The Flat Tax on Individual PAYE Income in Jamaica: What more is to be done?
By Dillon Alleyne PhD Department of Economics University of the West Indies, Mona. Jamaica.
1. Introduction
Jamaica introduced a flat tax on Income in the 1980‟s at a time when there was considerable momentum for tax reform. The pre-reform system was characterized by steep marginal tax rates1 and the value of non-taxable allowances and credits were as large as the revenue collected (Alm and Bahl 1985). The burden fell heavily on middle income PAYE earners due to the fact that high income earners found ways to reduce their tax burden and the self-employed evaded almost all taxes (Alm, Bahl and Murray 1991).
Subsequent reforms have not been able to bring significantly more self-employed into the tax net. However, there is more certainty in the burden with the introduction of a single rate, a personal exemption and a broader tax base. . This paper examines the structure and burden of the current direct flat income tax with respect to PAYE workers mainly and with the help of a micro simulation model, examines further reforms in light of the equity and efficiency effects of the system.
It is argued that the individual flat tax must been seen in relation to other taxes and contributions which forms part of the direct tax system and that the current structure of direct taxes, militates against the full benefits of a flat tax. For example, when the income
1
The top marginal rate was 57.5 percent on a relatively low level of income of J$14,00.00 .In addition, there were 16 credits and a number of non-taxable allowances.
1
tax rates are added to the other direct taxes and contributions, the wedge between employer and employer payments could climb as high 40 percent (Light 2004:24). This paper is divided into several parts. Parts 2-4 focus briefly on the major premises
of the individual flat tax, Parts 5-8 set out the structure of the individual tax system in Jamaica, its revenue contribution and fairness. Parts 9-10 look at the new tax measures using a microsimulation model and their impact of the individual and payroll contributions. Part 11 looks briefly at taxes, labour supply and savings. Part 12 examines reform options and the last section concludes.
2. Conceptual issues in the flat tax.
There has been a great deal of debate surrounding the implementation of a flat tax on in some countries but in Jamaica much of the discussion was muted because of the unfairness of the old system and the need for greater revenue generation (Bahl 1991). This section briefly examines the key elements of a flat income tax as proposed by Hall and Rabushka et al (1986) Hall and Rabushka (1995) and that of Bradford (1986, 1996,2001) although there are other proposals (See Bradford 1984; Graetz, 1978).
The flat tax is conceived as a low tax on a broad base with a personal exemption (Foster 1995). The personal exemption creates progressivity in the tax structure and removes a number of low-income earners from the tax net. However, because there is a single rate, the jump between taxable and non-taxable status is large. The tax is fundamentally based
2
on the consumption principle with income being taxed once and close to its source. The rate is usually a standard rate designed to reduce opportunities for exploiting rate differentials. Some flat tax schemes, argue for additional deductions, such as an earned income tax credit and allowance for payroll taxes, to increase the progressivity of taxes (Bradford 2001; Weisbach 2003, 2000). Other proponents have suggested additional rates or even transitional rates. (Armey, 1986; Bradford 1996). The single rate, with income taxed close to the source is assumed to be crucial to the simplicity of the tax system (See Hall and Rabuskha 1996)
Fossedal and Carey (1987) in a study of flat- tax regimes across the world have argued that flat tax regimes are the single most popular approach to taxation of income, however, in relation to income taxes, multiple rates are still preferred. Usually the flat tax is seen as part of an integrated system in which income is either wages or business income with a single rate on both.
3. Individuals Under the Flat Tax. Under the flat tax schemes, taxable income would be salaries and wages and excluded would be dividends, interest, rental income and capital gains. While pensions received by individuals would be taxed, pension contributions would not be part of the base of the business tax. Of course, some schemes may exclude pensions, mortgage interest and charitable contributions (Bradford, 2001).
3
Ideally, the personal exemption would be indexed. In Jamaica, the personal exemption has not been indexed but it has have been increased occasionally but by less than the inflation rate. This has brought wage earners below the threshold into the tax net. In addition, there is an allowance for income received by pensioners with has been increased periodically.
Such things as charitable deductions, pensions and mortgage interest would not be deducted under some flat tax schemes but capital gains would bear no taxes. In Jamaica, there are no capital gains taxes, dividends are not taxed for firms listed on the local stock exchange, but interest expense is deducted. In addition, interest income to individuals is taxed, dividends from some firms are taxed twice and there is no deduction for mortgage interest. Taxing dividends twice and interest income goes against the cannons of flat tax proponents.
