Open Letter to Ms. Angela Merkel

Dear Ms. Merkel,

I am sure you will agree that a good Chancellor of Germany must listen carefully once in a while to what Mr. and Mrs. Schmidt have to say.  Giving the extraordinary financial crisis Europe is currently undergoing and the key role that Germany must play in tackling such crisis, I expect you will also concur that the Chancellor of Germany must now extend this attention to Mr. and Mrs. Rossi, Garcia, Papadopoulos and da Silva. 

So here is your first letter from a certain Mr. Rossi.

Let me begin by asking you to pretend for a moment that tomorrow morning the Bundestag passes a law introducing a change to the German tax system by which all German citizens, except employees and pensioners, are entitled to declare to the tax authorities an income of their choice with respect to any income received in cash.  What can we envision might happen under such assumption? 

Conceivably some (or most likely many) of these very fortunate categories of German workers would set their nationalistic feelings aside and start requesting as many cash payments as possible in order to maximize the reduction of their gross taxable income.  Soon after the introduction of the new tax regime they would start declaring minimum income levels. German jewelers, for example, would suddenly declare an average annual gross income of say €14,300.  Cash payments would become so widespread that a well known German television programme would find out that most Members of Parliament pay their personal assistants in cash. Cashless payments in Germany would drop from current 205 payments per person per annum to just 65.

Hence, in order to compensate for the reduction in tax revenues Germany would experience under such a dim scenario, you would find yourself compelled to increase personal tax rates (in substance increasing taxes on employees and pensioners) and corporate taxes.  Obviously such measures would have a very negative impact on the spending power of most Germans (at least of all employees and pensioners), not to mention the competitiveness of German companies.  Most likely this would cause the average, long term GDP growth of your country to fall as low as 0.5-1.0% per annum.  At this point, unable to afford further tax increases without risking a recession and possibly riots, you would be forced to finance the deficit by increasing public debt, which in a few years could reach levels of up to 120% of GDP.  Financial markets would not surprisingly start to get nervous, rating agencies would add their weight into this equation, and the cost of debt would continue to increase reaching unsustainable levels.  At this point taking ridiculous new measures such as increasing VAT by 1% and taxing 34,000 people an extra 3% wouldn’t help.

Is it all just bad news, however?  No. The fortunate citizens who were granted the possibility to declare an income of their choice would sharply increase their savings, making the average German family net worth on disposable income ratio jump from 6.3 to 7.8 times.  These lucky people would presumably want to invest their substantial extra cash somewhere, so a further consequence could be that the price of an apartment in Berlin might rise from €2,500 to about €6,000 per m².  Luxury goods would become more and more popular among such citizens and in a few years four of the ten most expensive retail streets of Europe (in terms of rent) would be found in German cities (at present Germany has none).  There would also be some very good news for your automobile industry: in their home country they would sell cars in the €100,000 range in a number equal to three times the number of people who declare net incomes of €100,000 per annum or more.

I am sure Ms. Merkel that by now this description rings a bell. 

The situation we have just imagined is exactly what has been going on in Italy for decades, and the facts and figures I just gave you are the actual facts and figures of Italy.  No, we haven’t passed a law allowing certain citizens to declare an income of their choice, but in substance that is what has happened.  There are, of course, some honourable working citizens in all categories that have opted to be honest and have declared their income in full.  It is clear to everybody, however, that millions of Italians have declared only a fraction of their income, and that the non-declared income has been paid to them almost exclusively in cash.

You may be wondering why I am writing to you.  Dear Ms. Merkel, with this brief letter I would like to insist that you kindly ask whoever will run our country in the coming years to introduce a mechanism capable to eliminate most of Italy’s €200 billion tax evasion.  The measure I propose is to introduce a tax on cash withdrawals (both over the counter and from cash machines) as well as the prohibition to use cash as a method of payment for salaries and pensions (with minor exemptions to be made for the elderly).  The starting rate for this tax should be relatively low, say 2-3%, and rise to a level of up to 15% within 2 to 3 years.  Italians willing to learn how to make most of their payments using transfers, cheques, debit cards, credit cards and other simple and modern electronic means would only be marginally affected by this new tax, while those Italians who wished to continue paying cash for 75% of their bills and purchases would bear the cost of their laziness, privacy paranoia or desire to cooperate with tax evaders in exchange for a discount.  By the time we reach the 15% rate level, as if by magic, a very significant portion of tax evasion would have vanished.  By taxing cash withdrawals, indirectly we would have introduced the equivalent of a VAT on illegal goods and services such as drugs and prostitution.

At this point, what might Italy do with the enormous amount of taxes resulting from the emergence of such a large part of its underground economy?  No mistake can be made in this respect Ms. Merkel: it must be used to reduce personal tax rates as well as to abate the extremely high cost of labour that is killing Italian businesses.  Pensioners, employees and the honest workers among all other categories would certainly spend the extra available net income to purchase goods and services.  Large, medium and small enterprises would start hiring millions of qualified yet unemployed young people.  Ultimately, the Italian GDP would finally start growing at a decent rate making public debt sustainable.  Yes, unfortunately, luxury car sales would drop, one or two streets amongst Via Montenapoleone, Via della Spiga, Via Condotti and Corso Vittorio Emanuele II might fall below the top ten of the most expensive retail streets in Europe, and average residential prices in Rome and Milan might fall below their current €6,000 per m² level, causing Italian families’ net worth on disposable income ratio to fall below 7.8 times.  Believe me, most Italians could live with this.

Yours Sincerely,

M. Rossi