Dark tax shadow over Malta

I do not know whether customs duties, introduced by the Knights of Malta as a tax on limited consumption, was evaded at that time, or whether evasion did begin when the British representatives introduced new customs regulations in the mid-19th century. Closer to our times, in the early 1960s, more extensive customs duty provisions were put into place. I do not think I would be far off the mark if I suggest that evasion of those indirect taxes has taken place since then.

I was surprised to read in The Sunday Times that Malta has one of the worst black economies in the eurozone- Lino Spiteri

A tax on income was introduced by the first Labour government over six decades ago in the late 1940s. I have no doubt that evasion of it commenced straightaway. I was a young boy, then, but I remember local businessmen in my village swearing until they were blue in the face that the government was bent on robbing them, and they would do their best to beat it.

Political anecdote has it that, aside from the Nationalist opposition’s hard criticism of the tax during its passage through the Legislative Assembly, Archbishop Michael Gonzi had warned the Labour government that he would inflict spiritual sanctions on it if the top rate was set at above 50 per cent.

As it turned out the top rate reached 65 per cent, and no spiritual sanctions were thundered. But that marginal rate, combined with a provisional tax of 35 per cent on company profits, did trigger glaring tax avoidance on top of the ongoing evasion which lasted for decades.

The logic was beguilingly simple. Shareholders (mostly family) of local companies, aside from loading personal expenses onto their companies’ profit and loss account, took to retaining profits within their companies, rather than distributing them. Thereby they were provisionally taxed at the company level at 35 per cent, rather than at higher marginal rates up to 65 per cent on distributed profits. In fact, through time only a handful of individuals ever paid top-end tax at 65 per cent.

A Nationalist government closed the retained-profits window by equating the top personal tax rate to the tax deducted at company level, 35 per cent. That meant that Nationalists had departed from an earlier rash electoral promise to abolish income tax. But it was a sensible move, nevertheless.

Another sound move came from yet another Nationalist government, with the introduction of Value Added Tax, and its re-introduction after the 1996-98 Labour government had turned it into a hotchpotch of a roughly similar consumption tax. VAT reflected developing trends by extending the indirect tax base to fast-growing consumption of services. In addition VAT was intended to create a clear audit trail, to help reduce tax evasion.

While earlier Labour governments had resorted to deemed distribution of profits to counter avoidance by shareholders whose companies retained profits, recent Nationalist governments have deployed various measures to attack tax evasion, as well as avoidance through cosmetic schemes.

Some of these measures were of a temporary nature, like the repatriation against a penalty of undeclared (and so tax-evading) financial assets salted abroad, intensifying existing mechanisms like random tax audits, and setting up a tax compliance unit. Both Labour and Nationalist governments also used the capital transfers section of the Inland Revenue Department to send architects to value property transfers, in the context of an old bad practice of under-declaring transfer values both to reduce stamp duty payable by the buyer and capital gains made by the seller.

Given that extensive background of earnest government action to attack tax evasion and dicey avoidance, I was surprised to read in The Sunday Times that Malta has one of the worst black (the EU calls them shadow) economies in the eurozone. The EU estimated (conservatively) that in 2010 due taxes were not paid on the equivalent of 26 per cent of that year’s gross domestic credit.

I was aware that tax evasion was still rampant, that a well-known section of Malta’s gainfully occupied population still get away with fiscal murder, that the VAT audit trail has not really been marked out adequately. I have written about that in this column too, recently pointing out that a principal causal factor of the ongoing Greek financial tragedy was massive tax evasion.

But I have to confess that I did not dream that, not only is tax evasion in Malta on the increase notwithstanding all efforts to attack it, but we play the black game better (sic) than the Greeks. The EU estimated that the shadow economy in Greece totalled 25.2 per cent in 2010, against our 26 per cent.

Clearly, however, much is being done by the Inland Revenue Department – and Commissioner Conti recently gave a pithy up-to-date summary in a letter to this newspaper – much more is required. The shadow economy may be a global phenomenon and one cannot completely eradicate it, as an EU official told The Sunday Times. Yet very obviously, much more needs to be done, as the Auditor General has regularly stressed in his annual reports.

A radical measure being prepared by the government consists of an amalgamation of the tax-collecting departments. That still has to come about and it will remain to be seen whether it translates into a marked cutback in the shadow economy. It will not happen if the new giant department is not given further adequate resources in the context of fresh thinking on the issue. That will require higher spending, but it should generate more public revenue by reducing the number of those who rob others to pay themselves.