How Spain is planning to penalise the self-employed and become less attractive to digital nomads

The Status Quo

For some time now, there has been talk about a possible reform of the so-called autonomo system in Spain, i.e., the social security contributions that the self-employed have to pay each month. Up until now, autonomos pay a fixed quota between about €300 and €1250 per month. The actual amount is not coupled to your earnings but can be chosen freely from within the above range; essentially the higher the quota you chose, the higher your benefits (sick pay, unemployment benefit, pension). The obvious problem with this system is that these amounts are completely decoupled from a person’s income, e.g., a self-employed earning €4000 a month could elect to pay only €300 which would correspond to deductions of just 7.5%; in contrast, someone working only part-time or earning the minimum wage (currently about €1100) would loose 30-50% of their income even with the lowest quota of €300.

The large majority of self-employed are paying the minimum of €300 which does not provide them with sick leave or unemployment coverage, and their future pensions will be too low to live of without an additional source of income.

The New System

The current Spanish minister for social security proposed the following scheme:

Figure 1. New social security contributions for different income ranges (left-most column) as per the initial (propuesta anterior) and revised (nueva prupuesta) proposal by the Spanish Minister for Social Security, José Luis Escrivá.

Depending on your monthly income you would have increasing monthly social security payments. The initial proposal consisted of 13 income brackets and resulted in a maximum tax + social security burden of 55% for an annual income of only €49,000. This initial scheme was revised by eliminating the top two income brackets and raising the cost for the lowest income bracket (changes marked in red in Figure 1). E.g., if you earn €3200 per month, you are already in the top income bracket of the revised scheme and your monthly social security payment would be €991.44 (corresponding to a whopping 31%). To the best of my knowledge there is only one country where this percentage is higher: France. There, as a self-employed professional you must choose between paying about 22% of your turnover (!, i.e., without being able to deduct business expenses) to social security (micro-entrepreneur scheme) or you choose the other (and in no way less painful) alternative which is to pay an incredible 45% of your after-expenses income (régime réel) to social security. I guess this is probably as business-unfriendly as it gets. For comparison, in Germany there are no compulsory social security contributions at all for the self-employed who only require a private health insurance which costs between €200-300 per month. Returning to Spain: Here, unsurprisingly, the proposed changes have been met with considerable opposition from the self-employed community, especially since the government has so far failed to define what they will consider “monthly income” under this scheme, i.e., whether they will allow autonomos to deduct business expenses to calculate their income. The proposed schemes would result in the following deductions:

Figure 2. Monthly social security (SS) payments in Euros (left panels) and as a percentage of the actual income (panels on right) for a range of incomes.

In other words, autonomos with monthly earnings of <€500 would have to make social security payments that amount to >40% of their income. At the same time, someone earning €2330 “only” pays 25.6%, and if you earn just one Euro more, i.e., €2331, you will pay 31%. The lowest percentage will be paid by the highest income earners (e.g., if you earn €7500 you pay only about 13%). While the reform was brought in to increase fairness, I fail to see how these seemingly arbitrary rates would achieve that goal. It is also not clear why this scheme uses fixed income brackets instead of a fixed percentage which would prevent these jumps seen in Figure 2. Together with the income tax, autonomos may be looking at overall deductions of the order of 45%. In most Western European countries you would need to earn at least €80-100.000 per year to reach the maximum tax and deductions level; in Spain you reach this level already for the rather modest income of €38,300. In fact, if you do earn €80,000 as an autonomo in Spain, your overall deductions would only be 38%. Go figure!

Another problem I see with these high deductions is that people in Spain perceive their local authorities as inherently corrupt and incompetent, which not only explains the low tax morale in this country, but also implies that people here will be very reluctant to give 45% of their income to a government that they perceive as non-deserving and as mismanaging their money.

The Social Justice Argument

One of the arguments for this reform was that autonomos should have the same level of deductions as an employee (employer + employee contributions combined), thus creating a system that would be more just. While we have already seen above (Figure 2) that these arbitrary quotas are anything but just, also this last argument, albeit seemingly plausible at first, falls short of the fairness principle as it neglects some significant differences between the employed and self-employed: Employees typically only need to work 5 days per week for about 45-46 weeks per year to receive 52 weeks of salary. In contrast, autonomos need to work 52 weeks per year (including the occasional weekend) if they want to have a salary during all 52 weeks of the year. In addition, autonomos have the added burden of continuously having to procure clients, spend time on bookkeeping, collecting VAT, and submitting quarterly returns while having absurdly high fines (considered disproportionate even by the European Commission: slapped onto them by local tax authorities with a near-Francoist fervour for the very smallest of transgressions in a Kafkaesque tax system that even professional accountants struggle to comprehend.

