The PN has promised a reduced tax rate for small businesses, but Kurt Sansone asks if it has grossly underestimated the impact this will have on public finances

The tax cut for small businesses proposed by the Nationalist Party could leave a hole in public finances much larger than the projected €85 million, according to an exercise conducted by The Sunday Times of Malta.

It shows that the PN may have seriously underestimated the number of potential beneficiaries when it calculated the impact of the measure on the public purse.

The proposal, in a document aimed at retailers, is to cut income tax to 10 per cent on the first €50,000 in profits for small and medium enterprises. The assumption is that around 7,000 small businesses will benefit. But this is challenged by figures from the National Statistics Office that indicate a much higher number falling within the category.

When presented with the numbers, PN economy shadow minister Claudio Grech insisted the PN figures were correct and reflected only taxpaying businesses. He said the loss in public revenue would be recouped through economic growth and tax compliance.

It is evident the PN’s calculations only included retailers while excluding all the other categories the party is claiming would benefit from the tax cut

Mr Grech told this newspaper last Sunday that the €85 million was not a conservative estimate but a worst-case scenario, assuming that all beneficiaries would benefit from the maximum €12,500 tax saving.

However, it is evident the PN’s calculations only included retailers while excluding all the other categories the party is claiming would benefit from the tax cut.

In comments to the Times of Malta a fortnight ago, the president of the Chamber for Small and Medium Enterprises, Paul Abela, said the 7,000 figure only represented retailers. “There are many more self-employed people who would benefit, apart from other small and medium enterprises,” Mr Abela said.

His words are backed by the PN’s own advertising campaign for the flagship proposal. A full-page advert in the party’s daily organ In-Nazzjon last week listed all those who would benefit. These included service providers such as panel beaters, architects, tile-layers, lawyers, vets and doctors.

PN MP Robert Arrigo on One TV last week put the number of beneficiaries at around 40,000. Assuming his numbers are correct and taking into consideration the maximum tax saving, the PN’s worst-case scenario would easily hit the €500 million mark, an unrealistic figure by all counts.

Not all beneficiaries make a profit of €50,000, which means the maximum tax savings will not apply to all – this in turn implying a reduced impact on public finances. But the 7,000 figure on which the PN has based its workings is nowhere near the numbers suggested by official statistics.

According to the NSO business registry, there were 87,431 micro- and small enterprises in 2015. Eurostat, the European statistical agency, defines micro-businesses as those employing fewer than 10 people and small enterprises as those employing from 10 to 49.

Not all of these companies are necessarily active for tax purposes, but NSO employment figures for April this year showed there were almost 20,000 full-time self-employed individuals.

If they were to benefit from the 10 per cent proposal, as the PN is suggesting, the worst-case scenario would indicate an impact of €250 million on public finances.

The impact such a measure will have is crucial, because it could derail Malta’s drive to reduce its deficit. A sudden shortfall of €85 million in government revenue will undoubtedly cause headaches for the finance minister.

While some of the shortfall will be clawed back through increased economic activity and companies coming out of the shadow economy, it must be kept in mind that when the maximum income tax rate for those earning up to €60,000 was reduced to 25 per cent, the measure was phased in over three years. The global impact of that reduction was much less at €40 million, and yet the phase-in approach helped the country absorb the impact.

While economist Lino Briguglio has expressed his conviction that the €85 million will likely be mitigated through higher tax compliance, if the PN’s proposal punches a much bigger hole in the public kitty, the result may be a runaway deficit in the party’s first year in government.

Claudio Grech answers for the proposal

How did you arrive at the conclusion that only 7,000 companies or self-employed will benefit from the tax cut, given that it will apply also to corporate bodies on the first €50,000 of operating profit?

The tax measure is applicable to all SMEs that trade, collect VAT and pay income tax in Malta. However, the numbers you quote (87,000) are statistical figures of the number of existing companies/traders and not those who actually pay income tax. The numbers are much, much less than that.

Do you feel that the €85 million impact has been underestimated?

Absolutely not. This figure was determined after extensive computations and multiple tiers of assurances and reviews. This is the maximum cost that would be foregone in terms of revenue when it is applied to all SMEs that pay income tax. Moreover, it is not correct to interpret this as a cost. This is an injection in the economic activity of the small operators, which will generate a manifold return in terms of growth and tax revenue for government, as economist Lino Briguglio has duly observed.

Does the pledge to introduce this measure in the first Budget imply the full impact will be absorbed in the first financial year?

The tax credit will be introduced in the first PN Budget. Economic growth will be fuelled, tax revenue increase, employment conditions improve, not to mention the environmental improvements and contributions to local communities.

A €85 million (or more) drop in revenue in one year could seriously impact the deficit. Is this a price the PN is willing to pay?

Your premise is wrong. The injection for small businesses will generate an unprecedented growth stimulus and, as Prof. Birguglio explained, a significantly higher degree of fiscal compliance, which will invariably offset the investment. There is no doubt the measure will improve the government’s fiscal income and hence continue to address the deficit.

What is not helping is the spiralling increase in government operating costs. This year alone, the increase is a staggering €173 million. The PN is not willing to keep piling on the costs of an inefficient government whilst taxing small businesses for it.

kurt.sansone@timesofmalta.com