Türkiye raises taxes to help pay for post-earthquake rebuilding

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Turkey raised taxes as part of efforts to fund the massive reconstruction bill that resulted from February’s devastating earthquake, after spending more in the run-up to the last election.

The tax increase comes after President Recep Tayyip Erdogan promised to rebuild the 650,000 homes destroyed by the disaster. Analysts expect the cost of reconstructing residential and commercial buildings and key infrastructure in the vast part of southern Turkey hit by the twin earthquakes to rise to $100 billion.

Mehmet Simsek, who was appointed finance minister last month, has vowed to restore fiscal “discipline” after massive handouts, including free gas and big pay increases for civil servants, in the run-up to the May vote. Erdoğan won the elections to extend his rule over the country for a third decade, despite the severe inflation crisis that eroded his popularity.

Economists expect the Turkish government’s budget deficit to jump to 4.5 percent of gross domestic product this year, from just 0.9 percent in 2022, according to a survey by FactSet before Friday’s tax announcement, highlighting the overall fiscal risks.

“In light of the election-related deterioration, the earthquake in the budget balance and deeper structural issues, a major fiscal adjustment was necessary,” said Hakan Kara, former chief economist at the Central Bank of Turkey.

The tax increases are part of a broader economic shake-up led by Simsek and central bank governor Hafiz Gay Erkan, who were appointed in June to battle the economic crisis caused by Erdogan’s unorthodox policies. Ercan’s central bank has already nearly doubled interest rates, while the country has rolled back costly efforts to prop up the lira.

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

Turkey also more than tripled the registration cost of cellphones bought abroad to 20,000 Turkish liras ($770) to discourage consumers from avoiding taxes on consumer electronics. The site used to register cellphones became overburdened on Friday as residents scrambled to avoid the hike, which goes into effect on Saturday.

Liam Beach, of Capital Economics in London, said the VAT increase was “the right thing” because it would help cool consumption, which many analysts say remains overheated after years of ultra-loose monetary and fiscal policies.

Turkey’s biggest flaw was consumption power. “The spending has been very strong,” Beach said. “Any fiscal measures to rein in this spending are good measures.”

A value-added tax increase would generate government revenues of about 0.8 percent of gross domestic product, or about $7 billion annually, according to Beach, though he also said this would not be enough to adequately slow growth and narrow the budget deficit.

Kara said he was concerned that because fiscal tightening was focused on tax increases, making goods and services more expensive, it could “exacerbate inflation expectations in the short term.” Inflation is down from last year’s highs above 85 per cent, but still ran close to 40 per cent in June.

Beach added that there is a risk that revenue from the tax increase “will be spent on salaries and pensions” rather than being bailed out by the government.

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