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| Columns |
| Economic and Business Forum |
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by
D D Phiri, 09 June 2006
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06:52:03
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On taxes
In any parliamentary system the budget session is one of the most important sitting. Debates on the budget are seldom lively and the budget is often understood by only a few MPs and members of the public. All the same, hopes are raised and dashed by the end of this budget session.
It has become a mantra at the end of a budget session to criticise the Minister of Finance for allegedly favouring the rich over the poor. Seldom do the critics give analytical views why they think the budget is not pro-poor.
Some people talk as if the budget session is a harvest season when the national dividend is to be shared. Actually, the budget session is the beginning of the farming or manufacturing season. It is the time of giving out the seeds, raw materials and tools.
The fact that a budget has favoured rich people does not mean automatically that it is against the poor. It depends on what the rich do with the privileges they have been granted. Suppose taxes on their wealth have been reduced and the rich invest their windfall in new business or expanding the existing ones, will that be to the disadvantage of the poor? Not if the investment creates jobs for the poor.
For a government to render services to the citizens it must first raise revenue. The main source of government revenue is taxation. Hence when scrutinising a budget we must find out what taxes have been introduced, retained or abolished, and what the effects of these will be. Apart from taxes, a government raises revenue by charging for some of the services it renders such as school fees, wards in the hospital, drivers’ and road licences.
While some taxes are imposed solely for revenue purposes, others are designed to achieve other objectives. A tax on imports—customs duties—may be raised to the level that it deters the entry of imports that might cripple local industry. A tax on cigarettes and alcoholic drinks may be raised higher than is necessary for revenue collection just to discourage the consumption of these goods. Such a tax is colloquially referred to as a “sin” tax. Taxes on deceased estates are partly intended to redistribute the wealth of the nation from those who have too much to those who have too little.
Most people see the need for paying a tax, but they would rather it is the other guy who pays it and they just enjoy the services to which it is put. To be widely acceptable, a tax must fulfil certain criteria. It must be equitable, simple and efficient.
An equitable tax is a fair tax. The problem arises when people try to define fairness. Some people feel that a tax is equitable when everyone pays the same amount. But others feel that the only fair tax is that from which they are exempted.
A tax must fulfil the need for simplicity. It must be so written that both the tax collector and the tax payer understand what is required. Drafters of laws do not often simplify texts for the benefit of the layman.
A third criterion of an effective tax is efficiency. A tax should be relatively easy to administer. The costs incurred in collecting the tax should be less than the amount realised. Income tax fulfils this criterion easily especially when it is collected on the basis of pay-as-you earn.
Taxation is based on two main canons or principles: the benefit and ability to pay.
The benefit principle states that those who benefit from government services should be the ones to pay for them, and that those who benefit more should pay more. Everyone—poor or rich—benefits from security and defence services provided by the police and the army respectively. Though the rich and poor make use of roads, it is those who have motor cars that benefit most from good roads. This justifies surtax on petrol and diesel.
The benefit principles has the limitation that in practice from most government services the main beneficiaries are the poor. It is the poor who usually make use of free hospital services while the rich often go to private hospitals. The peasant farmers who no longer pay poll taxes are the ones who benefit from fertiliser subsidies.
The ability to pay principle states that the people should be taxed according to their ability to pay regardless of the benefit they will get from the uses to which the tax will be put. According to this principle, poor people should pay no taxes, people with moderate incomes should pay moderate taxes while very rich people should not only pay more but at higher rates than people with moderate incomes.
Taxes in execution show three characteristics: proportional, progressive and regressive.
Proportional taxation imposes the same rate on everyone regardless of income. Both a person who earns K10,000 and the one who earns K20,000 may be required to pay 10 percent in which case one pays K1,000 and the other K2,000.
As regards a progressive tax, the richer person pays at a higher rate than the one with lower income. In the example given above, while the one who earns K10,000 pays 10 percent the one who earns K20,000 would be paying 15 percent. The justification is that to a person with higher income 10 percent is less of a burden compared to a 10 percent on the lower income. For the person with higher income to feel the burden, he or she must pay at a higher rate.
A regressive tax is the one which imposes a higher percentage of taxation on those who receive less income. This happens mostly on expenditure tax. Certain goods on which a tax is imposed are bought by both the rich and the poor. It is in this way that the poor pays a greater proportion of his income in tax.
When a tax is introduced into the budget some people like to find out its impact on business, labour and social relationships.
A tax on business known as a corporation tax, if too high, may deter investment. Potential investors from abroad carefully scrutinise tax regimes of different countries competing for investors. Other things being equal, investors will prefer to build their factories in those countries where they will be required to pay lower taxes or even enjoy tax holidays of up to five years.
Taxes paid by those who earn salaries are called income taxes. If the rate imposed on an income is too high it acts as a disincentive to effort. That is, it discourages salaried people from working harder. They say: “Why should I work harder if the more I earn, the more the government takes away from me the extra pay.”
Taxes may be classified as direct or indirect. A tax is said to be direct when the burden remains with whoever pays it. An income tax is a direct tax. Once you have paid it there is no way you can take off the burden from your back.
On the other hand, a tax on goods you import—customs duty—can be shifted to someone else. The importers of the goods may be a merchant. In fixing selling prices, they will add the customs duty element. The incidence or burden then falls on the retailer’s customer.
The lowest paid people do not pay direct taxes in Malawi since the abolition of the poll tax but they pay indirect taxes on imported goods and on those like tobacco and beer on which surtax or excise duties are collected. Truly has been said that there is no free lunch.
In short, taxes have an impact on the growth of the economy, productivity propensity to save or consume and social habits. Taxes may reduce or aggravate income inequalities. Taxation is a tool of economic and social policy. |
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