23 August 2006

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Business Today

We are a responsible government

The whole package of incentives, whether in the form of tax cuts or increased expenditure, government is proposing for 2007 will be valued at Lm8 million. It may sound as a drop in the ocean but for Parliamentary Secretary TONIO FENECH, the decision to give the public some respite after three years of sacrifices is grounded in government’s belief that any such decision has to be “responsible” and “sustainable”.
Fenech insists that government cannot simply decide to send all caution to the wind after three years of budgeting intended to take the deficit below three per cent of GDP. Not even an election round the corner, he insists, will prompt government to go astray from the path it started on.
But Fenech is careful not to let the cat out of the bag. Calling an election is the Prime Minister’s remit and potentially there could be two budgets before the next general election, he says.
“We are committed to introduce the Euro on 1 January 2008. What this will mean in terms of when a general election will be held, you will have to ask the Prime Minister,” Fenech says.

The pre-budget document talks of an Lm8 million leeway that government has at its disposal to dampen the sacrifices people have been asked to make over the past three years. Does that global sum cater for all the proposed measures in the document such as a change in income tax bands, a change in NI for part-timers, the energy benefit and the child benefit?
We arrived at the sum of Lm8 million after evaluating income and expenditure levels, current growth and the long term sustainability of any fiscal measures adopted. The assessment showed us that at this stage, since the budget is normally drawn up in October and November when the figures for the third quarter become available, the country can afford either a loss in revenue or increase in expenditure, or a mixture of both to the tune of Lm8 million.
This means that all the measures listed in the pre-budget document would have to tally to that amount.
There are some measures that have an immediate negative impact with a subsequent positive outcome. The proposal to change the NI contributions made by part-timers into a pro-rata system will mean an initial loss of revenue to the tune of Lm1.5 million but it would hopefully lead to more part-timers entering the labour market and others to come out of the black economy. This would enable government to recoup its loss in the short term.

How much would you quantify the loss of revenue by changing income tax bands?
We have not quantified that since we have embarked on a totally different exercise. The pre-budget document presents a menu of proposals to which we expect the public to give us feedback. Some proposals are not costly and can be implemented in any case but we might have to choose between others and so we are asking people to give us their preference.

Does government have any particular preference on how it wants to distribute the Lm8 million?
I do have my preferences as to what I think are the measures that would benefit the economy most but government has not stated its preferences so as not prejudice the discussion. Otherwise what type of pre-budget consultation that would be?
This year’s document is different from last year’s since we are giving people options to choose from. As a government, prior to finalising the budget we are always presented with a number of options but finally the finance minister would have to decide what the country affords.
Emphasis by the public on any particular measure during the consultation phase may lead government to take certain decisions rather than others. We want to give people a chance to state their preferences.
People have to realise, however, that tax measures are a matter of choice and not taste.

But will Lm8 million leave a perceptible impact on people’s personal finances?
A change in tax bands to the tune of Lm8 million will have an impact but we are a responsible government. We’ve asked people to make sacrifices to bring the country’s finances on a sustainable level and it would be irresponsible to threaten the progress done so far.
Government would have definitely been more popular if it listened to Super One and proposed a Lm20 million tax cut. But at this stage, does the country afford that level of tax relief while keeping on track with its commitments?

The pre-budget states that any tax relief or measures costing more than Lm8 million would have to be recouped through a shift in taxation. However, the document says nothing of where and how this shift would occur. Are you considering any such move?
When we started the tax reform commission we had three streams of work. One was to analyse the corporate tax regime, another was to suggest proposals on how to make work pay more by analysing income tax bands, measures to encourage more female participation in the labour market and so on and a third was to study a shift in taxation.
In last year’s budget government said it was committed to shift taxation onto consumption and those who pollute.
But reality shows us that at this point in time, polluter pays taxation and consumption taxes would lead to higher inflation. Government turned down a number of proposals presented by the tax reform commission to shift taxation since they would have had an inflationary impact.

What about a tax on vacant dwellings?
Property is already taxed because we have a capital gains structure and a final withholding tax structure. In Malta, property is very much considered to be an investment and introducing a tax on vacant dwellings would risk creating a flight of capital with investors holding property in their portfolio possibly deciding to stock property elsewhere.

But they could also put that property on the market possibly leading to a decrease in the price of property…
That the price of property would go down, I very much doubt it but we also have to be careful not to create a property crash. There are people who would have used property as a security for a bank loan and by creating a property crash that lowers the value of their security they could be in for big trouble. Property is a very delicate issue and something you don’t just play with. Any change needs to be studied carefully.
At the moment government does not consider a tax on property that is not being used as a wise measure.

