How about taxing dividends?

State support for the private sector

The time has come for the self-denying ants (taxpayers) not to be paying for the self-indulgent grasshoppers (big corporations)

Par Aditya Narayan

In an open letter addressed to the Prime Minister, which was published in two daily newspapers on 27 April, former Finance minister Rama Sithanen took the government to task over how it is administering the wage subsidy program for businesses that have ceased operations due to the epidemic. He drew government’s attention to the fact that private sector companies are asking for financial assistance after having paid out “massive dividends”. The issue raised is highly relevant and must be analysed in its proper perspective.

The ex-minister made the following comment:

“There are many companies that have, for many years, declared massive dividends without any consideration for reserves for a rainy day. They have behaved like the reckless grasshopper. In some cases, dividend distribution is higher (yes, higher) than profit because of asset re-evaluation. You should request the Ministry of Finance to look into this problem and I am sure you will be appalled with the findings. Is it fair to the country that those who have distributed 80% of profit as dividends (in some cases more than 100%), be given support without asking them to plough back some of these excessive dividends? Or inject some money, while we give only Rs 2 550 per fortnight to a small planter, a fisherman, a hawker or a hairdresser and nothing to an unemployed single parent with kids. Surely this cannot be solidarity and sacrifice. There must be burden sharing.”

Photo – specials-images.forbesimg.com

Profit distribution

Mr Sithanen is right in asking one question that we have all pondered for years: is it fair for private sector companies to be given support (via stimulus packages or wage subsidy) in bad times when, in good times, they distribute their after-tax profits to shareholders without building up any reserves for the future. He seems to suggest that government should not help out those companies as they have enough money. However, he stopped short of proposing how, going forward, the government should treat dividends from an economic policy perspective. He might have thought that it was not opportune, in these dire times, to raise fundamental issues about profit distribution, corporate retained earnings and dividends. Or maybe he thinks that excessive dividend distribution is fine as long as the companies do not get government financial support. Be that as it may, profit distribution is an issue that needs to be addressed within the broader purpose and contextual framework of economic policy.

There is no doubt that government bailouts are reasonable for people who lost their jobs through no fault of their own, but not for those who did not save for a rainy day. The time has come for the self-denying ants (taxpayers) not to be paying for the self-indulgent grasshoppers (big corporations).

However, the critical question is how does one plough back some of the excessive dividends paid out by corporations? Obviously, there is only one way: it is the taxation of dividends, which is sorely missing in our fiscal tool-box. It is high time to start taxing dividends as a source of income in the hands of shareholders in the same way that income from employment or office is taxed. The need for a level playing field between employees and shareholders in terms of tax treatment has never been more pressing if we are talking about solidarity and burden sharing among people.

In their drive to attract investors and stimulate growth, successive governments since 2005 have pursued a low-tax policy that has deprived the Treasury of substantial revenue. Mauritius has one of the lowest tax/GDP ratios in the world, i.e., 18% compared to an average of 40% for the Scandinavian countries (which, by the way, have a better standard of living) and an average of 34% for the OECD countries. With personal income tax and corporate tax being levied at a flat rate of 15% (with 3% corporate rate for export companies) and without a tax on capital gains or dividends, government’s fiscal space has narrowed down considerably. That is one of the major weaknesses of our economic policy.

Deficits and taxes

The government runs annual budget deficits that add to the public debt, which is almost at 70% of GDP. Public debt servicing reached an astounding amount of Rs 28 billion in 2018-19, that is 20% of government’s current expenditure. The budget deficit is bound to increase substantially this year (up to 10% of GDP) with all the wage subsidy programs and other assistance being provided to employers in order to help them keep employees on the payroll during the crisis.

The government cannot borrow anymore without jeopardizing severely the solvency of the country and the exchange rate of the rupee. Do we want to go back to the 1980s when the country had to devalue its currency and surrender to IMF conditionalities under its structural adjustment program? Or does the country want to emulate Greece, a basket case of financial mismanagement that did not clean up its own fiscal house?

It is essential that government expands its tax base to increase fiscal revenue instead of depending on the traditional sources such as VAT and flat income taxes. The country badly needs a new economic paradigm to turn around the disastrous economic situation. A critical part of that new paradigm is tax reform with a view to taxing all sources of income, including dividends and capital gains on moveable and immoveable capital property

The argument that dividends are an after-tax distribution of profits (since profits are taxed before dividends are paid out) and should not be taxed again in the hands of shareholders is a fallacy. Dividends are a source of income for shareholders that should be treated like any other source of income (for example, wages and salaries for employees, and business income for corporations and unincorporated entities) if we want to achieve fiscal fairness in society. Whatever amount of income tax paid by corporations is their liability to the country as corporate citizens in return for the freebies they get from the State (public infrastructure, skilled labour force trained by publicly funded institutions, police service, etc.).

Claw back excess profits

Shareholders are owners of corporations. They are rewarded for their investment in capital by way of dividends just like employees are rewarded through wages and salaries. Both groups should be treated equally and fairly from a fiscal perspective. Taxing dividends at the present income tax rate of 15% is therefore a matter of economic equity (although there is more equity to be achieved with progressive taxation). The low-tax regime in Mauritius has caused an ouflow of capital to the extent that local residents have invested Rs 144 billion in other jurisdictions, as revealed by the MRA. Whether they paid any tax on that income before export is another matter.

It is a paradox that the country has so much wealth abroad when it is running short of money locally to fund business support schemes. If companies are paying out 80% or even 100% of profits as dividends, as claimed by Sithanen, then it’s time for the government to start clawing back part of the profits distributed with a tax on dividends.

Most capitalist countries that have a free-market economy levy taxes on personal income, corporate income, capital gains and dividends. Why is Mauritius the odd man out? Are those countries less smart or worse off than Mauritius? Unsurprisingly, it will be argued that now is not the time to tax dividends as we need private sector capital in order to come out of the doldrums. When times are good, we don’t think about tax reform. When times are bad, we are told we should not think about it. So when is the right time to talk about fiscal reform?

To paraphrase Abhijit V. Banerjee, Nobel Prize in Economics 2019, should we allow the three Is (Ideology, Ignorance and Inertia) to keep kicking the can down the road?

* Published in print edition on 1 May 2020