Strategic Slips

25^th January 2008

The Malta Independent - Friday Wisdom

As the current administration enters the final lap to the finish, it is appropriate to reflect on two measures taken by this government which in my opinion, in the fullness of time, will become a millstone round the economy’s neck. They will be a very heavy price to pay for the short-term palliative that these measures could have created at their inception.

The first such measure is the change in taxation system involving the facility to pay final withholding tax at source at 12 per cent on the sales value of property within the first five years from acquisition, which facility becomes obligatory after the fifth year.

This measure could have had a short-term palliative in making it fiscally efficient to sell long held property which realises huge capital gains that otherwise would have been taxed at 35 per cent. However beyond its short-term palliative that essentially rewards the lazy hoarders, it will start to punish the enterprising risk takers as once the property market slows down and property sales easily slip beyond the five years facility period, developers would have to pay withholding tax which will be higher than the 35 per cent tax on realised profits. If the property market slows down beyond a short-term breather it could also become a direct tax without direct profits.

Such mechanism could easily render a normal slowdown in the property market into a full blown crisis as developers would be forced to cut losses by offloading their stock at a discount before the five year time limit elapses. Temporary breather is a healthy economic check but a full-blown crisis is in nobody’s interest in a society of wide home ownership.

There is another very valid reason why this measure would need to be re-visited in the not too distant future. The payment of a final withholding tax is practically a licence to shred the VAT audit trail in the construction sector where VAT compliance was being gradually achieved with great difficulty through the widening of the audit trail net. What the government may be gaining through the withholding tax mechanism at point of sale it could well be losing a good part thereof in dilution of VAT collection on construction expenditure as compliance in the construction sector now has lost a crucial tool of the compliance mechanism.

VAT compliance is a very laborious process where data is built and refined year after year until the tax authorities are in a position to fine-tune a system which flags gross cases of laxity or evasion. The moment where an important economic activity like construction and property sales falls out of the system by the implementation of a withholding tax on sales rather tax on profits where costs have to be properly documented and justified, it is equivalent to drilling a hole in the tax net through which the big fish could easily slip through. We should be moving in the direction of tightening the net to enforce compliance rather than punching holes through the system.

Another measure which goes diametrically against the direction we should be aiming for is the extension of new measures of social security which are applicable universally without any means testing. Take the extension of children allowance to universal application irrespective of means. It is yet another case of transfer payment where the government pays the taxpayer part of what the taxpayer has already paid the government.

We should be moving to a system which cuts through these useless unproductive transfer payments and aims to have the citizen interacting with government at only one point i.e. at the direct tax system which in cases of merit proved by reliable means testing it could even become a positive tax system where government pays the citizen. But this will happen at one point avoiding the present system of spaghetti payments between the citizen and the government.

The issue of reliable means testing is a crucial point critical to our rate of economic development. It is an inescapable truism that future governments, left, right or centre does not really matter, will not find it possible to sustain the universal application of social services, health and education services and pension obligations, and still stay within the budgetary constraints of the Euro monetary system.

As sure as night follows day there will come a point in the not too distant future where government will be constrained to curtail the universal application and introduce means tested application aiming to keep such services free only to those who really cannot afford to pay for them. If means testing is to perform the intended role it has to be reliable, which presently it is not.

To achieve reliability we firstly have to streamline, simplify and render sensible the current maze of means testing regulations for different types of entitlements. And more importantly it has to accurately measure whatever criterion is used for means testing, whether income, capital or a mix of both. No reliable means testing is possible unless we achieve high tax compliance and high tax compliance is not possible without an effective policing system and without a reduction in the highest marginal direct tax rate to a level which makes it more economic to comply than to evade.

The vision to achieve these goals, even if on a long-term range, is noticeable by its absence.



   

Good Timing

 18th January 2008
The Malta Independent - Friday Wisdom

It would be flattering to think my contribution of last week inspired the very timely and informative media conference addressed by Opposition Leader last Monday about his current condition of convalescence and prospects for his state of health.

Probably it was more a matter of co-incidental timing and I believe Labour meant to deliver what they actually delivered to the media last Monday without need of any prompting. But they certainly did the right thing in being fully open about the Dr Sant’s state of health and particularly in supporting local medical opinions, competent as they undoubtedly are, by additional corroboration from international sources of unquestionable credentials.

Apart from rejoicing that Dr Sant has been certified fit to lead Labour into the next elections I consider we have been afforded credible re-assurance that from a health point of view there is a very high probability, in a world where the future remains uncertain to all, that Dr Sant can impart his duties as the next Prime Minister without any health handicaps.

So by the end of this month it would be business as usual and the Prime Minister will soon have to make a decision about the election date which could come on any Saturday between 1 March and 23 August.

Will the Prime Minister get his timing right? Is timing so important that it could influence the election outcome?

