By Jan Strupczewski
BRUSSELS (Reuters) - The International Monetary Fund is against further austerity in Greece and instead is calling for the creation of a modern welfare system financed with cash from a rebalancing of the Greek tax system and far too generous pensions.
The head of the European Department Poul Thomsen and chief economist Maury Obstfeld wrote in an article the Fund believed that euro zone insistence on a Greek primary surplus of 3.5 percent in 2018 was wrong and 1.5 percent would be enough.
"We warned that this would generate a degree of austerity that could prevent the nascent recovery from taking hold," the two senior IMF officials wrote of the higher euro zone target.
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The article appears as the IMF and the euro zone struggle to find common ground on the way forward for Greece that would allow the Fund to take part in the latest bailout for Athens, the third one since 2010, now fully financed by the euro zone.
Some euro zone countries like Germany believe that not only should Greece reach a primary surplus of 3.5 percent of GDP in 2018 but it should keep it at that level for the next 10 years.
The IMF believes this would be counterproductive.
"Perhaps through a Herculean effort Greece could manage the spending cuts needed to achieve the 3.5 percent...in the short run. But experience has shown that it cannot be sustained and is inconsistent with Greece's ambitious long-term growth target."
Germany insists on the higher primary surplus target because it means lower, or even no need for debt relief for Athens -- an important factor in an election year in Germany where public opinion is suffering from bailout fatigue.
Berlin believes that if Greece carries out all the agreed structural reforms there would be no need to grant it any relief on its debt mountain of almost 180 percent of GDP, now mainly owned by euro zone governments.
But the IMF, which Berlin very much wants on board for credibility reasons, has a different view.
"Greece's debt is highly unsustainable and no amount of structural reforms will make it sustainable again without significant debt relief," the IMF said.
The Fund believes that instead of further cuts in government investment and discretionary spending on public services or healthcare, Greece should tackle its income tax system, under which more than half of households don't have to pay any tax.
In the other 18 countries sharing the euro, the average number of households exempt from income tax is 8 percent.
Also Greece's pension system is extremely generous according to the IMF. Greece spends 11 percent of its GDP on pensions a year, providing a nominal pension similar to Germany's, while in other euro zone countries the average is 2.25 percent.
Greece has tried to reform pensions but the attempts were stopped in courts, or were inadequate, the IMF said.
At the same time Greece does not have unemployment benefits and other welfare payments that are commonplace elsewhere in Europe, the IMF said, adding they were critical for broad social support in a modern market-oriented economy.
The lack of such an unemployment benefit scheme made the Greek government reluctant to liberalize labor laws to allow for mass lay-offs, the IMF said.
"Rather than provide support to dismissed workers, the government instead restricts the ability of firms to dismiss them," it said.
"Pensions are no substitute for an adequate safety net, as this ad hoc arrangement has not been able to address the rise in poverty of the most vulnerable groups," it said.
Broadening the base for income tax and changing the pension system to a sustainable one should provide money to increase spending or cut taxes to support growth, the IMF said.
"The authorities should further reduce current pensions while increasing spending on a modern and well-targeted welfare system to protect those that are most in need," the IMF said.
"More should be spent on other essential public services and key public investments too. Rationalizing current pension benefits would also ensure a fairer inter-generational burden-sharing of the reform costs," it said.
(Reporting By Jan Strupczewski)