The snag in Greece's salary solution

NEW YORK (Fortune) -- Greek prime minister George Papandreou may have made a big mistake. As part of a plan to fix his nation's ruined economy, he announced Wednesday that he aims to cut 30% of civil servants' holiday bonuses which are part of Greece's "14th salary" payment schedule.

Papandreou has to walk the line between answering the demands of European Union nations who could bail Greece out of its crisis and rallying citizen support for his reforms. One way or another, he has to cut costs.

"The country hasn't lived within its means," says Barry Eichengreen a political science and economics professor at the University of California, Berkeley. "Now, the government has to tighten its belt, and the private sector does too."

But cutting a key part of the nation's employee benefits may not be the swiftest move. Greek civil servants would be willing to go to war over major changes in the 14th salary, the leader of Greece's largest labor union, Yiannis Panagopoulos, has reportedly said. And while holiday bonuses certainly sound like excess spending, they aren't necessarily.

The 14th salary works like this: Greek workers get their annual salary in roughly 14 installments. On top of 12 monthly payments, employees receive double their paychecks in December, right in time for Christmas consumerism. They also receive half of their monthly spending in the spring to shell out on goods for Easter. Then they get another half-salary boost in July, before their traditional summer vacation.

But the 14th salary system isn't the problem with the Greek economy, says Elias Papaioannou, an expert on international economics at Dartmouth College, "it's just an alternative way to distribute."

It's not even that alternative. Other EU countries use plans that are much the same. According to international salary guide website Just Landed, Belgium, Germany, France and Holland have similar holiday bonus-based payment systems that factor in to workers' annual salaries.

There is a difference between Greece's 14th salary system and special allowances given to some government employees -- the latter helped bankrupt the Greek economy. But many government employees don't have disproportionately high salaries, says Papaioannou. Greek families plan their spending around the 14th salary, and they have for a long time. The Greek Ministry of Labor officially launched the program in 1945 after the Nazi occupation ended in Greece.

"I think it comes out of this history where working class people didn't have spare cash under the mattress," says Eichengreen. "This was a way for everybody to be sure that they could budget seasonal expenses."

A real fix for the system

Another money-saving measure that Papandreou mentioned Wednesday was hiking taxes on luxury goods. But while the government has to start raising money somewhere, Eichengreen says it's a drop in the bucket. "The big problem is not that people don't pay higher taxes on their Gucci handbags; the big problem is that lots of people work off the books."

Unorthodox compensation has been a major complaint of the Confederation of Public Servants, a Greek organization for public service unions. In 2008, the group demanded a uniform pay scale, because the Greek government has a history of giving special allowances to groups of civil servants as a quick fix for labor unrest or to meet lobbyist demands. Dishing out special funds has thrown off the government's pay scale for public sector employees, allowing huge salary discrepancies to develop.

"In Greece, public state employees are asking their superiors to move to the Ministry of Economics and Finance," Dartmouth's Papaioannou points out, because of the sizeable special allowance bonuses there. That money plays a big part in Greece's government spending accountability problem -- it's difficult to track because some special allowances aren't fully taxed.

What the Greek economy really needs is more transparent government spending, says Papaioannou. He is hopeful that the economic crisis will force Greece to move in that direction. But EU leaders and Greek citizens are still waiting for a satisfactory proposal from prime minister Papandreou to tackle that monster of a problem.