I think that the Prime Minister already missed a favourable opportunity to go to the elections soon after last budget which would have given him a better opportunity to regain the electorate’s mandate. Now the novelty of the budget has worn out. The adoption of the euro could be cheerful for economists, bankers, and business leaders but for the average voter it is an administrative headache coupled with an unavoidable impetus to inflation, whether perceived or real yet to be decided.

Consequently it is doubtful whether the euro adoption could in any way be an issue which could make a material impact on the way people vote if the election were to be held in this first quarter of 2008.

Not the same could be said if the election slips beyond this quarter. Prices that have been frozen by voluntary agreements with importers and service providers until March 2008 will find the flexibility to move upwards solidifying the perception of euro induced inflation. In addition events in the international economy do not augur well for a favourable background to sustain strong economic growth during 2008.

The US economy is gently but surely slowing down to critical levels and it is presently tip-toeing dangerously on the borders of an outright recession which will no doubt effect negatively the economic tempo in all other economic regions, including the EU.

The currency of one of our major trading partners, the UK, is in a headlong downward rush on the exchange markets making our export products and services, including tourism, much more expensive in sterling terms than they were a mere three months ago when the sterling value against the euro was 10 per cent more than it is today.

It is almost an irony that this had to happen exactly to coincide with our euro entry but it does deliver a lesson to countries joining into a monetary union at an uncompetitive rate.

The UK could never until recently, seriously consider joining the euro monetary system because its strong economic tempo and consequent high interest rates were keeping its market determined rate of exchange at an unsustainable high level certainly not appropriate for fusion into the euro.

Now that the UK economy has started to cruise along at a much lower pace it can cushion the consequences by a fall in the external value of sterling. If the UK had fused into the euro at the high rate prevailing until recently the prospect for the UK economy would presently be much worse than they already are.

The latest economic figures coming out on the local front also indicate that for the rest of 2008 the local economy will be affected by the international slowdown or recession. Government finance data available until November 2007 show that the budgetary position is worse than what it is was in November 2006 and unless sizeable one off items land in the December 2007 budgetary statement the government will not meet its target for a reduction in the deficit in 2007.

The GDP for the third quarter of 2007 was 4.1 per cent higher in real terms compared to the same period of 2006. But from figures released this week by Eurostat it results that when seasonally adjusted this growth disappears. On a seasonally adjusted basis the growth rate of 4.3 per cent in the second quarter actually shrinks to 0.1% in the third quarter of 2007.

All economic lights are flashing that an election beyond the first quarter of 2008 will strengthen the opposition’s arguments that the economy is not as strong as the government would have us believe and provide a dimming background for the PN’s re-election prospects.

Dr Gonzi may have better credentials than his predecessor for general direction but he seems to lack Dr Fenech Adami’s daft skill for getting his timing right as evidenced by the timing of the referendum and general elections of 2003.

Timing is as important as the general direction. The difference between a fresh crisp salad and trash is timing.

The Mark of a New Generation

13^th January 2008
The Malta Independent on Sunday

 

There comes a point in time when it becomes evident that a new generation starts taking over from the older one.

It happened in 1968 when the baby boomers born in the decade after the end of the Second World War started reaching adulthood and saw their two political idols, brothers John and Bobby Kennedy, murdered by old forces that were not ready to accept the change that society was aspiring for.

1968 was the year when it dawned on the young people of America that they were fighting a lost war in Vietnam. It dawned on French students that the rigid let’s pretend sort of life they were expected to adhere to by their parents was suffocating their creativity, which longed for liberation. 1968 was the year when the baby boomers took over to render society more tolerant of diversity and less puritan in the matter of sex, arts, and religion.

2008 seems to have the potential to be another 1968. Like 1968 it started in the shadow of a political murder that happened the preceding year. It was Robert Kennedy in 1968 and now it is Benazir Bhutto who was murdered on 27 December 2007, throwing unstable nuclear-enabled Pakistan into a political turmoil that could benefit terrorist organisations with an eye on its nuclear facilities.

It is continuing with the primaries for the US presidential elections where the Democratic candidate is likely to be a woman. To become the first female president, she has in her own words to “break through the highest and hardest glass ceiling of them all”. Her main challenger is a black post-baby boomer of Kenyan descent born in Hawaii and who spent his childhood in Indonesia. Barack Obama is gaining momentum and is capable of giving Mrs Clinton a good run for her money, despite her edge of being supported by the party establishment where her husband and former President, Bill Clinton, still has a lot of influence.

Who could have imagined just a few years back that the next US President following the divisive and generally failed presidency of President Bush, which makes the Democrats clear favourites to occupy the White House this time next year, will in the end be a choice between the first female President and the first Afro-American post baby boomer President?

Who could have imagined that whiter than white Iowa would give a land-slide victory to a black presidential candidate, and that in New Hampshire clear favourite Mrs Clinton had to struggle to keep the momentum of Obama from edging her out in that State as well?

