Closing gaps in taxation is a necessary step to fairness. It can also boost growth, according to recent work from the IMF:
“Increasing the efficiency and equity of revenue collection is therefore crucial to help mitigate the negative distributional effects of the pandemic and higher commodity prices. A more efficient tax system would help boost revenue and fund social and infrastructure spending, which can spur growth and reduce inequality of opportunities.”
As it happens, the paper is focused on challenges in the Middle East and Central Asia, but it is clear that the arguments apply elsewhere too. We know generally that fairer tax systems are better for growth than those favouring the wealthy. And the prescriptions that the IMF staffers produce certainly seem to have application beyond the region:
- Reducing tax exemptions on personal and corporate taxation
- Removing inefficient corporate tax incentives and improving corporate tax design
- Increasing progressivity in personal income taxes
- Improving the design of value added taxes (VAT)
- Developing taxation of wealth
They also make a series of recommendations that effectively centre on bolstering the Rule of Law and increasing trust in institutions.
I won’t comment on all of these potential prescriptions. I’ve argued strongly before of the need to equalise capital gains taxation with income tax rates: the persistence of capital gains strongly suggests it is much more income-like in practice than its favourable tax treatment would imply. I’ve also argued that companies need to consider fairness in their approaches to taxation. I won’t repeat those arguments here. Instead I’ll look briefly at two further areas that may also be worthy of attention from policy-makers: progressivity in personal income taxes and closing VAT loopholes.
On both personal taxation and corporate taxation, the paper makes clear it is not so much the headline top rates of tax that matter, but the rates that individuals and companies in practice face. The existence of exemptions and incentives can distort effects, and it’s the overall structure of the tax is what matters. This chart, on personal income tax rates in what the IMF calls advanced economies, is particularly striking:
What the chart calls ‘redistributive capacity’ really means the extent to which redistribution is in practice delivered by the tax system – countries below the line are failing to deliver fully on their opportunity for more fairness through the tax system, while those above the line are delivering more fairly. There must be real value in exploring how those above the line are delivering greater efficiency in terms of the progressivity – fairness – of their personal tax systems. Others could follow.
To turn to VAT: sales taxes are usually deemed regressive, because they apply to sales whether they are to the poor or to the wealthy. However, a study by Rita de la Feria – recognised as one of the world’s leading experts on sales taxes – and Australian colleague Michael Walpole that considered European and Australian experiences with VAT and the ways in which the taxable base is manipulated argues convincingly that this is not true: “since consumption, even of essential items, is overwhelmingly by the highest income households, when there is a VAT reduction—assuming this reduction is passed-through—it is those households that primarily benefit from VAT decreases”. They note that this will be particularly true in developing economies with significant informal economic sectors (as in such situations, many transactions by poorer people will never be subject to sales taxes while the wealthier are much more likely to trade in the formal sector), but it is true more broadly.
Their conclusion on this is therefore:
“reduced rates of VAT…effectively subsidise the consumption of the households at the higher levels of the income distribution. This in turn means that, contrary to intuition, reduced rates of VAT, as with any other exclusions from the base, do not necessarily reduce the regressivity of the tax, but can, on the contrary, increase it.”
Clearly, the progressive impacts of sales tax increases (by removing distorting lower rates, including zero rates) will be bolstered if the increased revenues are used to enhance welfare payments or otherwise support poorer families. The study argues that this may be needed to overcome the likely arguments against reform, which will tend mistakenly to misuse fairness arguments. The study sets out a large range of ways in which sales tax systems around the world have embedded unfairnesses based on arbitrary distinctions between products that lead to significant differences in the taxable rate. This opens a significant opportunity.
The IMF team states: “Disruptions in lives and livelihoods as a result of the pandemic and, recently, the war in Ukraine have made revenue mobilization more pressing to fund critical infrastructure and social spending and support inclusion.” That’s true around the world. Rising to the challenge of tax fairness is a challenge for global governments, not just those in the Middle East, and it will help unlock growth.
See also: Taxing gains, closing loopholes
Talking with the taxman about fairness
Revenue Mobilization for a Resilient and Inclusive Recovery in the Middle East and Central Asia, Geneviève Verdier, Brett Rayner, et al, IMF Departmental Paper, July 6 2022
Middle East Needs Fairer Taxes to Aid Growth and Ease Inequality, Jihad Azour, Priscilla Muthoora , Geneviève Verdier, IMF blog, July 6 2022
The Impact of Public Perceptions on General Consumption Taxes, Rita de la Feria, Michael Walpole, December 2020, British Tax Review 67/5, 637-669