Taxation and work

The end of this month is near and now is the time when most of us have to submit their declaration of income and of income tax due. Companies send their income tax return depending on their year end.

In moments like these one wonders whether the tax that one pays is all worth it and whether one is getting any value for money for the tax that one is paying. Malta is no different to other countries and the public expectation generally is that we should have unlimited and encumbered access to government services (in whatever shape and form, and, therefore, including health, education, but also roads, etc.) whenever we need them, while we pay the least tax possible. This is the thinking that one makes from a micro point of view.

Then there is another line of reasoning that one follows from a macro point of view. How necessary are taxes on income for the governance of the country?

If government does not collect enough tax, what would be the services that it currently provides for free and which it would then start to charge for or even stop providing? Is there a rate of tax beyond which it starts to become counterproductive in terms of effort that one makes to earn more income or in terms of risks that one takes in undertaking further investment? Is taxation bad for the economy or is it an unnecessary evil?

Two weeks ago, I touched upon the issue of public goods and services, and I argued that, although over the years, the definition of such goods and services has changed, the basic ones such as health and education should remain free. I have also often touched upon the issue of water and electricity bills and I continue to argue that irrespective of the way one looks at it, it is unfair on the taxpayer that the tax he or she pays goes to subsidise someone else's water and electricity consumption. These two issues are essentially tied together by the notion that our tax should be spent judiciously such that the amount of tax on income that government needs to collect is as little as possible.

Why should the amount of tax on income be as little as possible? One of the main reasons is that it impacts on people's disposable income. Any increase in the rate of tax decreases the amount of money that persons have available for spending, and as such aggregate consumption decreases. However, the critical issue here is not so much the willingness to increase or decrease consumer spending, but rather the willingness or otherwise to increase one's income.

Let us take an example. Currently the highest rate of tax applicable in Malta is 35 per cent. In other words, the minute one's income goes beyond a certain threshold, the tax rate on that additional income is 35 per cent. Let us say government pushes that tax rate up to 50 per cent. Will such a tax rate serve as a disincentive for people to work less? Will such a tax rate serve as a punitive measure such that people would choose to work less rather than more?

As a country we have been through this experience in the reverse way. The highest rate of tax used to be up to the mid-1980s at 65 per cent. When the income tax structure was changed over the last 20 years such that the overall rate of tax went down, government has tended to collect more money from income tax.

Thus, our experience is definitely one where a higher rate of income tax serves as a disincentive to work. And a disincentive to work means a disincentive to create more wealth in the economy. One may also ask as to whether a reduction in the maximum rate of tax would serve as an incentive to work more and therefore to create more wealth. I believe that this is something worth exploring seriously, also in the light of the high extent of tax evasion perceived to be taking place in this country.

Linked to this issue is the level of corporate tax, which at present is also at 35 per cent, that is equivalent to the maximum rate of tax. Government has sought to provide an incentive to various sectors in the economy by granting tax benefits related to investment.

These tax benefits are seen to have worked well, generally, and they definitely have generated significant investment, both foreign and local. There are also tax benefits in connection with a range of financial services and this has created wealth in the country. Thus, in relation to corporate tax, experience has shown that a lower rate of tax does create jobs.

A discussion on the relationship between tax and work must also take into account tax evasion. I believe that tax evasion is a disincentive to work and leads to an element of laziness. There will always be an element of tax evasion irrespective of the rate of tax. We should not be complacent about this and our society, as a collective whole, needs to wage war on tax evasion, to enable government to reduce the rate of tax further thereby giving a further incentive to job creation.