At least in my mind, the effects of this new measure are quite obvious:

  • Those autonomos who can receive cash payments (e.g., local handymen and sole traders) will move even further into the submerged economy, either by not even registering as autonomo in the first place or by leaving substantial amounts of their income undeclared in order to avoid these high social security payments.
  • Autonomos with a 100% online business who cannot leave income undeclared because they receive 100% of their payments in electronic form will either leave the country altogether (with these new Spanish rates they would be better off financially in France or Germany where they would also have a much better social security coverage) or simply deregister here and establish entities (bank accounts, companies, etc.) in other jurisdictions.

We could also look at the social justice argument from a different angle. Say you have savings of about €500,000 which you invest in the stock market. You live off dividend payments and from occasionally selling off some shares (while keeping the principal of 500 k€ untouched – thus allowing you to maintain this lifestyle in perpetuity). To be able to make comparisons with the following paragraphs, say the yearly income from this (work-free) investor lifestyle is €35,000. In Spain, this would make you liable to pay €7,230 in capital gains tax and leave you with a net annual income of €27, 770, thus nearly €8,000 more than a self-employed in Spain who needs to put in >40h per week to generate €35,000 in pre-tax income (see below). At the same time, being a legal tax resident in Spain, the investor type would still be covered by the public health care system, without having to pay any contributions. So much for the social justice argument.

Compared to Other Countries

Based on the image below (Figure 3), Spain already had one of the highest social-security burdens in the OECD before the proposed reform, but with the new contributions, the average percentage for incomes up to €4,000 will increase to almost 31%, the highest value for self-employed in the OECD, especially considering that the values for the other countries correspond to the ratio between mandatory contributions divided by the mandatory contribution base, the latter is typically lower than the average income, which means that the actual percentages are likely lower than shown in the figure below.

Figure 3. Comparing pension and social security contribution rates in the OECD. For dependent workers, contribution rates refer to the effective rates for average-wage earners, i.e., total contributions paid (by employees and employers) divided by average earnings. For the self-employed, contribution rates refer to the rates paid on the mandatory contribution base by self-employed workers with taxable income equal to the average net wage before taxes, i.e., to mandatory contributions paid divided by mandatory contribution base (Source). The red marker corresponds to the average percentage post reform, i.e., the average of the actual contribution paid divided by the net income before taxes for incomes up to €4000 per month (based on the bottom right panel in Figure 2).

To give a concrete example: If you are a digital nomad in Spain and wish to have yearly earnings of at least €20,000 (after tax and social security payments – post reform), you will need to generate income of at least €35,000 per year (after expenses – corresponding to deductions of 43% for a relatively low income).

In comparison, if you want to have net earnings of €20,000 in Germany, you only need to generate a pre-tax income of €27,000 (€24,000 + 12×€250 for health insurance, see Table 1, corresponding to deductions of 25.9%) if you are single, or €24,000 if you are married. Considering that you need to pay for many things in Spain that are free in Germany (e.g., dentists, day-care centres, motorways), you will be thinking twice before choosing Spain as your base of operations.

Table 1. How much income you need to generate (pre-tax earnings) as a (single or married) self-employed in Germany to be left with a certain net income. The “tax owed” column does not include health insurance payments (about €200-300 per month).

The Bottom Line

In conclusion, the proposed reform will mean that anyone earning (or at least declaring) more than the minimum wage (€1125 per month) will have to pay more in social security contributions than before. A fairly modest yearly income of €38,300 will already place you in the top income bracket, leading to a 3.4-fold increase in your monthly social security payments, with overall deductions (SS+tax) that will amount to 45%. The average social security contributions for self-employed with incomes up to €4,000 will be about 31% post reform, the highest in the OECD. At the same time, you will be left with the same low level of social security coverage and political mismanagement of public funds as before the reform. This will have two effects: (1) Those who can receive cash payments (handymen and traders with a local walk-in client base) will move a larger portion of their businesses into the already sizeable submerged economy; and (2) those who receive their payments exclusively in electronic form (usually highly-skilled professionals with an international/online client base) will simply leave Spain (or not come here in the first place), contributing to the brain drain and further cementing the status of Spain as a “country of waiters and construction workers” and a no-go area for skilled professionals or anyone with any kind of professional ambition.

