VZCZCXRO6588
RR RUEHDA
DE RUEHAK #1537/01 1661313
ZNR UUUUU ZZH
R 151313Z JUN 07
FM AMEMBASSY ANKARA
TO RUEHC/SECSTATE WASHDC 2618
INFO RUEATRS/DEPT OF TREASURY WASHDC
RUEHIT/AMCONSUL ISTANBUL 2888
RUEHDA/AMCONSUL ADANA 2050
RUEHBS/USEU BRUSSELS

UNCLAS SECTION 01 OF 03 ANKARA 001537 
 
SIPDIS 
 
TREASURY FOR INTERNATIONAL AFFAIRS - JROSE 
 
SENSITIVE 
SIPDIS 
 
REF: ANKARA 1031 AND PREVIOUS 
 
E.O. 12958: N/A 
TAGS: EFIN TU
SUBJECT: Government Officials Deny Election-year Fiscal Loosening 
 
 
¶1. (SBU)Summary: A series of Government announcements on fiscal 
policy have led to increased suspicions of populist, election-year 
fiscal loosening.  The most high-profile and IMF-unfriendly of these 
was the announcement of Value-Added Tax rate cuts for tourism food 
and restaurants.  2007 tax revenues are also showing signs of 
weakness.  Both Government ministers, publicly, and ministry of 
finance bureaucrats, privately, deny or downplay the significance of 
policy changes and claim they will still be able to meet yearend 
fiscal targets.  End Summary. 
 
------------------------- 
Signs of Fiscal Loosening 
------------------------- 
 
¶2. (SBU) In recent weeks there have been a series of Government 
announcements and press reports suggesting the government is taking 
populist spending or tax policy measures which could undermine 
fiscal discipline.   Among these have been: 
 
---Cutting Value-Added Tax (VAT) rates on some foods to 8%, 
effective immediately, and on tourism, restaurants, and remaining 
food items effective in 2008; 
 
--Expanding the regional investment incentives to allow firms with 
only ten employees to benefit from the incentives, and removing the 
requirement that the employees be new hires; 
 
-- Reducing social security payroll taxes in 2008; 
 
--The press has also reported such items as free government 
circumcisions, payments to holders of bonds fraudulently sold by the 
failed Imar Bank, amnesties on loans to farmers, conversions to 
permanent status of public sector temporary workers, and partial 
debt forgiveness for municipalities. 
 
¶3. (SBU) As a result, market analysts are increasingly concerned 
that the government is loosening the purse strings in the run-up to 
July 22 elections and will have difficulty achieving yearend fiscal 
targets agreed with the IMF.  After the VAT rate cut was announced, 
Finance Minister Unakitan denied it was a violation of the 
government's commitments to the IMF, only to be publicly 
contradicted by the IMF Resrep.  More recently, IMF Deputy Managing 
Director John Lipsky, in Istanbul for the annual Investors Advisory 
Council, lamented the VAT rate cuts but said any election-year 
loosening would not "break the bank," and should be viewed in the 
context of the overall performance in Turkey.  The IMF has long made 
the case that only after revenue collection improved could rates be 
cut, and that they be cut across the board rather than sector by 
sector. 
 
--------------------------------------------- - 
Data Show Spending on Track, but Weak Revenues 
--------------------------------------------- - 
 
¶4. (SBU) January-May central government fiscal data, however, do not 
show a notable opening of the fiscal spigot.   Total non-interest 
expenditures were YTL 59.8 billion or 39% of the full-year target. 
This level of spending -- broadly in line with the target -- 
supports a mid-level budget official's claims that any election-year 
spending was minor, and that the government would not have any real 
problem meeting the yearend primary surplus target or falling within 
the IMF-agreed spending cap. 
 
¶5. (SBU) The revenue side on the other hand, showed surprising 
weakness.  Total January-May tax revenues increased only 8% in 
nominal terms from the same period in 2006 -- i.e. tax revenues fell 
in real terms and as a percent of GDP.  Corporate tax receipts 
declined 9%, Special Consumption Tax collections declined 1% and VAT 
increased only 4%.  The weak revenue performance raised questions as 
to the government's willingness to collect taxes aggressively in an 
election year. 
 
¶6. (SBU) Thanks to privatization revenues and profit transfers from 
state-owned banks and the Savings Deposit Insurance Fund, the 
overall budget balance was a modest YTL 3.3 billion deficit, only 
20% of the full year targeted deficit, and the primary surplus was 
56% of the full-year target.  The IMF, however, does not include 
privatization and profit transfers in its primary balance 
calculation, since the GOT committed not to spend this kind of 
one-off revenue. By the Fund's calculation, the January-May primary 
balance is only 31% of the full-year target. 
 
