Anticipation is building over Government’s decision on whether to lock the Maltese Lira with the Euro by year’s end in what is known as the Exchange Rate Mechanism (ERM II). The decision is a highly technical one and not without economic, social and political considerations.
The rate at which the Maltese Lira is pegged to the Euro is a sensitive issue that can have disastrous consequences on industry if calculated at the wrong level.
Since joining the Euro is a must by virtue of EU membership, it may seem logical for the debate to be conducted in a serene political climate. It would be unwise to turn the Euro into a political football but there are serious considerations to be made.
Experts hold differing views on whether Malta should rush into the Euro or postpone its adoption for a longer period to stave off social unrest, which may be brought about by Government’s relentless drive to adhere to the strict Maastricht criteria for deficit, debt and inflation levels.
Even if the Government and the Opposition do seem to have slightly differing views on the best course of action the worrying factor is the almost secrecy in which the decision is being baked. It is not enough for the Governor of the Central Bank to make a presentation to Cabinet and privately meet the Opposition to explain his views.
A wider, intelligent debate on the pros and cons of joining the Euro at the first possible chance is required.
A case for flat taxes
The five years spanning the period 1995 and 1999 were traumatic for Malta’s economy with the consumption tax structure changing form and substance for three consecutive times.
First it was VAT. Then came the deformed progeny CET, soon to be replaced with a new VAT regime in 1999. These changes created instability in the economy and caused serious problems for the tax collectors leaving Government finances with a veritable dent.
Within this context it may seem risqué to suggest a tax overhaul that would revolutionise the way we pay income tax. But in an ever-changing landscape where foreign competition plays a determining factor on how we conduct our business over here, Government has to think out of the box.
The phenomenon of flat taxes, where a single rate of tax replaces graded income tax bands, started in Estonia in 1994 and has taken root in other eastern European countries.
In Slovakia, individuals and businesses pay a single tax of 19 per cent on their income irrespective of the person’s wage or the company’s profits.
At the half-day seminar organised by Volksbank Malta last week for Maltese investors interested in tapping into eastern Europe’s growing markets, entrepreneurs heard of the lower tax regimes in various former communist countries, ranging from as low as 14 per cent to a maximum of 26 per cent.
It is with these new EU entrants that Malta is competing for foreign direct investment and with the highest income tax band standing at 35 per cent, Malta starts its race at a disadvantage.
Transforming the multi-band income tax system into a single flat rate has its advantages. To start with it grossly simplifies the paper work for company accountants who rather than calculating income tax due for each and every employee, would simply levy the percentage tax on all the company’s wage bill.
A single rate would hack away at the excessive bureaucracy associated with a multi-band system and could possibly reduce administrative costs at the Inland Revenue Department.
If set at the same rate as VAT to avoid the temptation of companies registering their employees as self-employed, the single income tax rate could effectively lower the tax burden leaving people and businesses with more cash in hand.
The change also comes with its down side. Our current system is a progressive tax system which stipulates that higher income earners are taxed at higher rates ensuring a sense of social solidarity between the various social classes. Thus a low income earner is expected to pay tax at 15 per cent while those earning most are expected to pay as much as 35 per cent tax.
A single rate would flatten out these disparities. Even so, a lower tax could significantly improve compliance from the highest earners, who in any case are the most likely to indulge in the skilful art of tax avoidance with the multi-band system currently in place.
Under a single tax rate there would still be scope for a minimum threshold of earnings which will be totally exempt from income tax.
Government may argue that such a shift could radically reduce tax collection and hence have a negative impact on public finances raising the deficit to higher levels than at present.
The pitfalls have to be weighed against the advantages but creating a task force with the brief to study all implications a single flat rate of income tax will have on social solidarity, Government finances and the economy in general could provide a cautious way forward.
Making this country competitive is a must for survival and radically altering the tax regime could be one of the solutions on the horizon.