Last spring the Spanish government named an external taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. reform committee to review environmental taxation, corporate tax, taxation of the digital economy, and harmonization of regional tax policies. The austerity policy plans tax hikes to close the 6.8 percentage point gap between Spain’s tax revenue and the Eurozone average as a percentage of Gross Domestic Product (GDP). One year later, the Finance Minister received a list of 118 tax reform measures, most of which consist of tax hikes.
Although the main difference in tax collection between Spain and the Eurozone, in terms of GDP, is mainly driven by the 4.3 percentage point difference in labor taxes, social security contributions, and income taxes, the main proposal in the reforms is aimed at the value-added tax (VAT). The experts calculate that replacing the different reduced tax rates in Spain (except for the ones applied in the Canary Islands, Ceuta, and Melilla) with the standard VAT rate applied to the whole tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. would increase VAT tax collection by more than EUR 17 billion (US $18.5 billion) on top of the current EUR 72.5 billion ($79 billion).
However, with a single standard rate of 21 percent, the report recognizes that compensation for the poorest households is needed. The report recommends a tax creditA tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly. which would amount to EUR 2.6 billion million ($2.8 billion).
The experts also considered a revenue-neutral reform where the general VAT rate in Spain could be cut from 21 percent to 15.4 percent. However, according to the European Parliamentary Research Service, by replacing the different reduced tax rates with the standard VAT rate applied to the whole tax base and on its entire territory, Spain could apply a VAT tax rate as low as 11 percent.
Additionally, the experts also recommend eliminating the VAT exemption for financial and insurance services. This would increase tax collection by EUR 2.8 billion ($3 billion). However, the report omits that the current 8 percent insurance tax rate (raised from 6 to 8 percent in 2021) and the recently introduced financial transaction tax would need to be repealed once insurance and financial services will be subject to VAT. Otherwise, applying VAT to financial services would be additional taxation on activities that are already being taxed.
An additional amount between EUR 5.9 billion ($6.4 billion) and EUR 15 billion ($16.4 billion) could be raised by reforming environmental taxation. The group of tax experts recommends repealing the energy production tax and reducing the electricity consumption taxA consumption tax is typically levied on the purchase of goods or services and is paid directly or indirectly by the consumer in the form of retail sales taxes, excise taxes, tariffs, value-added taxes (VAT), or an income tax where all savings is tax-deductible. , while increasing car registration taxes, diesel, natural gas, and agricultural fuel taxes. Additionally, new taxes on airplane tickets, use of road infrastructure, aggregate extraction, fertilizers, aviation, and naval fuels should also be implemented.
Separately from the tax reform committee, the International Monetary Fund (IMF) recently recommended Spain boost VAT and environmental tax revenue starting from 2023. According to the IMF report, VAT reforms could bring in additional revenue worth between 1.5 to 2 percent of GDP, and environmental taxes could amount to an additional 0.7 to 0.9 percent of GDP.
The Spanish tax reform committee also made recommendations on how to harmonize wealth and inheritance taxes among regions, especially in response to the wealth taxA wealth tax is imposed on an individual’s net wealth, or the market value of their total owned assets minus liabilities. A wealth tax can be narrowly or widely defined, and depending on the definition of wealth, the base for a wealth tax can vary. relief in Madrid and the reduction of inheritance taxAn inheritance tax is levied upon an individual’s estate at death or upon the assets transferred from the decedent’s estate to their heirs. Unlike estate taxes, inheritance tax exemptions apply to the size of the gift rather than the size of the estate. es in Andalucia, Galicia, and Cantabria. The experts recommend a minimum threshold and the maintenance of regulatory powers upwards and downwards for both the tax rate and threshold within a certain range (to be determined).
The experts recommend increasing the wealth tax threshold from the current EUR 700,000 ($763,098) to EUR 1 million ($1.09 million). Currently the highest rate is 3.75 percent in Extremadura. The experts recommend reducing the progressive taxA progressive tax is one where the average tax burden increases with income. High-income families pay a disproportionate share of the tax burden, while low- and middle-income taxpayers shoulder a relatively small tax burden. rates from 0.20 to 3.5 percent between 0.5 and 1 percent, in line with what other countries apply. Today, only two other European countries levy a net wealth tax: Norway and Switzerland. While wealth taxes collect little revenue, an OECD report argues that these taxes can disincentivize entrepreneurship, harming innovation and impacting long-term growth. Instead of reforming and harmonizing the wealth tax, perhaps regions in Spain should repeal the tax altogether.
The report also lays the groundwork for the reform and partial harmonization of the inheritance and gift taxes. Currently, regional statutory tax rates can reach levels as high as 81.6 percent, depending not only on the level of the amount inherited but also on the level of pre-inheritance wealth of the inheritor and familial closeness to the inheritor. The report recommends the abolition of the factor that depends on the level of the pre-inheritance wealth and tax rates cuts. These measures would bring the baseline for the statutory top rates to a maximum of 25 percent. It also recommends raising the inheritance tax threshold for close heirs from EUR 16,000 ($17,442) to up to EUR 250,000 ($272,533) and EUR 20,000 ($21,802) for more distant relatives. However, the regions of Andalucia and Galicia are currently applying a de facto threshold of EUR 1 million ($1.09 million) for close heirs.
If implemented, these tax reforms could benefit distant relatives in most Spanish regions and all heirs in Asturias, Valencia Community, Aragon, and Catalonia. However, depending on how the harmonization will be implemented, many Spanish regions could see their effective wealth tax rates increased.
While inheritance and gift taxes raise 0.58 percent of Spain’s total revenue, a recent study revealed that inheritances can in fact reduce wealth inequality as transfers are proportionately larger (relative to their pre-inheritance wealth) for households lower in the wealth distribution.
As the Finance Minister announced, this is not the moment to raise taxes and especially environmental and energy taxes. However, policymakers should consider repealing wealth and inheritance taxes that negatively impact entrepreneurial activity, savings, and work. Instead, they should focus on policies that do not undermine economic growth. Spain should consider instead full expensingFull expensing allows businesses to immediately deduct the full cost of certain investments in new or improved technology, equipment, or buildings. It alleviates a bias in the tax code and incentivizes companies to invest more, which, in the long run, raises worker productivity, boosts wages, and creates more jobs. for capital investment as a means to increase private investment and accelerate the economic recovery.
Additionally, the government is looking to boost its revenue and at the same time protect the poor. Because of this, policymakers should follow the tax experts’ recommendations on simplifying VAT and making it more efficient and neutral by broadening the tax base, lowering the tax rate, and eliminating unnecessary tax exemptionA tax exemption excludes certain income, revenue, or even taxpayers from tax altogether. For example, nonprofits that fulfill certain requirements are granted tax-exempt status by the Internal Revenue Service (IRS), preventing them from having to pay income tax. s. The government can then implement compensation measures for poorer households, such as targeted tax credits or direct transfers to low-income earners.
Policymakers should shy from unnecessary tax hikes and harmonization measures and implement the tax reforms that could eventually accelerate economic growth.
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