Introduction
Taxes are crucial for the development of every economy. It
is one of the main sources of revenue to finance government spending on goods
and services and undertake projects in healthcare, education, social
protection, and other programs that improve the welfare of the people. However,
implementing an efficient and fair tax system that generates sufficient revenue
without discouraging or distorting economic activity has long been a challenge
for policymakers.
In many developing countries, total tax revenue as a
percentage of gross domestic product (GDP) remains relatively low. Tax rates tend
to be high and concentrated on a few wealthy individuals and large businesses.
This is because most workers and businesses in those countries are in the
agricultural or small, informal sectors, and their earnings often fluctuate and
are not properly recorded, making it difficult to calculate their tax liabilities.
Furthermore, many of these informal workers in Ghana do not spend their
earnings in large stores accredited to collect consumption taxes like VAT,
which excludes them from the tax net.
Ghana, since its independence in 1957, has implemented
several tax reforms aimed at broadening the tax base, accelerating growth, and
reducing its dependence on foreign aid to finance its expenditure. Some of
these tax policies include inter alia, the Value Added Tax
(VAT), Communication Service
Taxes (CST), Betting Tax,
and more recently, the Electronic Transfer Levy (E-Levy). However, despite all these
tax policies, Ghana’s tax revenue to GDP (which stood at
15.7% in 2023 from 12%
in 2019) still lags slightly behind the
sub-Saharan Africa average of about 20%.
This low tax revenue, coupled with government ballooning
expenditures on the back of many statutory obligations, makes it difficult for
the government to finance its projects. Government revenue is often depleted
after the payment of statutory funds, compensation of public sector employees,
and servicing both local and international debts. This means that any other
expenditure item would have to be financed through borrowing or deficit
financing. However, deficit financing (borrowing
from the Central Bank) has
been restricted, at least for the next three years under the Extended
Credit Facility (ECF) with the International Monetary Fund ( IMF). In addition,
Ghana has lost
access to the Eurobond
Market (which has been its major source of revenue over the last
decade) due to its unsustainable debt
levels. Therefore, proposing innovative ways of raising revenue domestically
through tax reforms is not only sufficient but a necessary condition for
ensuring fiscal consolidation under the IMF program.
As a result, various political parties, as part of their
campaign for the Ghana 2024 elections, have proposed some tax reforms aimed at
achieving a broad-based, inclusive tax system. One such policy proposal that
has gained national attention is the flat tax policy proposal by the Vice
President of the Republic of Ghana and Flagbearer of the New Patriotic Party
(NPP), Dr Mahamudu Bawumia. Dr Bawumia, while launching his 2024 campaign
titled “Ghana’s Next Chapter: Selfless Leadership and Bold Solutions for the
Future,” promised to introduce a flat tax system if elected as president.
“The current tax system in place, since independence, has
proven ineffective. It is overly complex and burdensome for individuals and
businesses, leading to widespread non-compliance and evasion. My administration will introduce a
very simple, citizen- and business-friendly flat tax regime. A flat tax of a %
of income for individuals and SMEs (which constitute 98% of all businesses in
Ghana) with appropriate exemption thresholds set to protect the poor. With the
new tax regime, the tax return should be able to be completed in minutes! We
will also simplify our complicated corporate tax system and VAT regime,” he
told party supporters.
To Bawumia,
the current tax regime is too complicated and cumbersome, thus the need for a
simple tax system that will maximize compliance and revenue generation. This policy has received mixed
reactions from tax experts, with some questioning its feasibility.
But what exactly are flat taxes? In which countries have
they been implemented, and what have been the outcomes? How feasible are they
in the Ghanaian context?
What is flat tax?
A flat tax, also known as a proportional tax, is a tax
system that imposes the same percentage on all taxpayers, irrespective of their
levels of income. This is in contrast to our current progressive tax system,
where the tax rate increases with the levels of income. Flat tax systems are not new. First proposed
by Hoover
fellows Alvin Rabushka and Robert Hall in the early 1980s, flat taxes have
been implemented in many countries over the last four decades. Yet, its revenue-generation
potential remains a subject of debate among economists and policymakers.
Proponents of the flat tax system argue that it is simple to
understand and implement compared to the progressive tax system. It is also
fair as it charges a uniform tax rate to all taxpayers and eliminates
loopholes, deductions, and special treatment for certain income categories.
They also contend that a flat tax increases the incentives to work, save,
consume, and invest, thereby stimulating investment and economic growth.
Critics, however, disagree with these assertions. They maintain that implementing a flat tax will result in high inequality, as the flat tax will place a disproportionate burden on the poor and render the government powerless to use fiscal policy to redistribute income. They also maintain that a flat tax, if not properly implemented, may result in revenue loss.
