Trade unions and opposition political parties in Spain fear that a reform of personal income tax due to come into effect in 1999 will threaten public services, and that the reduction in revenue could weaken the state's function as a redistributor of wealth. For the government, the general objectives of the reform are to promote employment and to make taxation fairer.
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Trade unions and opposition political parties in Spain fear that a reform of personal income tax due to come into effect in 1999 will threaten public services, and that the reduction in revenue could weaken the state's function as a redistributor of wealth. For the government, the general objectives of the reform are to promote employment and to make taxation fairer.
The tax reform law agreed by the ruling People's Party (Partido Popular) and the nationalist parties in Spain has been the subject of controversy, leaks to the press and contradictory statements, which have resulted in a confused debate on the subject (ES9803250N). The opposition parties and the trade unions have criticised the reform of personal income tax (impuesto sobre la renta de las personas físicas, IRPF), which will come into effect in 1999 on the grounds that it will reduce state revenue by between ESP 600 million and ESP 1 billion, and will favour the highest incomes by making personal income tax less progressive. Furthermore, it is claimed that the reform fails to deal with the problem of tax fraud.
Justification and objectives of the tax reform
The report by the Ministerial Commission for the Study and Proposal of Measures for the Reform of Personal Income Tax published in February 1998 contains the most complete account of the reform of IRPF. This document is seen as the "white paper" of the reform insofar as it states its justification and objectives. The arguments for the reform of IRPF are based on the functional problems of the current income tax system. These are as follows:
it has negative effects on savings, employment and risk-taking by individuals;
it is unfair;
it does not substantially improve the distribution of income; and
tax collection lacks flexibility and does not adapt appropriately to the economic cycle. It also suffers from certain operational problems such as increasing complexity, lack of coordination with other taxes and insufficient levels of collection.
The trade unions agree that some of these functional problems are indeed contained in the current system, such as the lack of fairness and its failure substantially to improve the redistribution of income. However, they feel that the current system's main problem is the high degree of tax fraud, which in the above document is perceived to be treated lightly under the heading "improvable levels of performance".
The general objectives of the new system of IRPF are to promote an increase in employment and to make the new tax fairer. The specific objectives that must be met, according to the Commission, are to:
foster rapid growth in production in order to generate a high level of employment;
increase fairness in the distribution of the cost of public services;
promote compliance with tax obligations;
improve the distribution of income and wealth;
maintain an appropriate level of revenue; and
simplify the tax.
The tax reform plays a major role in the relaunch of economic activity and job creation in view of the restrictive monetary policy imposed by the European Union convergence process. The tax policy therefore seeks to promote an environment favourable to economic activity, with measures to stimulate consumption, production and investment and to avoid penalisation of job creation. According to government estimates, the tax reform will increase Gross Domestic Product (GDP) by half a percentage point over the period 1999-2000.
However, the unions consider it particularly counterproductive to base job-creation objectives on tax action, because in the long term this may have negative effects, especially in the recessive phases of the economic cycle. One of the risks of the reform is the need to reduce expenditure if there is a decrease in revenue, because the government is committed within EU Economic and Monetary Union (EMU) not to raise the public deficit.
Position of the unions
The unions maintain that IRPF currently displays a certain degree of fairness. It is not a tax on activity but a personal tax, and it therefore affects the personal and family situation of individuals. As table 1 below indicates, IRPF affects mainly income from work, and nearly 80% of the declared income in the last tax year comes from wage earners, compared with 9% from business income and 3% from professional activities.
| Source | Amount (ESP million) | % of total | Number of tax payers | Average income (ESP million) |
|---|---|---|---|---|
| Work | 24,138,481 | 80.0% | 12,077,131 | 1,998,693 |
| Company activity | 2,786,668 | 9.2% | 2,466,399 | 1,129,853 |
| Professional activity | 1,027,632 | 3.4% | 486,849 | 2,110,782 |
| Real estate | 216,805 | 0.7% | - | - |
| Household capital | 2,001,759 | 6.6% | - | - |
| Total | 30,171,345 | 100.0% | 15,030,379 | 5,239,328 |
Source:"Valoración del IRPF 1995", Ministerio de Economía y Hacienda.
