Another year, another new 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. proposal in Spain. Over the last several years, Spain has adopted a financial transactions tax (FTT), a digital services tax (DST), and a special value-added tax (VAT) on sugary drinks. On average, revenues collected from these taxes only amount to about 25 percent of what the government predicted they would be.
While countries like Italy and the UK are moving forward with pro-growth tax reforms, Spain’s latest tax developments might put a break on economic recovery or even push the country into a 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. . These developments are also contrary to Tax Foundation’s Principles of Sound Tax Policy and are being challenged in court by businesses and regional governments.
Two New Windfall Taxes and Doubling Down on 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.
At the end of 2022 new taxes were approved. Spain enacted a new windfall tax on energy operators after the first tax of this type, approved in 2021, was diluted by a series of exclusions that left many energy providers out of its scope. This new tax is a 1.2 percent tax on the sales of domestic power utilities, companies with an annual turnover exceeding €1 billion in 2019. A second windfall tax of 4.8 percent applies to banks’ net interest income and net fees if the net income from these sources exceeded €800 million in 2019. Both windfall taxes, which went into effect on January 1, will be in place for two years, 2023 and 2024. The government aims to raise €3 billion ($3.24 billion) in 2023—€1.7 billion ($1.84) from the energy sector and €1.3 billion ($1.41 billion) from the bank sector—and around €7 billion ($7.57 billion) over two years. However, the enacted measures are not proper windfall profit taxes—they go beyond merely taxing windfall profits. A tax on sales is not a tax on profits at all—it resembles more of an excise taxAn excise tax is a tax imposed on a specific good or activity. Excise taxes are commonly levied on cigarettes, alcoholic beverages, soda, gasoline, insurance premiums, amusement activities, and betting, and typically make up a relatively small and volatile portion of state and local and, to a lesser extent, federal tax collections. .
The third tax is a “solidarity wealth tax” on individuals with net assets exceeding €3 million ($3.25 million). This tax is not new; it’s a second wealth tax with a top tax rate of 3.5 percent in response to wealth tax relief enacted in Madrid and Andalusia. Spanish law grants regions authority to legislate and charge the wealth tax in their territories. 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, in September 2022 Andalusia approved 100 percent relief, while Galicia increased its tax relief from 25 percent to 50 percent. The rest of the Spanish regions levy a progressive wealth tax ranging from 0.16 percent up to 3.75 percent in Extremadura.
Under this new tax scheme, the central government will get to keep any additional revenue from the solidarity tax once the regional wealth tax collection is deducted. This new wealth tax will affect not only taxpayers in Andalucía, Galicia, or Madrid but all taxpayers that live in a region that approved a higher 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 IRS, preventing them from having to pay income tax. threshold or lower tax rates than the ones established by the central government.
These additional revenues, especially the ones from the two windfall taxes, will allegedly be used to offset the cost-of-living crisis. The two main measures that the government approved for the year 2023 are a temporary VAT cut and a minor reduction in the effective income tax rate for low-income earners.
Cost-of-Living Tax Measures
While the central government didn’t adjust the income tax brackets for 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. , it has approved a slight reduction in the effective tax rate for households earning less than €21,000 ($13,000) per year. However, while the withholdingWithholding is the income an employer takes out of an employee’s paycheck and remits to the federal, state, and/or local government. It is calculated based on the amount of income earned, the taxpayer’s filing status, the number of allowances claimed, and any additional amount of the employee requests. tax will be reduced and the amount of income tax paid during 2023 by low-income households will be cut, it is not clear that these households’ final income tax bills will be reduced.
Additionally, the government approved a six-month temporary VAT cut. For cooking oil and pasta, the VAT rate was cut from 10 percent to 5 percent. A 0 percent VAT rate was approved for cereals, vegetables, fruit, basic dairy products, and bread, previously taxed at the super-reduced rate of 4 percent. Nevertheless, international experts are cautious about VAT cuts. Rita de la Feria, a professor in tax law at the University of Leeds, said in an interview with Tax Notes, “prices did not come down in Spain after a VAT reduction on fresh vegetables.” Bloomberg’s monthly Paella Index also showed that paella costs more to cook even after the food tax cut.
Moreover, these minor tax cuts do not explain the need to introduce two new windfall taxes and a second wealth tax. Driven by VAT, personal, and 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. collection, Spain’s 2022 tax revenue up to November 2022 increased by 15.9 percent when compared to 2021, generating €33 billion ($35.75 billion) in additional revenue.
This is not the first time that the Spanish government introduced new taxes expecting to raise more revenue. Spain’s 2021 Budget came with two new taxes, a DST and an FTT. At that time, the Spanish government expected that the FTT and the DST would generate additional revenue of €1.818 billion ($1.97 billion) annually, while the tax revenue for 2021 for both taxes was only €462 million ($500 million) just 25 percent of their original estimates.
But even though it’s unlikely that the new taxes would raise the additional revenues expected, they would still likely raise prices, further hit banks that are already not profitable, distort competition in the banking sector, and punitively target certain industries without a sound 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. . Although the EU-wide windfall tax (called the “solidarity contribution tax”) is not a good option, it does not have as many problems as the current windfall profit taxes.
The flawed design of these windfall profit taxes has already created problems in the countries that have implemented them. Spain is no exception.
Challenged in Court
Two associations representing Spanish banks, along with Santander Bank and BBVA, announced that they plan to challenge the tax in court alleging that this is a tax on revenue and not on income. BBVA estimated this measure will cost the company an additional €225 million in tax.
Another association representing Spain’s largest electricity companies filed a motion with Spain’s High Court claiming that the new tax is “discriminatory and unjustified.” Additionally, Endesa’s CEO announced that the company would accept paying a tax on the windfall profit generated from its natural gas business alone but not a tax on all of the company’s domestic revenue. Endesa estimated that the new tax will cost the company an additional €208 million ($225 million) in tax.
Given the outcry from the Spanish government, the most important blowback to the Spanish central government’s tax policy is the plan of the infrastructure group Ferrovial to relocate its headquarters to the Netherlands. The company is pursuing a dual listing in Amsterdam and the U.S. The move, which is seeking shareholders’ approval on April 13, was motivated by the “Netherlands’ greater regulatory stability, attractive tax climate, and lower cost of financing.” The Spanish government is looking at whether it could use a takeover law, approved during the COVID-19 pandemic and economic crisis, to make Ferrovial seek official approval for its plan, since the relocation will happen through a reverse merger with one of Ferrovial’s units in the Netherlands.
It’s unlikely these implemented tax hikes will achieve their revenue goals, but they have the potential to negatively impact growth and economic recovery while generating legal uncertainty. As public spending, debt, and taxes are increased, Spain’s current economic challenges could turn into a long-term recession. Policymakers should avoid unnecessary tax hikes and consider repealing the two new windfall profit taxes, as well as the wealth, financial transaction, and digital services taxes. To increase private investment and accelerate economic growth, Spain should consider 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 and shift the tax mix towards less harmful consumption taxes by broadening the VAT tax base.
Spain should follow the examples of Italy and the UK and enact tax reforms that have the potential to stimulate economic activity by supporting private investment while increasing its international tax competitiveness.Share