Bowing to pressure, Spain walks tax reform tightrope
* Spanish tax take one of lowest in Europe, revenues falling
* Must try to boost income while nursing fragile recovery
* Reforms seen implemented in election year of 2015
* Rajoy to favour widening tax base over hiking tax rates
MADRID, Sept 10 (Reuters) - Spain's government has bowed to pressure at home and abroad by committing to tax reforms it hopes will boost public revenues without choking off a fragile economic recovery before parliamentary elections in 2015.
But it faces a series of politically unpalatable options for raising one of Europe's lowest tax takes, suggesting it will divide up the increased fiscal burden among a recession-weary public with one eye on its chances of staying in power.
Spain's tax take has fallen almost 50 billion euros ($66 billion) since the downturn started six years ago, putting total revenue at 36.4 percent of gross domestic product in 2012, nearly ten percentage points below the European Union average.
"Our tax system simply does not work," president of tax inspectors organization IHE Ranses Perez Boga said. "It doesn't bring the state the resources it needs, especially in times of economic crisis when the cost of subsidies rises."
Sources close to the Treasury, accountants and inspectors say that, rather than raising tax rates, the ruling People's Party - whose voter support has halved since it took office in 2011 on a no-tax-hikes pledge - is likely to focus on widening its fiscal base.
That may involve scrapping exemptions on income or corporation tax, they said, citing complex taxation rules for smaller businesses and tax breaks for homeowners as two areas that look ripe for change.
In reforms that are set to be implemented in 2015, the government might also be forced into ending hefty sales tax discounts on some basic goods, a move that would hit Spain's poorest citizens hard.
The drop in the tax take is particularly damaging for a country that, even after waves of public spending cuts, is struggling with one of the euro zone's highest public deficits.
Structural shortfalls were laid bare after the tide of tax revenue related to a decade-long property boom dried up around five years ago, leaving the government scrabbling to pay rising pensions and record jobless benefit bills.
The International Monetary Fund and the European Commission have urged Spain in recent months to step up reforms to its tax system, focusing on the need to widen the tax base.
"The tax take is not being done very efficiently. The balance between the rate of tax and the amount of tax is not very good," James Daniel, the head of the Fund mission to Spain, said in June.
A treasury ministry source said the government planned "a very generalized revision" of the whole tax system.
Think tank Fedea estimates that loopholes allowed corporations to sidestep 2.6 billion euros in potential tax payments in 2012, while income tax incentives were worth 10.3 billion.
"Tax rates in Spain are already relatively high (but)... revenue is low. This is due to a large number of tax breaks which must be eliminated," Ignacio Conde-Ruiz, economist at Fedea, said.
But that is easier said than done.
While company tax rates are higher than in most developed nations at 30 percent, intake is 1.9 percent of GDP compared to the EU average of 2.7 percent, bringing in just 10 percent of public revenue.
Corporate tax take has fallen 21.5 percent since boom turned to bust in 2008 and profits tumbled.
Spain's big companies have also upped the pace of their expansion abroad and medium-sized companies have followed, booking more of their taxable profits overseas.
A Reuters analysis of Spain's top 35 companies shows that the number of offshore units registered in countries with low tax regimes almost doubled to 517 in 2012 from 273 in 2009 - a process tax officials note is perfectly legal.
"There's a global trend for corporate tax to make up a lower proportion of revenue," said one Madrid-based tax expert at an international accountant. "Tax revenue from corporations in Spain is unlikely ever to hit its boom years peak again."
SALES TAX CLIMBDOWN?
The collection of income tax has been hit by an unemployment rate of more than 26 percent and tipped to remain high for years. It accounted for 7.4 percent of GDP in 2011, midway up the rankings for the European Union, according to Eurostat.
Here the government might choose to reduce the number of tax brackets, though Prime Minister Mariano Rajoy has already promised to reverse temporary income tax hikes by 2015 and even cut rates for lower-end earners.
A third option is to boost sales tax (VAT) which, as the second largest revenue generator after income tax, accounts for just under a third of state income and, in terms of GDP, is the lowest in the 27-country European Union.
Brussels complains Spain's system allows for too many items in its "super-reduced" tax category with a rate of 4 percent that includes basics such as eggs, bread, milk and schoolbooks.
Three years of sliding retail sales, along with a thriving underground economy estimated at around 200 billion euros or a fifth of the country's GDP, have also hit the VAT take.
Levying the general sales rate of 21 percent on more goods would be politically risky, especially after a 3-percentage-point rise last year - and a humiliating climbdown for Rajoy who had pledged not to touch VAT further.
The government has already started with some revenue-raising measures including temporary tax hikes and said in June it would scrap some corporate tax benefits.
High-profile tax avoidance crackdowns involving Barcelona footballer Lionel Messi - who paid 5 million euros to authorities in September - and Michelin-starred chef Sergi Arola have also generated headlines.
But the number of tax inspectors will shrink as spending cuts have led to a freeze on hiring, and those retiring are not being replaced, says tax inspectors union Gestha.