4. Economic Growth and Work Effort.
Flat tax proponents argue that it will stimulate growth through lower business taxes and higher take–home pay due to an expanded tax base and movement of the tax from income to consumption. A comprehensive tax base removes the differential between tax treatment of various assets and forms of income. This will also remove the dichotomy between formal and informal sector, which arises from the large tax wedge between the sectors. Lower tax rates are expected to raise the rate of return to labour, savings and investment. This, it is argued, will reduce the incentive to avoid or evade taxes and also reduce compliance costs. At the business level, the traditional incentives to capital
4
formation would be removed and replaced by the expensing of investment which it is anticipated will stimulate new investment.
Proponents of the flat tax also argue that a revenue neutral shift to a consumption tax will raise the savings rate due to the double taxation of income from capital and because capital gains, interest income and other capital income will not be taxed. This, as Gale points out, depends on how pensions will be perceived in the future, whether some savings already receive some no-tax treatment and the way transitional rules may affect the long term impact on savings (Gale: Brookings Institution).
5. Structure and Base of Income Taxes.
This paper argues that the individual income tax must be analyzed as part of a broader range of other taxes and statutory deductions, which make up the direct tax system. The reason is that these programs detract from the efficiency and equity of the income tax.
The base of the tax for PAYE workers is as follows:
Salary and Emoluments-Allowances-Enumerated Deductions2 – allowable deductions-Threshold [plus an allowance for persons 65years] = Taxable Income.
For the self-employed it is,
Income – allowable expenses plus emoluments3-enumerated deductions=statutory income.4
2
These are contributions to an approved superannuation fund, contributions to the Civil Service pension fund, contributions to the NIS etc. 3 Allowable deductions are expenses incurred wholly and exclusively in earning income. 4 For companies all income minus expenses=chargeable income.
5
PAYE workers operate purely on the withholding system except if they receive other sources of income and are then required to file a return. Individuals who have multiple income sources must file IT05 forms and use this to reconcile income from various sources.
Besides PAYE workers, other individual tax payers are mainly the self-employed and partnerships. The former group files IT01 forms and make quarterly payments. The latter file IT03 forms but must file separately as individuals to compute individual liability.5
Income taxes are imposed on worldwide income, including PAYE, tax on interest and dividends and on the self-employed as „other‟ income. Realized capital gains are not taxed but dividends are taxed at the company level and at the individual level, except for dividends from publicly listed companies.
An IDB (2003) study shows that the Jamaica tax code for debt-financed projects allows the nominal deduction of interest and depreciation, at historical costs, 6 for income tax purposes. As a result, equity-financed investment is taxed more heavily than debtfinanced projects especially in an inflationary environment (IADB 2003). Recipients of
5
IT04 forms are filed by life assurance companies and IT07 forms are used for making estimated payments and IT06 is the employer annual return. 6 The IDB (2003) study points out that neutrality is only achieved if real interest rates and depreciation are deducted ,and at the same time interest on savings are taxed at the individual level and dividends are exempt for individuals.
6
interest and dividends do not report taxes paid by firms and as a result, one is not sure how much goes to corporations and to individuals. 7
Workers also receive non-taxable allowances and among these are the following: meal and uniform allowance, housing accommodation, motor vehicle expenses and monies to purchase shares in Employee Share Ownership plans. As Wallace and Alm (2004) point out, the list is not wide and some are subject to specific rules and limits. The uniform and laundry allowances are provided to some workers and have limits.8
The housing allowance is significant in relation to the others and has the caveat that the annual value of the allowance should not exceed 15 per cent of the total emoluments paid excluding the housing value for the year. There are other complications, for example, if the rent is paid to the employee directly, if the accommodation is owned by the employer etc.9 There is also a motor vehicle allowance and this depends on whether the vehicle is owned by the employer or employee. Certain types of termination payments are also tax free and these are commutation of pensions, terminal gratuity, and severance pay among others.
The income tax is complicated by a variety of incentives to industry and tax expenditures which are a source of revenue leakage. The most obvious is that going to the Tourism
7 8
Wallace and Alm(2004) assumed that 50% went to corporations and 50% to corporations. The uniform and laundry allowances have a limit of exemption of $5,739.0 and $3,395.0 per year respectively and these go to Judges, attorneys-at-law, policemen etc. 9 The housing allowance is complicated by the type of accommodation, whether it be sub-leased, whether a 3rd party pays the rent, or whether the employer owns the accommodation.,
7
sector. For example, workers in the tourist sector benefits from non-taxable gratuities and bonuses, which are utilized by a broad range of income groups. In addition, properties under the Hotel Incentives Act, are entitled to income tax and import duty relief for 11-15 years. Properties under the Resort Cottages Incentives Act are entitled to relief from income Tax of up to seven years.
