How Will The Tax Reform in Greece Affects Its Growth and Development - Term Paper Example

Student’s Full Names Professor’s Name Economics 30th May 2012 How the Tax Reform in Greece Will Affect its Growth and Development Introduction Greece has always been known as a country that has a lot of economic growth. According to Massourakis, this nation’s four percent average growth in GDP has been far much above most of Europeans mature economies for the past twelve years (23). Just like these other mature economies, Greece has never been immune to the immense global pressure; given that its GDP growth forecast had been revised to 3.5% in 2008. Apart from issues of GDP, Greece tax structure and the infamous tax evasion habit has greatly impacted its economic growth. A number of reforms have been implemented since 2002 to 2010 to try to deal with tax evasion, reduce, the government debt, and increase this nation’s competitiveness in the international market. These tax reforms, especially the recent ones are expected to improve the functionality of Greece’s tax system and even make it more competitive in line with international standards. Irrespective of the intention or motive the Greek government had in implementing these tax reforms, they will definitely influence the economic and social development of the nation. This paper discusses how the tax reform in Greece affects its growth and development. Tax Reforms in Greece 1. 2004-07, 2008-09 Tax Reforms According to the Organisation for Economic Co-operation and Development (OECD), Greece has been implementing numerous reforms from 2004 to improve the functionality of its tax system and make it more competitive according to international standards (63). These reforms have focused on the reduction of tax evasion especially in the periods of 2004 to 2007 where specific measures in line with tax evasion reduction were taken. These measures according to OECD included; The introduction of value-added tax (VAT) on new buildings, Reductions in income tax weights for businesses and individuals, and The upgrading of the TAXIS or the principal tax information system of the Ministry of Economy and Finance (63). In November 2007, Greece approved a new law on tax evasion which provided for the establishment of the National Council which happened to be already in operation. This council had a main duty of directing efforts towards fighting tax evasion. This new tax law also served to improve the structure of tax administration and provide tax spurs for taxpayers to collect tax receipts for services. These receipts were issued as a way to reduce under-reporting of taxes. Additionally, this new law was to provide incentives for the disclosure of delinquent behaviour on tax issues. In a bid to curb the common tax evasion in the petroleum market, the Greek government in 2008 equalised the tax rates for home heating oil with that for diesel fuel commonly used in transportation. In relation to this act, the government stepped up its efforts in promoting public awareness concerning the negative impacts of tax evasion. These 2008 tax reforms included additional cuts in personal income taxes, where it reduced the two middle marginal rates of twenty-nine percent and thirty-nine percent by four percentage points from 2007 to 2009, to twenty-five and thirty-five percent respectively (OECD 64). Furthermore, measures to broaden the tax base like the imposition of a ten percent tax rate on capital gains and dividends were implemented. This reform package in addition abolished the tax-free threshold for incomes up to ten thousand five hundred Euros for the self-employed category and instead, applied a ten percent tax rate up to this amount. Eventually, these reforms managed to restore the tax-free bracket in the wake of the economic crisis. 2. 2002 Tax Reforms Prior to these 2004-2007 reforms, Greece had considered comprehensive tax reforms in 2002 when a special commission of experts submitted to the government a far-reaching reform proposal. According to OECD, this proposal covered all taxes that were levied by the central government on behalf of third parties inclusive of Social Security Funds (53). This proposal had five main objectives, which are; Simplifying the tax system and reducing related compliance and administrative costs, Removing some of the features which negatively impact Greece’s international competitiveness, Improving resource allocation especially allocation of capital, Shifting the tax burden to the relatively immobile capital assets to minimise the capital outflows, and Developing a more equitable tax system. The major reforms that this proposal targeted was to be carried out in; value-added tax, property holding and transfer taxes, income tax and other indirect taxes. In income tax reforms, the proposal advocated for a reduction in the number of income sources from the normal six to four. This reduction is advocated through treating income from agriculture, businesses, and from liberal professions as one income source. This proposal also recommended the abolition of most of the existing exemptions, reductions, allowances and special treatments of income that were evident in income tax from various activities. These reforms also advocated for the harmonisation of interest income taxation and the revision of the tax schedule including reducing the number of brackets from five to four, granting a larger personal allowance, increasing the lowest tax rate from five to twenty percent, and reducing the top marginal tax rate from forty to thirty-eight percent. These income tax reforms also advocated for the subjection of unincorporated companies that previously were taxed under the personal income regime to corporate income tax. 3. 