Tax reform inducing growth?
Danny Roberts, Contributor
BRITAIN'S CHANCELLOR of the Exchequer, George Osborne, announced some new tax measures "to reward work and support growth" in his presentation of the government's budget for 2012. In doing so, he summarised Adam Smith's four principles in the administration of the tax system as simple, predictable, fair and support jobs. He, however, went on to announce a 20 per cent sales tax on Cornish pasty - a cheap pastry bought primarily by workers and students - which is reported to have opened a 'never-ending class war' in the United Kingdom, with certain sections of the media attacking the tax as an assault on 'working class life.'
Adam Smith would certainly have been very pleased with this response because he had once declared that the taxes paid by each one of us as citizen should be seen as "a badge, not of slavery, but of liberty". Smith, regarded as the father of capitalism, argued that a 'fair tax' is tax paid proportionate to one's ability, and to 'support work' the tax system must as far as possible allow for as much disposable income in the hands of the people.
The four principles on taxation set out by Adam Smith in 1776 - which had a profound effect on the American founding fathers— now have universal acceptability. Every tax system, whether in developed or developing countries, is designed to be fair, equitable, efficient, simple and competitive. These are indeed laudable objectives on which there can be no disagreement, but to achieve them we must subject the proposals set out in any tax reform measure to the crucible of these principles since it is invariably in the details that the devil resides.
Unfair, inefficient tax system
Jamaica's tax system is generally seen as unfair and inefficient primarily because of a narrow tax base which places a disproportionate burden on the backs of the PAYE taxpayers. Many persons, primarily in the self-employed category, are not paying taxes proportionate to their ability, and the tax system mercilessly deprives all categories and classes of workers from having adequate disposable income to satisfy consumption appetite sufficient to stimulate investment which would create jobs and generate sustainable growth.
It is that stimulation which the Jamaican economy now needs; an increase in aggregate demand that can boost economic growth and generate jobs. In the present state of global economic depression, economists recommend that countries adopt counter-cyclical measures to reverse the cycle of decline in jobs, investment, growth and economic well-being. It is a position which the International Monetary Fund (IMF) accepts in principle but argues that Jamaica lacks the fiscal space to even contemplate what is undoubtedly the correct measure out of this crisis.
The way in which we can, therefore, begin to reverse the stagnation and halt the decline on the economic front is through a reform of the tax system. The tax system can be used to create the conditions for equity, growth and competitiveness in furtherance of the principles enunciated by Adam Smith, especially in the areas of horizontal equity in our tax administration and the support for jobs in the economy.
Surely, as is presently the case in Jamaica, it is patently unfair that among the personal income tax group, which constitutes about 50 per cent of PAYE taxpayers, their contribution to the tax revenue for the fiscal year 2011-2012 amounted to $55.8 billion, while the remaining portion of self-employed accounts for a mere $4.8 billion. The Tax Policy Review Committee Report of 2004 (the 'Matalon Report') estimated that personal income tax revenue could be 50 per cent higher if the self-employed were fully compliant, that is, another $28 billion in additional revenue could be earned if only the Government could summon the political will to deal with the tax dodgers. That would certainly begin the process of creating horizontal equity in our tax system and adequately allow for appropriate adjustments to the income-tax threshold and/or the rate of taxation.
The two critical tax principles of Adam Smith would therefore be satisfied, not through any complex meandering of the tax system, but simply an exercise of political will to broaden the tax base to achieve fairness and lower the tax rate to provide more disposable income to the working class. When we examine the numbers provided, a lowering of the GCT rate could readily be contemplated, which would eliminate the need to remove goods from the current exempt GCT category as suggested by the PSOJ Working Group. On that I would say the Private Sector Working Group's (PSWG) proposal for the lowering of the rate from 17.5 per cent to 12 per cent seems contingent on an argument that the wealthiest 20 per cent benefit more from the GCT exemption than does the poor. This is not a material point from two perspectives. First, the benefit to the wealthiest 20 per cent is not at the expense of the poorest group and so no correlation exists in relation to the equity question. Second, the alternative proposal to bring all goods under the GCT regime and then compensate the loss to the poorest group by way of cash transfers is not the kind of paternalistic option we would want to even contemplate at this time. It certainly does not support work and not as simple and predictable as the current GCT exemption.
Withal, the income-tax threshold must not be abolished as recommended by the PSWG. Both the Matalon Report and the Green Paper make recommendation for an increase in the income-tax threshold. The revenue loss from moving the income-tax threshold from its present figure $441,168 to $624,000 is estimated at $5.69 billion, and the lowering of the standard GCT rate from the 17.5 per cent to 12.5 per cent is estimated at $16.2 billion. By broadening the tax base, the Government can increase the income-tax threshold and reduce GCT, without removing goods from the exempt category, and come away with a revenue surplus of nearly $7 billion.
When it comes to corporate income tax, to keep it simple, there need not be any splitting of the taxes into two categories. The dividend withholding tax portion of 10 per cent can easily be manipulated to avoid the full effect of a company's tax obligation. A more desirable proposal as set out in the Green Paper would be to reduce the corporate tax rate from 331/3 per cent to 30 per cent or even lower. The potential revenue loss at 30 per cent would be approximately $3.3 billion. The approximation, I believe, is predicated on the 5 or 10 per cent compliant rate among registered companies. Once again, if we were to apply the principle of fairness by increasing the rate of compliance among companies, we would more than compensate for the $3.3 billion loss in revenue. We must, as well, bear in mind the approximate $5 billion which can be saved through the abolition of the discretionary waiver regime, a position fully supported by the Inter-American Development Bank.
There is one critical, overarching point which must be placed on the table if we are to align tax principles with our overall macroeconomic objectives. The question of achieving growth and competitiveness will not be attained by tax reform alone, but by a comprehensive reform of our labour market. The reform of our tax system must not appear to be an act of expediency because our next drawdown is contingent on a fulfilment of this obligation under the existing IMF agreement. We have to set the parameters right to benefit from a growth-inducement strategy which will only come after the IMF has gone. This is where our labour market must promote human-capital investments to remove the structural factors which impede quality jobs, as well as incentivise labour to stimulate sustainable growth and development. Adam Smith himself recognised that taxation policies could not eliminate inefficiency in the economic system and that in all cases tax reform will not bring about a general equity and fairness in the system. There is no mistaking the fact that in the final analysis the taxes on the owners of capital will somehow find their way back in the costs of goods and services to the consumers.
As our parliamentarians debate the proposals from the various interest groups on the Green Paper, they must remain cognisant of three interrelated objectives. The first is a responsibility to advance the cause of the common good, the utilitarian principle which maximises the benefit for the vast majority of people. Second, their authority to bring about equity through fair and appropriate measures; and third, their obligation in recognising that the right to impose taxes upon us must be commensurate with their responsibility to deliver on such services as proper infrastructure, good roads, potable water supply, adequate security, etc. Even the father of capitalism recognised that in a free market system the government must remain the custodian of that invisible hand.
Danny Roberts is head of the Hugh Lawson Shearer Trade Union Education Institute at UWI, Mona.