Between 2001 and 2003 maximum non-taxable portion of the bonus was $250,000, which created, an incentives for wages to be paid as bonuses. In addition, while the GCT was introduced in 1991 at a rate of 10 percent only 50 percent of this rate was imposed on the Tourism sector. When the rate was raised to 12.5 percent the sector paid a mere 6.5 percent. The rate in 2005 was raised to half the current rate of 16.5 percent. Given the importance of this sector to the Jamaican economy, these tax expenditures constitute a considerable revenue loss.
There are a range of other incentives to firms, such as the investment tax credit (ITC), which favor subsidizing capital10. 6. Other Direct Taxes and Contributions.
It is a mistake to examine the individual income taxes apart from the other wage based programs since they add considerably to the tax burden and crate horizontal and vertical inequities. There are five other programs, which are based on the earnings of workers, and these are the Education tax, the Human Employment and Resources Training
10
There are exempt activities, which pay no tax at all, and there is the ITC of 20% and 40% for some sectors. The ITC reduces the cost of an asset to 60% or 80% of the cost faced by other firms, but allow firms to depreciate by 100% of the asset value.
8
(HEART) Trust Fund, National Housing Trust (NHT), the National Insurance Scheme (NIS) and the Civil Service Family Benefit Scheme (CSFBS). While the Education and Heart programs are straight taxes, the NIS and NHT and CSFBS have benefit components and are properly described as contributions. There have been no recent actuarially fair studies on these contributions thus it is not clear what the extent of the tax element is.
Appendix I shows the rate structure and base of these programs. The CSFBS acts as a whole life insurance policy for officers in pensionable positions in the public sector who pay 4 percent of gross emoluments in the program.11Benefits are paid to family members is case of death of the officer. Alm and Wallace et al (2004:4) set out these benefits in detail.
The education tax is a proportional tax imposed on a base similar to the income tax. For PAYE workers, the base is gross emoluments (net of NIS and CSFBS) while for a person who is self-employed it is total income above the minimum wage and there is no standard deduction.12 Government departments and statutory bodies are exempt from the employers‟ share of the tax. The tax is withheld by the employer and remitted monthly to the Inland Revenue but compliance by the self-employed is very low.13
11 12
The CSFBS contributions are deducted from gross earnings before getting income subject to income tax. Allowances subject to tax are taxable under the education tax. There is no ceiling or standard deduction. 13 Exempt are also companies in which Government has a majority share.
9
The Heart tax is imposed on private businesses to provide skills training14 for workers and employment opportunities. Employers with a monthly payroll of $14,444 pay the tax. Employers can get a credit against their Heart liability if they employ heart trainees and retaining them over time (Alm and Wallace 2004:8).15
The NHT was established to improve and increase the housing stock by imposing a tax to fund housing programs. The NHT has the same base as the income tax and PAYE individuals pay 2 percent of gross emoluments and their employers pay 3 percent16 the for the self-employed it is 3 percent. Individuals are entitled to several benefits mostly a variety of mortgage loans and cash grants. Individuals are entitled to cash refunds after seven years at 3 % interest and for funds held longer at 8 5 interest. These rates are below market interest and the individual does not receive the employer‟s contribution.17
Finally the NIS which is the oldest and largest of the wage based programs is a funded involuntary social security system. Generally individuals pay 2.5 percent of their emoluments up to J$500,000 with the employer paying another 2.5 percent of emoluments. The tax base is gross emoluments including taxable allowances and it appears that most of the contributions are from withholding the tax. Beneficiaries are entitled to a variety of benefits such as old age pensions, widow‟s pensions and invalidity pensions. (See Alm and Wallace 2004:17).
14 15
The training programs are done in a number of institutions and there are a range of programs. The trainees and their employers are subject to NIS,NHT and the education tax. 16 The employer‟s share of the tax is an expense in computing company taxes. 17 This program obviously has a large tax element.
10
Alm and Wallace have shown that social security contribution rates in Jamaica are low by international standards while payroll tax rates other than social security contributions are relatively high especially with respect to Latin America and the Caribbean (Alm and Wallace 2004:3)
Given that thee programs are all involuntary there has developed tremendous incentives for dividing work time and work effort between the formal and informal sector among PAYE workers. In the case of the self-employed there may be outright evasion.
