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The merits of uprooting regressive taxes has recently hit the headlines. Dr Gonzi, the prime minister wishes to paint our taxes green. The idea is to jettison direct taxes and replace them with a new code based on environmental impact. A task force will be entrusted with studying this reform next year
Tax is always an emotive issue, and could prove one of the battleground issues at the next budget. The textbook approach tells us that oppressive taxation wouldn't be possible without an over burdened welfare state; it's useless opposing the former while "understanding" the latter. It goes without saying that Malta's complicated tax system needs a complete overhaul, not minor fixes. The large role the system plays in many of the political dramas has been dominating the daily headlines.
The pre-budget consultative document presented by Dr Gonzi proposes inter alia the formation of a task force to turn our taxes a lighter shade of green.
The FOI and GRTU both lament that it is unwarranted taxation by governments, rather than competition from foreign suppliers that is stifling economic and business development.
Typically the recent VAT amendment raises the ire of cash strapped businessmen. By sheer contrast, the ex-Communist countries that joined the EU have lost no time to reduce taxes and are registering higher GDP growth rates than ours. Tax competition is healthy as it tends to keep tax burdens lower, which creates pressure for less wasteful and therefore more efficient use of public funds. This may be another reason (albeit not the only one) why Malta seems to be caught in a time warp as it misses its share of FDI. In a world which generally espouses free cross-border trade and investment, multinationals are, in major part, free to structure and operate their businesses as they see fit, generally in a manner that makes most sense from a tax point of view.
Our 35 percent corporate tax rate is one of the highest worldwide - higher even than the rate in so called high tax countries such as France and Sweden. Should we be surprised that some jobs leave Malta when the tax code punishes investors for creating jobs here?
Take the issue of job security at STMicroelectronics which is benefiting from a favourable tax. Here salaries were dropped to counter competition in the emerging North African region.
Another issue is corporate "inversions," which take place when a company defends the interests of its shareholders by moving its manufacturing base to a jurisdiction with better tax laws and lower labour costs. Party apologists prefer to blame the Eastern European block for attracting business by affording better tax laws than us. But wouldn't it be a better idea if our politicians fixed the problems in the tax code?
The answer seems to be blowing in the wind. The pre-budget document suggests a changeover from direct taxation to environmental related taxes. Politicians have also been squabbling about the fact that our corporate tax is the fairest. They recite that upon distribution of taxed profits the resulting effect on shareholders is nil. But again, this happens only in theory since due to acute cash flow problems, companies rarely afford to distribute 100% of taxed profits. Again politicians are fond to circulate the story that companies rarely pay the full 35% tax rate.
This may be due to various untapped loopholes. Naturally it is difficult to make sense of this because we don't know whether these companies paid no tax because of loopholes or whether they paid no tax because they were losing money. But we do know one thing: the entire debate would disappear if we had a flat tax.
For a start we can implement this regime on SME' s and self employed. Under a flat tax, SME's would get no special deductions. The advantage of the reform is its simplicity and lack of loopholes.
It also minimises bureaucracy and paperwork which is enemy number one for small enterprises. They would simply add up all their revenues, subtract the wages they pay, as well as other costs, and pay a flat rate on their net income. Perhaps this looks too simplified and critics denigrate the system as it may also profit the laggards.
The problem isn't just with business taxation. There are plenty of disputes about personal income taxes as well. Ever since the enactment of income tax legislation in 1948 this was hailed by Socialist governments as a progressive tax. Each budget speech used to tinkle on the tax free bands supposedly to favour the lower paid workers. The result over the past 58 years has been a loophole ridden system that discourages initiative to earn more.
The erstwhile Mr John Dalli had attempted to trim the hedges by introducing a flat rate for overtime earnings and for bank interest, which can be deducted at source.
Union officials love to argue about whether the ‘rich’ pay their fair share. Much of this debate is nonsensical, especially since supporters of big government frequently assert that any household making more than the 35 per cent tax band is rich. This mentality urgently needs revision since the disincentive to work for working couples is draconian.
In any event, there is little doubt that our tax code is grossly unfair when comparing the lower flat rate paid in accession countries. In Malta due to successive hikes, total tax revenue has reached 33 per cent of GDP. A lot has been said by opposition spokemen about the money-no-problem attitude.
Invariably the USD5 billion debt accumulated over recent years has created a short lived feel good factor. It partly cushioned lack of job creation and was the price to pay for inefficient State enterprises and the burgeoning cost of the civil service.
Ironically our 'tax and spend ' mentality is now under the microscope. This naturally follows the constraints imposed on us by of joining the ERM 2 regime. Surrealistically commentators join in the chorus protesting that tax reform is imperative and overdue.
They warn us that complacency will lead us to be an envy-ridden nation that punishes people for being successful. This is why the flat tax makes so much sense. Every household would get a deduction based on family size, but then every income above that level would be subject to tax. Such a system would ensure that the rich paid their "fair share," but it would avoid the punitive tax rates that have caused so much economic misery in places such as Germany.
Simplicity means more transparency and higher fiscal morality. If you earn twice as much as your neighbour, you pay twice as much tax. Of course the system has to have inbuilt measures against tax evasion. The flat tax could even have specific measures to make sure that rich people couldn't evade taxes on dividends, interest and gains on capital. Taxes on these kinds of income would be withheld at source and paid by businesses and financial institutions.
Does it sound too good to be true? Well, it's already working in many other countries. Hong Kong has had a flat tax for a long time and has boasted the world's fastest growing economy for the past 50 years. Accession countries like Estonia, Lithuania and Latvia implemented flat taxes in the 1990s after getting their independence from the Soviet Union. They've been growing so fast that Russia decided to implement a 13 per cent flat tax in 2001. Now that the Russian economy is booming thanks to higher oil revenues it better affords a flat tax system. Locally after the neglect of ten years due to the over riding EU accession issue there is a pervasive case for deregulation. Countries that limit the growth of government, limit the reach of regulations, and keep taxes low enjoy a competitive advantage in terms of attracting foreign direct investment. Obviously, socialist inclined nations that subject citizens and businesses to the burdensome costs of big government do not like this global economic reality. They'd rather not compete when it comes to issues like relative tax burdens.
Maybe it's time for Malta to board the flat tax bandwagon at least where SME's are involved. It's frustrating to see other EU countries adopt the flat tax which in Malta has been resisted by tax lobbyists ostensibly as it may increase tax leakages.
This may well be true in the short term and it is no guarantee that a lower and simpler tax system will work magic. It takes years for the economic reforms to work through the system. Much depends on the superlative marketing efforts of Malta Enterprise, the Dar Malta team in Brussels and the commercial acumen of diplomats at Embassies.
To quote an example; in the second quarter of 2003, President Bush signed legislation that lowered tax rates on the capital that entrepreneurs invest in the economy - and those rate cuts took effect this year creating a bonanza of new jobs.
Quoting Karmenu Vella, a GWU section secretary, he lambasted politicians and fellow trade unionists. He said “we have chosen the luxury of indulging in internal conflicts… we cannot keep smelling a rat in everything and everyone but we now need to work together to get ourselves out of this limbo.”
Vella continued by attacking “the easy way out to increase taxes which is stifling the economy.”
Perhaps now is the time to act boldly when the political will is conducive to deregulate. Can we revisit our tax code to make it fairer with a lighter touch of green? In a world made dramatically smaller due to technological advancements, Malta cannot afford to let its cost of government creep too high.
A green touch may work wonders.
Feedback - gmm@pkfmalta.com
The author is a partner in PKFMalta an audit and business advisory firm
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