Turkey lifts taxes to help pay for earthquake rebuild

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Turkey has raised taxes as part of efforts to finance the huge reconstruction bill wrought by February’s devastating earthquake, after a spending bonanza in the run-up to the recent elections. 

The tax rise comes after president Recep Tayyip Erdoğan promised to swiftly rebuild 650,000 homes that were wrecked by the disaster. Analysts expect the reconstruction cost for residential and commercial buildings and key infrastructure in the vast part of southern Turkey hit by twin tremors could rise as high as $100bn. 

Mehmet Şimşek, who was appointed finance minister last month, has pledged to restore fiscal “discipline” after the huge giveaways, including free gas and big pay rises for civil servants, in the run-up to May’s vote. Erdoğan won the election to extend his rule of the country to a third decade despite a severe inflation crisis that dented his popularity.

Economists expect Turkey’s government budget deficit to jump to 4.5 per cent of gross domestic product this year, from just 0.9 per cent in 2022, according to a FactSet poll taken prior to Friday’s tax announcement, which underscores the perilous public finances. 

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

The tax increases are part of a broader economic shake-up, led by Şimşek and central bank governor Hafize Gaye Erkan, who were both appointed in June to battle an economic crisis triggered by Erdoğan’s unconventional policies. Erkan’s central bank has already nearly doubled interest rates, while the country has backed away from a costly effort to prop up the lira. 

Under the plans announced on Friday, the main value added tax on goods and services will rise to 20 per cent from 18 per cent. The rate will also be increased by two percentage points to 10 per cent for essential items such as basic food and textiles. 

Turkey also increased the cost of registering mobile phones purchased abroad by more than three times to TL20,000 ($770) to dissuade consumers from avoiding taxes on consumer electronics. The website used for registering mobile phones became overloaded on Friday as residents rushed to avoid the hike, which goes into effect on Saturday. 

Liam Peach, at Capital Economics in London, said the VAT rise was “the right thing” since it would help cool consumption, which many analysts say is still overheating after years of very loose monetary and fiscal policies. 

“The biggest imbalance in Turkey has been the strength of consumption. Spending has been too strong,” Peach said. “Any fiscal measures to rein in that spending are good measures.”

The VAT increase will generate government revenues of about 0.8 per cent of GDP, or around $7bn annually, according to Peach, although he also said this would not be enough to sufficiently slow growth and narrow the budget deficit. 

Kara said he was concerned that since the fiscal tightening was focused on tax rises, which make goods and services more expensive, it may “worsen the short-term inflation outlook”. Inflation has fallen from last year’s highs above 85 per cent, but still registered nearly 40 per cent in June. 

There is also a risk that revenues from the tax rise “will be spent on salaries and pensions” instead of being saved by the government, Peach added.