7. The Revenue Performance, and Taxable Capacity of Income Taxes
The personal income tax continues to be an important revenue earner and has contributed about 7.8 percent of GDP in FY 2003/04. The flat tax on income was first imposed at 33 1/3 percent in 1986 with an initial threshold of $8,580.0018 and the rate is now 25 percent with a current threshold of $195,00019. The key feature of the individual tax system has been the threshold or
standard deduction has been raised periodically to adjust partially for inflation. , thus
„bracket creep‟ brings many persons below the threshold into the tax net.
The threshold value relative to 1996 was just 53 percent in 2003. Despite this, the income threshold was relatively generous and covered 23 percent of household expenditure in 2003 and 17.7 in 2004 with a new threshold (Wallace and Alm 2004).
18
The threshold was $10,400.00 in 1989,$14,352.00 in 1992,$18,408.0 in 1993, $22,464.0 in 1994, 35,568.00 in 1995, $50,544.0 in 1996,$80,628.0 in 1997, $100,464.0 in 1999 and $120,432.0 in 2001. 19 In the last budget presentation the threshold was increased to 193440 in January 2006 and 275000 in January 2007. Thereafter it was to be indexed to inflation.
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Table 1:Revenue and Contributions as a Percentage of Total Tax Revenue
PAYE 1992-93 1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-20 2000-01 2001-02 2002-03 2003-04 2004-05 3,407.00 4,716.00 6,781.00 9,269.00 11,907.00 13,175.00 15,028.00 14,226.00 16,515.00 18,907.00 22,286.00 27450.7 35328.01 Iother Dividend ndividual 177.00 218.00 370.00 478.00 483.00 362.00 746.00 1,168.00 854.00 608.00 323.00 423.00 583.00 579.00 631.00 741.00 842.00 837.00 926.00 854.00 Education 666.10 1,052.60 1,540.70 2,046.00 2,653.90 3,119.80 3,365.50 3,541.50 3,820.70 4,234.30 4,872.20 5,711.99 6643.05 Interest 1,268.00 1,402.00 1,884.00 1,666.00 2,382.00 2,150.00 1,925.00 6,161.00 9,535.00 8,463.00 9,121.00 14,823.51 14864.2 NIS$M 237.44 314.51 228.31 340.09 1,928.56 2,337.14 2,459.37 2,531.82 2,640.70 2,654.36 2,981.52 NHT(Thous HEART((Th ands) ousands) CSFBS$m Tax Revenue 706.64 1,108.79 1,580.96 2,188.29 2,847.58 3,796.88 3,711.88 3,945.53 4,334.44 4,935.58 5,461.21 323.13 483.74 720.40 1,007.90 1,275.26 1,478.86 1,609.29 1,706.77 1,838.57 2,053.33 2,262.80 41.03 82.74 51.80 103.18 150.02 457.61 364.38 366.22 296.02 383.87 19,050.00 28,948.00 38,072.00 50,263.00 55,109.00 59,224.00 66,970.00 75,962.00 87,074.00 90,568.00 102,859.00 130,632.67 150205.24
135.00 1,114.00 307.9 1,668.11
261.7 1763.13
na na
1.2 1.1 0.6 0.7 3.5 3.9 3.7 3.3 3.0 2.9 2.9
na na
0.04 0.04 0.04 0.04 0.05 0.06 0.06 0.05 0.05 0.05 0.05
na na
0.02 0.02 0.02 0.02 0.02 0.02 0.02 0.02 0.02 0.02 0.02
na na
0.001 0.002 0.001 0.002 0.003 0.007 0.005 0.004 0.003 0.004
Percentage of Total revenue 1992-93 1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-20 2000-01 2001-02 2002-03 2003-04 2004/05 17.9 16.3 17.8 18.4 21.6 22.2 22.4 18.7 19.0 20.9 21.7 21.0 23.5 0.9 0.8 1.0 1.0 0.9 0.6 1.1 1.5 1.0 0.7 0.1 0.2 0.2 1.7 1.5 1.5 1.2 1.1 1.3 1.3 1.1 1.1 0.9 1.1 1.3 1.2 3.5 3.6 4.0 4.1 4.8 5.3 5.0 4.7 4.4 4.7 4.7 4.4 4.4 6.7 4.8 4.9 3.3 4.3 3.6 2.9 8.1 11.0 9.3 8.9 11.3 9.9
Note: The following: NIS, NHT, HEART, CSFBS are not added to total revenue. Source: Ministry of Finance and Planning;
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Table 1.Shows the revenue structure of direct taxes and contribution and their relation to total tax revenue between 1996 and 2004. Personal Income tax revenues have growth from 17 percent in 1992/93 to 23.5 percent in 2003/04. This growth has been steady but uneven due to fluctuations in PAYE employment. For example, income tax revenues were 21 percent in 1996/97 and 18 percent in 1999/2000. Total tax revenue has increased from $19 billion in 1992 to $150 billion in 1994, a growth rate of 18 percent while individual income taxes increased from $3 billion to $35 billion, which was a growth rate of 21 percent. The only other tax rivaling the income tax for revenue generation is the GCT.