2010 Tax Reforms Recent tax reforms in Greece led to widespread riots and protests all over the nation. The tax reforms were viewed as draconian and desperate attempts by the government to reduce its debt load (Tharp 23). Despite the negative reaction on these set of tax reforms, their aim was to introduce an efficient and a fair system which will simultaneously improve or even eliminate the defects and weaknesses in the prevailing Greek tax system. According to Tharp, there are five main reasons which motivated the Greek government to come with these major tax reforms, and they include; Low public revenues totally disproportionate to government expenditure, Decline in tax revenues from 2001, Increasing tendency for natural persons to contribute more to national taxes as compared to legal entities, Loss of profits from value-added tax of nearly six billion Euros, and The fact that a small section of tax payers are the ones who contribute majority of the tax (26). These new tax reforms introduced in 2010 are threefold covering; income tax, real estate property tax, and business tax (Miller et al. 52). In income tax, a new tax scale was introduced which does not distinguish between the various income sources. This new tax scale shifts its focus from the middle and low income earners to high income earning groups. Additionally, some features have been introduced like; receipts and tax-free thresholds, calculation of minimum income on evidence basis, removal of independent taxation, removal of tax exemptions, income determination according to actual generated expenses and income revenues for all professionals, and repatriation of capital from overseas. In real estate and property tax, these reforms focused on the; replacement of the special taxation of real estate property with one which is progressive on real estate property, and levying tax on real estate properties held by offshore companies. In business tax, these reforms have majored on the taxation of benefits accredited to corporate executives and extension of the scope of VAT among others. This new grab bag of taxes introduced by the Greek government ranged from ninety percent taxation on all banking and financial service bonuses to dividend taxes quadrupling on portfolios to about forty percent. Property taxes rose with a twenty percent surcharge with the hordes of foreign owners who tend to flock Greece for holiday getaways bearing the greatest burden. These new tax reforms came at a time when Athens had prepared itself to ask for financial aid from the International Monetary Fund despite growing evidence that it cannot survive solely through raising debt in its capital market. These new tax laws also focused on tax cheats especially in Greece’s infamous underground economy by forbidding cash transactions above two thousand dollars at businesses (Tharp 23). In place of cash transactions, this law requires that payments be made with cheques or credit cards or else shop owners will have their shops seized for violations. In addition, Athens will be paying whistle-blowers a ten percent bounty on all cash that they have assisted to recover from claw backs and cheats from secret banks in other nations. Furthermore, this new reforms have sought to abolish Greece’s infamous tax breaks by ensuring even the self-employed pay their taxes. Taxi drivers and lawyers, who are among the self-employed and have been forfeiting their long-held tax income rates as low as five percent, will now have to pay forty percent on incomes they earn above fifty-two thousand dollars (Tharp 23). Furthermore, households earning more than eighty-two thousand five hundred dollars will have to pay forty percent tax whereas those earning over one hundred and thirty dollars will have to pay a new rate of forty-five percent. According to Papaconstantinou and Provopoulos the government expected to obtain; benefits of around eight hundred million Euros, shift of tax burden from low and middle income earning groups to the high income earners, and a tax relief of up to four thousand Euros (32). This author further asserts that these reforms form part of efforts by the government to clean up fiscal finances and avail new opportunities for growth and development in Greece. Growth and Development in Greece 1. The Greek Economic Miracle Greece has never experienced a massive economic and social growth and development as the one it experienced between 1950 and 1973 in the Greek economic miracle. According to Badia, Honjo and Velculesco, Greece’s