The Government has decided to set up a High-Level Committee under the aegis of the Ministry of Finance to undertake a fundamental review of our tax system with a view to enhancing its fairness, efficiency and international competitiveness. This initiative is commendable, as our tax system has evolved over the years mainly through piecemeal changes, which have affected the overall tax structure and created distortions in the economy.

The case for change

It is an ambitious task and one that is long overdue, as our tax system has not been reviewed for years. We may recall that the last major income tax reform took place in 2008, with the consolidation of deductions and the introduction of a uniform rate of 15%. The 2023/24 attempt was more in the nature of a pseudore-form than a real one. In the field of indirect taxes, no reforms have taken place for decades. The sales tax was introduced in 1983 and was converted into VAT in 1998. As VAT became more prominent and raised substantial revenue, the rates of import duties declined. Nevertheless, some taxes remained unduly high.

The Committee will no doubt analyse the strengths and weaknesses of our tax system, assess the effectiveness of different taxes and examine the raison d’être of high rates on certain products. It is well known that the higher the tax rates, the greater the distortionary effects will be, for both direct and indirect taxes. Although not specified, I believe that the review will cover both forms of taxation. The predominance of indirect taxes in total revenue, accounting for more than two-thirds of revenue, may imply that the tax system as a whole is regressive and that a shift towards direct taxes is desirable to improve the progressivity of the system.

Moreover, the review should not be restricted to taxes but should extend to all forms of revenue. Non-tax revenue is projected to reach 4.2% of recurrent revenue in 2026/27, a contribution high enough to merit consideration. Sometimes, governments resort to raising nontax revenue, which does not elicit an immediate negative reaction from consumers and is not inflationary. It would not be out of place to look at municipal or local taxes, or property taxes, at a time when real estate activity is flourishing. The abolition of municipal taxes has had an impact on government finances, and the Government cannot permanently subsidise such expenses.

The benefits of such an exercise are manifold. It will help define our tax policy for the medium and long term, ensure an appropriate tax system compatible with our needs and level of development, optimise our financial resources and improve tax administration. The top priority should be to formulate a well-defined tax policy for the attainment of key economic objectives, such as encouraging investment and savings, generating employment, contributing to economic transformation, improving competitiveness, expanding exports and achieving economic growth.

The key factors

Normally, the first consideration in a review is whether the tax system can generate more revenue. But this is not a major weakness of our current tax system. First, it has an in-built elasticity which does not necessitate frequent changes and raises the much-needed revenue for the Government to meet its growing expenditure. Second, the tax burden is not low in Mauritius, with a recurrent revenue-to-GDP ratio of 27%. As such, we can discount the risk of more drastic changes that would raise the burden further. Nevertheless, there is room for rationalisation and improvement.

The main motivation for reform lies elsewhere: to eliminate the distortions that have crept in over the years and to improve the distributional effects of taxes. This is summed up in the stated objectives of fairness, efficiency and international competitiveness, which are important desiderata for the review. In fact, the first two have their origin in the four canons of taxation elaborated by Adam Smith two hundred and fifty years ago. Equity, certainty, convenience and economy.

A tax system is said to be fair when people contribute in proportion to their respective abilities, commonly known as the “ability to pay” principle. It underlines the philosophy of both horizontal and vertical equity. Horizontal equity, which is the cornerstone of any tax system, means that individuals in similar financial situations pay the same amount of tax. Vertical equity means that those who earn more should pay proportionately a larger share of their income in tax, which is the basis for progressive taxation.

Economy, or efficiency, means that the cost of collecting tax should be minimal so that revenue for the Government increases. If the cost of collection is very high, it defeats the purpose of generating more revenue. Cost of collection is an administrative measure. More importantly, economic efficiency is a broader concept in which resources are allocated efficiently and distortions are either minimal or eliminated.

International competitiveness is particularly relevant today, given our pattern of development and openness; the operation of some of our pillars, such as financial services and global business, depends crucially on the availability of international expertise, which is highly mobile in a globalised world. Our success depends on our ability to compete with well-established jurisdictions and to carve out a niche of our own. Our individual income tax rates and corporation taxes should therefore be competitive in order to attract both human and investment capital. Such talent obviously moves to lower-tax jurisdictions for better returns. It is perhaps for this reason that the Government has shied away from raising the marginal income tax rate.

A review of the tax system must necessarily look at the concentration of income and wealth. The top 20% of households derive 43% of income. The average effective tax rate of the top 5% of taxpayers was only 15%, which is indisputably low. But the key question is whether the tax system will play its due role in curbing income inequality and what the optimal rate should be to reconcile the two conflicting objectives in line with the Laffer curve. There is undoubtedly a trade-off between high marginal tax rates or corporation tax rates and the attraction of human and other capital.

The review should look into the administration of taxes. There has been substantial investment over the years in modernising and digitalising the revenue system in the country, with the MRA playing a key role. While the MRA provides information on taxes, the determination of revenue needs and their projections rests with the Ministry of Finance, whose technical capacity has to be enhanced for more accurate forecasts. In view of the availability of data, the MRA has been given other responsibilities that have nothing to do with tax administration, at the expense of its own effectiveness, and this needs to be reviewed.

The other side of the coin merits as much attention as taxes, namely expenditure. First, if the thirst for expenditure remains unabated, it will give rise to more tax modifications, put a strain on the tax structure and defeat the purpose of any reform. Second, the Budget is replete with measures to curtail expenditure, with commitment at the highest level. It even refers to the oversight of 34 parastatal and affiliated bodies that fall under the Ministry of Arts and Culture. The operation of many parastatals, which are a burden on the State, should also merit consideration. Third, we may be spending billions, yet the public still complains about the effectiveness of many public services. Improving the quality of education, health and other public services will ensure value for money. This is another area that should be explored to close the loop.