Overall direct taxes contributed 41 percent of total revenue in 1992 and 39.2 percent in 2004 suggesting a decline in direct contribution total taxes. The education tax and taxes on interest showed a steady contribution over the period.
One of the greatest failing of the income tax is the inability to raise additional revenue from the self-employed. While the sector has grown the revenue impact has remained the same. The revenue contribution has remained between 1.1 and 1.3 percent throughout the period.
Wallace and Alm (2004:34) examined the ratio of individual tax revenue to GDP for a number of countries and found that Jamaica‟s share was almost two percentages higher than the average. In addition, they computed the buoyancy and elasticity coefficients from 1993-2002 and found that the coefficients were 1.28 and 1.23 respectively. While
13
these coefficients represent strong revenue increases they concluded that in periods of economic decline, the growth in PAYE revenue is negative.
A comparison of taxable capacities across countries, can demonstrate whether the revenue stream of the individual income tax is typical for Jamaica. Wallace and Alm (2004) ran regressions for 35 countries based on the usual set of variables as percapitaGDP, openness and population size. By comparing the actual effort with a prediction from the equation they found that Jamaica‟s effort was among the highest in the world. While the predicted effort was 3.3 percent the actual ratio was 8.25 percent. They attributed this to the broad base of the system even though GDP may be understated due to the size of the informal sector.
8.The Fairness of the Income Tax and Contributions.
Because the income tax has always has been seen as central to affecting income inequality the fairness of the tax is important. Recently Wallace et al (2004) computed the burden of taxes and using the assumption that wage earners bore the tax found a progressive structure (Appendix 2). Despite this however, there are considerable inequities across sectors and among different workers.20 The fundamental challenge however, is the level of evasions and avoidance, especially among the self-employed.
Alam and Bahl (1985) found that the tax system lost revenue to the tune of 39 percent due to the self-employed non-filing. The PAYE workers constitute the main source of
20
There are 4 types of potential individual taxpayers and these are PAYE, self-employed, pensioners and recipients of dividends, interest and rental income.
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revenue for the individual income tax, and using the emolument survey of 2001(MOFP, 2003),21 Wallace and Alm (2004:42) estimated that there were 353,827 compensated jobs in 2003. Given that about half the jobs are from self-employment, they took half the employed labour force and found that at least 470,000 PAYE workers should be in the tax net. The implication was that about 120,000 workers or 25 percent were outside the tax net. On the other hand the self-employed have continued to pose and even bigger threat and one estimate is that 70-90 percent do not file returns. The level of evasion and avoidance impacts also on those who are paying and clearly the withholding system has been the most successful in ensuring compliance.
There are several other factors contributing to vertical and horizontal equity in the system. First, the use of allowances also creates a wedge between those who are entitled to allowances and those that are not. Secondly, there are also inequities between sectors, for example tourism workers versus others in the economy and between the public and private sectors for workers receiving the same level of compensation. Thirdly, persons over 65 who receive pension income receive a credit for that income and those of the same age who do not receive such income pay a higher tax rate.
Fourthly, there are differences between individuals who receive capital gains, which is not taxed and those who receive wages. Thus there is also an incentive to shift from wages to capital income in some businesses since capital gains are not taxed.
21
The sample was 177 firms and 20 government agencies and it was estimated that there were 355,500 compensated jobs.
15
Also those who receive dividends from publicly listed companies pay no taxes while those who receive the same amount from other companies pay the 25 percent rate. Given the higher corporate tax rate of 33 1/3 percent it may be rational to shift from corporate to non-corporate status to evade taxes.
9. The Impact of New Tax Measures, Microsimulation.
In the 2005/2006 budget22 a number of changes were introduced which will further impact on the income tax structure. Among these were the following: The threshold was increased from $100,432.0 to $169,104 in July 2005, and this was to be further raised to $193,440 in January 2006, and $275,000 in January 2007 after which it will be indexed to inflation. In addition, the tax free allowance for pensioners under 65 years has increased to $240,101 and those over 65 years to $259,104.By January 2006 the allowances for these groups will increase to a further $238,440 and $283,400.0 respectively.
