2. The Personal Income Tax

In 2018, tax income from Personal Income Tax rose to Euros 82,859 million, 7.6% more than in 2017. The two main causes of growth were as follows: an increase in withholdings on wages and good results for annual tax returns, although, other items such as staggered payments and withholdings on investment income also registered significant increases. Growth was limited due to the extension of the reduction on earned income since July (which lead to a decrease in earnings on the lowest incomes), and due to the refunds linked to maternity allowances, which started to be paid following the Supreme Court's ruling in October that this type of income is tax exempt.

In 2018, household gross incomes grew by 5.2%, more than one point above the growth recorded in 2017. All elements grew significantly (5% or more), except capital gains, which suffered a sharp correction compared to the significant increase registered in 2017. Performance throughout the year was characterised by the boost awarded to incomes in the second part of the year after an increase in wages and public pensions was approved in the Budget. In the first half of the year household income grew at a rate of 4.7% (prolonging the upwards trend that had started to become noticeable in mid 2017), and then continued to grow to 5.6% in the second half of the year.

Income from work, which is the largest component of household income, increased by 5% compared to 3.6% in the previous year. Within income from work, total payroll grew by 5.4%, one point more than in 2017. Unlike previous years, the increased growth was due to a rise in the average salary, which offset the lower job creation rate. The average salary figure had given signs of a recovery towards the end of 2017, and in 2018 this trend was consolidated, particularly since July when public sector employees joined their private sector counterparts in receiving a higher average salary. Following the increases recorded in 2018, the average salary is slightly higher than it was in 2009, which, up to that date had been the record high.

The other important element within income from work is the pensions bill, which grew by 4.4% in 2018, almost two points more than in 2017. This is the highest increase since 2011. Given the stability of population growth (since 2007, this has not deviated much from 1.1% per year), the increased pensions bill is due to the rise in average pensions, which changes when pensions are reviewed each year and because of the upturn that occurs when new people with higher pensions retire (the performance of private pensions also influences these figures to a lesser degree, as was the case in 2016 and 2017). New pensioners were responsible for practically all the increases in the average pension in recent years, which averaged nearly 2% per year between 2014 and 2017. Added to this in 2018 were the approved increases and the Budgets, which meant that average pension growth jumped to 3.2%.

Investment income (moveable property leases and capital gains) grew by 5.6%, which is below the 9.4% recorded in 2017 (Charts 2.1, 2.4, 2.5 and 2.6). The deceleration was caused by the performance of capital gains, which in 2017 increased by 29.5% and only 2.7% in 2018. This performance is linked to investment fund earnings, which, in turn, are related to the situation on secondary securities markets which reached a record high in 2017 and experienced a significant decline in 2018. Apart from this, the major news was the recovery of income from moveable property. This income had been in decline almost without interruption since the beginning of 2012, a trend that was broken in mid 2018, when growth of 9% was recorded. In the last quarter, this improvement was confirmed and accentuated. The main reason for the recovery was a rise in dividends and income from private debt securities (in 2018 bank account interest rates continued to fall; this time by 30%). Dividend yields were even higher due to the fact that towards year-end profit sharing was brought forward in order to avoid the change to the way income from savings of more than Euros 140 thousand are taxed, which had been provided for in the draft Budget for 2019.

Finally, business income grew 7.6% (6.2% in 2017). It is estimated that the number of business people and professionals increased at the same rate as in 2017 (1.9%). Accordingly, the increase in average income was slightly higher than in the prior year. With this result, and after six consecutive years of growth, average income is close to what it was before the financial crisis.

The effective rate on gross household incomes was practically the same as in 2017 (Table 2.1), although it was affected by several events. Firstly, there was the average withholding rate for salaries and pensions (Table 2.3). In salaries, growth stood at 1%, whereas it had been practically stable in the two prior years. Behind the rise is the increase in average salaries (also unlike previous years) and the consequent upturn in the average withholding rate. The pensions rate grew by 2.2%. It is of note that the effective rate for pensions rises systematically when people with a higher average pension are added to the system. However, the upturns in the average rate for both salaries and pensions were less than they would have been if there had been no change to regulations, such as occurred after the Budget was approved when the extension to the reduction on earned income entered effect. This change led to lower rates for the smallest salaries and pensions and limited hikes in withholding rates. Secondly and also with respect to the Budget, new family tax allowances were approved. The full impact of these new deductions on average tax rates will only become apparent when the annual tax return for 2018 is published (the extension of the previous family allowances had little effect on expected deductions, while other deductions such as childcare costs will only be applied in said annual tax return). These allowances offset the rise in tax rates for salaries and pensions and the stability observed in effective rates during 2018.

