Prior to the presentation of the Budget, I had written about the need to create a balance between maintaining fiscal prudence while going for growth.
The need for fiscal prudence arises from the fact that Malta needs to go down below the three per cent threshold of the deficit-to-gdp ratio.
Moreover, the level of public debt needs to be at sustainable levels in order to avoid having to tax future generations. The need for growth arises from the fact that our economy needs to grow further to generate more productive employment.
Our employment rate is still low when compared to the European average and the structural changes in the economy require the continual creation of new jobs.
At the level of the EU, the talk is very much the same. The European Commission has put forward a comprehensive and coherent package of reforms that will strengthen the Stability and Growth Pact, particularly through an increased focus on public debt and fiscal sustainability and the extension of surveillance to macroeconomic imbalances. Surveillance will also include competiveness divergences and structural reforms.
This is where the link between fiscal prudence and growth is created.
Fiscal policy cannot be looked at in isolation and reduced to a ratio. Possibly, this was one of the lessons learnt from the recession.
A fiscal imbalance can only be eliminated if other economic imbalances are removed. And the presence of such imbalances will hinder economic growth. Thus the presence of economic imbalances is a good signal that can alert governments to impending problems and of the need for structural reforms. Growth can only be achieved if structural reforms are implemented and competiveness is maintained. It is useless to expect fiscal prudence when competiveness is not being maintained.
The cause/effect process is fairly clear. Reforms remove economic imbalances; the removal of imbalances enhances competitiveness; competitiveness generates growth; growth enables fiscal prudence.
In this regard economists are looking at tax reform. They are assessing how tax reform can support both fiscal prudence and economic growth. This goes beyond addressing tax evasion and starts to address the type of tax structure a country should have.
The focus on tax reform has become necessary as restraining expenditure is not enough to achieve fiscal consolidation; a contribution from the revenue side will also be required. However, it cannot be taxation that inhibits growth, and neither can a government simply raise taxes across the board without giving due consideration to social issues.
The main finding of a study on tax revenues and tax reforms in EU member states is that shifting the tax structure from direct taxes to indirect taxes could yield additional tax revenue while minimising negative effects on growth.
Direct taxes on both company profits and personal income have a negative impact on those that produce income and generate economic growth. On the other hand indirect taxes reduce economic distortions.
The authors of this study also propose that governments find new sources of tax revenue rather than raising tax rates, such as taxing economic rents. The example this study gives is financial sector taxation. Another possible new source of indirect taxation is environmental taxation.
I believe that we have entered into a new era for fiscal policy. The traditional viewpoint that fiscal prudence and economic growth are anathema to each other is being consigned to history.
The concept of using tax reform to enhance economic growth is still uncharted territory, which requires serious analysis.
We have been through this process before, when low inflation and employment were seen to be anathema to each other. Then we worked out a way of how they can sit side by side and today no one doubts that low inflation is conducive to higher employment. There is a learning process that we have to go through.