eurozone.

Then there’s that 3-percent sales tax increase that becomes effective Jan. 1 in Germany.

“The authorities intend to use part [of it] to cut labor costs for employers,” says Paul Guest, chief European economist at Moody’s Economy.com. “The tax hike will be a short-term negative for the German economy, as it will depress already lackluster household spending during the early part of next year.”

But is it a healthy step, longer-term?

“This is one measure the German government put into place in order to get fiscal balance back into place,” says Naomi Fink, senior currency analyst at BNP Paribas.

“They’ve done this because Germany and Europe as a whole are recovering and they thought they could raise taxes without too adverse an effect on consumption.”

However, this is a tax that directly affects consumers. Fink mentions an economic concept, called the “Ricardian effect,” which describes the relationship between fiscal policy and consumption.

“If you are in a situation where consumer sentiment is healthy and you raise taxes — and the tax hike is well-anticipated — [the “Ricardian effect”] can fuel an acceleration of consumption ahead of implementation,” Fink explains.

Some economists say this has already happened in Germany, with consumers beefing up purchases in the second half of 2006 in an attempt to beat the tax increase. However, while it may provide a boost to gross domestic product (GDP) in the tail end of 2006, it equally should weigh on consumption and overall GDP readings in 2007, or so the theory goes.

BNP Paribas economists have attempted to quantify the actual impact of the VAT tax increase on GDP growth. Fourth-quarter 2006 German GDP growth is estimated at 3.2 percent year-over-year; without the VAT hike, BNP Paribas economists say it would have been only 3 percent. In 2007, BNP expects German GDP first-quarter growth at a 2.2-percent annual pace and to reach a trough at 0.7 percent in Q3 on an annualized basis. By third quarter 2007, they expect effects from the VAT hike to trickle into Eurozone GDP data, with a 1.1-percent reading vs. a 1.3-percent figure without the VAT hike.

“The hike is expected to lob 0.1 percent off fourth-quarter GDP next year, with a forecast for a 0.9 percent increase year-over-year,” Fink says.

Looking at overall GDP forecasts Moody’s Economy.com’s Guest forecasts a 1.8-percent GDP reading for the Eurozone for 2007, compared to about 2.4 percent in 2006.