Tax package stimulus

The final version of the tax reform package announced by Prime Minister Costas Simitis and Economy and Finance Minister Nikos Christodoulakis last week may not be perfect, but it avoids some of the pitfalls of an earlier version of much more generous tax reforms, contributes to the simplification of the tax code, is much more focused, and seems to provide some modest fiscal stimulus to the economy for next year. It may be fair to say that this tax package is incomplete; it is unfair, however, to say it does not help promote economic growth. The Greek government announced last week a series of tax relief measures, estimated to cost some 1.4 billion euros in 2003, in a bid to simplify the country’s cumbersome tax system and provide tax breaks to low-income salaried employees and families with children and small and medium-sized enterprises. Central to the new tax measures is an increase in the tax-exempt income for wage earners and pensioners. This will rise to 10,000 euros a year in 2003 from 8,400 euros this year, and to 20,000 euros for families with three or more children. At the same time, tax deductions for life insurance, medical expenses, tuition and rent will rise. Presumptive taxation for some small and medium-sized enterprises will also be abolished. From a macroeconomic point of view, if there is something objectionable about this tax package, it is the fact that it helps to further boost an economy already projected to grow by 3.5 percent to 4.1 percent this year and some 4.0 percent next year – that is, more than double the eurozone’s average growth rate; at the same time, Greece’s inflation rate is estimated to average 3.5 percent in 2002 and some 3.0-3.2 percent in 2003, when eurozone inflation is expected to average 2.2 percent this year and 1.8 percent next year. Along the same lines, one might have objected to the reduction of personal income taxes, citing comparative figures with the European Union showing that Greek personal income taxes comprise a much smaller share of GDP (gross domestic product), just 5.5 percent versus some 11 percent in the EU. On top of this argument, Greece needs to bring down its high debt-to-GDP ratio, which exceeds 100 percent and is third highest in the EU. And yet, the announced tax package provides a cushion against adverse macroeconomic and market conditions abroad next year, especially in the large eurozone countries, without pouring too much oil onto the inflation fire. Indeed, the effect of the announced tax breaks on private consumption and investment will be less pronounced than if the government had chosen either to increase government spending by an equal amount (1.4 billion euros) or to adopt a much more generous tax package containing a wide array of tax breaks envisaged a month or more ago. In either case, government spending or more tax breaks, the multiplier effect on economic output would have been much larger next year, fueling inflationary expectations and possibly canceling out some of the economic growth effect. Moreover, by raising the tax-exempt income bracket, the tax package helps reduce the number of taxpayers who file every year, therefore reducing the administrative burden on and increasing the efficiency of tax authorities. This is important for a country with many self-employed individuals and small and medium-sized companies that are prone to tax evasion. In addition to this, it provides tax relief to large families, a move deemed crucial for a country facing adverse demographics and a related pension crisis in the future. All this, however, is not to say that the announced tax package is perfect and that no changes should have been made. Indeed, reducing the top marginal tax rate from the current 40 percent to a lower level, or making the 40-percent tax rate applicable for personal incomes exceeding 2.5 times the average gross salary, as in most OECD countries, instead of less than twice the average gross salary as in Greece, would have been positive but perhaps unfeasible given the budgetary constraints. The same could have been said about the corporate income tax rate, though with a less convincing argument. Indeed, the Greek statutory corporate tax rate, currently at 35 percent, is generally lower than in many other EU countries. More importantly, the effective tax rate is estimated at about 22 percent due to a number of tax exemptions for corporations. Analysts have pointed out that the difference between the statutory and the effective corporate tax rate is one of the largest in the EU. The recent tax reform measures to be implemented next year clearly go in the right direction. They help simplify the tax system and somewhat boost the income of low wage earners and the country’s «threatened species,» that is, large families, while supporting GDP growth without overheating the economy. It may not be perfect, but it is one of the best tax packages for years and will help the Greek economy next year. Indeed, the only really strong case that can be made against it is that it provides an unnecessary stimulus to the Greek economy in 2003, presupposing normal market conditions and a global economic recovery in 2003. However, both of these are undoubtedly strong assumptions at this point.