economy grew by an average margin of seven percent each year, second only to Japan at this time period (34). This period of time also saw industrial production growing by an annual margin of ten percent, unfortunately, this growth widened the gap between the poor and rich and further intensified political divisions. Prior to this economic boom period the occupation of Greece by the Axis during the First World War and fierce fighting with Greek Resistance militia had negatively affected the economy and infrastructure of Greece. According to Asteriou and Agiomirigianakis, the forced loans that the occupying regimes demanded from Greece by severely devalued the economy and the Greek drachma (482). Additionally, the Greek Civil War that ended in 1949 totally devastated the Greek Economy, and by early 1950 this nation’s economic position had dramatically deteriorated. According to Asteriou and Agiomirigianakis, Greece’s income per capita in purchasing ability declined from sixty-two percent in 1938 to about forty percent in 1949 (483). The rapid economic growth experienced in the Greek economic miracle was facilitated by measures like the Marshal Plan European economic stimulation, attraction of foreign investments, drastic devaluation of the drachma, development of the service and tourism sectors, development of the Greek chemical industry, and the massive construction activity that was related with the expanded infrastructure and rebuilding projects in Greek cities (Badia, Honjo and Velculesco 45). Expanded infrastructure and rebuilding projects resulted in an urban renewal and the development of cities. The economic miracle era abruptly ended in 1974 when the reign of the military junta was brought to a close. At this time this nation recorded its lowest annual reduction in GDP of approximately five percent. The military junta which took power in 1967 only sided with large economic interests like urban real estates and tourist enterprises while at the same time failing to solve the humanitarian issues that were sizzling beneath. Additionally, this economic miracle period was adversely affected by the 1973 energy crisis and the consequent international monetary turmoil (Badia, Honjo and Velculesco 45). Furthermore, the failure of exports to cover the high costs of foreign oil created a large deficit in the Greek balance of payments resulting into a serious inflationary pressure in the local economy. Consequently, these economic problems increased popular resistance to the dictatorship ruler ship and contributed to the collapse of the Greek economic miracle in mid 1974 (Asteriou and Agiomirigianakis 485). 2. Entry into the European Community/Union Towards the end of the Greek economic miracle, the annual GDP growth rate declined from 7.6% in 1961-70 to four percent in 1971-80 and to a mere 1.4% in 1981-90 (Asteriou and Agiomirigianakis 485). This rate was so low that the democratic government that followed the junta was unable to restore its growth. Fortunately, Greece picked up its economic fragments and began to economically re-orient itself after it became a member of the European Union; formerly the European Community. According to Dritsakis and Adamopoulos, Greece gradually began to shape its legislation to fully accommodate the movement of capital and labour and full liberalization of trade (548).this entry into the European Community allowed Greece to increase its imports of foreign manufactured goods. Greece also adopted the Euro as its currency in place of the high inflation risk drachma. The Euro enabled it to get access to competitive loan rates and Eurobond’s low market rates. Eventually consumer spending increased drastically and a significant economic growth boosted by this increased spending was experienced. Greece GDP rose steadily and between 1997 and 2007 it averaged four percent; nearly twice the European Unions average GDP. 3. The 2008 Economic Crisis and Greece’s Public Debt Unfortunately, the 2008 financial crisis and the resulting real economy slowdown took a toll on Greece’s economic growth rate slowing it down to two percent. Eventually, Greece’s economy went into recession in early 2009 where it contracted by 2.4% due to the world financial crisis and its effect on access to world trade, credit and domestic consumption; which was Greece’s engine of growth. The global financial crisis resulted into recession through the major structural and fiscal weaknesses in Greece’s economy. Consequently, this nations high 2009 fiscal deficit; which was revised upwards to 15.4% of GDP from 13.7% made many markets to start questioning the sustainability of its public debt (Dritsakis and Adamopoulos 550). This public debt was revised upwards from 115.1% of GDP to 126.9%. These ever-increasing pressure and market doubts resulted in Greece incurring higher and higher costs in borrowing throughout the winter and spring seasons of 2010. Eventually, this unsustainable borrowing cost forced made Greece to lose market access forcing it to request for emergency assistance from the IMF. The IMF eventually, approved a three-year one hundred and ten billion