Despite these considerations, the unions base their criticisms on three points. Firstly, one of the main problems lies in the fact that businesses pay tax through an indirect system of estimating income that does not reflect real income, so they pay less than would be fair. This is clearly shown by the fact that the average income declared is lower than the average income from work declared. Secondly, it is believed that the greatest proportion of tax fraud, calculated at around 5% of GDP, corresponds to income from business and professional activities. Thirdly, tax is not progressive for incomes from capital gains, which are taxed at a flat rate of 20%, nor for business income, which is taxed through the "module system". In other words, capital gains and business and professional incomes receive a favourable treatment, whereas progressive rates are applied only to income from work.
Comparison with European Union average
The collection of IRPF in Spain is 3.2 percentage points lower than the average for the EU in terms of GDP; in terms of tax revenues it is 2.6 points lower. As table 2 below indicates, f"iscal pressure" (total revenue, including social security contributions, measured on the basis of GDP) in Spain is 7.8 percentage points lower, which means that the state has less of a capacity to finance public expenditure. In other words, the countries with a lower fiscal pressure are also those with less social protection.
| Country | Fiscal pressure (% of GDP) | Social protection (% of GDP) |
|---|---|---|
| Denmark | 53.3 | 33.7 |
| Belgium | 46.5 | 27.0 |
| France | 44.5 | 30.5 |
| Luxembourg | 44.0 | 24.9 |
| Netherlands | 44.0 | 32.3 |
| Greece | 41.4 | 16.0 |
| Italy | 41.3 | 25.3 |
| UK | 35.3 | 27.8 |
| Spain | 34.0 | 23.5 |
| Ireland | 33.8 | 21.1 |
| Portugal | 33.8 | 28.5 |
Source:"Revenue statistics 1965-6", OECD, 1997.
Revenue from IRPF in Spain represented 8.1% of GDP in 1995, compared with 11.3% from income tax for the EU as a whole. In other words, it can be argued that neither the Spanish tax system nor the IRPF system generate an excessive revenue, as the government has claimed in presenting its new reform. On the contrary, the figures compared with other countries reveal that Spain collects far less revenue in taxes, which helps to make it one of the less developed countries in the EU in most fields requiring public funding: education, health, infrastructure, social benefits and so on. Therefore, the unions believe that the reform of IRPF should help to reduce the deficit in revenue in order to maintain and extend the cover of the welfare state. However, the new reform goes in the opposite direction.
Commentary
The reform of IRPF will mean less revenue for the state, but perhaps the moment chosen, a period of economic expansion with a growth rate of over 3%, will help to disguise its negative effects. The difficulties will arise when the economy goes into recession, and the lower revenue of the state will lead to cuts in public expenditure and in particular in social expenditure, which would lead to a wider gap between the provisions of the Spanish welfare state and that of other EU countries. The government estimates that the total cost of the reform will be about ESP 600 billion, a figure that the social partners and opposition political parties consider excessively low.
The tax reform has been based on a short-term perspective without sufficient consensus between political agencies and social partners, whereas a serious IRPF reform should be based on a long-term perspective to provide security for taxpayers and to facilitate economic decisions. It should be more structural and therefore reflect a greater consensus between the political parties and the social partners.
Lastly, the basic objective of the reform of IRPF should not be job creation, which is not exactly the function of IRPF, but rather redistribution and social fairness. The use of fiscal policy as a central element of employment policy demonstrates the existence of serious limitations in the use of monetary policy as an instrument for expansion. (A Martín Artiles, QUIT-UAB)
Il-Eurofound jirrakkomanda li din il-pubblikazzjoni tiġi kkwotata kif ġej.
Eurofound (1998), Reform of income tax creates controversy, article.
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