Why Tax Policy Should Be Detailed in Affidavits

Charity is a cold grey loveless thing. 

If a rich man wants to help the poor, 

he should pay his taxes gladly, 

not dole out money at a whim.

Clement Atlee, Former British Prime Minister

Which affidavits? The ones candidates and political parties in the forthcoming general election will swear before we shortlist them as worthy of our votes. We’ve seen how irresponsible income and corporate tax cuts implemented since 2006 have extensively damaged the economy and the social fabric under three different PMs. While Navin Ramgoolam’s position on taxes during the past five years has oscillated between lowering them further to 13% for women and not raising them should he return to power. This is kind of worrying because it is the most urgent and important thing to do to avoid a significant degradation of an atmosphere that’s already pretty bad. So until we have recall elections and statute referendums we need affidavits and debates on their contents. Because politicians put something in their manifestos and then do the exact opposite.

Let’s fact-check some of the things that have been thrown at us to justify the implementation and the maintenance of such regressive policies and look at some related issues.

1. We experienced triple external shocks (TES) in 2005 and Sithanen’s response was to lower top tax rates for corporations and individuals. This was supposed to generate 8% growth rates (growth rates are an important component of social contracts aka projet de societe along with how the baked cakes are distributed). But as chart 1 shows we never got close to this target in any of the last 13 years (the distribution not shown here has also been the most unfair we’ve seen in at least 27 years). So it has failed completely. It should be scrapped and tax brackets should be added back at least to 35% next week because the cost of maintaining this losing policy has been enormous and will only worsen.

We could have avoided this disaster if we had looked at how the Reagan and Bush Sr. tax cuts in the 1980s had not generated the higher growth rates Laffer had promised but ended up increasing US public debt by 2.6X and 4X over eight and twelve years. In fact the only three times in the last 42 years that we’ve clipped rates of 8% or higher happened under a regime of progressive taxation. Plus as was demonstrated back in June 2006 before Sithanen started screwing up the economy really badly the TES are fallacious arguments. Ramgoolam was briefed end of April of that year that the guy was misreading the situation but either the then PM didn’t understand or he didn’t give two hoots which is as bad.

2. The flat tax has made us resilient which is why we were not hit hard by the 18-month Great Recession (GR). Untrue. We didn’t suffer that much from the GR because our banks didn’t have the kind of exposure to toxic assets as their American, British and Icelandic counterparts. Besides in 2008 the Rs5.8bn combined profit that MCB and SBM bagged were at the time record profits. Not exactly what you would call a financial crisis or a collapsing banking system.

Speaking of resilience, it is interesting to consider three episodes after which our economy did rebound (see chart 2). The first one is Claudette which smashed us into a depression (a deep recession) as from the last week of 1979 and wiped out two years of economic progress. Although real GDP collapsed by more than 10% we rebounded the following year with a 5.3% growth. The second is how a lack of planning caused a ‘drought’ to halve growth to 2.6% in 1999 before the economy surged ahead the following year with a growth rate exceeding 8% for the last time - now we don’t even have a ministry of plan and it shows. The third and final episode is when the textile industry rebounded after shedding about twenty thousand jobs in two short years. It is important to note that all three cases happened under a regime of progressive taxation. This is kind of obvious as we know that our welfare state keeps about one-third of us out of poverty and is therefore a very important source of resilience that our progressive taxation system used to make sustainable. Passionately tamper with progressive taxation like Sithanen did and you can kiss resilience goodbye.

3. We’ll get the promised 8% growth rates once the Great Recession ends. This didn’t happen either. As chart 3 illustrates it’s been 10 years since the GR ended and still no trace of average 8% growth. In fact we’ve had eight consecutive years of growth below 4% or half the target. That’s basically an L-shaped growth recession by our standards and at our stage of development. But this was expected after Sithanen killed savings (he’s now worried about low savings), broke the economy, created serious structural problems (he’s been worried about that for ages), hatched double-digit inflation, depreciated our rupee, crafted a controversial stimulus package and created massive inequality (guess what? that’s another of his worries). And because his successors sticked with these trickle-down policies. Please note that we haven’t even spoken about the controversial hire-fire laws and the elimination of the TCSB.

4. Increasing income and corporate taxes will reduce growth. It won’t. On the contrary this will help put the right dynamics back in place especially if they are accompanied by adding progressiveness in the VAT structure. They will for example help prevent Fond du Sac from getting flooded for a fourth consecutive year and hopefully get rid of the rodents in one school there. It’s good to note that in January the suggestion of newly-minted US congresswoman Alexandria Ocasio-Cortez (AOC) to tax annual incomes higher than USD10 million in America at 70% was raised in Davos - they are currently at 37% - and Michael Dell of Dell Technologies responded that he’s more comfortable giving money to his foundation than giving it to government through taxes and that higher tax rates would not help growth. Prompted to explain his point he challenged the moderator to name just one country where taxes this high had ever helped growth. The answer came instantly from fellow panelist MIT’s Erik Brynjolfsson: the United States! He mentioned that between about the 1930s to the 1960s the average tax rate was 70% with a peak of 95% and that these were good years for American economic growth. He could have used Mauritius and Scandinavia too.

Similar fears were raised in 1992 when Bill Clinton campaigned to increase taxes on the rich to reduce the deficit and get out of the growth slump that trickle-down economics had dumped the US economy in. Clinton raised taxes and ended up presiding over the longest economic expansion in US history with a 3.8% average growth - same as us for last ten years but theirs is in US$. You don’t want to compute ours in USD especially not in the first quarter of 2015. Unless you want to feel depressed. What you want check instead is the tax rates in OECD countries. It’s also quite an irony for Ramgoolam to have borrowed the ‘Putting People First’ slogan from the Clinton 1992 campaign playbook in 2005 and then to sponsor very regressive tax cuts which have thrown us into a growth recession.