Are you satisfied with the longer term sustainability of economic growth especially given the crash in tourism and the fact that exports, which have only just started to recuperate, are heavily dependent on the cyclical turbulences of one big company, ST?
We need to acknowledge that today economic growth is not dependent solely on these two sectors. They do influence and have an impact but the services sector is increasingly having an impact on our growth figures.
Even by looking at employment figures, the growing importance of the services sector is evident. Our economy employs around 140,000 people. Manufacturing, including the construction industry that employs some 8,000 workers, employs around 30,000 people. Tourism does not employ as many people. The biggest chunk, 50,000 work in the services sector. Today, the services sector employs more people than manufacturing, excluding construction and tourism put together.
Our economy has quite a spread and our eggs are not all in one basket. Our manufacturing export figures and profitability levels of the sector tend to be very much influenced by ST. If the level of prices at ST go down it will have an impact. In the beginning of 2005, ST actually produced and sold more but could only manage cheaper prices for its products. ST’s profitability was lower so GDP and exports were lower.
With the shift we’re having in manufacturing because of the pharmaceutical sector we are going for higher value added and I believe there is a sustainable turnaround in the sector after a rather painful restructuring process during which jobs were lost.
Tourism is definitely an issue. We need to see better improvements in the numbers. The summer figures, although still below expectations are not bad. There are hotels that are not feeling the lower figures, which quite frankly are those in the higher employment segment. Five Star hotels, who employ most people and register higher profitability are doing well. But looking at the three star category, they are not doing well.
But other sectors of the economy are performing. Growth in the first quarter was satisfactory and as things are progressing, we will probably be witnessing a similar trend in the second quarter.

What growth are you envisaging for this year?
It is still too early to set any benchmarks since we normally allow the figures for the third quarter to be issued before projecting growth for the year. But the economy is definitely performing even if we look at employment figures.

The question is whether the economy is growing big and fast enough to make up for higher interest rates levied on public debt?
But the economy still has a lot of slack that can be cut down. It definitely has a lot of potential to grow. Growth does not jump upwards it is a gradual process.

Are you still of the opinion that Malta should be moving towards a balanced budget as stated in the convergence programme presented to the EU?
We are bound by the stability and growth pact that paints an ideal scenario of a controlled deficit and balanced budgets. But it needs to be done in a responsible manner. I think we proved our critics wrong when they told us we were focussing solely on reducing the deficit and ignoring economic growth.
Government has managed to focus on reducing the deficit without compromising economic growth. By controlling the deficit we have also regained the trust of investors.

One of the criticisms levelled towards government was that its deficit reduction drive was primarily fuelled by increasing or introducing new taxes rather than cutting expenditure.
I do not agree because we have shown in two consecutive budgets that government has controlled expenditure. The only expenditure increases were recorded in the areas of pensions and other social security benefits.
If you look at government expenditure last year it only increased by 0.6 per cent.
The increase in VAT was the single largest tax hike since it raised up to Lm30 million. Then there was the passenger flight tax, the tax on mobile telephony and eco-taxes, which collectively totalled to around Lm10 million to Lm12 million and they were new taxes commensurate to projected government shortfalls.

Yet, on the ground people do not seem to be sharing this positive feeling of an economic turnaround?
I also speak to people and only recently I was talking to a group of professionals who give service to industry and they were saying that companies were declaring good profits. In the words of one of them, people seem to have got used to a negative mood that it makes it uncomfortable for somebody to talk in the positive out of fear that he will be hounded by the taxman. There could be this tendency.
But it is mistaken to judge the performance of an economy on what people have to say. We look at the figures and it is evident that profits are being declared because we are witnessing higher income tax receipts.

But there was also a drive to collect all dues owed to government…
That does have an impact but not as substantial. It may rake in an additional Lm3 to Lm5 million but if we were to look at growth in income tax receipts it notched up to Lm15 to Lm20 million.
For banks to make profits the way they are doing the economy needs to be functioning. You may argue that banks levy charges and that is how they rake in their income. But even here, they are making money from charges because the economic wheel is spinning. Banks tell you there is a lot of activity going on. There are businesses that have restructured and are doing well, but others who have not are finding it hard to go on.
Consumption has also been on the increase and despite the massive job losses at Denim and other companies, unemployment levels are the same as last year’s. This is a sign that the economy is performing and creating jobs.
Perception is definitely not the tool to measure the success or otherwise of the economy.

Health is a high expenditure component. Is it sustainable to have a completely free healthcare system?
We have to focus on this sector more and more because new medicines and scientific developments are ongoing and they do raise costs. But obviously it’s a matter of choice. Our health system may be free at service level but we do pay for it through our taxes.
At the moment we are looking at areas where to change things but we are not talking of a big reform that would include payment for health services. That is not on the cards. For example, we need to have adequate structures that ensure only those entitled for free medicines would be getting them. These changes will ensure sustainability in the medium term.

The general election and the introduction of the Euro: which of the two is conditioning government most in preparing the next budget?
The timing of a general election is the prerogative of the Prime Minister and we could be having another budget apart from this one before an election.
But the Euro is a commitment we have to achieve and if we fail it, we cannot be doing so in those areas which are completely within our reach. We will not be throwing caution to the wind because of an election and suddenly go for a higher deficit.
We are committed to achieve the targets to join the Euro. If something extraordinary happens and the price of oil shoots out of the window in the process raising inflation that is something we have little control over. But the deficit and debt are within our control and those targets we will achieve. As things stand we also believe that the target for inflation will be met because we are not too far off from the reference value.
We are committed to introduce the Euro on 1 January 2008. What this will mean in terms of when a general election will be held, you will have to ask the Prime Minister.

Tonio Fenech was interviewed by Kurt Sansone

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