Obama is electrifying crowds with his passionate speeches. His gift of oratory and excellence at story telling is unmatched by any other candidate on both sides of the fence. Halls are becoming too small even for standing crowds and though short on specifics, his policies based on “hope” and “change” carry the mark of an inspirational leader who can carry the nation with him once he gets into the hot seat.

Hillary Clinton tries to make capital on her experience and the support she gets from her husband who has done it before, and did it quite well (sexual indiscretions apart), given the popularity that Bill still commands. She tries to belittle her opponent by depicting him as a dreamer lacking experience and not a safe pair of hands to lead America following the disastrous Bush years.

Yet in spite of the inexperience that comes with the young age of 46 for a presidential candidate who is a first term senator, Obama is proving a good match who, though short on execution details, is quite clear on objectives. He was consistently against the war in Iraq and is promising to withdraw swiftly if elected.

He is the only candidate who shows a preference for persuasion before guns and offers dialogue to America’s enemies almost in biblical spirit where the Son of God was willing to speak to sinners because it is the sick that need the doctor.

Free from support ties of the establishment and gaining substantial funding with minimum reliance on corporate handouts, Obama seems to carry more credibility in his claim to give America a social soul starting with universal health care. Obama is shaping up for America into something like what Tony Blair was for Britain but without the Iraq baggage which tarnished Blair’s legacy.

It is far too early to hold out any reasonable hope that Obama can build enough momentum to seize the Democratic Party nomination from the hands of Hillary Clinton, who seemed to have it already wrapped up before the start of the primaries. But if Obama can pull a feat of gigantic proportions and become the next President of the United States, we can certainly speak of 2008 as a year when the new generation takes over the running of this world from the baby boomers who did not live up to their promise to free the world from war and to make society more just and honest.

As the baby boomers start to retire they have to let go and give a fair chance to the next generation of which Obama is a prime specimen – the generation of globalisation.

When Privacy Hurts

11^th January 2008

The Malta Independent - Friday Wisdom

 A great sense of national decency is how my great friend Charles Flores, writing in last Sunday’s sister paper, defined the moderation showed by the local media in general, with regard to the major surgery that the Opposition Leader had to undergo just after Christmas.

I don’t know if he is still of the same opinion, following the scathing criticism in the same Sunday edition regarding the secrecy about details of the Opposition Leader’s illness and its treatment.

While a dose of moderation is always called for in such matters concerning the health of an individual, now that we have been assured that the surgical intervention was successful and that Dr Sant is recovering well and will be able to lead Labour’s bid for re-election at the next general election, which could be a mere fistful of weeks away, even I am starting to feel that the sense of national decency shown towards Dr Sant has not been reciprocated with equivalent decency by Labour’s media in keeping the electorate informed as it should be under the circumstances.

Dr Sant’s health is not simply a private matter. He is the Opposition Leader, and has been incessantly pitching for re-anointment as leader of this nation for the next legislature as the current one will draw to a close next May. In making its proper choice, the electorate has a right to know the full details of Dr Sant’s state of health. They want to know, not only that Dr Sant will be able to lead Labour’s pitch for the next election, but particularly whether if elected his health will permit him the necessary energy, stamina and clear thinking needed to lead this country forward.

In my past writings I have been severely critical of Dr Eddie Fenech Adami’s decision to retire early in this legislature, which he was elected to lead without having made clear his intention to resign soon after being elected. With consistency I maintain that it is Labour’s and Dr Sant’s responsibility to inform the electorate about the details of his illness and his state of recovery therefrom together with certified medical opinion on the most likely evolution of his state of health for the next five years.

Dr Sant owes this transparency, not only to the electorate in general, but to the Labour Party and its supporters in particular. There can be no doubt that to get elected one of the major parties has to attract votes beyond its hard core of supporters that on their own cannot guarantee a majority. Floating voters will decide which party will lead us for the next five years. Floating voters will want to know whom they are voting for. They are unlikely to be attracted to vote Labour if they perceive a risk of having a leadership change soon after the elections. Objective people generally dislike giving open cheques and avoid making leaps in he dark

They might be happy to have Alfred Sant as their next Prime Minister, but may not take the risk, if lack of transparency about his illness and state of health leads to doubt about whether they will, in fact, end up having Charles or Michael or George or Joe or Evarist or Emanuel as their next Prime Minister.

A floating voter once told me that the more he hears political arguments the more confused he gets about whom he should vote for. So, in the end he had a picture of both party leaders and by looking them in the eyes he would let his conscience judge in whose hands he could trust his family’s future. If such floating voters, when looking at Dr Sant’s picture perceive that he will not be there to execute their mandate, the swing in favour of Labour in the floating sector swath could well stall when it most matters.

