It’s the time of the year when the focus is on the upcoming National Budget, scheduled to be announced on Oct 7. One key question would be how the government plans to deploy fiscal policy tools that can both support long-term sustainable economic growth and generate higher tax revenue to reduce debt and accommodate growing expenses.
It is interesting to witness a varied approach to tax reforms adopted by governments around the world. Over the last week, Sri Lanka tabled major tax reforms, leading to a significant increase in personal and corporate taxes and the removal of reliefs. This was on the back of Sri Lanka’s economic crisis, which was caused by a combination of factors. One of the many factors may have been the country’s 2019 tax reforms, which included the reduction of tax rates on almost all types of taxes and the introduction of tax incentives, which in turn contributed to the lowest ever revenue-to-gross domestic product (GDP) ratio of 8.7%, and an increase in the government debt-to-GDP ratio to a whopping 104.6% in 2021.
At the other end of the spectrum, the UK’s newly appointed chancellor of the exchequer Kwasi Kwarteng has just launched the UK’s biggest ever package of tax cuts, amounting to around £45 billion of reductions for people and businesses by 2027. In an immediate reaction, the UK currency fell to record lows against the US dollar.
Did Sri Lanka, an overly conservative nation, see its proposals result in a significant regression of the economy? Will the UK’s proposed tax reforms lead to massive economic growth or will it follow the path of an unsustainable drop in tax revenue as witnessed by Sri Lanka? Is there a clear answer or approach to address an issue like this?
Studies in the past have generally propagated the view that economic growth can be increased by gradually moving the tax base towards consumption and immovable property, especially residential property. Furthermore, studies have shown that tax changes that appear to demonstrate the most promise, in terms of both increased growth and economic recovery, come from the reduction of income tax of those in the lower income bracket. This appeared to stimulate demand, increase work productivity and reduce income inequality. It is also imperative that the impacts of changes to tax policy are closely and critically monitored. If it appears that the policies are not achieving the desired objectives or are even having a negative impact on the economy, brave and immediate mitigation measures must be taken. In today’s volatile and uncertain economic environment, governments must be flexible and bold.
Recently, the Asian Development Bank’s report on “Asian Development Outlook 2022, Mobilizing Taxes For Development” put forth several recommendations to gradually increase tax revenues for sustainable development.
I have outlined below some considerations from this report:
1. Efficient public spending: there is a need for a thorough study and plan to improve the efficiency and effectiveness of public spending. For example, replacing broad-based subsidies with targeted cash assistance to low-income families would reduce government expenditure while ensuring that financial support goes to the groups that truly need this and who will benefit the most. Efficient public spending will free up additional fiscal resources and promote inclusive development.
2. Expansion of a broad-based consumption tax that can provide a stable flow of tax revenue and is not subject to the fluctuations of economic cycles.
3. Strengthening tax administration through the better use of information and communication technology and improved services. The digitalisation of tax administration, including the introduction of e-invoicing and e-reporting in many countries, has been very effective in curbing tax leakages, increasing compliance and thereby increasing tax revenue collections. This also has the potential to support the growth of Malaysia’s digital economy. There are new studies that show cutting business registration costs, which is possible through digitalisation, can reduce the share of the economy occupied by the informal sectors and boost tax revenues.
4. Simplify the tax system. A simpler tax system facilitates and enhances compliance and reduces tax leakages. Simplicity should be the mantra, from legislation to compliance procedures. Time and effort required for compliance should all be kept to the minimum. In this regard, the government should consider the introduction of a simplified tax system for small medium enterprises (SMEs). In introducing its comprehensive 2022 tax reform, Mexico established a new tax regime which aims to improve the tax payment process and simplify the taxation of small and medium-sized companies and individuals carrying out business activities with income below US$1.7 million. The new regime applies a progressive rate structure taxing gross income (without allowing for any deduction) of US$14,798 at a tax rate of 1% and income exceeding this threshold at a rate of 2.5%, with effect from 2022.
5. Introduction of green and health taxes that can both raise revenue and contribute directly to meeting Sustainable Development Goals.
In conclusion, tax reforms to boost revenue are politically challenging, but global experience shows that strong leadership can inspire buy-in and bring success. Furthermore, the recovery period from a crisis, in this case the Covid-19 pandemic, is an opportune time to institute tax reforms. These may be seen by some to be small steps, but together they can prepare the country to respond to future shocks.
Amarjeet Singh is the EY Asean Tax Leader and Partner at Ernst & Young Tax Consultants Sdn Bhd