Why Spain despises its intellectuals

A common joke in France is that “Europe ends at the Pyrenees” (the mountain chain separating France and Spain). Unlike in Germany or France, where intellectuals can reach near-celebrity status, intellectuals in Spain are often considered suspect (at best) or may be outright despised. As Michel Houellebecq wrote in his novel The Possibility of an Island which is set in Madrid:

“Spaniards don’t like cultural programmes at all, nor culture in general, it’s an area that is fundamentally hostile to them, one occasionally has the impression when talking about culture to them that they are sort of personally insulted.” – from Michel Houellebecq’s The Possibility of an Island

This can also be seen in how Spanish people pronounce foreign and in particular English words. Even if they would happen to know how to pronounce the word correctly, they basically need to mispronounce it if they do not want to be ridiculed and considered a snob. Anglicisms are now fairly commonplace in many European languages but Spain is the only country where I have seen people actively strive to mispronounce them. In other words, in Spain you need to dumb down and hide your education in order to be accepted.

While other languages also have their fair share of derogatory terms for smart or educated people, nowhere are they used with as much passion and ease as in Spain (perhaps with the exception of the US). In Spain, terms like cultureta (loosely translated as “educated snob”) or listillo (a diminutive of “smart person” used with contempt) can be used at the mere display of education or talent (similar to egghead, brainiac, nerd, or poindexter in the US). In contrast, to be scalded for your education in the UK, Germany, or France, you really need to show off your education in some exaggerated and self-aggrandizing manner. It is not enough to simply be educated.

Why is this? I can offer some suggestions.

For one, Spain is a country where job recruitment is often based on personal connections rather than merit. As a result, many high profile jobs are filled by individuals that are less qualified than their subordinates. Obviously, they do not like to be reminded of their lack of ability/suitability for the job and consequently need to stifle any display of knowledge or education by scalding it.

A second factor is that Spain had the longest lasting military dictatorship of any European nation in the 20th century: 39 years. As in any military/populist regime, also Franco had declared intellectuals to be the enemy of the people and persecuted, killed, or exiled them. So with two generations of Spaniards having been told that intellectuals are the enemy, we cannot expect this attitude to change over night. In addition, Spain never really broke with Franco (to this date it is forbidden to investigate this period) and people have never really been told (officially) that Franco’s policies were wrong. This is perhaps the biggest mistake and an outright scandal for a supposedly modern democracy, which may explain why the current Catalan nationalists have no qualms about mounting their own little Catalan version of cultural discrimination and outright racism against Spanish speakers.

A third factor is that Spain has been a relatively poor country for a very long time. It remained largely agrarian under Franco and only when Spain joined the EU in the mid 1980s did things start to pick up economically for a broader middle-class. It is difficult for people, who are forced to take on all sorts of menial jobs just to stay afloat, to not distrust people who can make a living by simply using their minds. This is particularly the case in rural areas. In the 1980s, Spain chose the path of cheap mass tourism as its business model. Maybe this was without alternative since you cannot create a high-tech manufacturing industry out of nothing when Franco had been wiping out the educated class for nearly 40 years. But as a result, Spain became what is now often called “the country of waiters and construction workers”. Young people, not seeing the value of education, drop out of school to make some quick money in restaurant and construction jobs (and generally in jobs that require no or only little education). Once the economy cools down, these jobs are the first to go and people eventually end up as so-called ninis (ni estudia ni trabaja which translates as “neither studying nor working”), a term similar to NEET (Not in Education, Employment, or Training) that was coined in the late 1990s in the UK. And even to this day (see the policies of the Aznar and Rajoy presidencies), the R&E and cultural budgets are typically the first to be cut in Spain when the financial situation becomes tight. And thus, the exiling of intellectuals and artists continues even today as they are forced to leave the country if they want to keep working in their respective professions.

A fourth factor, not particular to Spain though, is the internet. Put bluntly, the internet allows stupid people to find other stupid people who then, as a fairly coherent group, loose any awareness of their own intellectual limitations. Before the internet, people were exposed to all sorts of opinions and levels of education in their daily interactions. This made the less educated people more aware of their own limitations and thus more coy and cautious about voicing their opinions. Now, due to the internet’s echo chambers, this coyness has all but disappeared and people with extreme or uneducated opinions feel increasingly justified and encouraged to (loudly) voice these opinions (the climate change debate in the US is a prime example). People who did not read any newspapers in the pre-digital age can now be reached (and manipulated) via Twitter, Facebook or some pseudo-journalistic blog irrespective of the validity or truthfulness of its content. As such, the internet is much better for targeting and catering to people’s individual predilections, something that was much more difficult to achieve with a medium like TV. Populist parties and their supporters use it to their great advantage as we can see in many election results today.

Clearly, none of the above points will change any time soon. Nevertheless, the horrors of the 20th century should provide sufficient motivation to the political classes in Spain and elsewhere not to neglect or underestimate the value of an educated and enlightened society.