It’s Sales Time

<a href="http://www.ie.edu/IE/php/en/profesores_medios_detalle.php?id=325">Francisco López Lubián. Professor. IE Business School</a>

4 March 2008

The winter sales came to end with February, but the sales are still on where tax reductions are concerned. These particular sales are necessary, but they can be dangerous if they are merely election campaign games.

In the war of promises that always takes place at election time, the Spanish prime minister, José Luis Rodríguez Zapatero, announced last Sunday that if he wins the elections, he will apply a deduction of €400 to each taxpayer in their annual income tax return. The measure would come into effect in June and would affect approximately 13.5 million workers and pensioners. It would have an estimated cost of approximately €5,000 million. According to socialist sources, the first cabinet of ministers of the new government would decide how the reduction would be applied: handing out the amount of €400 or deducting it from the monthly tax payments.

As is logical, the reactions to this promise have not been long in coming. And, as is also logical, the comments have ranged from the most elaborate praise (considering it as a truly progressive measure) to the sharpest criticism (labelling it as irresponsible and vote-buying).

Regardless of what they propose, the two main parties standing for the coming elections coincide in that the reduction of taxes is a necessary measure for compensating the effect of the current recession on the financial markets and its anticipated move over to the real economy, as also brought up by the new managing director of the International Monetary Fund.

Indeed, to create economic value (both individually and collectively), new after-tax cash flows that can be sustained over time need to be generated. Accordingly, the appropriate tax policies and planning are increasingly important in the creation of wealth.

If we accept these premises, the relevant question is to what point are the tax measures proposed by the PP and the PSOE in their economic programmes for the coming elections appropriate? In other words, what is needed for the tax measures to contribute to the creation of economic value (wealth) for individuals and the country alike?

The following considerations may help answer this question:

1) The tax reduction must be sustainable over time in order to generate additional cash flows that are also sustainable over time. It is not a matter of improvising and/or maintaining merely reactive standpoints. The party that considers this measure as something extraordinary to deal with an extraordinary situation would be wrong.

2) From the taxpayer´s point of view, there is no sense in paying upfront to then recover the money. Paying taxes in advance may be very praiseworthy from a patriotic point of view, but rarely does it generate economic value. Accordingly, consideration should be given to a tax reform on matters that affect the payment of taxes (phases, minimum exemption levels and retentions).

3) Since we are speaking of reductions, what about corporate tax? A reduction of this tax would generate greater liquidity for enterprises and increase their capacity for financing projects that generate value, with the subsequent improvement in competitiveness and sustainable growth.

4) Whatever the case, together with the tax reductions, we should also speak about greater control over public spending, especially with regard to the discretionary items and items with little social content.

5) In recent years, the Spanish economy has accumulated a number of imbalances that make it vulnerable in a more uncertain globalised environment. A tax policy that focuses on economic value may help correct these imbalances.

We are about to enter the month of February, which, in Spain, is usually synonymous with lowering sales prices even further, and this in the year of an election campaign. As is well known, election periods are lavish with generous offerings and proposals for improvement. Whether or not these promises become a reality will depend, among other factors, on the realism and reason of the measures proposed and on how they are monitored by voters.

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