Accrued Personal Income Tax grew 5.3% in 2018, less than the 6.2% increase in the prior year (Table 2.1). Given the stability of the effective rate, growth was solely down to the performance of income. The lower increase in comparison with 2017 is the result of the negative impact of the family deductions discussed above. Without these deductions, or the total tax liability, accrued tax grew 6.3%, almost two points more than in 2017.

The main component of this tax, withholdings on income from work, grew by 6.5%, with a similar increase in salaries and a 6.7% rise in pension withholdings (Table 2.3). Higher salaries and average tax rates were able to offset lower job creation rates. Growth in pension withholdings was relatively stable throughout the year. However, the composition of this item before the increase in average pensions and decline in withholdings was different to its composition after these events took place: Income grew by nearly 3% before the increase and by almost 5% afterwards, whereas the effective rate rose by 3% before and by 1.4% after the reduction in withholdings.

In other items, the following were of note due to sharp increases: withholdings on income from moveable property (8.5%) and payments and withholdings on business earnings (7.4%) and, due to sharp declines: withholdings on capital gains from investment funds (-21.1%) and the tax on lottery winnings (-17%). The last tax was affected by regulatory changes (the exemption limit rose from Euros 2,500 to Euros 10,000), but with a minimum impact on income.

As has been shown, tax revenue grew by 7.6%. The difference between this growth and accrued tax growth (5.3%) is due to when the annual tax return is recorded: income includes the results of the tax return for the prior year (so, results for 2017 were recorded in 2018), while results for accrued tax are recorded in the year in which they occur. The contrast between the two is so pronounced in 2018 because of the different ways they performed. In 2017, the result was slightly better than in the previous year (such that almost Euros 1 billion was contributed to tax collection growth); however, it will deteriorate due to the impact of the family allowances.

The main causes of the increase in tax revenues were the rise in withholdings on wages and the good annual tax return results. Withholdings from work and professional activities grew by 6.5% in 2018, with an increase of 7% in the private sector and 5.8% in withholdings on salaries and pensions paid by the AA.PP. The dynamics throughout the year in both sectors were also different. In the private sector, growth became less intense as the year progressed due to the decline in the job creation rate. This trend was strengthened in the second part of the year, when the extension to the reduction on earned income that was approved in the Budget entered effect. The reduction in withholdings on the lowest salaries resulting from this measure particularly affected SMEs (in the third payment of the year, which was the only one affected by the measure, the growth in withholdings for SMEs was down to 4.% instead of the average 7.3% for the two prior quarters). In contrast, for Public Administrations the growth in withholdings was more pronounced in the second half of the year after the increases in salaries and public pensions were approved. As discussed above, the year ended with an increase of 5.8%, while growth to July had stood at 4.5%. However, part of this difference is attributed to the delayed payments that were effected in the first months of the second sixth-month period.

The annual return (for 2017) contributed more than Euros 1 billion to growth in Personal Income Tax. Gross income increased by 11.3%, while rebates grew only 1.1%. It is of note that these rebates include Euros 94 million in refunds following the ruling on maternity allowances, such that, without said allowances rebates would have been practically the same as in 2017. A similar situation arose with regard to the results of the annual tax return for this year, with sharp increases in income. The reasons are similar in both years: substantial growth for the prior year in income not fully subject to withholdings and payments on account (business income, income from property, capital gains), the tax for which is settled in the annual tax return. The only difference with respect to 2017 was the fact that capital gains were less pronounced in 2018.

With regard to other tax elements, of note is the increase of more than 6% in staggered payments and withholdings on income from moveable property. On the negative side are the 20% reduction in withholdings on capital gains on investment funds and the nearly 13% decline in the tax on lottery winnings.