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Reforming a country's tax code can often be an agonizing process

Kitty Miv, Editor
27 July, 2015

Kitty's Country Rankings are below, with a description of how they are compiled. This week, as every week, I give out Encomiums to countries which have done Good Things, and award Execrations for countries which according to my highly personal and partial views have done Bad Things.

Something of a tax reform theme emerges from the news this week. And unlike in some countries (I'm talking about you in particular USA), some governments and legislatures are actually putting words into action for a change.

Let's start in India, where the Government is inching ever closer to its goal of introducing the highly anticipated goods and services tax (GST) in April 2016. It's not often you hear that a tax is expected to actually improve the functioning of a country's economy and lead to higher levels of commerce and growth, but this will probably be the case in India, where at the moment several inefficient indirect state taxes exist, some of which cascade as goods are traded across state borders, discouraging intra-Indian trade. The GST promises to sweep these taxes away and replace them with a cleaner system, which will be levied concurrently at central (federal) and state levels akin to Canada's Harmonized Sales Tax. Except that getting the states to agree on it has been a far from harmonious process, with many states expecting to collect less in tax as a result of GST. The BJP Party, which has won back the confidence of domestic and foreign investors alike, has made GST one if its top priorities, and has managed to push the legislation further along the legislative road in the space of a year than the previous lot did in 10. Encouragingly, the upper house of parliament's GST panel largely endorsed the proposed change to the Constitution that will be needed before GST in its proposed form can be introduced. However, it did recommend that the central Government provide a more extensive revenue compensation package to the states than it has been prepared to give, which has been one of the major stumbling blocks all along. There are signals coming from the Government that it is prepared to relent on this point. But some crucial details still need to be finalized, and the indications are that opposition parties will block the bill quite easily in the upper house, where a two-thirds majority is needed to change the constitution, if their demands aren't met. Yet again, it could be a case of so near, but yet so far, for tax reform in India.

Reforming a country's tax code can often be an agonizing process. Often, it starts with the formation of a panel of experts or parliamentarians, charged with studying various options for reform. Then, the panel will publish a report detailing where the tax system is failing, and proposing ways in which it can be fixed. The report will then be submitted to parliament or the government, upon which the finance minister will laud the great work and dedication of the panel and its chairman. Within a week of this, it'll probably be forgotten about. Or, if a tax reform bill is eventually drawn up, it will be so divisive as to be virtually impossible to approve, with the result that it gets batted back and forth between lower and upper chambers, finance committees, and constitutional courts. Some members of the legislature with a particular interest in tax reform will try to keep the issue in the Government's consciousness, and the Government will be reminded on a regular basis by the IMF, the OECD, et al, not to forget about that tax reform bill it promised. But rarely does a country manage to make a clean sweep of its tax code. So, it was refreshing to read that Turkey is on the brink of making fairly seismic changes to its tax legislation, a process that so far has taken a relatively brisk two years. The draft tax code will merge the two separate laws for the taxation of corporate and individual income, and by all accounts will strip away many overlapping and confusing provisions, reducing the number of articles by 200 to about 320. Of course, one of the main aims is to bring more people into the tax net and widen the tax base - i.e. it will raise revenue – but it is also said that the changes will make Turkey a considerably easier place to do business, so it merits an encomium.

It remains to be seen whether the conclusions of South Africa's Davis Tax Reform Committee, led by Judge Dennis Davis, will be acted upon by the Government or quietly shelved. I suspect this process will lead to some changes, but mainly to wring more revenue out of the tax system; the Government has admitted that the budget deficit is growing, but it intends to increase public spending. Last week, the Davis Committee released two options papers on the subject of value-added tax reform. One of the terms of reference of the committee is to consider ways in which the South African VAT system can be made more efficient. Or, in other words, how the Government can raise more tax from the system for less effort. However, inconveniently for the Government, South Africa's VAT regime is already one of the most efficient in world, according to the conclusions of an IMF report, which was actually commissioned by the Government to support the work of the Davis Committee. Therefore, the IMF said, there is limited scope for improvements to VAT in South Africa. It's quite a delicious irony really. The IMF is routinely heard to tell countries to widen their tax bases, and the Government was probably hoping for the same response to justify some stealthy revenue-raising measures of its own. If that was the plan, it's certainly backfired. But the Government will probably make the changes it wants to make anyway, IMF or no IMF.

The UK Government might also be careful what it wishes for as it presses the Office of Tax Simplification back into action to study merging the income tax and National Insurance systems. National Insurance contribution (NICs) were first introduced just prior to World War One to help working people insure against periods of unemployment and illness. They were expanded immediately after World War Two to help pay for the new National Health Service. However, revenues from NICs have long ceased to be ring-fenced and, in reality, the National Insurance system is just another item of general taxation. Merging NI into income tax would achieve huge administrative savings for both governments and employers, and the proposal is strongly supported by business, which sees NICs as a large tax on employment. Yet, the Government is on dangerous territory here. For starters, merging NICs into income tax would make personal taxation much more transparent, showing people just how much tax they are really paying on their salaries: if employer NICs, charged at 12 percent on wages, were combined with income tax, the basic rate of income tax would rise from 20 percent to 32 percent. And unless significant changes were made to the rate structure, there would be some bizarre results. The Adam Smith Institute calculates that effectively there would be 10 tax bands if the two systems were merged under their current parameters, with those earning over GBP100,000 paying from 42 percent to 62 percent. There are also other issues. Pensioners don't pay NICs, so they would have to be put on a separate regime with lower rates. There is also the employer National Insurance contribution of 13.8 percent to consider, and it is unclear how this would be absorbed into the new system. Moreover, merging the two regimes, which have entirely separate IT systems, could be highly disruptive, expensive, and time consuming from an administrative point of view, which is one of the reasons why the Government didn't pursue this reform in the last parliament. George Osborne has at times been a bold finance minister. This move, if he goes ahead with it, could be the bravest of the lot.


Kitty's Encomiums and Execrations

Methodology: each week (this is the 147th) one or more countries are given encomiums and one or more are given execrations. Those are the entries below with descriptive links. In the following week, each encomium counts as + 1 for that country, and each execration counts as – 1, being added to that country's existing score. Over time, therefore, a ranking will build up for each country, and further countries will join the listing. Germany is at minus 2, since in the second week it had an execration and in the first week it had an encomium, leaving it at neutral; then it had an execration in week four, thus dropping to – 1, and another one in week six, dropping to – 2; finally in week 13 it got something right, so it went back up to – 1; then in week 16 it gained a further star, so then it was in neutral territory until week 23 when it dropped back to minus one, but reverting to neutral territory in the following week, then dropping to minus one in week 50, and back up to plus one in week 51, then to plus two in week 52. Some weeks ago it dropped a place, but then quickly recovered one step. Etc etc.

The rankings are intended to be a proxy for business friendliness; evidently they are highly partisan, but as time goes by they are becoming useful for decision-making. For any country in negative territory, you should think carefully before starting a business there.

Kitty's Encomiums

India inch-by-inch

Turkey refreshing

United Kingdom brave

Kitty's Execrations:

South Africa backfires



About the Author

Kitty Miv, Editor

Kitty was born in Argentina in 1960 to a Scottish cattle rancher and his Argentine wife. Educated in Edinburgh and at Princeton, Kitty worked for the World Bank as an economist, where she met and married an emigre Iranian banker. During her time with the Bank, Kitty worked in a number of emerging markets, including a spell in the ex-USSR as a Transition Economies Team Leader. Kitty is now a consultant in Brussels and has free-lance writing relationships with a number of prominent economic publications. kitty@lowtax.net


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