21 September 2005

The Web

A flat Holy Grail

The success of implementing a single tax rate in the accession countries has spurned others to look again and seriously evaluate its merits. Some fiscal consultants have hailed this quiet revolution as a mile stone in unseating fiendishly complex tax laws.
Not surprisingly complex European tax codes are under the microscope after decades of post–war tangle that has from time to time stultified economies and slowed down growth. All this is the culmination of pent up bureaucracy that has piled layers of complex provisions and anti-abuse rules over the once simple progressive income tax concept introduced in European countries in the post World War II era.
So what is the raison d être that is driving all this hype towards the sudden introduction of a flat tax in emerging countries. The answer partially lies in the competitiveness issues that are battering the economies in Western European laced with lack lustre growth when compared with the roaring economies of China and India. Simplicity is the mark of genius. Here one may cite the many loopholes in a complex tax code as an easy path for the rich and powerful to exploit with impunity. Furthermore the cost of bureaucracy and the resulting objections by taxpayers thus stymied the flow of taxes and makes the need for ever more stiffer and draconian measures to collect arrears.
There is no magic nor guarantee that a flat tax system or a hybrid version will work in Malta but can we ignore the trend for tax simplification in Germany, Austria and most of the accession countries. Why is this issue so important for us?
With hindsight we notice that in the sixties the island blazed the trail for low and simple tax rates, for example through the concessionary tax-free 10 year holidays that attracted so many foreigners to set up manufacturing plants. Over the past decades we witnessed the steady build-up of high value added industries. Hopefully as members of an enlarged EU club there will be big benefits in enterprise, productivity and investment if the island wisely maximises aid entitlement under its objective one status.
So what is the ideal solution? This appears to be the pertinent question blazoned on top of the government agenda. Can we start by revising the tax code as suggested by the pre-budget document. To mention one example, Greece which suffers from wobbly public finances hopes that a flat tax rate of 25 per cent will revive the moribund economy. Greece thinks it can turn the tide and reduce evasion, attract high earners and send revenues pouring into the coffers of Athens. Only time will tell whether the thesis is correct but the Greeks are trying it.
The remedy is never so simple yet we notice that the OECD countries reduced the top corporation tax rates on average by nine percentage points between 1985 and 2000. Typically, the top rate of corporate taxes in Ireland fell from 38 per cent to 12.5 per cent between 1996 and 2003, a period in which growth rallied by nine per cent per year. Our top income tax rate was hiked to 35% and has remained unchanged for the past decade. Pro flat tax lobbyists remark that our current system lowers national income and government revenues by inhibiting economic activity. They sing in unison that with Dr Gonzi’s vision and political will, the cobwebs entangling our system can be reformed. The fruits out of a root and branch reform will be threefold - freer economic activity, increased national wealth and greater revenue for the state coffers. In fact the pre-budget document allows some measure of leeway for reform in this regard. A partial reform was spearheaded by Dr Austin Gatt the minister for Investments to help incentivise the film industry.
Another novel idea is to appoint a tax Ombudsman who can act as a shelter for taxpayers protecting their rights against potential misuse of ex ufficio assessments. The Tax Compliance Unit is costing us millions to staff and with a simplified tax code we may end up freeing this manpower to more fruitful pastures. Another solution that is complementary to the tax reform is the creation of a venture fund combined with effective tax concessions for seed capital.
But in Malta, can politicians ever contemplate removing the progressive income tax rates so beloved by the unions based on the Marxist concept of from each according to his means? Undoubtedly the introduction of a system, which scraps progressively higher tax bands in favour of a uniform and usually low percentage, would be controversial, with opponents claiming it is little more than a tax cut for the rich.
Paradoxically flat taxes have so far only been introduced in developing economies seeking to attract foreign investors. A paperless solution which will be politically popular may be that workers and businesses will simply complete a tax return the size of a postcard. All deductions and credits would be eliminated, while the only income not subject to tax would be a generous personal exemption for every taxpayer. But can we afford not to take this opportunity now?
We have few options here, many cite Slovakia, where FDI increased sharply after a 19 per cent flat tax was implemented. Naturally the advantage of the flat tax is more psychological and in our case linked with a modest reduction in corporate taxes it will go a long way. In the UK, corporate tax was cut from 52% to 35% and reduced to 33% by 1991–92. Hot over its heels, the Labour government has cut the rate from 33% to 30% and introduced a small companies’ rate ranging from 24% to 19%.
Sadly we note that locally there is no attempt to distinguish the tax rate which SME’s pay from that charged to the larger quoted companies such as banks. Ask any politician about the possibility of rallying the economy and he /she will start ranting about the deficit having an indefinable strain on tax revenues. The deficit is relatively high but this is under control and is being reduced under the ERM2 convergence strategy.
What is certain is that a streamlined tax code could still go a long way toward restoring public trust by plugging existing loopholes and cutting down on the mountain of regulations and red tape.
Could this be the discovery of our flat Holy Grail?


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Editor: Kurt Sansone
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