Isn’t abolishing personal income tax viable option?

Uganda certainly needs to significantly boost its domestic resource mobilisation to address the twin problems of fiscal deficits and debt accumulation.
The World Bank in its recent economic updates, made some recommendations, including expansion of tax base by casting the tax net wider to include the informal sector, improving tax administration and linking tax payments to service delivery and social contract to enhance tax payment compliance.
Several scholars have made similar recommendations before. One of the biggest constraints in an economy like that of Uganda is the dominance of subsistence agriculture and the informal sector, which are difficult to tax.
My article, ‘Scrap income tax, impose land levy’ in the Daily Monitor of February 2000, made some recommendations on how to deal particularly with the informal sector. And one of the recommendations was ‘Do not tax income, only tax consumption’. By then, the consumption tax (read VAT), was not yet introduced in Uganda. The article attracted a lot of hostile re-joinders, especially from tax officials, but it still generated interesting debates.

The recommendation of abolishing income tax arose out of my study on ‘Estimating un-reported income of Uganda’s informal sector: Unobservable dependent variable approach’, which was funded by the African Economic Research Consortium (AERC).
We all know that those in the informal sector are not obliged to reveal their income and, therefore, do not pay income tax. On the other hand, the income of those in the formal sector is taxed at source as PAYE. The recommendation of abolishing the PAYE was, therefore, to provide a level playing field for both those in the formal and informal sector – only tax them when they are spending on consumption goods and services.

This is not an argument about having higher or lower tax revenues. That is a good argument to have. But let us assume that the level of tax revenues raised is constant, but raised in a different way. A simple proposition would be to simply abolish income tax – all the money you earn is yours. In this case, we would need to compensate for the PAYE from somewhere else to replace the foregone income tax revenues. This is not unheard of in the world. For example, Mexico has a similar reliance on consumption taxes.

What would be the effects? Too often, this discussion is strangled at birth by hysterical claims that consumption taxes are regressive and only income taxes are fair. But this argument ignores the question of what government does with its spending.
It looks at only the side of the fairness equation – what people pay in, rather than the balance between what they pay in and what they get out. It is entirely possible that progressive public spending can more than cancel out the regressive effects of a particular form of taxation.

It would also be possible to make other taxes more progressive to compensate for any regressive effects.
Apart from the powerful psychological and philosophical benefits (you keep what you earn, you choose between consumption now and saving for later benefit, etc.), there could be a number of positive structural effects on the economy. Firstly, people are likely to save more – trying to avoid paying the consumption tax.

Saving would be encouraged by people having a greater choice between consuming now and not-consuming now and by the fact that the income from savings (interest, dividends, etc) would not be taxed so the returns are higher. Secondly, investment should increase - funded by the increased savings. Thirdly, people are likely to work more as the marginal tax rate is zero, so all extra income is their own.

Fourthly, the tax base would be widened as consumption taxes capture spending funded by people’s wealth (which is untaxed) as well as by their income. This is increasingly important given the emerging inter-generational tensions about high income taxes levied on younger working age people to fund the entitlements of older people, who are increasingly wealthier than them. Finally, it could be a lot cheaper to collect consumption taxes than income tax. VAT works well and there are ways to improve its efficiency with modern technology.

Furthermore, policy choices could allow more tax on “bads” (eg unhealthy goods) and less tax on “goods” (eg life-long training). It could also allow some radical policy shifts such as a consumption tax on the carbon used to create domestic and imported goods to replace all sorts of bad policies on climate change. Of course, the decision about this sort of policy shift is not binary.

It would be possible to pursue lots of interesting variants. For example, perhaps we could only abolish income tax on incomes below a level that would mean that most households paid nothing – for example, increasing significantly the present untaxed income threshold to say, Shs120m per annum. And there would need to be a transitional period to avoid extreme turbulences and shocks in the tax revenue collection.

Finally, I am also mindful of the fact that tax policies in Uganda must be in tandem with other members of the East African Community. But given our needs in Uganda for the potential benefits of this shift in how we tax ourselves (increased saving, more investment, more exports, greater competitiveness, etc), shouldn’t we start a debate about it? And if it turns out to be good for us, then it is probably good for the rest of EAC member states.

Mr Obwona works with National Planning Authority. [email protected]