THE TAX SIDE TALK
THE government recently announced that they are now accepting tax proposals for the 2019 tax year. One would suppose that there will be a number of organisation that will take this opportunity to submit their tax proposal to enrich the budget preparation process.
Although I imagine there will still be others that stand by the sidewalk until the budget is proposed, in time to offer their criticism. That is not the point of this article however. The point is to dwell briefly on the challenges faced by those tasked with formulating tax policy and posing a relevant question on the relationship of the tax rates to tax revenue growth.
Just last year in late September 2017, the former Minister of Finance Mr. Felix Mutati unveiled the 2018 national budget which outlined a total spend of around K71.6 billion or about 25% of the Gross Domestic Product (GDP). The key sticking point about this budget is how much of it was to be financed by domestic sources. Of the budget announced the former Minister of Finance had noted that K49 billion or 68.5% of the budget was to be sourced from domestic revenues with K2.4 billion coming by way of grants from various co-operating partners, while the balance of K20.1 billion was to be financed from domestic and external borrowing.
In short, the budget gap represented by grants and non-fee/tax revenue income was anticipated to be around 31.5%, a 3rd of the total budget for 2018 or in economic language when compared to the GDP at about 7% deficit. That is a huge gap and it makes budgeting and choosing alternatives a nightmare. And the only hope when one is faced with this massive gap is that the policy alternatives selected will spur productivity which in turn will lower deficits in future.
With this gap, there is obviously no question about the need to improve the country’s tax collection performance so that domestic resource mobilization can increase to support the various social and developmental programmes the government is engaged in. Yet the challenges in tax administration remain significant and made more difficult by the issue of tax evasion.
In my article of April 2017, the Turnover tax challenge, there was a quote from Kimaru, T. and Jagongo, A (2014) who wrote the “Adoption of Turnover Tax in Kenya: A Snapshot of Small and Medium Enterprises in Gikomba Market, Nairobi Kenya. International Journal of Social Sciences and Entrepreneurship, 3 (1), 18-30” which detailed these conclusions that are also applicable to other tax types:
•“Most traders who trade busi- nesses in busy markets and other markets do not understand the tax administration system and are usually busy therefore are unable to understand the system. Thus, they remain non-compliant.
•Most traders feel discouraged with the complexity of the system and that the staff are usually not friendly to them or their businesses. It was also noted that most of the small businesses found the tax computation tedious.
•Other businesses believed that tax administration did not provide an even playing field for all businesses by ensuring all owners of the businesses meet their tax filing and paying requirement. It was noted that the educational and assistance role was lacking with only the enforcement role being seen to be visible.”
The research noted above concluded that most of the traders in Kenya experienced difficulties in dealing with government in general and the tax administration staff and consequently were less compliant thus fuelling tax evasion.
At the basic level that conclusions has to do with the need for improvements in tax administration and making tax compliance less complex, however this is not an issue of cut and paste.
There are other causes of tax
evasion that are more serious than those noted above and it has been an interesting journey in the past years to see some of the tools that the government has tried to introduce to address this aspect. One has in mind the engagement of VAT Agents, the introduction of T-Pins for all bank holders etc. as some of the innovative actions introduced to bring remedies in some aspects of tax collection. It will be worthy to see how the tools assist in that aspect in future, however, there is another interesting aspect of tax theory, which is often overlooked when putting up the measures to reduce the budget deficits.
This is an issue in tax theory about how the country’s tax rates impact economic growth. In the United States, political parties have been divided for centuries around that cause alone and up to now and particularly in Republican leaning States, this issue alone can win or lose someone an election. The theory has been that the lower the tax rates, the higher the productivity, and thus in most cases claims are made that tax cuts lead to increased economic growth and prosperity and thus increased tax revenue. Whereas on the other side is a group that tend to advocate for a progressive tax that impact the rich more. The reason behind the latter group’s conclusions is that reducing taxes tends to deny the poor in our society of the social incentives that they would otherwise be able to access and that most of the benefits that come with the tax reduction tend to favour those that already are well off.
The tax theory supporting the above scenario is that productivity tends to deteriorate as the tax rate increases given its disincentive for people to work harder. In other words as the tax rate increases the likelihood that tax evasions increase among the tax payers is positively correlated.
In Zambia, we have seen the advocacy for increased tax rates particularly in the mining sector, however if the past result is anything to go by, there are specific conclusion to draw with respect to the royalty increase in the mining sector. In October 2014, the Minister of Finance at the time announced the revision in the mining tax structure which included an 8% Mineral Royalty for underground mining operations as a final tax; 20% Mineral Royalty for open cast mining operations as a final tax. Yet instead on an increase in tax revenue as would have been expected, there was instead a huge outcry from the mining sector, a huge disincentive to invest in the sector and generally much reduced taxes from this important sector. Others still argue that the reason for the slump in this sector at the time were much more than this simplified version, but maybe that is a story for another day.
Importantly in Zambia, there are different tax regimes for a number of different economic sectors and the suggestion that the lower the tax rate the more productive a sector would be, could be proven easily by research into how we have fared. We know those tax rates applying in the agricultural sector are different from those in the Mining sector and further different from those applying in the retail sector. Having noted the above, the recent upswing in agricultural activities is all too visible if one decides to travel around the Country. Could this be that the tax rates applying in this sector are among the lowest? It may help if a research is conducted to help citizens understand how the different tax rates applied in past budget cycles have impacted on economic growth in the specific sector and on tax collection.
The point for this article is as we begin to submit tax proposals in advance of budget preparation for 2019, it is necessary to acknowledge that government tax revenue will not necessarily increase as the tax rate increases. It is likely that government could earn more tax revenue at lower denominators of tax rates than it would when the tax rates are higher due to the disincentives that result from higher tax rates.
In conclusion, the theory of the relationship between tax rates and growth was popularised by the Laffer curve which is a theory that states that lower tax rates boost economic growth. That is that at 0%, no tax revenue is collected, however as the tax revenue move past the binomial point C on the curve, the tax revenue declines for any further increases in tax rates given the disincentives created for people to work more and to invest. Thus at a 100% tax rate, there is no incentive for anyone to work. Therefore, as we propose the different tax mechanism, it must be borne in mind that increases in tax rates alone may not be an effective mechanism to increase taxes. We need to be more innovative. About the Author Kelvin Chungu is an Assurance and Advisory professional and is contactable on +260-976377484.