Introduction
So serious are the defects in our tax regime I do not believe that Guyanese will be fobbed with anaemic or banal recommendations from the Tax Reform Committee. In the two preceding columns, I treated with eight of the nine analytical constructs, which underlie all tax regimes: (tax giveaways; tax level and structure; tax buoyancy and elasticity; tax volatility; tax stability; taxation and economic efficiency; tax burden; and, the cost of taxation). This week I will consider the ninth and most contentious ― taxation and fairness or equity. Before I address this however, let me add a comment to the cost and economic efficiency of taxation, which, were considered last week.
Two major generalisations arise from that earlier discussion. First, because from an economic standpoint, taxes transfer scarce resources from the private to the public sector, in order to minimize their distorting economic effects, economists recommend that tax rates should be kept as low as required to reach a given revenue target. And, secondly, the tax base should be made as broad as possible, given the desired goals of the tax system.
Estimates for rich developed economies (with sophisticated tax systems) show that the economic efficiency costs of maintaining well-functioning tax systems, normally range from about one-fifth to one-third of the total value of the taxes collected, although in unusual circumstances this value is considerably higher. In small poor open developing economies like Guyana (with lower administrative sophistication and weaker markets) one can project a worse outcome. Readers would recall from earlier discussion that the economic distortionary costs of taxes derive from their impact on relative prices, with empirical studies revealing that these are proportionately related to the square of the tax rate. Thus, if the tax is doubled or trebled, the distortionary costs would grow four-fold (2×2) or nine-fold (3×3).
Triad of considerations
Apart from being highly contentious, tax fairness (equity) is widely recognized as perhaps the most important consideration in the design and reform of tax regimes. Recall that, from an economic standpoint, taxes transfer resources from the private to the public sector. As a consequence, tax fairness emerges as one of a triad of fundamental considerations around which well-functioning tax systems revolve (the other two being, how efficiently and how cheaply are taxes raised).
Regrettably, there is, and indeed can be, no objective standard of tax fairness. Different classes, groups, communities, as well as individuals, hold their own and therefore, widely differing notions of what constitutes a fair tax system. It is for this reason, more than any, why I have strongly advocated a National Commission on Tax Reform as the way to proceed in Guyana. To my mind, this is the only workable modality for arriving at a broad social consensus or contract on what is socially, politically, culturally and economically acceptable as a fair and equitable tax system.
What is tax fairness?
Some economists however, approach tax fairness through the concepts of horizontal and vertical equity. Horizontal equity purports that persons in similar economic circumstances should pay the same amount of taxes, because they have the same ability or capacity to pay taxes. In the tax code this is defined as their having the same amount of taxable income and wealth. While plausible sounding this is illusory. The devil lies in the details of translating this requirement to taxable income and wealth in the tax code; consider a few examples. What if tax-payers have different abilities to evade taxes? This can readily occur in Guyana because tax-payers have differential access to illegal untaxable income trafficked in the underground economy. Alternatively, what if taxpayers in similar economic circumstances have different tastes and expectations? Do these taxpayers enjoy the same welfare? Correspondingly, persons supposedly in similar economic circumstances may be differentiated in their access to the benefits to be derived from government expenditures funded from taxes.
Vertical equity however, purports that ‘appropriately‘ differentiated taxes should be applied to tax-payers with unequal economic circumstances (taxable income and wealth). Vertical equity focuses on pre-tax inequalities while horizontal equity focuses on pre-tax equalities. This creates a unique philosophical conundrum, in that tax fairness embodies notions of both sameness (persons in the same circumstances being treated the same) and difference (persons in different circumstances being appropriately treated differently).
Discussion on tax fairness inexorably raises concern about whether the overall tax structure, and/or groups of taxes and individual ones are progressive, proportional or regressive in their impact on the distribution of the tax burden. Progressivity exists when tax rates rise as income rises. That is, the tax structure is graduated in a manner designed to ensure higher income brackets pay a higher share of their income in taxes, than the share paid by lower income brackets. Proportionality requires that all taxpayers pay the same rate or percentage of their taxable income in taxes. Finally, regressivity requires that taxpayers with higher taxable income pay a lower tax rate than those with a lesser amount of taxable income.
Conclusion
The preceding discussion indicates that Guyanese need to agree on what economists’ term their preference function or the ethical framework, which should guide the tax regime. It is my considered opinion that this cannot be arrived at by a group of “experts”, no matter how well-qualified they are. In this sense therefore, the triad on which a good tax system rests (administrability, efficiency and fairness) has to be forged through the potentially inclusive and participatory modality of a representative National Commission. By the same token, as we shall see in coming columns, reforming the tax system is inextricably linked to concerns about how our taxes are spent. Tax fairness should be seen as budgetary fairness, combining both taxes and spending.
Next week I shall proceed from the observation that tax fairness is illusory and cannot be arrived at without broad-based national dialogue and consultation.
