Finance Minister Clyde Caruana recently described changing Malta’s corporate tax regime as a bitter pill to swallow.

Malta offers attractive corporate tax rates for businesses from abroad but local businesses are taxed at a much higher rate. This has led to a situation, as the minister himself describes, in which the majority of local businesses are not, in fact, paying profit taxes.

Making profits is a cornerstone of businesses and, while individual businesses may, during some years, break even or even sustain losses, on the whole, a thriving business community needs to have a surplus.

In economic theory, Arthur Laffer is often cited as behind the idea that once tax levels reach a high enough level, they will, in fact, crowd out enterprise activity to such levels that even the tax revenues might become lower with a higher tax, as economic activity shrinks.

In fact, already in the 14th century, Tunisian economist Ibn Khaldun presented the same theory. The situation in Malta for local businesses is very much in line with this theory. Were their tax levels to be reduced, many more would become profitable and, thus, the tax base would grow.

On the whole, Malta does have a low tax as share of GDP, with the exception of high local corporate taxes. The low-tax oriented economic policies are behind Malta being able to grow its economy at a time when, in much of Europe, economic growth is stagnating and people are going towards lower real purchasing power due to inflation.

On average in the European Union, the growth projection is currently merely 0.8 per cent growth of gross domestic product in 2023 and 1.6 per cent in 2024. Malta, however, is expected to grow at 3.1 and 3.7 per cent respectively. Ireland does even better with 4.9 and 4.1 per cent. The two countries combine an Anglo-Saxon legal tradition, which tends to be the system of many leading world economies, with a low tax burden overall.

For companies with over €750m revenue, Malta has no choice but to raise taxes- Nima Sanandaji

Both countries have also attracted many companies from abroad, typically businesses with high value crea­tion per employee, and have both progressed as knowledge-intensive economies through the combination of overall good business climate and lower taxation levels.

However, this important competitive advantage of Malta is undermined once companies that are attracted from other parts of Europe to Malta have their taxes raised considerably.

The finance minister is correct in describing it as a bitter pill to swallow for Malta when taxes on large multinational companies that employ around 20,000 people could be raised from five to 15 per cent soon. To compensate for this, a solid policy choice might be to lower taxes for local businesses and retain the tax system for medium-sized and smaller international companies.

As a small island nation, one must remember that Malta faces challenges with economics of scale. Once having no tax benefit to remain in Malta, multinational companies will have incentives to migrate to larger countries, with economies of scale reducing their costs.

For companies with over €750 million revenue, Malta has no choice but to raise taxes and this will impact the economy of the nation. Yet, the government can limit this raise to larger companies.

If Malta remains competitive for smaller and medium-sized international companies, this could compensate for the job and revenue losses that a tax raise for larger companies would result in.

Over time, Malta could attract new medium-sized and smaller companies, high up in the value chain, and this would allow the country to prosper and continue to develop as a knowledge economy.

The corporate tax regime can be less or more bitter, which is an important issue for long-term prosperity growth.

Dr Nima Sanandaji is director of the European Centre for Entrepreneurship and Policy Reform (which publishes the Brain Business Jobs index and Superentrepreneurs index). He has been a resident of Malta for seven years.