On Sunday, Prime Minister Robert Abela announced that in the upcoming Budget the Government will be implementing its ‘biggest tax cut in history’ for Malta’s middle-class.
Without divulging much detail about how the tax cuts will be implemented, Dr Abela remarked that tax bands will be widened in a way that incentivises middle-class income earners.
However, In June, he had already hinted at the measure noting that parents earning up to €1,000 a month would no longer be charged income tax and that such measures would translate an additional €600 per year for middle-class families.
As global economies have faced numerous challenges in recent years due to the pandemic, inflationary pressures, and conflicts, and with the Government forking out million in subsidies to support businesses and individuals to fight the cost-of-living crisis, questions arise about the sustainability of reducing government income at this time.
Answering such concerns, Philip von Brockdorff and Charmaine Portelli, academics within the Economics department at University of Malta speak to WhosWho.mt analysing possible risks and benefits of the upcoming tax measures.
Prof von Brockdorff comments that the objective behind widening of tax bands, “presumably for persons earning less than €60,000,” is to reward persons and households whose income is deducted at source and hence paid directly to the Inland Revenue Department.
Ultimately, he notes, that the economic benefit of a lower income tax burden will boost consumption spending and aggregate demand within the Maltese economy. Such an incentive, he adds, might also boost work and possible higher productivity, “though the latter depends on a host of variables.”
In addition, he remarks that lower taxes for middle-class earners might also reflect an increase in savings and investment.
Dr Portelli highlights that this measure would benefit the economy by leaving more disposable income in the pockets of employees, “raising VAT revenue as well as the profits of those who benefit from the increased sales of goods and services.”
Furthermore, she adds that such measures can promote economic development, employment, and social equity in the short term.
“The macroeconomic effect is sensitive to where in the income distribution the tax is targeted. For example, in case of a tax cut for the middle-class, one expects that the resulting increase in economic output exceeds the loss in revenue,” Dr Portelli says.
Nonetheless, they both believe that this measure has potential downsides. Dr Portelli emphasises that one should not undermine the impact of the net forgone tax revenue and any potential pressure it might put on the budget.
Sharing the same thoughts, Prof von Brockdorff highlights that an increased budget deficit would come at a time when Malta is already facing an excessive deficit procedure, when the European Commission is insisting that subsidies on electricity consumption are to be phased out.
“Maybe the Government is paving the way for the withdrawal of the subsidy by widening the tax band for middle-income earners,” he adds.
Interestingly, Prof von Brockdorff notes that tax evasion should also be considered in the equation.
He points out that tax evasion remains an issue in the Maltese economy. This, he notes, is particularly accentuated in self-employment, where fiscal receipts are not often provided and possible employees who make an agreement with their employers to pay part of their wage in cash, and therefore avoid declaring the full amount.
“I doubt whether the widening of the tax bands would stop this tax evasion,” he remarks.
On her part, Dr Portelli elaborated that in terms of risks, if tax cuts are not financed by immediate spending cuts, the Government will risk an increased budget deficit, which in the long-term will reduce national savings.
“There is also a risk concerning the net impact on growth. Moreover, while tax measures have no effect on the long-term size of the economy, they may also create trade-offs between equity and efficiency,” she continues.
She suggests that while reducing taxes on labour income is likely to stimulate economic activity, there is less certainty about the dynamic effects of tax cuts and their ultimate impact.
Dr Portelli further notes that this measure could potentially lead to negative distributional effects, particularly over the longer term.
Prof. Brockdorff also comments that if this measure leads to higher levels of consumption and aggregate demand, it could subsequently lead to higher prices for consumers. He argues that such circumstances could erode away any initial gains derived by middle income earners.
Philip von Brockdorff / LinkedIn
Within the context of global economies, are tax cuts sustainable?
When asked about the sustainability of tax cuts in the global economy, Prof von Brockdorff notes that this is dependent on a number of variables.
This includes the growth rate of the economy, the fiscal commitments decided by the Government from one budget to the next, the global economic environment and whether Malta complies with the new fiscal rules as agreed at EU level.
“The latter in particular is of immediate relevance and the status of excessive deficit procedure requires the Government to cut down on costs and provide incentives to raise more tax revenue through higher levels of economic growth,” he notes.
He reasoned that the challenge with economic growth rate is that the country is facing several capacity problems that have “clearly reached unsustainable levels” in a number of sectors.
Meanwhile, Dr Portelli says that while there is a notable positive macroeconomic response to a tax cut, it is “unlikely [to be] strong enough to prevent the cuts from being revenue losing.”
This, she adds, undermines fiscal sustainability and leads to challenges such as fiscal imbalance and debt pressure.
She emphasises that this poses a significant challenge for the budget team, which must address the gap through a combination of expenditure cuts and revenue increases.
“This leads to the pertinent question concerning how expenditure can be cut while supporting the needed infrastructural maintenance and upgrade and how revenue is increased unless through taxation,” she adds.
In this context, she questions whether this is the right measure Malta “needs and whether the time is ripe for it.”
Here, Prof von Brockdorff chimes in and shares that in line “with the glaring need” for the economy to grow sustainably, tax incentives should be directed towards economic sectors that are more sustainable and result in visible environmental benefits.
‘One way of offsetting revenue loss from tax cuts is focusing on tax enforcement and collecting what is due’
For many years, the Government’s strategy of driving economic growth has seen a rapid population growth. This has in turn rendered itself as unsustainable in many aspects with overpopulation, pressures on public health and energy supply being the most concerning issues for citizens.
With this in mind, how do the economists envision the Government offsetting revenue loss from the proposed tax cuts, without relying on continued population growth?
Put simply, Dr Portelli notes that one way to challenge this is for the Government to focus on tax enforcement, “and collecting what is due to the government.”
Such an initiative has already been taken by Finance Minister Clyde Caruana, or at least attempted to. The Government had announced plans to set up a new AI tax collection setup, a system which is used in many countries. While this was announced in May 2023, it is not yet clear whether this system has been adopted or introduced and whether the Government investment has reaped any fruit.
From his end, the Professor notes that the country needs to make hard choices.
“Do we allow the current economic growth model, which has generated higher levels of tax revenue from unprecedented growth or do we transit towards a far more sustainable model especially from an environmental perspective?” he questions.
He remarks that a transition to a more sustainable approach will take years to come about, along with tax reform that incentivises sectors that comply with sustainable policies while also penalising those that do not.
“Again, this would need to happen gradually to avoid shocks to the economy and to fiscal stability,” he says.
Impact of lower taxes ‘might not fit with what businesses are considering as necessary’
In a recent interview, Malta Employers Association President Kevin Borg said that local businesses are seeing profits being eroded. This was attributed to a mixture of increased costs and an over reliance on domestic demands.
Mr Borg had suggested a bigger focus on export-led growth. Would lower taxes for the middle class begin to address this?
Prof von Brockdorff doesn’t believe so. He remarks that he has his doubts whether lower taxes will boost Malta’s exports to any significant degree.
“If anything, if lower taxes result in higher levels of spending, this could increase sales of retail products and entertainment services, a substantial part of which are imported,” he shares.
Similarly, Dr Portelli notes that while this measure promotes additional disposable income and consumption in favour of businesses, “this might not fit exactly with what businesses are considering as necessary.”
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