Progressive taxation under concerted attack

Facts and ideology

Progressive taxation is not a socialist scheme, still less a Machiavellian or Manichean move to penalize high income earners. It is a well-balanced system that exists in most capitalist countries of the OECD

By Aditya Narayan

The 2020-21 budget proposed to inject some measure of progressivity in the personal income tax system with a 25% Solidarity Levy on the highest income earners, which would have set a top marginal tax rate of 40%. However, facing a backlash from the richest segments of society, the government backtracked to limit the proposed levy to 10% of the total net income of the taxpayer. Effectively, the top marginal tax rate will now be 25% (15% plus 10%) instead of 40%. Still, some critics are claiming that Mauritius has become a high-tax jurisdiction. Really?

Tax heaven for tac dodgers – Photo – ei.marketwatch

Following the Budget Speech of the Minister of Finance where he announced an increase in the Solidarity Levy from 5% to 25%, the original proposal faced a concerted attack from the private sector with its official spokesmen taking turns in the media (radio, web tv and newspapers) to describe it as an “unjust tax grab”. Employer organizations, accounting firms, some opinion leaders and neoliberal economists (all of them on the right of the political spectrum)bcalled in unison for a reversal of the proposal. They predicted doom and gloom for the local economy, which they said would suffer from a brain drain, a loss of foreign investment and a lack of tax competitiveness vis-à-vis other jurisdictions.

Scare tactics

The pressure was so intense on the minister that finally he agreed to compromise and tone down the measure originally proposed. While buckling to scare tactics from the well-heeled people is not good for any government, it shows how public policy can sometimes be hijacked by vested interests. We knew about State capture by powerful lobbies; now we have fiscal policy capture by the high net-worth individuals (HNWIs).

Actually, what the government proposed was not really a fully progressive income tax system. Before the budget, personal income tax was based on a basic rate of 10%, a first marginal tax rate of 15% and a second marginal tax rate of 20% (15% plus the Solidarity Levy of 5%) on income in excess of Rs 3,5 million per year, including dividends. The budget proposed to increase the Solidarity Levy from 5% to 25%, which means that the second marginal tax rate would have been 40% (15% + 25%).

Ideally, as some unions and progressive economists suggested, a fairly progressive income tax would have a basic rate of 10% and marginal tax rates of 15%, 20%, 25%, 30% and 35% on higher income brackets. The government was expected to adopt this system but, in its wisdom, decided to impose a higher solidarity levy on the HNWIs (citizens of Mauritius only) instead of widening the tax base across the board. The proposal was expected to raise additional revenue of Rs 3,5 billion per year.

The proponents of a low flat tax (15% ) have been successful in their campaign to scare the HNWIs to the extent that they disingenuously confused the people about the basic tax rate and the marginal tax rates. They focused on the proposed top marginal tax rate of 40% as if all HNWIs were going to pay 40% tax on their total income. That’s far from the truth. The proposed 40% marginal tax rate was going to apply only to the excess of income over Rs 3 million per year, including dividends. A basic calculation shows that a taxpayer making Rs 4 million per year would have paid on average 20% of tax on total income before deductions and 17,4% of tax on net income after deductions (see table 1).

Confusing marginal and average rates

However, the opponents of progressive taxation conveniently did not talk about the average tax rate (the total amount of tax paid as a proportion of total income). They kept harping on the top marginal tax rate of 40%, which confused and scared the layman. The amount of intellectual dishonesty injected in the debate was shocking, specially coming from people who claim to be economists.

A crisis creates an opportunity for reform. The present crisis was an opportunity to engage in a meaningful tax reform in order to put the country back on the path of fiscal sustainability without going to the extreme. Progressive taxation is not a socialist scheme, still less a Machiavellian or Manichean move to penalize high income earners and deprive them of their hard-earned money. It is a well-balanced system that exists in most capitalist countries of the OECD and is supported by all mainstream economists, including progressive economists who have won the Nobel Prize in Economics,such as Paul Krugman, Joseph Stiglitz, Amartya Sen, Abhijit Banerjee and Esther Duflo.

Undoubtedly, the low flat tax regime, wherever it exists, has widened income inequality as high income earners pay the same proportional tax rate as lower income earners. It does not make sense for a millionnaire to pay the same tax rate of 15% as a low or middle-income individual.

In absolute terms, 15% of tax on Rs 1 million (Rs 150,000) is higher than 15% of tax on Rs 500,000 (Rs 75,000), but that is not progressive taxation, which is predicated on the idea of taxing high income earners at higher marginal rates with a view to curbing excessive income and wealth accumulation in the hands of 1% of the population.

The 3000 HNWIs who will pay the top marginal tax rate of 25% represents only 0,2 % of the population. The 25% top marginal tax rate compares favourably to the top marginal tax rate in other countries such as India (30%), Canada (46%), USA (43%), France (55%), Danemark (56%) and the UK (45%).

Government has made another concession: foreign residents will now be subject to the same Solidarity Levy on their taxable income, thereby ending a suspected discrimination against Mauritian citizens. With a top marginal tax rate of 25%, a taxpayer with annual income of Rs 3,4 million (including dividends) will pay an effective tax rate of 15.15% (average rate) before deductions and 13.6% on net income after deductions, as illustrated in table 2.

Ideological backlash

The backlash against progressive taxation is purely ideological. Neoliberal economists complain about “tax and spend” policy in their crusade against what they call Big Government, which they claim steals the rich to spend on the poor, regulates the so-called wealth creators and penalizes personal productivity. However, through low taxation, they try to “starve the beast” (as it is said among conservatives) by depriving the State of sufficient fiscal revenue.

When the government struggles with a structural deficit (due to low tax revenue), they advocate deep expenditure cuts, including cuts to the Welfare State for the poorest. They gladly quote Arthur Laffer, the American supply-side economist who theorized that a high marginal tax rate causes tax revenue to peak and then decline in an inverse U-shape curve, in their defense. However, trickle-down economics does not ensure that a rising tide will raise all boats at the same time.

The fierce debate over the merits of flat taxation versus progressive taxation is overcharged with emotion and preconceived ideas and it overlooks economic evidence. As early as 2004, the IMF and the World Bank have sounded the alarm over the country’s narrow tax base. In 2004, a WB report stated that direct taxes (on income and profits) had not accounted for more than 3% of GDP over the past five years. Personal income tax in propotion to GDP has varied from 1.46% in 2006 to 2.10% ten years later. Total taxes (direct plus indirect) as a percentage of GDP was18.7% in 2006. The tax/GDP ratio has not exceeded 19% since then. No country can survive with a low tax/GDP ratio without incurring debt to finance public expenditure.

The same people who say that the country is too indebted don’t want to contribute their fair share to national revenue. The same politicians who lambasted the government for not paying the promised PRB compensation increase for civil servants want to deprive the State of the means to raise revenue. Where will the money come from? At least public sector unions came out in favour of progressive taxation. The same ex-MLAs who draw a non-contributory parliamentarian pension are against a tax-and-spend policy. How hypocritical?

* Published in print edition on 19 June 2020

Add a Comment

Your email address will not be published.