Spain’s central government could learn some valuable lessons from its regional governments about sound 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. policy.
The Tax Foundation recently released the 2023 International Tax Competitiveness Index (ITCI). Since 2019, Spain has dropped from 26th to 31st (out of 38 countries) in the ITCI due to multiple tax hikes, new taxes, and weak performances in all five index components. While Spain’s central government is the main driver behind this drop, Spain’s regional governments also play a role in the country’s overall international tax competitiveness.
In Spain’s case, some of the 40 tax policy variables in the ITCI are set by regional governments. Therefore, the Spanish Regional Tax Competitiveness Index (RTCI) complements the ITCI by comparing the 19 Spanish regions on more than 60 variables across five major areas of taxation: individual income taxAn individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S. , 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. , 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. , transfer taxes and stamp duties, and other regional taxes.
Spain’s 2023 International Tax Competitiveness Index Score and Ranking by Category
|Score (out of 100)
|Ranking (out of 38)
|Corporate Income Tax
|International Tax System
Corporate Income TaxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax.
Spain scores poorly on corporate tax policy, ranking 33rd, due to several poor policy choices. First, Spain has both a patent boxA patent box—also referred to as intellectual property (IP) regime—taxes business income earned from IP at a rate below the statutory corporate income tax rate, aiming to encourage local research and development. Many patent boxes around the world have undergone substantial reforms due to profit shifting concerns. and a credit for research and development. Second, it is one of eight countries in the Organisation for Economic Co-operation and Development (OECD) that has implemented a digital service tax (DST). Third, it has a relatively high corporate tax rate of 25 percent (28 percent in Navarra), above the OECD average of 23.6 percent.
Spain’s individual tax component is also weak, dropping from 14th in 2019 to 17th. Spain has one of Europe’s highest top income tax rates. Nevertheless, when the Spanish central government increased the general top marginal income tax rate from 45 percent to 49 percent, Madrid approved a general tax cut, setting the overall (central and regional) top marginal income tax rate at 45 percent. Other regions like Andalucía and Murcia followed Madrid’s example and cut the top marginal income tax rate to 47 percent.
While in 2023 most European countries indexed their income tax to inflationInflation is when the general price of goods and services increases across the economy, reducing the purchasing power of a currency and the value of certain assets. The same paycheck covers less goods, services, and bills. It is sometimes referred to as a “hidden tax,” as it leaves taxpayers less well-off due to higher costs and “bracket creep,” while increasing the government’s spending power. , the Spanish central government refused to do so. At the regional level, Madrid indexed its income tax to inflation to avoid bracket creepBracket creep occurs when inflation pushes taxpayers into higher income tax brackets or reduces the value of credits, deductions, and exemptions. Bracket creep results in an increase in income taxes without an increase in real income. Many tax provisions—both at the federal and state level—are adjusted for inflation. . It also raised the basic 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. and child tax credit, and increased the generosity of the personal income tax measures to support large families. Following Madrid’s example, other regions governed by right- and left-wing parties indexed the income tax for inflation for low-income households and raised the basic tax credit and child tax credit. This pressured the central government to slightly reduce the effective tax rate for households earning less than EUR 21,000 per year.
Spain ranks 19th on the 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. component. However, less than 50 percent of consumption is covered by the value-added tax (VAT) due to exemptions that complicate the overall system and distort consumer choices. A broader VAT base could create fiscal space for lowering the overall VAT rate of 21 percent.
Of the ITCI’s categories, Spain scores the worst on property taxes (ranking 37th). Spain has multiple distortionary taxes, including a tax on real property, a property transfer tax, capital duties, and a financial transaction tax.
Additionally, Spain levies a net wealth tax, an inheritance tax, and a gift taxA gift tax is a tax on the transfer of property by a living individual, without payment or a valuable exchange in return. The donor, not the recipient of the gift, is typically liable for the tax. . However, not all regions in Spain levy a net wealth tax. In 2008, when the Spanish central government repealed the net wealth tax and then reintroduced it three years later, Madrid preserved 100 percent relief from the tax. Following the example of Madrid, the regions of Andalusia, Cantabria, and Extremadura (the region with the highest top wealth tax rate in the world) approved 100 percent relief, while Galicia offered 50 percent relief. The rest of the Spanish regions levy a progressive wealth tax ranging from 0.16 percent (in Navarra) up to 3.75 percent in the Valencia Community.
