Out of Focus

The Malta Independent - Friday Wisdom

The best label for Budget 2006 is ‘out of focus’. Whilst it should aim for achieving fiscal sanity through economic growth it is instead trying to achieve it at the expense of economic growth.

There are huge and important differences between the two approaches. The proper and common sense approach is to achieve fiscal sanity through economic growth. This acknowledges that the ultimate aim of economic policy is to achieve long term sustainable balanced growth, superior to that of our competitors. By doing so and by restraining government expenditure to grow at a slower pace than the economy, the government could achieve higher revenue flows without raising taxes and thus narrow the budgetary gap in a relatively painless manner.

To achieve such growth there must be clear economic restructuring policies that render the economy more flexible and competitive in order to attract investments and grow exports of goods and services at a rate exceeding general world trade growth.

The budget simply fails in this respect and unashamedly admits its failure. Expecting a growth rate of just 1.1% for 2006 when we have capacity to grow at 5% or more, is a certificate of having economic policies in general and the budget in particular out of focus.

The end result of such misdirected policies is that measures to prop up government revenue flows and to restrain its recurrent expenditure in order to achieve fiscal deficit targets, when applied in the context of a stagnant economy, cause dangerously explosive social pain which generally becomes intolerable at the political level when it comes to stitch on the remaining two annual budgets between now and the next election.

Claims that the budget is free from additional tax burdens are almost laughable. Following the price hikes in energy prices announced a few days before the budget, both those that take on immediate effect but especially those that are planned to creep in by monthly increments over the next two years, there is de facto no spare capacity for additional tax measures. But the budget contains additional taxation by stealth.

When tax bands are frozen for several years at a particular level, rather then adjusted at least to reflect the real rather than the nominal value of money, that is taxation by stealth. When VAT is applied on increased energy prices, that is taxation by stealth.

The 2006 budget does little to stimulate growth by rendering the economy more flexible and competitive. If anything it does just the opposite. The most glaring faults are those of omission.

Not only we have kept on the COLA – semi wage indexing system irrespective of productivity grains – but we have given it a further dose by indexing ahead of time expected inflation increases in the last quarter of 2005. Growth based policies would require liberation from a system that is clearly out of date and out of touch with the current competitive environment, leaving wage fixing policies to free collective bargaining while keeping legislative increases only to the minimum wage to protect non-unionised labour.

Compare this to efficiency gains of more than 4% being registered by a mature economy like the US which in effect means that while wages there increase in absolute terms the unit cost of labour per productive unit is decreasing making the US economy more competitive. Our economy, with much bigger scope for efficiency gains, is showing competitiveness in reverse gear.

The much promised reform to link expenditure on health services by capping them to specific revenue items has again been regularly promised in the pre-budget document but not delivered in the real thing.

The pension reform has again been put to wait for yet another year and government seems to be suggesting introducing a compulsory second pillar which raises our labour costs and compromises further our competitiveness.

And a few days before the budget a collective agreement was signed for public sector employees guaranteeing their privileges, indeed adding to them, until 2010 thereby sanctioning the apartheid in our labour market. This inevitably creates political pressure in the run-up to any election for people to exchange productive private sector jobs for cosy public sector employment rather than create the necessary economic dynamics for shifts in the opposite direction. Indeed I consider the need to re-balance the rights and obligations in the labour market between public and private sector employees as a pre-condition to achieving real effective restructure. This may have to wait for 2010.

As to the sins of commission the only significant measure announced in the budget, the switch to 12% final withholding tax on sales value of real estate, is clearly ill-thought and needs urgent reconsideration.

How can we create a fiscal system that taxes profits where no profits exist and eases taxes where huge profits are made? How can we create a system which effectively nullifies the audit trail which was being built layer by layer by the VAT system by rendering tax payable on property sales independently of relative costs? How can we do exactly opposite to what Jesus thought us in the Gospels by rewarding the lazy who hoarded their talents and punishing the enterprising who put them to productive use? How can we introduce such sharp changes in the tax system so offhandedly rather give our tax systems the consistency needed to render them fair, understandable and effective?

The 2006 Budget is out of focus. It compromises our competitiveness and could kill the growth in real estate and construction which was helping the economy to keep its head above the water. It is evidently the product of amateur economists who see fiscal discipline as an end in itself rather than a means to the end of economic growth which is the only real source to sustain and improve our standards.