My motivation in writing this piece is that of seeing Labour spend a fair amount of its time in government, a time as long as possible and as is consistent with clear democratic credentials.

In the interest of Labour Dr Sant should not prejudice its chances of re-election. If, as I sincerely hope and pray, his health will recover to permit him not only to lead an election campaign, but to lead this country as its next Prime Minister with all the responsibility that the post demands, then Labour should say so in the most eloquent terms, and provide medical opinions to make such claim as credible as possible.

If there is any reasonable doubt about this then he should take the honourable step and let Labour choose a new leader sooner, rather than later, in order to provide the electorate with a clear choice. No one person is bigger than the organisation he or she represents.

 

 
   

An Ode to the Lira

 4^th January 2008
The Malta Independent - Friday Wisdom

I mean to fill a great void. As we celebrated the switch of our currency to euro, while champagne corks popped, fireworks lit our skies in celebration and so many self-congratulatory speeches were made to mark our entry into the European Monetary Union, nobody seems to have found it proper to pay due respect to our own lira as it fades into history.

So, dear lira, I pay you my respects. Not because I have any regrets about your being replaced by the euro. On the contrary, I think this was an essential step to sustain our economic development. Some things have an air of inevitability and it was inevitable that in a globalised world a small country like ours could not afford to keep barriers which act as a drag on our participation in the global economy. So, sooner or later, you had to go like a valiant old warrior who can relate great history but can do little to overcome future challenges.

But you should be allowed to go with dignity. Your passing away should not be seen as a kick in the behind. As we celebrate our making the grade to participate in the much larger monetary union that is gaining market share in the international payments system and is shaping up as a formidable challenger to the dominance of the US dollar in the international foreign exchange reserves held by foreign central banks, we should also pay you due homage and express our heartfelt gratitude to the role you played in the long journey to make this possible.

I leave it to the historians to decide the date when you were actually borne. Although you officially existed in some form even before we gained independence, I think that officially you came into recognised existence when we became an independent state.

But as with so many other things this was a great change that left practically everything as it was. Dear lira, you continued to live in the shadow of the sterling pound, and when in November 1967 this was devalued (then it was said that Britannia that used to rule the waves was humbled and forced to waive the rules of the then existent Bretton Woods fixed exchange rate system) you swiftly followed to retain the long standing parity.

So I think that in practical terms your coming of age was in 1972 when the sterling area disintegrated. It was then that you started to part course from the British currency and follow your own destiny by establishing your own value rather than shadow sterling in strict parity. This was soon followed in 1973 by the dismantling of the Bretton Woods fixed exchange regime to be replaced by a floating one. I still remember President Nixon informing the world that America was “temporarily” suspending the conversion of the US dollar into gold at $35 an ounce (currently it is worth some $850) which was the anchor of the fixed exchange rate system in force for 25 years after the second world war.

The temporary suspension proved permanent in what is, in substance, the biggest daylight robbery and transfer of wealth from the poor to the rich in the history of humanity.

Our political leaders and monetary authorities showed great foresight at that time in linking your external value to a basket of currencies that broadly reflected our international trade patterns. This was a novelty at the time, but it was soon imitated by many other countries who were no longer a satellite of a single bigger country but were converting their newly found political independence into economic prowess by extending their trading networks.

You suffered a setback in 1992 when our two main trading partners, the UK and Italy, saw their own currencies come under international pressure as the then existing European Monetary System permitting exchange rate fluctuations within a very narrow band disintegrated as inflation differential between various EU countries grew too great to bear.

We decided to devalue you by 10 per cent to avoid a shock misalignment with the currency of two of our main trading partners. However as this step was not accompanied by other necessary measures to ensure that inflation did not spiral up to dilute the temporary competitive fillip, regret at such a measure was not long in coming.

So much so that even in the run up to the entry into the first stage of the European Monetary Union in May 2005 we avoided making a necessary one time downward adjustment to ensure that we join the euro at a competitive rate which helps, rather than hinders, economic growth.

The experience of 1992 and our inability to marshal consensus on a set of complementary measures to avoid igniting an inflationary spiral forced us to keep you stable and switch adjustment to the real economy. I was very sceptical that this would work out, but luck was on our side. The EU economy went into an unexpected growth path, which made adjustment less painful than expected.

So as we all rush to change you into euros we salute you for serving us well. Some say this could be an “au revoir” rather than “adieu” as the history of monetary unions without a political union does not augur well for longevity. But I don’t want to raise your hopes too high, as things in this globalised world are not what they used to be and we have to have faith that this is an irreversible step.

Wish us well in putting away political short term manoeuvering and finding the courage to take the necessary steps to render our economy more flexible in order to survive and prosper under your Euro successor. Starting of course with all measures which institutionalise legislative pay increases linked to cost of living rather than productivity. But these are arguments for after the election.

Thanks, lira.