Although most OECD countries have repealed their wealth taxes, Spain’s central government introduced a national temporary solidarity tax on high-net-worth individuals for the tax years 2022 and 2023 (to be collected in 2023 and 2024), with tax rates between 1.7 percent and 3.5 percent. This is an additional wealth tax that complements the regional one, and taxpayers can credit their regional wealth tax contributions against the national solidarity tax liability.
With this solidarity tax, the central government expected to collect over EUR 1.5 billion, but in the end, it only collected 40 percent of that amount: EUR 0.6 billion.
Not only did the solidarity tax not collect the revenue announced, but also three regional governments of Madrid, Andalusia, and Galicia appealed the “solidarity wealth tax” to the Constitutional Court. However, after the Constitutional Court ruled that the solidarity wealth tax is constitutional (despite what experts argue), Madrid, Cantabria, and Extremadura (and soon Andalusia) restored the wealth tax so that the regional governments retain the revenues the central government plans to collect in 2024. Additionally, to compensate for this tax hike, Madrid is looking to cut the income tax. Meanwhile, Portugal’s decision to extend its tax regime for non-residents is timely, since more Spanish taxpayers are considering changing their tax residence.
Similar to the net wealth tax, the inheritance and gift taxes in Spain are collected and administered by regional governments. Regional statutory inheritance tax rates in Spain can reach levels as high as 87.6 percent (in Asturias). Unsurprisingly, Spanish regions have the highest inheritance tax rates in Europe.
Tax competition has proved effective. In 2022, Andalusia was the first region to cut the top statutory inheritance tax rate from 81.6 percent to 49.6 percent, just below Germany’s and Switzerland’s top tax rate of 50 percent. Additionally, in 2022, only three regions had no inheritance tax for close heirs. Nevertheless, after May’s elections, the newly formed regional governments of Aragon, Balearic Islands, Canary Islands, Extremadura, La Rioja, and Valencia Community have already slashed the inheritance tax for close heirs.
While inheritance and gift taxes collect little revenue, a recent study revealed that inheritances can reduce wealth inequality as transfers are proportionately larger (relative to their pre-inheritance wealth) for households lower in the wealth distribution. And this is especially true for Spain where inherited wealth as a portion of net wealth reaches 95.6 percent. Therefore, given their limited capacity to collect revenue and negative impact on entrepreneurial activity, savings, and work, policymakers should consider repealing inheritance and gift taxes.
What Is Next?
Spain, like many other countries, introduced temporary rate reductions to excise duties and value-added taxes on energy and food products as a price support measure to cushion the impact of a sharp rise in energy prices and inflation. Nevertheless, many of the tax relief measures implemented during the past year are set to expire in 2024, increasing the cost of living for all households.
Additionally, the government coalition agreement planned to make permanent two windfall taxes introduced temporarily for 2023 and 2024. But after Repsol, one of Spain’s biggest oil producers, criticized the country’s lack of fiscal stability and signaled that Repsol’s investments could be cut and its green hydrogen business transferred elsewhere, the government is now considering reviewing the energy windfall tax during the 2024 budget approval. For now, both taxes have been extended for one more year.
Even if the windfall and solidarity taxes become permanent, the central government will need more tax hikes to comply with requests from separatist groups in Spain. One such request, the amnesty law, is raising concerns at the EU level about the rule of law in Spain, and it could put at risk the EU funds that Spain is currently receiving. Other requests—such as the pardon of part of Catalonia’s debt and giving full fiscal autonomy to Catalonia—will impact Spain’s budgetary stability for the coming years.
While the exact amount of all these requests is difficult to measure both in the short and long term, only the pardon of Catalonia’s debt could cost EUR 90 billion—entirely offsetting the benefits Spain receives from the EU (EUR 69 billion). Additionally, giving Catalonia, the region with the least competitive tax system in Spain, full fiscal autonomy will most likely increase yearly transfers from the central government to Catalonia.
As public spending, debt, taxes, and transfers to Catalonia increase, Spain’s current economic challenges could turn into a long-term recessionA recession is a significant and sustained decline in the economy. Typically, a recession lasts longer than six months, but recovery from a recession can take a few years. . Policymakers should avoid unnecessary tax hikes and consider repealing windfall, solidarity, and wealth taxes.
Instead, Spain should implement tax reforms that stimulate economic activity by supporting private investment and employment and attracting highly qualified workers. To increase its internal and international tax competitiveness, perhaps Spain’s central government should look to its successful regional governments for ideas.
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