Budget Day 2015: tax reform was not invited to budget party
- Government budget in 2016 mainly dominated by tax cuts
- Not reforming the tax system is a missed opportunity
- Government deficit is lower mainly due to economic growth
- Development of public finances is a point of concern for the medium term
Budget feast and forecast
On September 15th the Dutch government presented its plans for 2016 at Budget Day (Prinsjesdag, traditionally held at the third Tuesday in September). The most important budget proposal was a € 5 billion tax reduction package, which will be mainly aimed at reducing taxes on labour. Modest spending increases are geared towards softening the impact of ongoing health care reform, increased security challenges and the refugee-crisis. The tax reduction is the sole remnant of what was supposed to be a serious overhaul of the tax system. As a result, budget day was somewhat a budget party, with reform not being invited to dance along.
The economic forecasts of the Netherlands Bureau for Economic Policy Analysis (CPB) on which the government plans are based are in line with our own expectations, given the acceleration of private consumption and exports (table 1). Although there are clear downside risks to the economic outlook, we think that the 2016 budget is based on reasonable economic assumptions.
Tax reform not invited
The planned tax reduction of € 5 billion should boost household consumption and thus economic growth next year. In addition, by lowering the taxes on labour it also contributes to strengthening the growth potential of the Dutch economy. Yet we view the tax plan as a missed opportunity. Complexity and fiscal disturbances, of which there are many in the Dutch tax system, are not tackled at all.
The only major change is the adjustment of the capital gains tax, which becomes progressive. However, it will still be based on fictitious investment returns as opposed to a realised capital gains tax, while the economic literature clearly states that a realised capital gains tax is economically more efficient.
What remains is a tax cut of five billion euros and a missed opportunity to improve the tax system. Finance Secretary of State Wiebes stated himself that five billion euro was needed as a necessary 'lubricant' to compensate the losers in a major tax reform. Giving away this lubricant without pressing ahead with the reform itself arguably will make future tax reform even harder.
Although the government hasn’t been able to push through a comprehensive tax reform, it should be noted that in other areas government reform has been successful. In the last couple of years the government has been able to structurally reform part of the labour market, pensions, the health care sector, the financial sector and the housing market. Apparently reforming the tax system as well proved to be too ambitious.
Structural deficit higher than allowed
The economic and budgetary figures show a reduction of the government budget deficit, to 1.4% of GDP in 2016 from 2.1%-GDP this year and 2.4% in 2014 (Figure 1). The government debt ratio will be reduced toward 64.5%-GDP in 2016, down from 67.9% in 2014. This includes an assumed cumulative 1%-GDP drop from the planned sale of part of ABN-AMRO.
The economic recovery – and the accompanying higher tax income and lower expenditure on welfare payments – is strong enough to compensate for the negative budgetary impact of lower revenues from natural gas mining and the planned tax reduction and higher spending. The latter will lead to a policy induced deterioration of the budget balance. As a result, while the headline deficit will be comfortably below the European 3% threshold, the structural budget deficit will deteriorate to more than 1% in 2016 against a Medium Term Objective of 0.5%.
This is clearly not in accordance with the preventive part of the Stability and Growth Pact. Given that the Dutch finance minister is chairman of the eurogroup, this may seem a bit odd. It will lead to negative judgments on the budget both from the Council of State in its role as the official independent budgetary supervisor on Budget Day itself and from the European Commission later this year. But the domestic political logic behind this budget is being shaped by the fact that elections for the lower chamber of Parliament are to be held in March 2017 at the latest.
If the government wants to hold on to the budgetary rules then they ultimately have to reduce their spending or tax cuts in order to restore the structural balance. It could also be the case that they expect that the economic recovery will have an upward effect on the potential level of economic growth. This would lead to a lower structural deficit since a higher measurement of potential GDP indirectly leads to a lower structural deficit, all else equal.