A number of complication have also been creeping back into the tax base for example, public sector workers under the Memorandum of Understanding23 will receive $400 per week with income less than 250,000, those with incomes greater than 250,000 and less than 650,000 will receive $600.00 weekly and those over $650,000 will receive $500.0 weekly. In addition, staff- loans which were once taxed would now be tax free. In addition changes have been made to lower the amounts of commissions and gratuities. These have been aimed especially against tourism interests, which utilize most of these.
22 23
The changes followed recommendations by The Tax reform Committee The Memorandum of Understanding is a three year agreement between the public sector unions and the government on wage restraint.
16
Commissions will be capped at 15 percent of gross income and gratuity at 5 percent of gross income. The impact of the recent changes to the tax burden is analyzed using a micro simulation model developed by Wallace and Alm (2004:66) for PAYE workers, and updated to 2003/2004(See Appendix 4). Table 2 sets out the distribution of direct taxes for 2004 without accounting for the changes in commissions and bonuses. The rate is definitely progressive and eliminates the first four income groups from the tax net.
Table 2: Total employment, Gross emoluments, tax Liability and tax rates for 2003/04. Liability by Liability as Income Number of Gross Income %Paye Group Employees Emoluments((J$Millions) Class Emoluments < $50,000 30866 1030 0 0 50,000-100,000 45582 3524 0 0 100,000-120,432 30059 3389 0 0 120,432-150,000 17197 2320 0 0 150,000-250,000 57143 11414 295 2.31 250,000-500,000 81887 29194 2906 9.50 500,000-1,000,000 71600 50104 7919 15.55 1 – 5 million 43626 78508 16126 19.94 Greater than 5 million 1072 7586 1765 23.20 TOTAL 379032 187069 29012 15.50
These rates do not include other incomes made by PAYE workers including interest income, dividends and other forms of income. Wallace and Alm (2004) showed that the distribution dividends rose from .7 percent of income <$J50,000.0 to 37.6 percent for income between $1 to 5 million. For interest it was 6.67 percent to 22.87 percent for the same income levels. It is clear that when these are included the distribution would be far less progressive.24Table 3 reports the major allowances, which are a great source of
24
Such incomes as work done in the informal sector or a second is not reported. For example, teachers teaching after school.
17
distortion in the direct tax system and support the argument for flat taxes in which all allowances are made taxable.
Table 3.Not-Tax Allowances 2003/04 ($M) Income Groups Total non-tax Total non-tax Total non-tax Total non-tax Total non-tax Total non-tax Group Allowance Uniform Housing travel Meals Motor Vehicle < $50,000 35.3 34.9 0.4 0.05 0.03 0 50,000-100,000 54.5 18.8 10.0 1.3 12.5 0 100,000-120,432 13.7 7.7 4.1 0.76 0 0 120,432-150,000 35 10.1 3.3 0.9 19.9 0 150,000-250,000 553.1 86.7 81.8 28.9 7.3 0 250,000-500,000 1629.1 93.1 155.5 327.8 66.7 0 500,000-1,000,000 3241.6 42.2 523.0 1089.5 575.6 51.5 1 – 5 million 3715.4 20.3 115.5 2506.2 165.6 42.6 Greater than 5 million 91.8 0.5 0.0 64.2 0 3.2 TOTAL 9369.5 314.3 893.6 4019.6 847.6 97.4
Allowances were 9.3 billion with the bulk coming from non-taxable travel and housing. It is clear that they are largely concentrated in the range$250,000.00 to 1.5 million dollar range. The allowances are clearly a means of reducing the tax burden. Table 4 shows the tax rates with and without allowances among individual PAYE taxpayers. The difference between these rates do not include changes in limits for commissions and gratuities (difference 1).When these are included the difference (difference 2) is also reported.
Table 4: Tax Rates with recent changes in tax structure with and without Commissions and Gratuities. Difference 1- Difference 2Tax Rates No with without Tax Rates with commission commissions Income Groups Allowance Allowance and gratuities and gratuities
18
< $50,000 50,000-100,000 100,000-120,432 120,432-150,000 150,000-250,000 250,000-500,000 500,000-1,000,000 1 – 5 million Greater than 5 million TOTAL
0 0 0 0 2.7 11.73 17.44 21.27 23.82 17.1
0 0 0 0 1.52 6.91 13.81 18.33 22.5 15.7
0 0 0 0 1.18 4.82 3.63 2.94 1.32 1.4
0 0 0 0 1.01 3 2.79 2.87 1.27 -
Figure I shows the tax burden with and without the recent changes to commissions and bonuses. Notice that when the changes are included (difference 2) the line becomes flatter which suggests that the rates had been greatly reduced between those who receive commissions and bonuses and those that do not.
