‘A blue ocean budget’

The Finance Minister has gone on record to say that income-tax cuts in the next budget are not possible in the circumstances. He is reported to have said: “With revenue for this year expected to be €80m short of projections I will not be taking any gamblish decisions”.

I think it is the right time for Malta to re-think its long-term economic strategy. I see the recession as an opportunity for the Maltese economy to develop an innovative strategic approach which includes a radical overhaul of the Malta taxation system.

The strategic intention of the government has (rightly) been to shift the emphasis from an economy reliant on manufacturing and tourism to a more evenly balanced economy in which services (particularly financial services) account for at least a quarter of our GDP. We clearly have the resources – human capital and educational set-up – to deliver but may need to invest more. Plus our location, climate and size complement this strategy.

It is the structural conditions, which perhaps need our ingenuity and creativity. So why doesn’t the government use this unique global situation to aggressively reform our tax system so as to create the right conditions for growth instead of worrying about COLA increases, tax cuts or subsidies (old economics)?

I suggest that we radically overhaul the way we tax companies or persons that create and/or add value in this country.

How can this be done? I think, for instance, that we can take a leaf out of the Dubai success story. True, the current recession has shaken the very foundations of Dubai’s recent success but once the global economy picks up Dubai will still have succeeded in doing what no other Arab-oil-dependent state has done to-date i.e. to radically change how it makes money, to reduce oil-revenue dependency from 30 per cent to five per cent and to integrate into the global economy as an important player!

Business research shows that this has been achieved by adopting a blue ocean strategic app-roach (Kim & Mauborgne). For the non-expert reader, blue ocean strategy has its roots in the emerging school of economics called endogenous growth and is commonly referred to in business strategy as a “reconstructionist app-roach”.

In brief, the theory postulates that by developing and aligning the three fundamental strategic propositions, new market space can be secured, which translates into long-term growth away from cut-throat competition in existing and crowded market space. Malta can do this but it must first identify a value proposition that attracts “customers”, a profit proposition that enables the country to make money out of the new value proposition and a people proposition that motivates Maltese citizens to help execute the strategy.

I think reform of our tax system is the key to all this. Imagine the Maltese economy in 2020, when one-quarter of its wealth creating capability comes from professional services and where tax in general is levied only at the expenditure side. Put another way, income tax and/or corporate taxation would no longer exist (i.e. there would be no tax on any income generating activity). The government would instead have in place a multi-level VAT system segmenting luxury goods (e.g. 40 per cent VAT), essential goods (e.g. five per cent VAT) and other goods/services (e.g. 20 per cent) appropriately. The whole economy would thus be incentivising hard work and entrepreneurial endeavour, since tax would not be levied on any income-generating activity. One could, incidentally, also exempt all those people living close to the poverty line so as to be socially fair and responsible.

In addition, the country would have a future fund (similar to Australia’s future fund) which would take care of Malta’s long-term financial well-being. That is to say that any budget surpluses which occur over the economic cycle or government one-off sell offs or income from the leasing/selling of government assets plus employee pension contributions would be channelled into a future fund for long-term investment income of the country.

In this new economy, it would also make sense to introduce a pay-gap ceiling between top management and their staff. I offer this idea as a side point and within the context of recent global controversy which seems to be (foolishly) advocating that governments start interfering in the pay packets of chief executives (especially those in banking). A recently quoted example being Bart Becht, CEO of Reckitt Benckiser, who last year earned a whopping £37m when the average salary of his workers stood at £26,700 or Sir Terry Leahy of Tesco’s who was paid 900 times more than the average Tesco employee.

In fact, UK business research reveals that the average ratio of chief executive-to-employee pay has risen from 47 to 128 in the past 10 years. I don’t think we have the same problem in Malta but let’s pre-empt the problem (and scrap among other things COLA in the process) by linking the success of the organisation to all of its employees and workers. Perhaps a ratio of 10:1 for Malta would make sense. The actual ratio is irrelevant for the purpose of this article, since it is more the principle that I am trying to promote. But this would mean that if the lowest paid salary at a company is €10,000 the CEOs salary should not be more than 10 times that. So if the CEO get’s a rise because the company is doing well so does everyone else proportionately.

Returning to the subject of Malta’s recommended blue ocean strategy, we would as an economic space (Malta) offer Maltese nationals and foreign investors alike (who effectively constitute our “customers”) a value proposition in which everyone benefits from a zero tax rate on any income generating activity. This will attract foreign direct investment, enhance Malta’s reputation as a business friendly location and strengthen the competitive offer of Maltese professional service providers who would by such time account for one-quarter of country’s GDP.

It would also complement our tourism industry by making Product Malta more attractive to a highly sought after customer segment. But how does Malta generate revenue to support the state – what’s the profit proposition? Instead of exploiting conventional income channels, we would generate tax revenue from all expenditure activity in our economy which should increase with the influx of foreign investors/people, boost the economic multiplier effect and obviously employment opportunities, and attract more money to our shores because of our reputation and innovative tax system. Lastly, Maltese citizens would be encouraged and empowered to be more enterprising and hard-working (the people proposition) hence there would be total buy-in from them especially as they compete in the EU single market with this home advantage.

The budget should not be a reactionary and/or a political compromise but an innovative proposition with a clear long-term vision that defines a generation. A vision that sees Malta as an attractive state to international businesses and internationally mobile persons who don’t want to be punished for hard work but willing to pay their dues at the expenditure side of the tax equation. The value proposition, profit proposition and people proposition must be carefully considered by Malta so as to come up with a unique offering to international customers who will flock to our shores to invest their money in our country. Similarly, any local person or business in Malta should be encouraged to work his/her socks off in the safe knowledge that the government will not tax them both from the income and expenditure side. That’s what I call a blue ocean budget!

Mr Fenech is a partner at Fenci Consulting Ltd.

www.fenci.eu