After Budget 2011, countdown to 2013: tax cuts looming on the electoral horizon

So far the second Gonzi administration has followed the budgetary cycle of the previous legislature: two austerity budgets, one bland budget mid-term. Will the government follow the same plot again with tax cuts in the two pre-electoral budgets?

The sequence seems to be as predictable as the rhythm of water gushing from the ground in St George’s square opposite parliament, the one Gonzi lauded for giving Opposition MPs no choice but to look at this unequivocal sign of the progress, as they enter parliament. At times, these frivolous remarks reveal the fault-lines of the prime minister’s depth.

The timing of the promised tax cuts featured highly in both leaders’ speeches in parliament this week. While Lawrence Gonzi argued that reducing tax cuts now defies economic rationality, hinting they would be postponed (probably closer to the election), Joseph Muscat harped on broken promises and his 10-point fiscal manifesto: “less taxes, more growth”.

Gonzi blamed the delay on his pledge to cut tax from 35% to 25% (except for €60,000 plus earners) on the recession. Muscat on the other hand adopted it as his own proposal, exposing himself to the risk of being disarmed right on the eve of the election, when Gonzi will slash income tax. This would deny Muscat valuable ammunition in the battle for the pale blue voter.

“Do you honestly expect me to be so irresponsible, in the midst of this international crisis, to keep a promise that cannot be implemented at this time?” Gonzi asked amid interruptions by the Opposition.

But you have admire Gonzi’s double-game. For the past years he has gushed about Malta being out of the recession, and how successful it was in avoiding austerity measures. So why not cut tax now?

The PM suggests that the international climate remains too unstable for comfort. It will probably remain that way for quite some time, with no guarantee it will recover by 2013. But even in 2008, the prophetic Gonzi warned of rising energy and food prices well ahead of the Lehman crash, and talked of the ‘dark cloud on the horizon’ and the need for a safe pair of hands. But he still promised generous tax cuts (even more than the ones in the budget in 2007) in a bid to galvanise his core middle class vote.

Now he hints that he will honour his pledge in due time. “What I tell the leader of the Opposition and his colleagues is that this promise will be implemented at the appropriate time.”

This suggests a perfect coincidence between electoral convenience and economic rationality. The opposition cannot easily dismiss Gonzi’s argument against tax cuts at such a sensitive time, when anyone following the international news is aware of the turmoil facing other countries. And it will be difficult for the opposition to criticise the government when it finally decides to cut taxes.

Electoral tax cuts

Even governments like the ones headed by Angela Merkel in Germany and Silvio Berlusconi in Italy, both elected on a platform of tax cuts, have found it difficult to honour their pledge. While Italy has not moved an inch, Germany has made timid moves in that direction. But in the UK, concurrently to drastic cuts the coalition government has initiated the process to cut taxes for lower-income earners.

Gonzi cannot be blamed for not anticipating the collapse of financial markets when he promised tax cuts before. But the austerity measures of the past two years will give him space for the cuts in 2012.

As they betrayed their frustration on his unfulfilled tax promise, complaining he would cut taxes before the election, Opposition MPs were met with a barb from Gonzi: the PM replied that the baying Labour MPs based their thinking according to electoral timetables.

Of course, the same criticism can well be levelled against him. Both leaders have the election in mind. But Gonzi can steal Muscat’s thunder by slashing tax at a more strategic moment.

Apart using the international crisis to justify delaying his commitment to reduce taxes, the Prime Minister went on to claim that the hike in utility bills was related to the need to protect jobs: “It’s true that water and electricity bills were high, but the fact that jobs have been saved shows that the sacrifices made have not been in vain”.

Such justification for a utility hike may make sense if it’s to encourage people to save energy and use solar panels, or to close the deficit gap. But the link with saving jobs is certainly unclear. Perhaps, what Gonzi meant was that by saving on subsidies to Enemalta, he had the cash to assist the ailing manufacturing sector and avoid job losses.

