A low flat tax would be fair
24 February 2015
Posted by: Author: Jasson Urbach
Author: Jasson Urbach (the Free Market Foundation)
Hopefully Finance Minister Nhlanhla Nene will do the right thing and reduce wasteful expenditure, and thereby, taxes, says Jasson Urbach.
Tomorrow, Finance Minister Nhlanhla Nene presents his inaugural Budget speech to Parliament.
Many South Africans and foreign potential investors are no doubt wondering how he plans to balance the national accounts. Faced with falling revenues, mounting debt and a dismal economic outlook, to supposedly soften the looming fiscal catastrophe, the government may be tempted to raise taxes, particularly on the wealthiest citizens.
Most tax reform debates lead with the premise that any new tax system has to raise roughly as much or more revenue as the one it is to replace. That doesn’t necessarily have to be the case. Government spending has steadily increased from less than 10 percent of GDP in 1960 to over 32 percent – a massive 88 percent of government spending consumed by wages.
To have a better chance of raising the amount of funding, the government should be looking for ways to reduce the total tax required, and to do this, it is imperative that it gives urgent attention to reducing the expenditure side of its budget.
Contrary to the view that the state should play a greater role in the economy, time and time again history has demonstrated that economies that allow their entrepreneurial and hard-working citizens more freedom to use their skills to the best of their ability, and earn a worthwhile reward, tend to grow faster and prosper.
The best way to "stimulate” growth is to allow people to work, save and invest. Unfortunately, labour policies in this country discourage the hiring of low- and unskilled workers. High marginal tax rates and other pernicious taxes discourage savings and investment. When we combine all taxes, many people are paying upwards of 40 percent of their annual earnings. Typically, these are the individuals who would fund new investment in the economy, which in turn would create new jobs.
The late, great Nobel Prize-winning economist Milton Friedman proposed a flat tax system in the early 1960s to simplify collections and to encourage people to work, save and invest.
He acknowledged that individuals respond to incentives and take steps to further their interests and argued that highly progressive taxes induced taxpayers to find and exploit loopholes to reduce their tax payments by hiding or converting income into other forms, either legally or illegally.
A proportional or flat tax, as opposed to a progressive tax system, is one in which the ratio of tax to taxable income is the same at all levels of income.
It replaces the tax bands that feature in a progressive regime with a single rate. A "true” flat tax makes no provision for exemptions and provides no special dispensation for low-income earners.
However, for both compassionate and practical reasons there is no merit in taxing the poor. The compassionate reasons are obvious, while the practical reason is that below a certain level of income, the cost of collecting taxes from the poor exceeds the amount collected. Low-income earners should, therefore, be exempt from paying tax on personal income.
Consider for example if the exempted income is R60 000 per year and the tax rate 13 percent, a person earning R60 000 would not pay tax, whereas a person earning R100 000 would pay R5 200 (effectively 6.5 percent). A person earning R2 million a year would pay R252 200 (12.61 percent) in tax.
A low flat tax would be fair; broaden the tax base; improve incentives to invest; make tax evasion more difficult and less lucrative; increase economic growth; raise local investment by encouraging capital formation and create new jobs by increasing real wages and improving the incentive to work. It would also encourage taxpayers to be honest and would attract foreign investment.
Globalisation dictates that tax reform is not only desirable but essential, especially for developing economies. The globalisation process consists of increased movement of goods, capital, technology, ideas and people across borders.
Gone are the days when governments, firms and organised labour could cosily ignore the rest of the world, while providing citizens and consumers with below-average service at high cost.
To beat the competition for capital, both financial and human, countries have to have attractive, competitive tax systems. South Africa is no exception. Once tax rates are increased, it’s very difficult to reduce them, so hopefully Finance Minister Nene will do the right thing and reduce wasteful expenditure, and thereby, taxes, which will lighten the load already borne by cash-strapped South Africans.
This article first appeared on iol.co.za.