Most of the eurozone countries that are struggling to balance their finances amid the continent’s spiraling debt crisis have resorted to tax increases to meet their short-term fiscal targets. The long-term economic cost may be severe.
France’s socialist government announced €20 billion in additional tax increases last month to help the country reach its 3 percent deficit target for next year. European fiscal treaty requires deficits to be under 3 percent of gross domestic product although many countries in the currency union have posted higher shortfalls in recent years.
France’s €20 billion in additional tax revenue is supposed to be split equally between businesses and high-income earners and does not take into account the new 75 percent tax rate for millionaires. The wealth tax threshold is slated to be reduced from €1.3 million to €800,000 while investment income will be taxed at the same rate as regular income which will only deprive the country, already among the most hostile to foreign investment in Europe, of capital.
The conservatives, who lost their majority in June, previously raised taxes on liquors, tobacco and soft drinks and imposed a “temporary” 5 percent corporate tax increase. France’s 34.4 percent corporate rate was already more than twice as high as Germany’s which is 15.8 percent.
In Spain, too, taxes for high-income earners have been raised. When they were in power, the socialists there introduced two new tax brackets for wealthy Spaniards. Tax credits for self employed workers were revoked. The consumption tax rate was raised from 16 to 18 percent as were excise duties on tobacco and gasoline. Spain’s conservatives, after they assumed power in December of last year, further increased the sales tax to 21 percent.
Even the Netherlands, considered one of the fiscal hawks in the eurozone, recently increased insurance and sales taxes although the income tax is supposed to be reduced in two years’ time.
It is doubtful whether French and Spanish policies will yield significantly more revenue. Higher business taxes discourage enterprise and job creation so do little to reduce unemployment. Because each country has generous unemployment insurance programs, the financial burden imposed on the state by high joblessness is likely to outweigh whatever fiscal benefit can be derived from higher income taxes.
Especially income tax increases are unwise. Countries that lowered income tax rates usually saw an increase in revenue. When Britain’s Conservatives gradually decreased the top tax rate during the 1980s from 83 to 40 percent, the wealthy began paying a bigger share of the tax burden.
As Allister Heath writes in The Telegraph, during the 1970s, “the top 1 percent of earners contributed 11 percent of income tax.” After the rate had fallen to 40 percent, their share of the tax burden more than doubled in 1999 and reached 25 percent in 2007.
Lower taxes fueled a hard work culture and an entrepreneurial revolution. Combined with globalization and the much greater rewards available for skilled workers, Britain’s most successful individuals earned a lot and paid a lot in tax.
Already, the effect of higher taxation is evident in Spain where corporate tax revenue has tumbled by almost two-thirds compared to the years before the housing market collapsed in 2008. Small businesses are failing and a growing number of corporations is seeking profits abroad.
Yet, for all the talk of “austerity,” public-sector spending in both Southern European countries continues to climb.
Government spending in Spain increased by a yearly average of 7.6 percent since the start of this decade, from some €250 billion in 2000 to nearly €500 billion in 2009. As a share of gross domestic product, spending remained stable at around 40 percent but growth was fueled by a bubble in real estate, obscuring the dramatic expansion of government. After the crisis of 2008, when the economy contracted, government spending as a share of GDP reached a record high of 46.3 percent.
France’s public-sector spending is already the second highest in Europe and expected to increase another €6 billion to 56 percent of GDP this year.