Turkey removes tax to help pay for earthquake reconstruction

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Turkey has raised taxes as part of efforts to finance a huge reconstruction bill triggered by February’s devastating earthquake, following heavy spending in recent elections.

The tax increase came after President Recep Tayyip Erdoğan promised to rapidly rebuild the 650,000 homes destroyed by the disaster. Analysts expect the reconstruction cost of residential and commercial buildings and key infrastructure in the vast swathes of southern Turkey hit by the twin quakes to rise to $100 billion.

Mehmet Simsek, who was appointed finance minister last month, has promised to restore fiscal “discipline” after lavish gifts including free gas and big pay raises for civil servants, ahead of the May vote. Erdoğan won the election to extend his rule over the country for a third decade, despite a severe inflationary crisis that affected his popularity.

Economists expect Turkey’s government budget deficit to jump to 4.5 percent of GDP this year from just 0.9 percent in 2022, according to a FactSet poll conducted ahead of Friday’s tax announcement, underscoring perilous public finances .

“Given the fall in the budget balance related to the election and the earthquake, and deep structural issues, substantial fiscal adjustment was necessary,” said Hakan Kara, former chief economist at Turkey’s central bank.

The tax hike is part of a wider economic overhaul led by Simsek and central bank governor Hafez Gay Erkan, both appointed in June to fight an economic crisis caused by Erdoğan’s unorthodox policies. Erkan’s central bank has already nearly doubled interest rates, while the country backs away from a costly effort to prop up the lira.

Under the plans announced on Friday, the core value-added tax on goods and services will increase from 18 percent to 20 percent. The rate for essential items like basic food and clothing will also be increased by two percentage points to 10 percent.

Turkey more than tripled the registration cost of mobile phones bought abroad to TL20,000 ($770) for consumers to avoid taxes on consumer electronics. A website used for registering mobile phones was overloaded on Friday as residents rushed to avoid the hike, which will come into force on Saturday.

Liam Peach at Capital Economics in London said the VAT hike was “the right thing” because it would help spur consumption, which many analysts say is still heating up after years of very loose monetary and fiscal policies. Is.

“The biggest imbalance in Türkiye has been the power of consumption. The cost is too high,” Peach said. “Any fiscal measures to rein in that spending are good measures.”

According to Peach, the VAT increase would generate government revenue of about 0.8 percent of GDP, or about $7 billion annually, although he added that it would not be enough to substantially slow growth and reduce the budget deficit. .

Kara said she worried that since fiscal tightening was focused on tax increases that make goods and services more expensive, this “could worsen the short-term inflation outlook”. Inflation has come down from last year’s high of over 85 per cent, but still stood at around 40 per cent in June.

Peach said there was also a risk that revenue from the tax hike would be “spent on wages and pensions” rather than saved by the government.