Euros adjustment program to Greece. Under this program the Greek nation promised to carry out major fiscal consolidations and implement substantial structural reforms so that it can place its debt on a more sustainable path. In addition, this nation promised to improve its competitive ability so that its economy can recover its positive growth trajectory. This three year reform program included plans like; Cutting government spending, Reducing the size of the public sector, Reforming pension and healthcare systems, Liberalizing the product and labour markets, and Tackling the issue of tax evasion. For any substantial economic growth to be experienced in Greece, all these economic aspects need to be dealt with. Tackling the issue of tax evasion alone, does not amount to considerable economic growth, since this growth depends upon other factors like; Government spending, Exports and imports, Savings and consumption by households, Investment levels, and External economic pressure among others. Effects of the Tax Reforms on Economic Development Tax rates have always been used as tools of manipulating economic growth either by increasing or reducing tax rates. According to Darst, supporters of tax cuts claim that reduced tax rates will lead to high economic growth rates and prosperity (24). The others claim that reducing the tax rates will results into the rich acquiring all the benefits since they are the ones who pay most of the taxes. 1. Effect on Productivity and Social Welfare Taxes influence economic growth and productivity in a number of ways. First of all, increase in taxation results into a decline in productivity since people will choose to work less and evade paying their taxes. From fig.1 below, an increase in taxation from T1 to T2 would result into a decrease in productivity of employees from P1 to P2, inferring that increase in taxation would lead to a decrease in productivity. The higher the taxation, the more time workers will spend evading taxation and the less the time they will use on productive work. The reverse is also true, in that the lower the tax rate the higher the value of services and goods that workers will produce. This is because; they will spend most of their time on productive activities. Secondly, the government’s tax revenues will not necessarily increase with increase in tax rates. According to Darst, a government cannot earn more tax income at 100% tax rate that it would have earned at 10% tax rate due to the existence of disincentives high tax rate cause (26). Fig.1 effects of increased taxation on employee productivity Taxation alone cannot result into increased economic growth since economic development is pegged upon other factors like social issues. It has been argued that as the citizens of a given government work to help the economy grow, they need to see the benefits so that they can continue to help the country to develop. These benefits include an increase in their private income, and better services for their communities. Apart from social issues, economic development is further influenced by: labour factors like; skills, abilities, training, and education; labour motivation or enthusiasm; labour numbers; and capital factors like investments, savings, technical progress, and technological knowhow among others. 2. Effects on Aggregate Demand Aggregate demand refers to the total demand that a given economy has for the goods and services it produces at given price level and time. It also refers to the total goods and services in the economy that consumers will purchase at al the available price levels. Taxes never have a positive effect on both aggregate supply and demand. According to Darst, increased taxation will shift both the aggregate demand and supply curves to the left. Taxation tends to reduce the available disposable income tat is available to consumers since goods will become expensive and cost more since the taxes will be passed forward to the consumer by the suppliers. In the end, the consumers will have less income to afford goods, and will thus buy less of the goods being availed. When consumers buy less of the available goods, suppliers will ultimately reduce the supply of their goods. This reduction of supplies due to increased taxation can also lead to the collapse of some companies and businesses. This collapse comes about due to reduced aggregate demand which has come about due to the expensive nature of the available goods. Figure.2 Aggregate Demand Curve From the figure.2 above increase in taxation will lead to a decline in the aggregate price level from r1 to r0 and a decrease in aggregate output from Y1 to Y0. Decline in aggregate price level and aggregate output will lead to an inward shift of the aggregate demand curve from AD1 to AD0. This shift indicates that increase in taxation will lead to a decline in aggregate demand. Challenges towards Implementation of the Tax Reforms From the discussion above increased taxation tends to negatively influence growth and development since workers get demoralized and start spending more of their times in evading these taxes rather than spending more of