Spain’s inefficient tax system

Fernando Fernández. Professor. IE Business School

30 April 2014

Spain’s tax system has proved to be ineffective because in spite of levying high rates of tax the amount of money collected is relatively low. In the run up to a possible reform, it is necessary to gauge if citizens prefer to have more disposable income than tax credits, and if European countries with high levels of VAT and social security payments have lower levels of employment, and more generous social services.

Spain collects too few taxes because in spite of having high rates of tax it does not have an effective collection system. For example, if Spain’s current VAT system were applied to Germany’s tax base, the amount collected in terms of percentage of GDP would be roughly the same as in Spain. So let’s hear less about fraud, although it is always a good thing to keep fighting it, and let’s pay more attention to the legal mechanisms of tax evasion, to the exceptions, deductions and discounts that explain the real tax rates and the scant amount of taxes collected in Spain.

Spain is not good at collecting tax because it collects too great a percentage via direct taxation methods, which is even more manifestly excessive if we include national health payments, which are an unstructured tax on salaries and employment. It also obtains a proportionally scant part of taxes through consumption, including so-called special taxes, which are those levied on goods with negative externalities, which means that their consumption has a negative effect on social well-being. As if this were not bad enough, Spain charges too many taxes on the transfer of property, and not enough on the property itself.

In short, it is a tax system that discourages employment, savings and growth. And to make matters worse, we Spanish have an incredibly contradictory attitude to taxation. We want fabulous public services free of charge but we only want to be taxed at third-world levels; We cannot stand more cutbacks, but we deliberately forget that Spain still has the highest public deficit in the European Union after the three countries that received bailouts. It’s time to correct this situation, which is both unfair and inefficient, and to contribute to an informed and rational tax debate on the proposals in the report on recommendations for fiscal reform.

The report is centered on two objective facts. First, fiscal consolidation is not a fad, or not even a German obsession, but rather the necessary consequence of globalization and previous excesses. Excesses that have resulted in a structural déficit – which does not depend on an economic cycle – which still stands at over 4% of GDP, and which places public deficit on the road to comprising 100% of GDP. There is nothing progressive about the public deficit. What is really happening is that there is an inter-generational transfer of income whereby we are condemning future generations to restricted incomes (because I hope that nobody is naive enough to think that brushing off debt doesn’t come at a price).

And even if the objective is still to have a tax burden of around 38% of GDP, the natural deduction that can be made - from the proposed measures and their dynamic effectiveness, including measures against fraud - is that when the economy recovers, it will grow as a matter of course. And this will make it easy to reduce the deficit early, as long as we do not commit the mistake of generating additional recurring expenditure.  Social and sectorial policy should be drawn up by the public expenditure side of government. Tax policy, on the other hand, has to be stable and predictable. If the government wants to legitimately bestow privileges on determinate productive sectors or social groups, it should use state budgets and explain subsidies or corresponding transfers on an annual basis, but it should not hide behind a wall of tax legislation because doing that has the added effect of rendering these so-called subsidies permanent.  

In light of all the above, and given the current economic scenario,  all the Commission of Experts  for Fiscal Reform wants to do is propose a systematic restructuring the tax burden in Spain by raising indirect and environmental taxes, and reducing direct taxes. The ideal scope and timing of this action is arguable, and should not be decided by a commission of experts but by the government in question; but it is the only responsible direction to take. Likewise, fiscal devaluation, the replacement of national insurance payments with indirect taxes, could be phased in over time depending on the will and capacity to solve political and institutional problems that the report sets out in detail; but few technical doubts remain that if Spain wants to reduce its level of unemployment significantly  some day,  it will have to significantly reduce  the level of tax burden on a truly scant resource, namely work.

The main recommendations of the report are already known, and I will therefore cover only the more controversial of them and underscore those I believe that have gone strangely unnoticed. There are two points that have featured heavily in the press: first the rise in VAT from 10% to 21% with three exceptions, housing, public transport, and tourism, and second, the  proposed treatment of housing related taxes. About the rise in VAT I can only say that (i) our studies allow us to say that in combination with the proposed significant reduction in personal income tax it will have no regressive effect whatsoever. (ii) It is proven that individuals prefer to have more disposable income than tax subsidies - let’s call a spade a spade- for determinate consumer goods; (iii) the subsidies revert above all to the producers and distributors of these goods, and  (iv) European countries with high rates of VAT are also those which have the most generous social services. Anyone who reads the report carefully and without pre-conceived notions will be able to see that we like the Danish model and we underline the fact that people should not confuse the Welfare State with a specific way (that is also unfair, inefficient and insufficient) to fund pensions.

With regard to housing, as in the treatment of corporate funding and the deduction of financial costs, we are basing our proposal on an indisputable macroeconomic fact: the part of the current crisis caused by the housing and finance bubble was the result of tax incentives for the purchase of a home and corporate debt.  If you take both of these out of the equation, it can only serve to make the economy more stable and more capitalized. In the case of housing, without going into too much technical detail, the objective is to achieve tax neutrality between living in one’s own property or renting a home,  between investing in a real estate asset or financial asset, and between consuming housing or other goods. All this has led us to propose a rise in tax on the ownership of a house, and reduce tax on its transfer. We are aware that current realities respond to many years of incentives in one direction only (the purchase of a home) and we propose a gradual adaptation to a new scenario. And all this with a regime that is generous in its exceptions for more disadvantaged sectors and for lower value properties. But one thing is certain: we want to discourage people from putting their savings into housing, and we want them to save for their retirement, not for their children.

I don’t want to finish without mentioning that the report also examines important effects vis-a-vis redistribution among different regions. The proposals cannot be said to be based on a recentralization process, but rather on the systematic restructuring designed to recuperate economic efficiency. It is not logical to expect autonomous regions to depend on revenues that are too cyclical when the spending is structural. Nor is it a good idea to weaken market unity by desperately seeking new things to tax, or calling just about anything ecological as if a region’s environment were another source of tax. What we do propose is to streamline tax administration, but we do not offer an opinion on how this joint administration should be carried out.  There are several consolidated federal models that work well, but none as disperse and chaotic as the Spanish system.

There are not many Spanish precedents of a global and systematic restructuring of a country’s tax system. The UK’s Mirrlees report is perhaps one of the best known and appreciated. We, with all the inevitable exceptions, have tried to do something similar. I would like to think that our work has not been in vain. That when all the electoral noise dies down, and we can talk rationally and calmly about the best way to collect tax, it will be brought out and used, together with common sense, as a reference guide. 

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