Tax reform inside out (Part 1)

Edward Seaga, Contributor

A man was shot in a bar in Texas because he was overheard to say how good it was to be raised in Texas. His attacker thought he had said that it was good to raise taxes.

In the United States, tax collection is carried out by the Internal Revenue Service (IRS). This is generally one of the most feared agencies because the public perceives that to be on the IRS roll of taxpayers can be equated with death, since the only two things certain in life are death and taxes. Politicians know that raising taxes is a career hazard, just as reducing them can be a career booster.

It is with these caveats in mind that the Government prepared a tax-reform programme to fulfil many urgent needs.

This is not the first time a comprehensive programme of tax reforms would be undertaken. In 1986, during my tenure as prime minister, the first programme of comprehensive reform was undertaken. This is reported in my autobiography, My Life and Leadership Vol. 2, pages 86-89, from which I quote selectively:

"Reform of the taxation system is as an urgent priority to enhance the motivation of individuals and corporations to produce. The punitive tax rates and complex system of tax assessment badly eroded revenue collection through excessive use of tax avoidance and evasion.

"It was necessary to replace this system with one which would be moderate, equitable, simple and growing at a pace in keeping, with the rate of growth of GDP.

"Moderation was essential to avoid resentment to the payment of tax. There is general acceptance of the need to pay taxes so long as the rate is not excessive. Rates at 20 per cent to 30 per cent or lower, on income or profit, found more positive acceptance than 40 per cent to 50 per cent.

"The taxpaying public bitterly resented a system of taxation in which direct taxes on personal income and company profits were excessive and in which the greater amount of taxes paid was by a minority. This was considered unjust and counterproductive to economic performance.

"A Tax Structure Examination Project (TSEP) commenced work in July 1983 to "develop a system of taxation that is consistent with the objectives of economic development". The scope of work was comprehensive, inclusive of direct and indirect taxes.

"Of special concern was the impact of the excessive and complex system of taxation which stymied personal and corporate earnings and profits."

Dysfunctional system

The problem then was a seriously eroded and dysfunctional tax system, as indicated in my biography as follows:

"Individual income tax was assessed in the traditional manner, on a graduated scale, which increased the tax rates in a progressively higher band as incomes increased. These rates reached a tax band of as high as 57.5 per cent of taxable income, which was even more punitive since the income band to which this rate applied began at the pay level of weekly paid working-class taxpayers.

"As the graduated scale was applied to higher levels of income which increased with inflation, taxpayers used every device available to reduce their tax liability as much as possible. The most popular device was to load the pay package with non-tax-deductible allowances to minimise the wage and salary component in the package, thereby reducing the amount of tax on income.

"Indeed, it was not unusual for pay packages to consist of 60 per cent taxable wage or salary and 40 per cent tax-deductible allowances. Naturally, the revenue suffered as taxable income and tax receipts were effectively reduced."

"The Tax Structure Examination Project was carried out by a team of Americans and Jamaicans headed by Professor Roy Bahl of Syracuse University. It was financed substantially by United States Agency for International Development. Some 50 experts, specialists and consultants were involved in this massive, comprehensive project."

"The recommendations of the Tax Structure Project team radically changed the pattern of low salaries and high allowances by eliminating all but one allowance, housing. The income previously derived tax free from these allowances would now be substantially increased as taxable income. The consequence would be an unbearable increase in taxes due.

"Hence, the tax rate had to be substantially lowered to reduce the taxes due to a reasonable level. A new tax rate of 33.33 per cent was introduced. This was a very substantial reduction of the tax rate, compared to the previous high of 57.5 per cent, an achievement which stood out as a strong motivation to taxpayers. A unique feature which was a special attraction was the assessment of the 33.33 per cent as a flat rate for all income brackets, instead of complex calculations on the graduated scale by which as income grew, tax increased disproportionately. Further, tax liability could now be simplified. Instead of deduction of several credits and allowances in order to determine the tax due, a simple back-of-the-envelope calculation was now possible: deduct housing and tax threshold allowances and pay one third of the balance. This system of a flat rate existed in only a few countries."

The company profits tax was similarly treated. Reduction of the company profit tax from 45 per cent to 33.33 per cent of profit was a most welcome relief. The additional company profit tax was also abolished. This reduction benefited corporations and the revenue by motivating compliance.

The revenue collected did not decrease, as forecasted by critics. In fact, it increased somewhat in the next year from 26.9 per cent to 27.5 per cent of GDP. Income tax also showed an encouraging increase, from 7.9 per cent to 8.6 per cent, indicating that the income tax reform was impacting positively on the revenue.

The double benefit of lower tax rates and simple assessment was a big success.

Another major reform was to group eight indirect taxes, which had to be paid individually, into one tax, the general consumption tax, making one, instead of eight different computations and payments. The eight taxes included: Excise Duty; Customs Duty; Retail Sales Tax; Telephone Service Tax; Entertainment Duty; Hotel Accommodation Tax; Consumption Duty other than alcoholic beverages, tobacco products and petroleum products which are covered under the Special Consumption Tax, Additional Stamp Duty levied on the importation of goods except for in-bond shops, protected goods, alcoholic beverages, tobacco and petroleum products.

More palatable

"This reform made the tax process simpler. It was also designed to be more palatable because it was intended that the GCT would be applied at a modest rate of five per cent, making it virtually revenue neutral, that is, no increase in revenue from the tax charges.

"However, the GCT designed in the 1980s was not enacted until October 1991, by a new government, and at that time the introductory rate was raised from five per cent to 10 per cent, double the original intention. What was intended to be a palatable single tax replacing eight taxes at a composite low rate of five per cent became a burdensome tax at 10 per cent. Indeed, at the present level of 16.5 per cent, GCT has become painful, with numerous exemptions required in sensitive areas to mitigate the pain, where necessary."

The reduction and simplification of the individual income and corporate tax systems, together with introduction of a single indirect tax, the GCT, as another measure of simplification, comprised the most far-reaching tax reforms ever accomplished to that time.

Economic growth increased significantly in the last half of the 1980s. How much this was caused by the tax reforms of 1986 has never been studied, but arguably, the reforms, by their nature, did improve the environment for growth meaningfully, as can be recognised from the increased buoyancy of the economy that followed.

Edward Seaga is a former prime minister. He is now chancellor of the UTech and a distinguished fellow at the UWI. Email feedback to columns@gleanerjm.com and odf@uwimona.edu.jm.