As usual John Legat from Imara provides us with insightful info on Zimbabwe and more specifically taxation in Zimbabwe and the continuing story of a country struggling to recover from economic and political chaos. Good reading. Will Government take note of these recommendations and insights. No probably not.
Herewith John’s latest newsletter:-
Investment Notes September/October 2010
“Budget 2010: Boost Tax Revenues by Cutting Tax Rates!”
The Hon Minster of Finance, Tendai Biti, launched the National Budget Consultative Process on 31stAugust as preparations for the mid November budget. Back in June he also provided details of the re-drafting of the Income Tax Act which we suspect will take affect at the end of this tax year. With this in mind, in these Investment Notes we will outline our own proposals to boost tax revenues to the benefit of all Zimbabweans.
The current Income Tax Act is based on the “source principle” where tax is levied on income originating in Zimbabwe. Income earned outside of Zimbabwe falls outside of the tax base. This is similar to the UK (although this will likely change) but is contrary to the US, South Africa and Australia where residents are taxed on income earned globally. Zimbabwe’s new Income Tax Act will move to a residence based tax system and away from the source principle implying that all those resident in Zimbabwe will be taxed on their income earned outside of Zimbabwe as well as on that earned here.
That might be a scary prospect to many and may even tempt some to move to a country with a more favourable tax regime. But it need not necessarily be that way. The Zimbabwe authorities have a once-off opportunity to not only encourage residents to stay here but also to encourage income earners from other parts of the World, especially Zimbabweans, to return home. The answer is simple. As the new Income Tax Act is made law, introduce a simplified low flat tax system as a complimentary measure.
“ A flat tax is a tax system with a constant tax rate. Usually the term flat tax would refer to household income and corporate profits being taxed at one marginal rate , in contrast with progressive taxes that may vary according to such parameters as income or usage levels. Flat taxes generally offer simplicity in the tax code, which has been reported to increase compliance and decrease administration costs.” (Wikipedia)
Estonia was the first country to introduce a flat tax regime in 1994 with a rate set at 24% but with the aim of reducing the rate to 18% by 2012. Russia introduced a flat tax of 13% in 2001, Slovakia of 19% in 2004, Romania of 16% in 2005, Ukraine of 15% in 2007 and Macedonia of 12% in 2007. In SADC Mauritius introduced flat taxes of 15% in July 2007.
In developed countries the tax system has become extremely complicated, confusing and expensive to operate. More often than not it creates enormous distortions and is open to tax evasion if not fraud. Tax rebates and allowances are commonplace and means-tested taxes become bureaucratic and expensive to operate. The cost of operating such tax authorities absorbs a substantial amount of tax revenue that could otherwise be spent more efficiently and effectively. In 2005, estimates for the United States, whose tax regime, despite the best efforts of Congress, was by no means the world’s most burdensome, put the costs of compliance, administration and enforcement between 10% and 20% of revenue collected (nearly half of the budget deficit at that time!). In Russia, the tax system was too complicated and tax rates were high. In 2001 President Putin introduced a flat tax of 13%, that rate being applicable to all personal income. He reduced corporation tax from 35% to a single rate of 24%. In just three years, his tax reforms had resulted in a significant increase in government revenues and a reduction in the informal economy.
By removing allowances and rebates, a huge layer of bureaucracy disappears. A flat tax on personal income above a certain tax-exempt level, can be taken at source (PAYE) and will not require complicated or expensive tax returns to be completed. In short, only businesses, those with overseas income and the self-employed would need to liaise directly with the tax authorities. Flat taxes cover ALL taxable income and profits WITHOUT exception or exemption. With tax, simplicity is golden and flat taxes provide the simplicity.
Flat taxes also remove distortions. If income taxes and corporate taxes are at the same level, there is little incentive to hide behind a company or a person to achieve the lowest tax rate. If a country chooses to have a capital gains tax, it makes sense to equate the tax rate to that of income tax, again to avoid distortions and evasion. That said capital gains tax rarely raises sufficient funds to cover the cost of running the bureaucracy to manage it, as capital gains are complicated by inflation and investment additions. For this reason, many countries choose not to implement capital gains taxes as a direct result.
In the SADC region, flat taxes have been introduced successfully in Mauritius, whilst Botswana has a low tax regime. Mauritius introduced a 15% flat tax on incomes and corporate profits on 1st July 2007. There are no capital gains taxes in Mauritius.
The Government has made it clear in STERP that it wishes to attract skills back to Zimbabwe, especially from those in the diaspora. The net result of low tax rates if successful will be immigration and a rising population which will immediately add to consumer demand, investment in new businesses and a boost for the construction industry as housing investment rises. That in itself will lead to a growing tax base.
