Fri | Aug 18, 2017

Tax policy bigger than petty politics

Published:Tuesday | April 5, 2016 | 4:00 AM
Peter-John Gordon

The Gleaner's editorial of Sunday, March 6, 2016 titled 'Bankable numbers, please' examines the proposed adjustments to the income tax regime in Jamaica. Most of the editorial, like almost all the discussion around this proposal, focuses on the implications of such a reform to the Government's fiscal situation: Can the giveback be afforded?

Would the proposal derail the country's International Monetary Fund-backed economic reforms of the past four years? The discussion has taken place exclusively in an 'accounting' sense: "Do the sums add up?"

As important as this 'accounting debate' is, I contend that the more important implications are to be found in economics, not accounting. What would the proposed reform do to incentives and, hence, productivity and economic outcomes? If a helicopter flew over the Ministry of Finance and dropped the amount of money to finance the proposal, while keeping the Government's fiscal accounts in order, there would still be consequences to the proposal that are likely to have greater impact than that which could be created by a destabilisation of the Government's accounts.

The proposal is to remove all income tax for persons earning $1.5 million or less; for people earning between $1.5 million and $5 million to remain on the current system; and for people earning over $5 million to have removed the income tax threshold, i.e., for these people to pay taxes on 100 per cent of their income.

 

TAX LIABILITY

 

Someone who earns $5 million would pay $1,101,800 in taxes (tax threshold of $592,800 and a tax rate of 25 per cent). If his income increased by $1, his tax liability would increase to $1,250,000, an increase of $148,200.3. At $5 million, the marginal tax rate would become 148,200 per cent, i.e., an additional $1 earned attracts additional tax of $148,200.

Looking now at the $1.5-million threshold, someone who earns $1.5 million would pay no income tax. If his income increased by $1 to $1,500,001, his tax liability becomes $226,800.3, a marginal tax rate of 226,800 per cent.

The likely outcome is that people who earn between $1.5 million and $1.803 million would all prefer to earn $1.5 million. A person would have to have an income of $1.803 million before his take-home pay becomes equivalent to a take-home pay of $1.5 million with no tax. All persons earning between $1.5 million and $1.803 million will find a way to bunch their income just below $1.5 million; this could be done by taking a smaller pay cheque or by hiding income. Presumably, one works harder to get more money, so here people could choose to work less to get more money and more leisure time.

All the persons who earn between $5 million and $5.197 million would not want their income to go above $5 million. So we can again expect a bunching of these persons at an income level of $5 million or just below. The additional income will either not be taken or shifted to the underground economy.

 

RAISE INCOME

 

An alternative response to the perverse effects of the tax proposal is to have employers raise incomes to levels that leave the employees no worse off. This, of course, would decrease the demand for labour in this income bracket and the number of persons employed.

Countries which have a progressive income tax regime, i.e., where people who earn higher incomes pay a higher marginal tax rate, ensure that the marginal tax rates never exceeds 100 per cent - the closer these rates get to 100 per cent, the more perverse their effects on other economic variables.

The proposals call for marginal tax rates of 226,800 per cent and 148,200 per cent. A marginal tax rate of 100 per cent would mean that every additional dollar worked would go to the Government in income tax. Imagine a worker trying to decide whether to work on a weekend or not. If the marginal tax rate is 100 per cent, this implies that the entire income he earns from this overtime would go to the Government. We don't have to wonder what decision he will make.

The situation is even worse if, by going to work on the weekend, he has to pay more taxes on the income which he earned during the week i.e. he would end up taking home less money for the week by working more.

Tax policy is a complex economic issue, not primarily an accounting one. It is extremely difficult to deal with such technical matters on the political hustings. One commentator asked for serious issues to be discussed during the campaign and listed among the matters of importance a fixed versus flexible exchange rate. Like tax policy, these aren't issues that belong on a political campaign. The laws of economics are not rewritten by electoral outcomes.

• Peter-John Gordon is a lecturer in the Department of Economics, UWI, Mona. Email feedback to columns@gleanerjm.com and pjmgordon@hotmail.com.