The Tax Policy Implications of the Spanish Elections at the Regional, National, and European Levels

The Spanish election results are moving the country away from pro-growth tax reforms while launching the government’s tax agenda, and the agenda of the Spanish presidency of the Council of the European Union, into uncertainty.

Despite gaining 16 more seats than the Socialist Party, the People’s Party (PP) does not have a ruling majority. Even a possible right-wing coalition between PP, Vox, and the Navarrese People’s Union would be five seats short of an absolute majority. On the left, a coalition government of the Socialist Party, Sumar group, and all the nationalist and separatist members of Parliament (MPs) would also leave incumbent Pedro Sánchez short of a majority.

This leaves a ruling coalition government contingent on the support of Together for Catalonia (7 seats), the party of the fugitive Puigdemont. Together already announced that its support for Sánchez is conditional upon amnesty for everyone involved in the 2017 referendum and a firm commitment to a Catalan independence vote. The Canary Coalition Party, with only one MP, also announced its willingness to possibly support Pedro Sánchez.  Negotiations regarding a new regional financing system and regional debt pardon are underway.

The Impact of the Spanish Elections at the Regional and National Levels

This general election in Spain comes after the left-wing coalition government’s parties performed poorly in May’s local and regional elections. At the regional level, the PP gained enough votes to negotiate coalition governments in most regions where they haven’t secured outright majorities.

Over several years, Spanish regions governed by PP have committed to pro-growth tax reforms that have advanced them in the Spanish Regional Tax Competitiveness Index (RTCI).

Regional tax competition has proven effective; some Spanish regions have copied Madrid and other leading regions’ tax reforms. In 2022, Andalusia was the first region to cut the top statutory inheritance tax rate from 81.6 percent to 49.6 percent, just below Germany’s and Switzerland’s top tax rate of 50 percent.

Regions are considering repealing or cutting wealth and inheritance taxes that negatively impact entrepreneurial activity, saving, and work, instead focusing their tax policy on creating an individual income tax system that boosts wages, employment, and workers’ mobility. Last week, the newly formed government of the Balearic Islands, with the support of Vox, slashed the inheritance tax for close heirs. This trend is likely to increase in the following months as more regions are now governed by the PP or coalition governments they are a part of. It is this regional tax competition that stopped Spain from becoming Europe’s tax hell during the five years of Pedro Sánchez’s presidency.

At the same time, the tax policy reforms at the national level have greatly harmed Spain’s international tax competitiveness. Since 2020, Spain has dropped from 26th to 34th (out of 38 countries) in the 2022 International Tax Competitiveness Index (ITCI).

Over the last several years, Spain has adopted a financial transactions tax (FTT), a digital services tax (DST), and a special value-added tax (VAT) on sugary drinks. Additionally, at the end of 2022, new taxes were approved. Spain enacted a two-year windfall profit tax on banks and energy companies.

If the latest short-sighted tax policies introduced at the end of 2022 and the beginning of 2023 are not repealed, then they will reduce the country’s overall ranking in the 2023 ITCI even more.

Conversely, during the electoral campaign, PP candidate Alberto Núñez Feijóo announced tax reforms that were looking to “attract investment.” He planned to abolish or reform the two windfall taxes and review the wealth tax that Sánchez passed last year. He also showed concern regarding Spain’s public debt and is keen on cutting the budget deficit.

Additionally, Vox, concerned with Spain’s drop in its overall international tax competitiveness and the fall of household income in real terms, advocates for cutting the general VAT rate from 21 percent to 18 percent, cutting the income tax down to two brackets at rates of 15 and 25 percent, and gradually reducing the corporate income tax rate to 15 percent. The group also pledges to automatically adjust income tax brackets for inflation and to eliminate double taxation of income by abolishing both wealth and inheritance taxes.

Apart from these tax reforms, Spain should abolish the FTT and DST. To increase private investment and accelerate economic growth, Spain should consider full expensing for capital investment and shift the tax mix toward less harmful consumption taxes by broadening the VAT tax base.

Spain should implement tax reforms that have the potential to stimulate economic activity by supporting private investment and employment and attracting highly qualified workers, increasing its internal and international tax competitiveness.

The Impact of the Spanish General Election at the European Level

The Spanish elections have also impacted tax policies across the continent, especially as Spain holds its fifth rotating presidency of the Council of the EU.

As an honest broker, the Spanish presidency is expected to continue discussing the key files addressed by the Swedish presidency, like the “VAT in the Digital Age” package as well as the “UNSHELL” proposal to prevent the misuse of shell entities for tax purposes. But the lens might be different: in June, Spain presented some of its tax-related priorities for the upcoming months—the consolidation of the “Social Pillar” by establishing a common minimum standard for corporate taxation across all Member States to combat tax evasion by large multinationals. It also intends to continue reforming the fiscal rules combining transparency and the flexibility required by the green and digital transitions.

On one hand, these priorities are likely to remain the same if Sánchez successfully forms a government. Specific proposals might receive more attention; for instance, the UNSHELL proposal has broad interest and clear prioritization by the Commission to further the fight against tax evasion.

On the other hand, a change in government might give room for maneuvering in other files—like Own Resources. Traditionally, Sánchez has favored European-style “Marshall Plan” public investment programs—but has not prioritized developing a plan to reimburse these programs.

Feijóo has not made many direct comments about the EU Own Resources, but his pro-growth tax reforms and views on fiscal responsibility are likely to be reflected at the European level. If Feijóo successfully forms a government, the shift towards repaying European debt might be more important, focusing increasingly on discussing the Own Resource files. President of the European Commission, Ursula von der Leyen, would likely support such a focus.

The inconclusive results of the Spanish elections at this stage seem to point to the fact that the presidency of the Council is running on autopilot. Without a clear change in government, the priorities will likely remain the same as the ones announced in June. After all, this is part of the logic behind the Council’s presidency trios.

In the current political vacuum in Spain’s leadership, the Commission could try to steer discussions on the Own Resources files. These files could move swiftly in the Council before the Union enters the European Parliament election frenzy or less cooperative Member States hold the presidency.

What’s Next for Spanish and European Tax Policy?

The Spanish election results are moving the country away from the much-needed pro-growth tax reforms. At the EU level, this power vacuum might well come at the perfect time for those interested in moving forward with the Own Resources and UNSHELL files.

The Spanish Congress will reconvene on August 17, and, after meeting party leaders, King Felipe VI will determine who has enough support to become prime minister. An investiture vote could take place in September, but if no one can form a government, then new elections could be called for December or January. Nevertheless, if Sánchez is able to form a new government, then the addition of Together for Catalonia to the mix will complicate the approval of any landmark legislative reforms, acceptance of the annual budget proposal, or compliance with the EU budgetary rules. In any case, the next government will most likely face challenges balancing electoral promises with reducing public debt.