Thus, the views on the potential effects of flat taxes on
the economy are mixed. The question of its empirical impact on the economy can,
therefore, be addressed by reviewing the evidence from other countries that
have implemented it.
Which countries have introduced a flat tax?
An analysis of the economies of countries that have
implemented the flat tax system is a great way to assess the potential effect
of the policy on the Ghanaian economy. Although every country has a unique
context, and tax policy is just one of the several factors that affect the
economy, analyzing the development of economies that have been through such a
policy gives one a sense of the benefits and effects of the flat tax system.
Estonia was the first country to implement the flat tax in
1994. Following its successful implementation, many Eastern European countries,
the majority of which are former communist states, including Ukraine,
Lithuania, Serbia, Hungary, Slovakia, Georgia, Macedonia, and Romania, have
also implemented it.
In Estonia, the flat tax system was initially introduced at a rate
of 26% on personal and corporate
income. It was later reduced to 20% in 2009. Although its
implementation led to a
decline in personal income tax
and corporate tax relative to GDP, it has made the Estonian
tax system one of the most competitive in the world, simulating
foreign direct investment and
economic growth.
In 2001, Russia introduced a flat rate of 13% (which was increased to
15% in 2008) on personal income of above 4800 rubles. Since then, revenue from
personal income tax has risen by 50%. In addition, Russia also
experienced a reduction in tax evasion and
improved tax compliance following the implementation of the tax.
In the United States, more states have switched to flat taxes in recent years. For instance, from 2021 to 2022, five states, including Georgia, Arizona, Lowa, Mississippi, and Idaho, enacted legislation to adopt a flat tax system. Already, a flat income tax is being implemented across nine states, including Colorado, Illinois, Indiana, Kentucky, Massachusetts, Michigan, North Carolina, Utah, and Pennsylvania.
In the United States, more states have switched to flat taxes in recent years. For instance, from 2021 to 2022, five states, including Georgia, Arizona, Lowa, Mississippi, and Idaho, enacted legislation to adopt a flat tax system. Already, a flat income tax is being implemented across nine states, including Colorado, Illinois, Indiana, Kentucky, Massachusetts, Michigan, North Carolina, Utah, and Pennsylvania.
The benefits of flat tax systems have been tremendous in
many countries that have implemented them, although the magnitude differs from
one country to the other. Increases in tax compliance, reductions in tax
evasion, and rising investments have been reported in some countries following
the implementation of the policy. However, it has also resulted in worsening inequality
in other countries, particularly in Eastern Europe. Thus, the flat tax policy
is not “one size fits all” for all countries. It must be implemented within the
context and circumstances of the country.
How feasible is this policy in the Ghanaian context?
Ghana's current progressive tax regime is saddled with many
challenges, including complexity and non-compliance, with many exemptions,
deductions, and special treatment for certain groups of people. Dr. Bawumia
argues that the complexities in the current tax regime system make it difficult
for tax filing and
collection. He posits that introducing a flat tax will make tax filing simple
and easy, thereby improving tax compliance and promoting economic growth.
Of
course, a flat tax could yield short-term benefits for the Ghanaian economy.
However, it may result in far-reaching negative consequences for the economy in
the long run.
This is
because a flat tax policy may not necessarily address low compliance.
Furthermore, a flat tax system must be set optimally to ensure it does not
disproportionately burden the poor while also not being too low for the
wealthy.
In the
Ghanaian context, this policy could have significant effects. First, setting
the tax rate too low could result in revenue loss for the government.
Conversely, setting it too high could exacerbate existing inequalities,
increase the cost of doing business, and raise the cost of living. Furthermore,
critics argue that Ghana’s commitment to the ECOWAS Common External Tariff
(CET) and the
External Credit Facility from the IMF makes the implementation of a flat tax highly
unlikely, at least for the next three years.
Drawing from the arguments of supply-side economists, it appears the NPP still has some hope. Supply-side economists argue that certain tax policies can pay for themselves due to the positive incentives they generate in the economy—such as incentives to save, consume, invest, and produce. If this argument is anything to go by, setting a flat tax at a relatively low rate could generate positive incentives in the Ghanaian economy, potentially leading to increased investment, economic growth, and revenue generation in the long run. However, the big question remains: even if a flat tax creates substantial positive incentives in the Ghanaian economy, are these incentives enough to offset the revenue loss resulting from its implementation? The answer to this question remains an empirical one.
Conclusion
In conclusion, a cost-benefit analysis is needed to understand the benefits and potential effects of a flat tax system on the economy. Given our current economic difficulties and our commitment to the IMF programme and the ECOWAS Common External Tariff, implementing this policy at this time could have far-reaching negative consequences for the economy.
penplusbytes.org