5. The new normal for us is 4% growth and 3.8% growth is better than what countries like France are getting. People who are now saying that 4% is the new normal should have screamed at the top of their lungs in 2006 that Sithanen’s plan to flatten the tax structure to get 8% growth was completely cuckoo. Do you remember hearing anything like this? Anyway if 4% is the new normal, top tax rates can’t stay at 15% — because these are apparently compatible with 8% growth — and need to go up to at least 35% if we don’t want a major social crisis on our hands soon.

6. We can keep the flat tax if we cut wastage. Cutting wastage whether it’s in the private sector or the public sector is good. For instance back in 2005 a figure of Rs5bn of government wastage was floated after the publication of the government audit report. That was equivalent to 2.6% of GDP. If it has not risen to more than Rs12.8bn in 2018 then its share of GDP has fallen. We can find out by going through the audit report and come up with an aggregate number or as has been suggested to the National Audit Office for them to come up with these kinds of basic and handy totals. But the GDP and government revenue shortfalls are of a different order of magnitude. For instance there was about Rs58bn of government revenue missing in 2018 compared to what the flat tax was supposed to bring in. The corresponding shortfall for the private sector was Rs232bn. These will increase by Rs68bn and Rs271bn this year if PJ doesn’t do what’s right in a few days. By the way, we’ve never seen Sithanen’s estimates of the toohrooh he has hatched eh?

7. We can keep the flat tax if we implement enough targeting. Taxes were slashed by Sithanen to get 8% growth. This 8% growth would have generated an extra Rs115bn of government revenue by 2015 - roughly the size of the NPF at the time - even if we reduce the growth target in the Great Recession and assume that the additional government revenue generated by the higher growth rate had merely kept up with inflation which are very conservative assumptions. This would have allowed more generous pension payments or a game-changing sovereign wealth fund to be established and move us on a more intelligent growth trajectory. 95% or more of the population would also have felt tangible results of the tax cuts. But nothing of the sort happened because the 15% flat tax is economic snake oil. So the joke should end now and top tax rates should increase to 35% or more. We should also consider a 70% tax rate for dividends of Rs200m or more to catch up.

8. Restoring progressiveness in the tax structure is enough. Keeping the maximum tax rate at 15% and adding brackets of 5% and 10% will do the trick. Nope. Just adding progressiveness at a lower level will make matters worse because it would mean even lower government revenue. Instead we need to add more tax brackets all the way to 35% for starters because as chart 4 shows we’re in a deep deep hole aka the Sithanen toohrooh - GDP for 2024 is expected to be only 49% of the level promised by the flat tax.

9. We’re a sovereign country and we’ve decided to set tax rates at 15% flat. We’ve never voted on this. Such an important matter like proportional representation requires a referendum. Sovereignty, what sovereignty? Because the flat tax has broken the economy we don’t even have money to pay for an eye-hospital, the full cost of a weather radar, save at least 75 lives on our roads every year within five years, no 24/7 water for all yet, plenty of national issues remain outstanding while central government budgetary debt has increased by over Rs170bn over the last thirteen years (see chart 5). Public debt would have increased even more if governments did what governments are formed for: solve national problems one after the other.

10. PJ would be crazy to increase taxes in an election year. Not really when we consider two things. First a scan of the relevant comments on social media reveal that a fairly large majority of them are favourable to higher corporate and personal tax rates and the return of tax brackets. It’s no different from the situation of wealthy French citizens and American billionaires asking to be taxed more because they don’t want to live like depressed idiots in gated communities or watch their back each time they go buy milk. The second is that counting on a toohrooh which would have increased by 2.5X to Rs4.4tn (see chart 6) to return to power in 2024 because the next government will have the option to maintain the destructive tax cuts in place is dangerously naive. It’s good to remember that a Rs541 billion Sithanen toohrooh was enough to end impressive electoral winning streaks by Ramgoolam and Boolell in 2014 - Ramgoolam deserved a 60-0 in 2010 for his ultra liberal policies but clever manoeuvering and the presence of the on/off specialist on the political chessboard allowed him to keep his job but nothing could save him from something worse than a 60-0 four years later. PJ will face a toohrooh that’s more than three times bigger this year but he can present a budget a la Clinton on Monday and spell out his tax plans in an affidavit later this year.

Time to Get Rid of
The Economic Snake Oil 

As expected nothing good has trickle down in the last 13 years. Savings are in single-digits and at a 54-year low, Lepep avoided the last by-election and didn’t organise one in January 2017 when power was transferred from father to son. Besides we know after the Parmalat scandal that the use of special purpose vehicles has to raise eyebrows especially when the definition of public debt has been altered, its ceiling has been raised and the horizon to meet it extended. The 15% flat tax was to make available another fund the size of our NPF by 2015 or government debt-free by the end of last year. No trace of such a fund and central government budgetary debt is approaching Rs300bn. For all these reasons PJ should increase top rates for income and corporate taxes with enough brackets to at least 35% if he wants to help avoid political mayhem in a few months as this will be good for pretty much everybody now and absolutely everybody soon enough. It will help prepare our exit from the middle-income trap we’ve been stuck in for almost three decades. Another priority is to come up with measures to drastically slow down the growth of the car pool and send unambiguous signals that the punch bowl fueling real estate speculation will be taken away.