Each decade had its share of contribution in the development of the income tax system. The nineties were not different. The reform process continued with changes in the personal deduction, tax rates and the emoluments relief being the prominent ones. The trend was clearly towards declining income tax burden. The average tax rate hit a low of 6.5% in 1985/86 and then was on the rise. In the mid-nineties it was declining again hovering around 7%. But the most significant development was the introduction of pay as you earn (PAYE), which has become administratively the principal means of income tax collection.

The introduction of paye

In the beginning of 1993, the then Minister of Finance, Rama Sithanen, proposed the introduction of PAYE. It was not the first time that the question of PAYE was evoked. In 1979, a similar announcement was made in the Speech from the Throne and the Budget Speech. This project was shelved because many trade unions, taxpayers and other associations were opposed to it. Moreover, it was premature as much groundwork had to be done prior to its introduction without which it would have been difficult to administer the system. That was a time when the income tax system or even all revenue systems were not fully computerised.

In 1993, there was much progress in computerisation to the extent that the Income Tax Department felt confident that it could cope with the new system. The PAYE came into effect as from in the 1993/94.

PAYE has several advantages and embodies certain principles that a good income tax system should have. By collecting taxes at source, it ensures fuller compliance as the declaration of income is not left entirely to the discretion of the income recipient. It thus reduces the possibility of tax evasion. In addition, by linking tax payments to current income rather than lagged income, the responsiveness of tax to income changes is enhanced. Moreover, deduction of tax at source renders a service to the taxpayer who knows exactly his purchasing power and which therefore prevents him from overspending.

It was essential for this measure to be accepted by taxpayers. To ensure a smooth transition, two important steps were taken. First, there were apprehensions that the introduction of PAYE would imply payment of taxes for two years concurrently since taxpayers would have to pay taxes for the preceding year and for the current year as well. A doubling of tax liabilities in a single year would have made the income tax burden unbearable.

With the introduction of PAYE, tax payable by an individual taxpayer on his emoluments during the financial year 1992/93 was waived much to the relief of taxpayers. This was a clear advantage to taxpayers as, at retirement, they would not be burdened with the tax liabilities of the previous year when their income would be reduced substantially since their pensions are far lower than their final salaries. We may add that when Britain introduced the PAYE, the tax for the previous year was also cancelled.

Second, to ensure a smooth transition and for the general acceptability of the new system, the personal deduction of Rs 18,000 was more than doubled to Rs 40,000, an unexpected substantial increase favourably welcomed by taxpayers. Although this measure was an enticement, its attractiveness was somehow mitigated since the personal allowance stayed put for the subsequent three years. Additionally, this measure eliminated low-income earners from the tax rolls thereby releasing resources which enabled the income tax department to cope with the higher administrative work the new system entailed.

The PAYE ensured that the administrative burden on the taxpayer is reduced to a minimum but it imposed an additional burden on employers. The rise in the personal deduction helped to reduce the administrative costs to the employer for collecting and remitting tax to the Income Tax Department. Moreover, the system does not rely only on the taxpayer for the provision of accurate information; it depends on information already available to the Income Tax Department which is crosschecked and verified upon submission of income tax returns. In the UK, taxpayers are not required to submit annual returns. One criticism which was levelled against the operation of PAYE was that taxes were overpaid which entailed refund of taxes. There were numerous complaints regarding undue delay in refunds mainly due to the large number of overpayments. In the 2006/07 Budget Speech, the Minister of Finance, Rama Sithanen, took cognizance of this problem whereby there were some 80,000 refund cases each year and introduced the cumulative PAYE system.

In spite of the higher personal exemption, PAYE led to greater compliance and higher revenue. The tax base was broadened. We estimate that the number of tax returns increased by 25% by 1996/97 compared to 1992/93. Part of this increase was due to the fact that a wife electing to be assessed separately was counted as one taxpayer as from 1993 whereas earlier a married couple was counted as one taxpayer. The system was revenue productive since income tax receipts increased by 26.5% between 1993/94 and 1994/95. It is worth adding that there was a spectacular increase in revenue and in the number of taxpayers when PAYE was introduced in England.

Higher deductions

The income tax system did not change much after the introduction of PAYE except for periodic increases in deductions and decreases in tax rates.

First, there were generous increases in the personal deduction which attained Rs 85,000 by 2005/06. The real value of the deduction was maintained since inflation increased by almost the same rate between 1993 and 2006.

Second, the Emoluments Relief was raised to 8% in 1988/89 and the ceiling eliminated; it was further increased to 12% in 1990/91. However, a ceiling was re-imposed in 1997/98 to tune of Rs 39,000. A year later the ceiling was Rs 65,000. This was a low figure at a time when earnings had been rising fast due to the dynamic labour market and the various PRB reports which led to significant pay increases at higher levels of the civil service echelon. In 1999/00 the relief was increased to 15% subject to a higher ceiling of Rs 100,000. By 2006/07 the ceiling was Rs 135,000.

Third, the top marginal rate was lowered to 30% in 1991/92 and remained constant throughout the nineties. At the turn of the century, it declined to 28% and in 2001/02 it was reduced to 25%. However, it went up to 30% in 2004/05. There was a lack of consistency in the trend with different perspectives on the part of different Ministers of Finance. They may have divergent goals like revenue maximisation, stimulation of savings, investment and growth or improvement in income distribution. But there should be more policy coherence in the longer term.

Conclusion

The income tax system has not been static. It has adapted well to the needs of the country. The system has continued to evolve through ad hoc changes. Twenty years after the reform of 1985/86, the country was poised for another reform especially with the higher degree of openness of the economy and the development of our pillars.

It was therefore expedient to keep up with the trend worldwide which was towards lower and flat rates. Countries which had made the transition to lower rates derived economic dividends. Mauritius could not lag behind. It adopted a new income tax regime in 2006/07 which will be dealt with in another article.