10. Other Taxes and Payroll Contributions
As has been argued before, the benefits of the income taxes may be undermined by the other direct taxes and contributions. The education tax for example has ceiling and its base is total emoluments net of NIS and CSFBS. The income tax rate, in addition to those of the payroll contributions, adds to the low income tax burden. Clearly some integration of the whole system is necessary especially since the administration of the various programs is also different.
Alm and Wallace (2004) have shown that the statutory burden of the payroll contributions for private sector workers, ignoring the employers contribution, varies between 4 and 6.5 percent and when the employers‟ portion is included it rises to between 18 and 13 percent. (Appendix 3). The regressive pattern is due to the ceiling of 500.000.00 on the NIS for high-income earners. For government employees, the marginal
19
rates (employee‟s share only) varied between 8 and 10 percent and when the employers‟ portion is included it varied between 17 and 22 percent. Interestingly, for the selfemployed the rates varied between 5 and 10 percent. The results suggest that there were considerable vertical and horizontal inequities across income groups.
Table 5 shows the effective rates for the payroll contributions, without the CSFBS and the results suggest that when the worker is assumed to bear the burden of their own contribution for 2004, the average rates varied between 3 and 4 percent and when the employer portion is added it varies between 7 and 10 percent with a generally regressive pattern.
Table 5:Effective Tax rates on Payroll Contributions, with recent tax changes Employer Employees only & employee Average Rate Average Rate Income Groups
< $50,000 50,000-100,000 100,000-120,432 120,432-150,000 150,000-250,000 250,000-500,000 500,000-1,000,000 1 – 5 million Greater than 5 million TOTAL
4.44 4.43 4.30 4.44 4.43 4.43 3.79 2.76 2.15 3.30
9.72 9.71 9.38 9.71 10.00 10.84 9.78 8.15 7.19 8.90
11. The Effect of Payroll Programs on Labour supply and Savings
20
The heavy tax burden on labour creates income and substitution, the impact of which is uncertain. Although compensated labour supply elasticities for Jamaica are relatively small (Alleyne 1997; 2000) they are not negligible25. Recently Light (2004) computed the welfare cost of individual taxes using a general equilibrium (GE) model for Jamaica. The results depended on the net-elasticity of labour supply. When the elasticity is low, labour bears the burden of the tax, as we would expect among some PAYE workers in Jamaica. The argument is that as firm substitute away from labour, workers cannot respond easily. On the other hand when elasticities were high, workers are able to sell less labour and shift away from consumption to leisure, thus the efficiency of the tax falls. The issue here however, is not just labour time (which is usually fixed) but the intensity of work, and shirking26 by employees in the formal sector. The analysis did not include the drift of workers to the informal sector or workers having a second job, which implies that supply elasticities are high for some workers, and this would increase, considerably, the welfare cost of labour taxes.
The direct tax rates together with the 16.5 percent of the GCT create a considerable burden especially on middle-income earners. Light (2004:27) suggests that reducing labour taxes by 20 percent and raising the revenue through a uniform GCT would actually lower efficiency costs, a strategy which the government seems to be pursuing with increase in the threshold and increases in the GCT.
25 26
These are results from partial equilibrium studies with both linear and non-linear budget constraints. This includes the use of the employer‟s premises and overheads by workers especially in the public sector, to conduct other business.
21
Many workers also migrate to the informal sector, as a way to allocate their labour time so as to minimize taxes.27 As labour moves between sectors the gross-of-tax return will increase in favor of the informal sector encouraging over allocation of resources to this sector( Alm and Wallace 2004);.
Since the bulk of the payroll taxes and contributions are collected from PAYE workers, there is considerable incentive for workers to move to the informal sector and to selfemployment, since the tax rate can be driven down as low as possible.
Another important consideration is the impact of the payroll programs on savings. Because there are both tax and contribution elements in the programs, their impact may be different. The Education and HEART programs like the income tax are straight taxes and may have a pure income effect causing a reduction in current consumption and savings. In terms of contributions, the results are less certain. Theoretically, using a lifecycle model, one expects the tax to reduce savings by the full amount of the contribution28, yet national savings may not be reduced. The contributions are usually invested in Trust Funds a used to purchase government securities which pay low rates. Given the significant tax element in these programs they will have an impact on savings. It is clear that any revenue neutral reduction in rates on the taxes and contribution would possibly increase savings and work effort.
