Direct and referred pain

Taxation is described as a burden. And a burden, unless it is a labour of love, usually makes for pained muscles and a sore body. Knowing where the pain is coming from does not make it go away, or mitigate it. Yet knowledge is important, under any circumstances. These include the state of the national health.

A healthy economy yields the government a good tax take. Economic growth in nominal terms gives more revenue to the government, without rates being raised. That allows the government to consider various options.

In financial terms, if it is running a worrying fiscal deficit, economic growth empowers it with the option to retain the rising net revenue, while trying to ensure that expenditure does rise by less than the increase in revenue. Thereby, the deficit will go down in absolute terms.

If the country achieves economic growth at current prices fast enough, the reduced absolute fiscal deficit will also decline in proportional terms, relative to GDP, at market prices.

Such movements in current value terms have limited relevance to the well-being of a country and its people. What really matters, though, is how far the earnings of a society will stretch to purchase a given basket of goods and services once rising prices are taken into account.

The true relevance of economic growth and spending is their measurement and strength in real terms - after the effect of inflation has been removed from the various aggregates.

Assessment in nominal (market prices) terms can easily mislead. If government spending on education (say) rises from Lm100 to Lm102, but inflation over the same period rises by three per cent, there is a drop in the outlay on education in real terms. Fewer - not more - resources are channelled to the sector through the Lm102 allocated spend.

At a given constant level of efficient and effective spending, less can be done in the year of the Lm102 allocation, than with the Lm100 available the previous year.

That is the proper measure of economic performance. It is an approach that should be adopted by the government itself, at least in its pre-Budget consultation document.

It certainly ought to be the basis of appraisal by the trade unions, constituted bodies and all the rest who wish to really try to understand the socio-economic significance of fiscal proposals and outturns. That is what Economics Professor Joe Falzon tried to do in his pre-Budget 2007 study for the GRTU.

The Prime Minister and his Finance Parliamentary Secretary would have used their Budget debate time better had they analysed in similar fashion, rather than trying to minimise the objective relevance of the Falzon study on the grounds of its selected basis year.

Economic measurement in real terms aside, another option open to the Finance Minister when revenue is projected to outstrip expenditure is to 'give back' some of the assumed continuing excess. The minister can do so by cutting effective direct and indirect tax rates, or raise the rate and extent of social benefits, in particular the non-contributory part, which goes to the neediest.

Or, of course, to come up with a combination or more of that.

Any government's choice depends on its social inclination and the political cycle. In the 2007 Budget the government paid more attention to the cycle - the next general election - than to social justice. Governments are entitled to select their strategy and tactics.

Whatever the social orientation of a government, it tends to be boxed in by the dictates of political expediency. National policy is masterminded more than ever by the party machine. That was particularly evident in the Budget for 2007. The Prime Minister, still doubling as Finance chief, elected to make a calculated political statement that, right now, he needs to massage the so-called middle class, defined according to income level.

He did not allocate much of that part of the projected increase in revenue he felt he could give back by redistributing more towards the most needy.

Governments will play their preferred games to try to be re-elected. While they go about having their fun, knowledge by society in general of how the burden of taxation is made up, remains very essential, both to understand the pain, as well as to work out whether it is worth it.

Financial pain - income lifted out of our pockets through direct and indirect taxation - is inevitable. It seems ludicrous to suggest that such pain may be 'worth it'. Not that ludicrous, though. Knowledge allows understanding of why the pain is necessary, and of appraisal whether that necessity is being met justly as well as efficiently.

It is necessary because governments need revenue to finance the administration of the country. Some funds may flow in, for a while, in the form of grants from foreign sources (currently, the EU). By far the larger part of revenue required to administer the country comes from taxation, with borrowing filling up any remaining gap.

The good citizenry has direct knowledge of whether the government of the day is spending efficiently and effectively. It enjoys the benefits of good administration, and bears the consequences of inefficiency and neglect. Most of us tend to have less knowledge of how the taxes and fees of office we pay, add up.

The National Statistics Office has provided that knowledge, up to 2005. In a recent Economy and Finance media release it gave the basic measurements of the tax burden as we, the people, bore it last year. And the "we" is, here, correctly used. There are many who are not liable to income tax, aside from others who evade or avoid paying their proper due. But everybody who is gainfully occupied legally - and not luxuriating in the black economy - pays social security. That is part of the tax burden.

Furthermore, whether or not we pay income tax or social security contributions, we are all consumers. There remains evasion of VAT but all consumers pay indirect taxes - the element of VAT, excise or customs duty included in the price of so many of the goods and services they purchase.

The raw figures given by the NSO provide raw knowledge. For that to be more relevant it has to be related to income distribution, as well as to consumption patterns. A very difficult task that may be attempted in the near future.

Meanwhile, the NSO's aggregates tell their limited but factual story.

Total tax revenues during 2005 amounted to Lm691.1 million, an increase of 8.3 per cent over the previous year. The 2005 chunk was equivalent to 35.6 per cent of GDP - meaning that more than a third of the value of our combined production went to the government. The chunk was 1.3 per cent higher than in 2004.

Which in turn means that the burden of taxation - the tax-take relative to nominal GDP - had grown heavier. Contrary to popular perception, the driver in that direction was income tax - the ratio of direct taxes to GDP remained unchanged. The burden of taxation rose because the ratio of contributions and consumption tax to GDP rose.

Indirect taxes - VAT, import duties, excise and other specific taxes on services, and on financial and capital transactions netted the government Lm313.6 million, or 45.4 per cent of total 2005 tax revenues. The consumption tax (VAT) was the heaviest indirect burden - Lm161.3 million. It was followed by taxes on products (including excise duties, mainly on cigarettes and petroleum) at Lm59.2 million.

The knowledge provided regarding direct taxes confirms the continuing shift towards indirect taxation, which many consider to be socially unjust, whereas economists usually consider indirect taxes as more economically efficient. Direct taxes in Malta are mostly taxes on income, including capital gains, and on sales and transfers by inheritance of immovable property. Direct taxes yielded Lm237.4 million in 2005, making up 34.4 per cent of total revenue.

The remaining tax revenue came from Social Security contributions. These compulsory social contributions made by employees, employers, as well as by self- and non-employed persons are defined as tax because the relevant amounts are no longer disposable to the contributor. This category yielded Lm140 million (net of the State contribution) in 2005, or 20.3 per cent of total tax revenue.

Direct taxes and (proportional) social security contributions outstrip the percentage of the tax take derived from indirect taxes. It is also as a measure of social justice on the one hand and economic efficiency on the other, that one relates the proportion from indirect taxes to that from the direct counterpart.

The data are broken down much further in the NSO's release. But the evidence points to the same direction: there is a continuing shift towards indirect taxation.

The knowledge provided by the official statistics helps the people understand better where direct and referred fiscal pain are coming from. It also shouts out a political conclusion.

The shift towards indirect taxes is felt by most of the people, most of the time. The reduction in the direct (income) tax burden is felt by far fewer people. Conclusion: massaging middle-income earners by reducing direct taxes, ignoring consumption taxes, and showing much less the skimpy concern for social justice will not yield the high political return sought by the PM and Finance Minister from tinkering with the income tax thresholds, bands and rates.

The opinion polls may have offered the government and its worried party bosses relief from the pain of plummeting popularity. The cry of the needy and the grumbling of consumers may yet bring about greater pain.