A flat tax in which the ratio of tax to taxable income is the same at all levels of income — and which replaces various tax bands that feature in a progressive tax regime with a single tax — would allow the South African government to gather more tax at lower rates, Free Market Foundation (FMF) economist Jasson Urbach has argued.
Writing in the FMF newsletter on Thursday, Urbach said such a tax allows governments to gather maximum tax rates that avoid negative behaviour by providing taxpayers with what they judge to be an acceptable reward for their extra effort and risk-taking.
Higher tax rates reduce the incentives of entrepreneurs to risk their capital and sacrifice their time and energy to earn higher incomes, he argued.
They interfere with the ability of individuals to pursue their goals and result in low after-tax incomes for workers and therefore smaller disposable incomes.
“Less disposable income means less saving, less saving means less capital formation, less capital formation means lower labour productivity, and lower labour productivity means lower real wages.”
Urbach said for both compassionate and practical reasons there is no merit “whatsoever” in taxing the poor.
“The compassionate reasons are obvious, while the practical reason is that below a certain level of income the costs of collecting taxes from the poor will exceed the amount collected. Low-income earners should therefore be exempt from paying tax on personal income.”
South Africa, at 40%, has one of the highest marginal tax rates of all middle-income countries.
“By comparison, other middle-income countries have relatively low top marginal rates. Consider the following examples: Botswana (25%), Brazil (28%), Malaysia (28%), Mauritius (25%), Namibia (35%) and Uruguay (0%).
“A decade ago there were 10 different tax brackets in South Africa, which has since been rationalised to six, so we could argue that we have been moving towards a flat-rate system. Indeed, the major impetus behind the rationalisation is that it is easier to administer fewer brackets. One bracket would obviously be the simplest of all.”
Higher tax compliance and the expansion of economic activity contribute to a broadening of the tax base, noted Urbach.
“This explains one of the most paradoxical features of flat tax: the fact that it rapidly brings in more revenue at a lower rate because the lower rate is charged on more income. At a low tax rate, higher-income taxpayers may pay not only more tax, but also a higher proportion of the total. When the United Kingdom cut its tax rates in the 1980s, the top 10% of earners, who had contributed 32% of income tax before the cuts, contributed 45% afterwards.”
Recognising the apparent paradox, a number of countries have recently introduced a flat tax in order to stimulate economic growth, the economist noted. They include Estonia, Iceland, Lithuania, Latvia, Russia, Serbia, Ukraine, Slovakia, Georgia, Romania and Macedonia.
“Average economic growth for these countries in 2004/05 was 6,9% compared to South Africa’s average growth rate of 4,7%. These countries also enjoyed higher rates of gross capital formation as a percentage of GDP with an average of 24% in 2004/05 compared to South Africa’s average of 17,5%.”
Urbach noted that the African National Congress government has already demonstrated that a reduction in the level and variation of tax rates “achieves better returns”.
“They have achieved this by collecting higher taxes through some rationalisation and by cutting the rates established by the previous regime. This helped to change a shrinking economy into a growing economy. Higher tax collections and higher economic growth rates could be achieved by doing more of the same,” he said. — I-Net Bridge