their time on productive activities. Presently, Greece is struggling to stoke economic growth after it had been seized by its debt crisis. According to McElroy, measures have been put in place by this nation’s premier to attract the badly needed investments and create hundreds of thousands of new job opportunities (20). These measures included the transformation of the nation into a green economy through installing solar panels and wind turbines all over Greece. In its bankrupt position, this nation was under pressure to implement the requirements levelled against it by the IMF in order for it to receive its twelve or seventeen billion Euros of financial aid. These reforms included the aspect of dealing with the infamous tax evasion in Greece among others. Greece has been losing close to thirteen billion Euros in tax evasion and corruption alone every year. According to McElroy, tax evasion in business still remains rife in this nation despite the 2010 increased taxes that had been imposed through property tax, VAT, property tax, taxes on central heating oil and petrol (2). This situation is further exacerbated by the corrupt tax officials who embezzle certain percentage of fines that have been imposed on tax defaulters. According to McElroy, only twenty percent of fines are usually collected, forty percent are written off and the remaining forty percent embezzled by these corrupt tax officials (3). Greek citizen’s tax evasion habits have been singled out as the sole reason behind this nation’s fiscal policies. The tax reforms were simply efforts by the government to clean up fiscal finances and avail new opportunities for growth and development in Greece. Despite the fact that these recent tax have experienced widespread riots and protests all over the nation, they could lead to considerable growth and economic development in Greece. According to Tharp, these draconian tax reforms had an aim of; reducing the government debt load and introduce an efficient and a fair system which will simultaneously improve or eliminate the weaknesses in the prevailing Greek tax system (23). These reforms were motivated by five major findings by the Greek government which are; low public revenues in relation to government expenditure, decline in tax revenues, increasing tendency for natural persons to contribute more to national taxes, loss of profits from value-added tax , the payment of tax by a small section of tax payers. The new tax reforms will positively affect growth and development in Greece if only the issue of tax evasion is totally dealt with. According to McElroy, the IMF had speculated that the implementation of the tax reforms will see the Greek economy grow by 1.1 % in 2011, almost two years after it plunged into one of the deepest recessions ever experienced in any country in Europe (3). Despite the fact most of the Greeks believe that it would be after many years before Greece can experience any sustainable growth, the new austerity measures are likely to reduce this time-gap. According to McElroy, some of the tax efforts by Greece have started paying off (6). For example, even though the economy had contracted by 4.5% percent in 2009, Greece managed to reduce its deficits by five percent of GDP. Recent research has also showed that enforcement of the tax reforms loosened in the months leading up to the Greek elections since the incumbents did not want to annoy their contributors and supporters (McElroy 4). Furthermore, even if the new tax system managed to track down the tax evaders, it was almost impossible to get them to pay up. This was because the tax courts typically took almost seven to ten years to resolve any case. According to as at February 2011, these courts had a backlog of three hundred thousand cases. The Greeks citizens in addition have low tax morale and would prefer to pay their taxes when they have faith that their fellow-citizens are doing likewise. Evaluation of the Tax Reforms 1. Relationship Between the Revenue Raised by Taxation and Taxation Rates From the Laffer curve below zero tax revenues are collected at two marginal tax rates; 0% and 100%. When the tax rate is 0% no amount of taxes will be collected and when the tax rate is 100% no tax revenue will be collected since no one will go to work since their entire income will be taxed away. At 100% tax rate, the employees will perceive working as more dangerous to their survival since they will reap no benefit. Increase in tax rates as proposed in the 2010 tax reforms would cause the tax revenues to increase. For example, increasing the tax rate from X percent to Y percent will increase the tax revenues from Tx to Ty as shown in figure.3 below. Ty B Tax Revenue Tx Tz A C 0 X Y Z 100 Tax Rate Fig.3 Laffer curve Decreasing the tax rate would cause the tax revenues to increase. For example decreasing the tax rate from Z percent to Y percent will increase the tax revenues from point Tz to Ty. In this respect, the best strategy that Greece would have chosen is to reduce taxes so as to increase tax revenues. Though these tax reforms are capable increasing economic growth, the only problem