---------------------------------------- 
Tax Administration Explains Weak Revenue Performance... 
---------------------------------------- 
 
ANKARA 00001537  002 OF 003 
 
 
 
¶7. (SBU) Like his budgetary counterpart, a Deputy Director of the 
Tax Administration, while admitting to fiscal impacts from the rate 
cuts and other measures, downplayed the extent of the problem.  The 
tax official offered a point-by-point explanation of the relatively 
weak revenue performance.  Corporate tax revenues only looked weak 
in relation to the first 5 months of 2006 because the corporate tax 
rate reduction from 30% to 20% had come into effect as of April 1, 
¶2006.  Special Consumption Tax (SCT) collections were weaker largely 
because of the slowdown in domestic sales of automobiles, a major 
source of SCT revenues. 
 
¶8. (SBU) The Tax Administration official explained that the slowdown 
in VAT collections was entirely attributable to a surge in VAT 
rebate payments to exporters.  Gross VAT collections were growing at 
a healthy 14-15% rate but rebates had surged about 35%.  Though much 
of this surge can be attributed to strong export growth so far this 
year, the Tax Administration was investigating firms showing 
outsized increases in rebates.  (Comment: Combating export tax 
rebate fraud has long been a challenge for the Tax Administration. 
End Comment.) 
 
--------------------------------------------- -- 
...denies Government going soft on collections... 
--------------------------------------------- -- 
 
¶9. (SBU) The tax official denied that the Government was going soft 
on tax collection in an election year.   On the contrary, the Tax 
Administration continued to implement its restructuring -- a key 
structural reform supported by the IMF and World Bank -- which is 
designed to improve tax enforcement and collection.   The Tax 
Administration now has regional offices -- as opposed to less 
effective Finance Ministry offices -- in 29 provinces accounting for 
94% of total tax revenues.  The IMF-mandated Large Taxpayer Unit has 
been established in Istanbul to handle the 500 largest taxpayers 
(soon to be expanded) and has its own special team of auditors. 
The Tax Administration continues to invest in more elaborate 
information technology systems.  Its improved data base now allows 
auditors to monitor taxpayers' bank account data, for example.  The 
Tax Administration is working with the EU to establish a risk-based 
auditing system which will better identify which taxpayers should be 
audited. 
 
--------------------------------------------- ----- 
...but Admits Costs Associated with Policy Changes 
--------------------------------------------- ----- 
 
¶10. (SBU) The Tax Administration Deputy Director admitted there were 
costs associated with some of the recently-announced measures.  His 
boss, Tax Administration Director Osman Arioglu, had announced 
publicly that next year's VAT rate cuts would cost about 800 million 
YTL (about $600 million) and that the immediately-effective food VAT 
rate cuts would cost about 100 million YTL this year.  In our 
meeting, the Deputy Director defended both the tourism rate cut as 
necessary to bring Turkey's taxes on tourism into line with 
competitor countries, most of which had single digit VAT rates for 
the tourism sector.  He said the lower VAT rate for restaurants, 
while discouraged by an EU directive, was allowed by derogations for 
many accession countries and still exists in many of the 
pre-enlargement EU-15 countries, in some cases at rates lower than 
Turkey's 8% rate. 
 
¶11. (SBU) The government has yet to disclose the details of its 
plans to cut social security payroll taxes, but a five percent cut 
was recently floated by Minister Unakitan.  The Tax Administration 
official confirmed that this cut would be part of a package of labor 
market reforms the Government is working on with the World Bank, 
which is expected to be announced after the new government is 
formed.  He said the income tax withholding on wages was only 6%, 
whereas the social security taxes accounted for the bulk of the tax 
"wedge": 14% from the employee and 19% from the employer.  Comment: 
World Bank officials tell us their studies show that any tax loss 
from lower payroll taxes will be partially offset by increased 
registration of employees with the social security system, as lower 
payroll taxes reduce the incentive not to register.  End Comment. 
 
¶12. (SBU) The Tax Administration confirmed that parliament had 
passed legislation expanding access to the (IMF-opposed) regional 
investment incentives scheme.  Whereas in the past firms had to 
employ 35 new hires to be eligible for the incentives, under the new 
law they would only need to have 10 employees and they need not be 
new hires.  He expects a loss of revenue from this change of 
approximately YTL 900 million per year. 
 
------- 
 
ANKARA 00001537  003 OF 003 
 
 
Comment 
------- 
 
¶13. (SBU) Government Ministers' statements that they are not 
relaxing fiscal discipline are contradicted by the announced 
measures.  Nevertheless, as Lipsky's remarks suggest, the measures 
so far do not seem severe enough to put yearend targets -- or 
agreement on remedial measures with the IMF -- out of reach of the 
next government. 
 
Wilson