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Logic dictates that if we want to reduce our taxes and trim our deficit then something has to give
The pre-budget document holds a new revelation that shows how the perception that workers are over taxed is a fallacy. It is heart-warming to read that over a third of Maltese workers do not pay any income tax. But is this a reflection of the benevolence of the tax code or is it a clever way how workers have managed to dodge the upper tax band of 35%. It is not easy to decipher given that there are so many vested interests and politicians have over the years tried to shore up votes by appearing to be overtly generous. Official statistics show, however that not withstanding the number of luxury apartments, yachts, designer clothes and other open manifestations of riches, about 37 per cent of workers claim they earn under Lm3,100, the threshold for single persons, or Lm4,300 in the case of married couples. What is most surprising is that as the average salary for civil servants is close to Lm6,000 there are less than a fifth of taxpayers paying over Lm400 per annum. Surely even though most of the workers are taxed directly under the PAYE scheme since the early seventies there must be tonnes of income which they must be earning through moonlighting schemes that are escaping the tax net.
This is mostly prevailing in the categories of handy man services, small household repairs and naturally in the part-time employment category within the construction and tourist industries.
So is there an equitable solution that will end up with those earning more to contribute proportionately to their bonanza without stifling the present slow growth strangling the domestic economy?
Economists have long speculated that government tax policy can positively affect economic growth. According to these economists a comprehensive corporate tax reform should both stimulate growth and raise corporate productivity. The result also implies that abundant inflows of foreign direct investment should turn the tables towards a better standard of living and surpass the 3.1% GDP growth registered during the first quarter of 2006.
Estonia is considered a success story with its recent reform of personal and corporate taxes. Many of the smaller accession countries want to emulate it. The most significant change is expected to take place following the reduction of the income tax rate. According to the amendment, the flat rate of individual income tax will be reduced from 26% to 24% starting from 1 January 2005, to 22% from 1 January 2006 and to 20% from 1 January 2007. In retrospect we note that Tonio Fenech, the parliamentary secretary within the ministry of finance proposed the introduction of new tax credits for SMEs.
In his opinion, these could actually encourage domestic firms to be resilient and active while the new measures for the self-employed will encourage further growth.
The Chamber of Small and Medium Enterprise - GRTU has called for a radical revision of the taxation system in the 2007 budget. They demand reforms in order to help boost consumption and investment for their members. The retailers’ association unveiled its budget proposals contending that several small enterprises had the potential to grow and create new initiatives but were holding back because of high taxation levels. The disincentive to grow is many times linked to draconian tax regimes and government induced costs which render small and medium sized companies unprofitable. Being what it is, the situation has prompted some to look for greener pastures abroad where returns are brighter. The GRTU did the sums and suggested a number of tax reforms that incentivise the middle income workers who are usually those hitting the higher income brackets.
A salary of Lm14,000 was chosen as this epitomises the combined amount of the two spouses plus any hitherto undeclared income and a number of schemes offered to slash down the disincentive to work. Regrettably, the structure was lambasted by the parliamentary secretary within the Ministry of Finance Tonio Fenech as too ambitious and not affordable. He replied that it would result in a tax leakage of Lm44 million.
Prudence will dictate that with a Damocles sword hanging over our heads to meet ERM2 targets this cut in revenue will be suicidal. Perhaps it may be opportune to make temporary adjustments to catch a higher yield from certain categories while conceding a lower rate for smaller firms.
But this may not be enough to make up for the shortfall from reduced personal tax in the shorter term. Government collects on average Lm82 million from employment income and an additional Lm500,000 from the self-employed. According to the parliamentary secretary it all boils down to thinking about a proper mathematical model to discover how much of the black economy is not being taxed at the present 35% rate and how much will be captured under any proposed lower ones. Realistically we all know that to make ends meet and further improve their standard of living, workers carry out a second and even third job. Reliable sources contend that as only one third of the work force is taxable then it follows that only a small part of the moonlighting revenue is declared even though government issued a concession about a flat tax of 15% on overtime (limited to Lm3,000 per annum).
The argument therefore calls for a proper econometric study as revealed in the pre-budget document. It did not arrive a moment too soon. This study may also wish to compare the heroic tax cuts when the personal tax rate, then referred to as a surcharge was reduced from 65 % to 32.5% by the Du Puis reform in the late eighties. As a result of the Du Puis cut the tax catch did in fact blossom. Of course, there was no VAT or Eco tax then and the state of the economy was booming at six per cent GDP growth and the debt problem was negligible.
Logic dictates that if we want to reduce our taxes and trim our deficit then something has to give. We cannot have the cake and eat it for ever. The tempting answer will be to trim our social services. But there is no political consensus for this option. A more pragmatic approach will be to control recurrent government expenditure such as overlapping of duties in ministries competing for scare resources and commanding more productivity from departments that should lead to tangible savings in capital projects. Bureaucracy in Malta is expensive. Government payroll totals Lm203 million. Trimming the hedges can only reveal more undergrowth that needs deeper uprooting. It goes without saying that tough decisions were not taken during the previous legislation when government was careful not to alienate the electorate in the run-up to the EU referendum.
But cost-cutting can be reaped and taxes lowered if we use the opportunity to discuss the pre-budget document and persuade government to simplify the tax code and discourage the wider participation of people in the black economy which is rampant. For example, in Luxembourg tax collectors work with no fewer than 17 different tax brackets, to ensure rich citizens pay a greater proportion of their income than their slightly less rich workers.
All this adds up to unmitigated bureaucracy and breeds more loopholes for experts to discover on how to evade taxes. The modern trend is for simplification and a flatter concertina of rates. Naturally, fewer brackets are simpler to administer but some of the accession countries have gone the extra mile and replaced all by one bracket . Under a pure flat tax, the taxman takes the same cut from the last lira you earn after deducting a reasonable tax credit. Unions may cry out in protest that this measure will benefit the fat cats.
They will protest that first we have given three amnesties for high rollers with millions of undeclared funds and now we are clamouring for a one size fits all tax system. Obviously, the appeal to high earners is palpable. Regrettably the operational superiority of such a simplified flat tax system is not immediately apparent given that any savings in administrative costs may not meet with alternative use of surplus human resources.
No system is perfect and politicians have an implacable habit of reaching compromises with unions according to mystifying political agendas not necessary reflective of the state of the economy.
One thing is clear, the brainy taxman is the type who manages to pluck the maximum amount of feathers from the goose with the least amount of hissing.
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