in their implementation path is the instability of the Greek government. These tax reforms have been enforced in a spotty manner, and chances are high that the trend is highly likely to persist. For example even though Athens has done much to do away with the erratic system of disbursement of pensions, a great deal of pension cheques is still being mailed to ghost pensioners. Additionally, big businesses in this nation still send considerable amounts of their profits to offshore tax havens and in respect depriving the economy of its needed income. On top of this, there are moves by the government to limit public investments as it attempts to pay down some of its debts. This removal of the vital source of stimulus that could assist in cutting unemployment rates of sixteen percent over-all and forty percent among the young graduates. 2. Other Options for Greece Effective implementation of the 2010 tax reforms has faced a number of challenges like, corruption among the tax officials and increase in tax evasion tendencies among others. These challenges have rendered this policy ineffective and Greece should look for other alternatives of eliminating its big public debt. These options include; opting out of the Euro and reviving its drachma, depreciate its drachma to repay the debt, seek financing outside the Euro, or repudiate its debt. Debt repudiation is never the best option since it will lead loss of confidence by citizens and foreign states on Greece. Additionally, members of the European Union may decide to take military action against Greece to recover their loan or alternatively the may boycott it if it repudiates its debt. Apart from taxation, the Greek government can opt to increase its exports and reduce the imports. In this way, this nation can use the surplus balance to lessen the debt burden. Greece can also choose to opt-out of the Euro and revive and retain its drachma currency given the present debt crises that have faced the Euro and the Euro zone nations. After reviving its drachma, Greece can devalue it and start doing business with the other nations and provide them with services and products at a cheaper value because of its depreciated currency. This will ensure a sustained trade surplus and an increased domestic consumption which will enable it pay of its debt obligation. If reviving the Drachma is not plausible, then Greece can involve foreign nations to the Euro zone like China. China is known for having one of the largest foreign reserves of nearly four trillion dollars and most of its trade exports cover larger parts of the European Union. China’s enormous foreign reserves can be of great help to Greece in paying of its debt obligations in exchange for high interest long term returns. Conclusion In conclusion the tax reforms implemented by Greece can bring development and growth to the Greek economy. Attempts by the Greek government to bring about reforms to its tax system and structure; dates back to the 2002, 2004-07, and the recent 2010 reforms. The 2004-07 reforms focused on reducing tax evasion, through the introduction of VAT on buildings, reducing income tax burdens on individuals and businesses and upgrading the TAXIS. The 2002 tax reforms on the other hand focused on removing some of the negative features in the tax system that have negatively impacted Greece’s competitive ability in the international market and coming up with a more equitable tax system. The 2010 tax reforms on the other hand focused on reducing the government’s debt load and dealing with the infamous tax evasion. These later reforms faced widespread opposition and have since been implemented in spotty manner due to the instability and corruption in the Greek government. From the time these new tax laws were implemented considerable development has been seen in Greece, the only problem is that it may be short-lived if important issues relating to tax evasion and embezzlement are not dealt with. Greece’s manner of handling tax evaders has been criticised as being slack, given that tax evasion is among the major reason that made it slip into financial debt. The failures of these tax reforms may force Greece to pursue other options like bailing out of the Euro and reviving its Drachma, involving foreign investors like China, or repudiate the debt among others. Works Cited Asteriou, Donald, and George Agiomirigianakis. “Human Capital and Economic growth: Time Series Evidence from Greece.” Journal of Policy Modelling 23.5 (2001): 481-489. Print. Badia, Marialuz, Keiko Honjo, and Delia Velculesco, Greece: Selected Issues.Washington, D.C.: IMF, 2010. Print. Darst, David. The Art of Asset Allocation: Principles and Investment Strategies for any Market. 2nd ed. East Windsor, NJ: McGraw-Hill, 2003. Print. Dritsakis, Nikolaos, and Antonios Adamopoulos. “Financial Development and Economic Growth in Greece: An Empirical Investigation with Granger Causality Analysis.” International Economic Journal 18.4 (2004): 547-559. Print. Massourakis, Michael. “Country Report: Greece.” Global Finance Mag 20 Jun. 2008: 70-71. Print. 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