As Governments in the developed World are boosting their own spending as a direct result of the global credit crunch, tax rates in these countries are inevitably rising. The UK increased its top rate of Income Tax to 50%! For a country like Zimbabwe, which is starting with a clean slate, rising global taxation provides a great opportunity to attract skills back to the country. In very simple terms, if Zimbabweans living in South Africa are paying 40% in income tax at the top band, 15% provides an attractive incentive to relocate back to Zimbabwe. (It is for this reason that South Africa and SARS may fight such a proposal from Zimbabwe, but Zimbabwe should resist at all costs citing Mauritius and Botswana who have set a precedent within SADC).
In recent years, taxation methods in Zimbabwe have been geared to hyperinflation. Paying taxes in advance of earning revenue is one such tax, as is the ‘presumptive’ withholding tax on capital gains, gains which are far less certain with US dollar deflation! Such taxes should be abolished now that hyperinflation is a thing of the past.
For Zimbabweans today already living in the country, high rates of income tax plus levies can total over 45%. This provides a great incentive to attempt to evade tax wherever possible, perhaps by becoming self employed to enjoy lower corporation tax rates. A low tax rate will, as we have seen in Russia and many other developing economies, encourage people to legalise themselves and to pay the necessary tax. Furthermore the informal sector will slowly be encouraged to join the formal sector, especially where good policing can discourage under hand/illegal dealings.
A lower tax rate results in higher after-tax income and hence higher disposable incomes. That in itself encourages greater consumption that will imply higher VAT receipts. It will also result in greater demand for goods and services from businesses which will see revenues and profits rising and hence corporation tax receipts rise. The multiplier effect of a lower income tax rate on other taxes in the economy can be significant. Lower corporation tax increases after-tax returns on investment and hence encourages more investment!
ZIMRA needs to be as cost effective and as efficient as possible. By keeping the tax system simple, less civil servants will be required to manage that system, and hence less cost to Government. As we have seen in the developed World, tax authorities have grown exponentially as allowances, tax rebates and means-tested payments have been introduced to offset high tax rates imposed on the hardest hit in the economy. Low flat tax systems do away with such allowances as those for single parents, housing, disability etc, which require a large civil service to administer and are prone to fraud.
Low flat taxes will avoid unnecessary distortions in the economy by doing away with preferences or allowances to specific sectors. A case in point were the tax reductions on capital equipment and vehicles for the tourism sector. It is likely that many smart entrepreneurs entered the tourism sector in order to primarily take advantage of those tax incentives rather than to boost Zimbabwe’s tourism sector! It presumably also required many civil servants to analyse the ‘tourism’ projects and to provide the approval for the tax incentive to be given. Apart from increasing civil service overheads it can also encourage corruption which this Government is keen to stamp out.
Zimbabwe is a land-locked country far from the Coast. This makes importing and exporting goods and minerals that much more expensive than for coastal nations such as South Africa. It is hard to reduce these costs and therefore Zimbabwe will need to ensure that its other costs are that much cheaper. That may mean the cost of utilities such as power, and the cost of raw materials. Whilst import duties have represented a high component of overall tax revenues, this is changing as the economy gains momentum allowing personal and corporation taxes to become the main revenue earners. It should therefore be stated Government policy to reduce import duties to as close to zero as possible on all goods with deadlines given on differing bands eg 20% by end 2010, 10% by end 2011 and zero percent by end 2012. In that way foreign and local investors can plan ahead, confident of the taxation roadmap given by Government.
Reducing import tariffs will also make it unnecessary to introduce sector specific allowances that inevitably will cause distortions as discussed in the preceding paragraph with respect to the tourism sector.
Removing import tariffs will also remove at a stroke, the huge civil service that has to administer these taxes. The border posts would be slimmed down substantially thereby reducing the time spent for people and trucks at our border posts. It would also cut out much corruption which currently reduces the import duties actually collected at the border. Smuggling would become unnecessary.
Zimbabwe should take advantage of its clean slate economic environment. The country can start from scratch using the revised Income Tax Act as the trigger.
Our suggestions would therefore be as follows:
With the introduction of the revised Income Tax Act, initiate the following:
1. Announce Zimbabwe’s intention to introduce a flat tax system taking all taxes to 15% and to provide a roadmap of falling rates to achieve that level with a target date for the final level of 15% to occur eg from Jan 1st 2013.
2. Provide a roadmap to take import tariffs to zero. Eg from Jan 1st 2013.
3. Remove capital gains taxes in line with Mauritius.
Tax revenues so far this year have been far above the Ministry of Finance’s November 2009 budget. Cutting taxes boosts growth and hence tax revenues.
In short our proposal should ensure that Zimbabwe’s overall tax base will expand dramatically, tax revenues will soar but the costs of collecting those taxes will plummet. A “Win Win” solution for all honest Zimbabweans.
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