In reality however, the surcharge on utility bills was imposed well before the global recession. Because Gonzi’s ‘cost-recovery’ is all about his government’s fiscal zeal to remove subsidies across the board: not just energy, but on development permit fees, gas, the dockyards, tourism and public transport. Take the decision to recoup subsidies to low cost airlines with an increase in VAT on tourism accommodation. From here, Gonzi will find leverage to reduce income tax while still maintaining his spending on health and education.

Rightly, he takes pride in avoiding deep cuts in essential services like his European counterparts. But this ignores the fact that Malta was not directly affected by the financial crisis as Britain was. Like Italy, Malta’s banking sector emerged largely unscathed. The crisis did have a collateral impact on tourism and manufacturing, and Gonzi should be credited for taking timely action to avoid lay offs and restoring the fortunes of the tourist sector. And the awareness gained on deficits by successive governments since 1996 also saved the country from a Greek tragedy.

Marshmallow politics

On his part, Muscat attempted to present an alternative vision. He referred to Eddie Fenech Adami’s vision to put economic growth before fiscal considerations. Ironically, Gonzi reacted by conjuring the spectres of Dom Mintoff and Karmenu Mifsud Bonnici, to say that unlike Muscat and his predecessor Alfred Sant “never lost an occasion to speak about job creation”.

On an ideological level Gonzi tried to appeal to old Labour instincts that are ready to sacrifice middle class consumption for the sake of saving jobs. And Muscat tries to project himself as a pale blue alternative by extolling the virtues of Fenech Adami. One wonders how Alfred Sant feels as the two leaders extol his two major political adversaries.

“Gonzi believes that to bring in more money, one should tax more,” Muscat said, stressing that he would reduce the tax burden to bring in more revenue.

But this could be a bit too simplistic. At best, more VAT from greater consumption will only offset cuts in income tax. Without solid revenues, the first blow from the world economy would make public services like healthcare even more vulnerable than they are now.

In fact Muscat’s pledge to cut tax could conflict with his commitment to strengthen the welfare state and keep health free for all. The absence of any reference to windfall taxes on the mighty, such as the ones introduced by Tony Blair in 1997, make this commitment even more difficult to keep.

Where will Muscat make his cuts in government expenditure? Surely there’s much lard in pork-barrel politics, but the bulk of spending is in social services, pensions and health. Promoting social mobility is the only long-term way to combat costly welfare dependency, but even this costs money.

Uncomfortable questions: should rich students receive stipends when working class children are not making it past secondary school? Should parents who send children to independent schools get tax benefits? None of this pain was in Muscat’s speech except generic ministerial cuts.

Muscat’s edge lies in putting increased female participation and social mobility at the top of his political agenda. Gonzi fails in producing a concerted vision to encourage working-class women to enter the labour market, save for token measures for more childcare centres and significant fiscal incentives for women to return to work after pregnancy.

And Gonzi still has reservations on extending maternity leave as proposed by the European Commission. Muscat says he would have spent the €80 million for the new parliament to help employers extend maternity leave.

The entry of women in the labour market would be the greatest injection in working-class incomes and a step towards a more middle class society. And yet Gonzi boasts of 68,000 workers who, thanks to the fact that they don’t earn any more than a meagre €8,000 a year, they pay no tax. He may have just said that the lack of social mobility in Malta was only aggravated by his shock and awe measures.

For despite his talk on increased spending on education, working class kids do not seem to be doing any better than their parents.

Muscat’s priorities may be right but he is coming off as a lightweight without pointing out the hard choices a future Labour government must make to balance his ambitious social commitments with fiscal realities.

His inability to confront any sector of society is symptomatic of a marshmallow brand of politics that just pleases all and sundry. His small hint to shift the fiscal burden from producers to polluters suggests he still has more surprises up his sleeve. But will it be enough of a mandate for Muscat to stand up against powerful lobbies once he is elected to power?