Budget (non) Vision

2^nd November 2007
The Malta Independent - Friday Wisdom

 

If anything stands out clear from the budget debate it is that both the government and the opposition are on political trip of fiscal patchwork that sees no further than the next election. The short-termism is palpable.

To my point of view the objective of a budget ought to be the delivery of sound fiscal policy that stimulates operational efficiency and long-term sustainable economic growth to develop the economy to its full potential.

To achieve such objective a budget has to carry as proximate targets the need to keep marginal taxes low enough to stimulate economic activity and promote tax compliance by making it more economic than tax evasion. It also has to minimise transfer payments as these serve to bloat the government’s share of the economy and leads to inefficiencies as the government takes money from taxpayers with one hand and gives it back to same taxpayers with the other hand without adding value. It just adds inefficiencies as the government takes our taxes and gives us back part of our own money in children’s allowances.

The budget fails to generate such vision. It effectively does the opposite. Marginal tax rate is kept at 35 per cent, which is high by today’s standards when many competitor countries are working with flat tax rates at around 20 per cent or less. There is no vision to continue with the shift of fiscal impact from earnings to expenditure and instead leaves the economy to operate with marginal tax rates that are high enough to make evasion more economic than compliance.

Furthermore we continue with the social blasphemy in our fiscal laws where the fruit of labour is charged at a rate (35 per cent) higher than the fruit of capital (15 per cent in case of withholding tax application on investment income).

The opposition proposal to exempt overtime from income tax further complicates matters as it creates distortions in the composition of pay packages and discriminates against white collar middle income employees who are not paid overtime. It also discriminates against blue collar and junior white collar employees who in the absence of overtime opportunities at their main employment supplement their income through part-time jobs.

Our fiscal structure needs a total overhaul. It certainly can do without pre-election patchwork which puts some sugar on the front end and makes the long-term overhaul that much more difficult.

Our objectives should be twofold. To reduce marginal tax rates to the same level of the VAT rate so that we will have one common rate throughout the economy applicable to all marginal income, whatever its sources, and to all marginal expenditure. This rate will be low enough to make compliance more economic than evasion as the experience with withholding tax on investment income clearly indicates.

The second objective should be to reduce transfer payments so that the individual interacts with the government at only one point i.e. through taxation which could be positive or negative. The only other point of interaction would be in payment of contributory benefits like pensions the arrangements for which will remain intact.

Such a system would ensure that all government departments, with very few exceptions like justice, law enforcement, foreign affairs and the revenue departments, would operate on a strict commercial basis with as wide competition as possible to ensure maximum efficiency. The government would retract itself to become the enforcer of standards and consumer protection and will reduce its role even in delivery of services that can be delivered by market forces even in the field of infrastructure and maintenance, education and health.

This is not a vision that could be implemented through a single budget in a big bang method. But each budget has to make a contribution towards this destination. Regrettably the 2008 budget takes us in the opposite direction and proposals from the opposition do not help either.

We have lost our vision which needs to go much further than optimistic hopes of balancing the budget by 2010. We have to target growth, real growth at our maximum potential. We have to extend the limits of our potential and we have to economise on the use of resources by giving a huge impetus to efficiency by changing the way we do things around here. That which in MBA programmes is commonly referred to as the culture.

Electoral exigencies conditions politicians to fiscal patchwork. Let’s hope the newly elected government will focus of fiscal restructuring that deliveries the bacon over a medium term so that we can continue to earn an enhanced standard of living in a very competitive world.