Why a ‘flat tax’ system could work best for South Africa: FMF

As South Africans prepare themselves for finance minister Malusi Gigaba’s budget speech on 21 February, several analysts have made it clear that a number of new taxes and increases are likely to be on the cards.

However, despite their being a clear shortfall in this year’s budget increasing taxes may not be the best way to go, according to Jasson Urbach, a director at the Free Market Foundation (FMF), who says that government should be looking for ways to reduce the total tax required.

“Faced with falling revenues, mounting debt and a dismal economic outlook, to supposedly soften the looming fiscal catastrophe government may well be tempted to raise taxes, particularly on South Africa’s wealthiest citizens.

“However, the key focus should be on reducing expenditure and an already over bloated state and raising taxes should be avoided at all costs,” he said.

“Most tax reform discussions and debates lead with the premise that any new tax system must raise roughly as much or more revenue as the one it is to replace.”

“But as Winston Churchill famously quipped, ‘I contend that for a nation to try to tax itself into prosperity is like a man standing in a bucket and trying to lift himself up by the handle’.

“Unfortunately for South Africans, government spending has more than doubled in relative terms from less than 10% of GDP in 1960 to over 20% at the end of 2016,” he said.

Urbach added that for South Africa to have a better chance of raising the amount of funding required, government should be looking for ways to reduce the total tax required, and give urgent attention to reducing the expenditure side of its budget.

“The best way to ‘stimulate’ growth is to allow people to work, save and invest,” he said.

Changing the tax system

Urbach cited Nobel Prize winning economist, Milton Friedman, and his proposal of a flat tax system as a possible means of encouraging South Africans to work, save and invest.

“(Friedman) acknowledged that individuals respond to incentives and take steps to further their interests and argued that highly progressive taxes induce taxpayers to find and exploit tax loopholes to reduce their tax payments by hiding or converting income into other forms, either legally or illegally,” said Urbach.

A proportional or flat tax, as opposed to a progressive tax system, is one in which the ratio of tax to taxable income is the same at all levels of income. It replaces the various tax bands that feature in a progressive tax regime with a single rate.

A true flat tax makes no provision for exemptions and provides no special dispensation for low-income earners.

However, for both compassionate and practical reasons there is no merit whatsoever in taxing the poor, said Urbach

“The compassionate reasons are obvious while the practical reason is that below a certain level of income, the costs of collecting taxes from the poor will exceed the amount collected. Low-income earners should therefore be exempt from paying tax on personal income,” he said.

“Consider for example, if the exempted income is R75,000 per year and the tax rate 15%.

“A person earning R75,000 would not pay tax, whereas a person earning R100,000 will pay R3,750 (effectively 3.75%). A person earning R5 million per annum would pay R738,750 (effectively 14.78%) in tax.

“A low flat tax would be fair, broaden the tax base, improve incentives to invest, make tax evasion more difficult and less lucrative, increase economic growth, raise local investment by encouraging capital formation, and create new jobs by increasing real wages and improving incentives to work.

“It would also encourage taxpayers to be more honest and attract foreign investment,” he said.

Read: 3 big tax changes to expect in 2018

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Why a ‘flat tax’ system could work best for South Africa: FMF