In a recent article, Dr Azad Jeetun argues that the budget 2006-2007 has not rationalised our tax system but rather oversimplified it with the result that “too much simplification breeds inequity of its own”. However, he welcomes the advent, in 2009-2010, of a uniform income tax rate of 15% which he qualifies as “the only silver lining in the clouds”. Now uniformisation means radical simplification and is far better, both in theory and in practice, than a timid transitional package of piecemeal changes.

Dr Jeetun starts his argument with a weird premise that “income tax is a mechanism for encouraging savings and investment, for greater work effort and productivity, for channelling resources in economically and socially desirable sectors”. Oh really? Income tax simply cannot do all that.

Income tax is just a penalty on individual effort. No more no less. It is also a mechanism which removes money out of the taxpayers’ pockets when, alternatively, this money could have been put into savings or investment.

<B>An oversimplified statement</B>

Worse, income tax is a means for state intervention made at the expense of economic efficiency. If the Mauritian private sector has remained averse to diversifying into other activities, it is precisely because the heavy hand of the State has misallocated resources in unproductive sectors. Money doled out by government encourages rent-seeking which destroys wealth.

History testifies that the most efficient allocator of resources is the market which knows best where to create wealth. The gains that the economy derives from the impersonnal market process override the economic costs caused by the government’s interfering pervasively in the allocation of resources.

Dr Jeetun asserts further that “the system will breed much hardship in the middle class that will have a bearing on investment in education”. This is quite an oversimplified statement, not to say that the director of the Mauritius Employers’ Federation is defending rather the interests of the high class. Since he agrees that a decline in the personal income tax rate to 15% “makes the need for differential treatment unnecessary”, he is mainly concerned with the situation of those who will be taxed at the marginal rate of 22.5%, that is taxpayers who will earn a total income of more than Rs 715,000 (category A), Rs 825,000 (category B), Rs 885,000 (category C) or Rs 925,000 (category D) in the course of the year 2006-2007. Can we reasonably classify those income earners as middle class people? Surely not.

Under the former tax system, a person could deduct Rs 85,000 from income tax for his dependent spouse. The new system will allow him to claim, instead, a higher additional income exemption of Rs 110,000 as he falls in category B. In case he has a child receiving tertiary education in Mauritius (a second dependent – category C), his total additional exemption will be Rs 170,000, higher than what he would have claimed as deduction under the former system (a maximum of Rs 165,000). If he has another child receiving free secondary education (a third dependent – category D), his total additional exemption will be Rs 210,000, still more than under the former system (a maximum of Rs 195,000).

Normally, both spouses must work to be able to send two children to a tertiary educational institution in Mauritius. In this scenario, only one spouse can claim an additional income exemption of Rs 170,000 whereas, under the former system, the combined deduction for the two spouses would have been up to Rs 160,000. Of course, in case the two children attend a university outside Mauritius, the new tax system allows for less deduction than the former one. But let us be honest: only rich families can afford to give their children overseas education. They can therefore pay more tax...

At this stage, the four income exemption thresholds appear, indeed, to be on the low side, the more so as taxable income is not restricted to salary but includes interest among others. When one reads paragraph 173 of the budget speech, where it is said that “a family with one dependent can earn up to Rs 25,000 a month, including end of year bonus, and not pay any income tax”, one could be under the false impression that the Rs 25,000 are related to salary only (Rs 325,000 in a year, an amount which tallies with the income exemption threshold of category B). It is also worth noting that the National Residential Property Tax (NRPT) will apply to exempt income (such as dividend) together with taxable income: the sum may quite easily exceed the exemption threshold of Rs 215,000.

The proof of the pudding is in the eating. Next year, we will really know whether 40,000 persons currently paying income tax will have been swept out of the tax net and whether only 33,000 families will pay the NRPT. If this is not achieved, the government will have to make some adjustments in the next budget as tax issues are always politically sensitive. It should either reintroduce an interest exemption threshold or raise the income exemption thresholds.

<B>Increased exempt levels in future budgets</B>

For Mauritius to survive in today’s competitive world, we must foster individual initiatives and help our talents move out of the salaried class to become entrepreneurs. The rationale behind the current fiscal reform is that it flattens taxes on personal and corporate income to promote the emergence of a new entrepreneurial class. Experience is proving that it works: Estonia has seen its economy flourish after introducing a single uniform income tax rate of 26% in 1994.

Under a flat tax regime, the rich cannot exploit complexities to avoid taxes. Taxing pay packets and profits at the same rate discourages tax arbitrage. The costs of compliance, administration and enforcement are reduced. And the system sharpens the incentive to work harder.

It is commonly held that flat tax rules out the principle of progressivity and thus favours the rich. This is a specious argument by virtue of the proportionality principle: the more income you earn, the more tax you pay in absolute terms. In fact, since it combines a threshold with a single rate of tax on all income above it, a flat tax on personal incomes is progressive in that these two variables (threshold and rate) can be varied.

It is understandable that, in order to clean up public finance, the incumbent government has started with rather low income exemption thresholds in its first budget. But the Ministry of Finance will come under mounting popular pressure to top up the exempt amounts in subsequent budgets. We can possibly imagine a flat income tax that is not levied on savings (such as interest and dividends), in which case it would act as a consumption tax like Value Added Tax.

A system that taxes less on income but more on assets should pass successfully the test of efficiency and equity. To quote a study on tax rates in the world, carried out by the Canadian think tank CD Howe Institute, “personal and corporate taxes with high marginal rates are much more harmful to growth than levies on consumption and immobile assets such as land”.

The American Revolution occurred in the wake of a simplifying tax reform. Every government, in every country, dreads a conservative backlash against tax changes. Here, in Mauritius, while some bank on a tax revolt fuelled more by emotion than by the pursuit of reason, we must hope that the flat tax policy will trigger a new dynamism that will transform our economic and social landscape from backwater to bellwether.

<B>Eric NG PING CHEUN</B>