27
For example many PAYE workers may have a second job or business. A good example is school teachers who keep classes after school. People may also use the work day to conduct other private business activities. 28 Given the current inflationary environment Jamaicans are aware that the contributions are not significant and this may increase savings.
22
12. Reform Options:
The individual income taxes, together with the payroll contributions, create a complicated system of direct taxes with an uncertain overall burden. With respect to the income tax, the allowances, even though reduced, still create an avenue for evasion. While Wallace et al(2004) in a study of the incidence of taxes found that interest income and dividend payments were progressive (Appendix 2 ) the non taxing of capital gains, the lack of indexation for inflation and the use of allowances, create vertical and horizontal inequities among workers.
Various problems with the Payroll contributions can be summed up in a number of points. First the bases of the programs could be made more uniform since they introduce inequities in the system. The joint programs add a significant burden to labour despite their benefit components and with subsidies to capital, there is a disincentive to hire labour. One major change that is needed is to impose the payroll programs on the same tax base and move towards eliminating most of the allowances. We set out a few points, which may constitute the next step in the reform process.
The first of these is the waste of having a separate education tax, which brings lowincome earners into the tax net. If the threshold were maintained then the tax would imply an additional 7.4 percent increase in rates 29 and this would eliminate the need for any additional administrative procedures. Table 6 shows the average education tax
29
Wallace and Alm found a rate of 5.1 percent for 2002/2003.
23
revenue for 2004 and the additional revenue required, by income groups, to eliminate the education tax and convert this to an income tax.
Alm and Wallace (2004) have considered in their reform proposals removing the HEART tax from employers and raising the same revenue through income taxes. There is little momentum to give up this secure form of revenue given the size of HEART programs.
Table 6:Average Education Taxes and revenue required to convert this integrate this with the income tax.($thousands) Average Average Education Additional Tax Revenue Revenue Income 2003/04
Group
< $50,000 50,000-100,000 100,000-120,432 120,432-150,000 150,000-250,000 250,000-500,000 500,000-1,000,000 1 – 5 million Greater than 5 million TOTAL
1713.60 3916.33 4946.67 6134.13 9484.30 17087.25 33139.18 84310.23 343833.65 24658.19
0.00 0.00 0.00 0.00 1534.38 11689.07 33262.79 108584.10 498114.25 24639.76
The proposal here is to bring all the allowances into the Payroll contribution base thereby reducing the overall rates. The HEART tax has a threshold level higher than the personal exemption. This could be brought in step with the threshold when it increases. If the HEART tax is paid by all employers (government plus the private sector) and the NIS ceiling of $500,000.0 is lifted the revenue neutral rate is now 4 percent and the overall 24
pattern is progressive rising from 3 to 4 percent. Most importantly, the NHT and HEART rates will be cut in half30.
It seems that there is a limit to which more rate reduction can occur without reducing overall revenue under the current direct system. The key to further rate reductions is in bringing more of the self-employed into the tax net, taxing capital gains including shares of companies on the stock exchange. A final proposal is to integrate the company tax with the income tax along the lines of flat tax proposals thus creating a seamless system of direct taxes and business income. At the moment there is a wedge between the individual rates, the corporate tax rates and 0 rates in the informal sector and this may encourage firms to move from corporate to noncorporate status to evade taxes.31
13: Conclusion The reform options many of which have been pointed out before will create a better flat tax structure but this will also be limited without integration with the business tax. Overall the amount and number of allowances have become quite small with manageable limits, however there is still room for shifting the burden. The real impact of reform on middle-income PAYE workers will be a reduction in overall rates. This can only come about, given Jamaica‟s dire fiscal situation, if more self-employed are brought into the tax net.
30 31
The benefits of the programs would have to be adjusted. The corporate rate is 33 1/.3 percent.
25
26
Fighure 1:The Ratios of PAYE, Dividend,Other Individual, Education and Interest toTotal Revenue
25.0
20.0
Percentage
15.0
10.0
5.0
0.0 1992-93 1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-20 2000-01 2001-02 2002-03 2003-04 2004-05 Fiscal Years
PAYE/Revenue Education/Revenue
Dividend/Revenue Interest/Revenue
O.IND/Revenue
27
Appendix I. Tax Base and Tax/Contribution Rates in the Payroll Programs
PAYE Worker Employ ee Rate Self-employed Worker Employer Rate Tax Base Rate Individual Benefits?
Program
Tax Base
Gross emoluments of government employees in “pensionable” offices No ceiling(a) Emoluments, net of NIS and 2. Education CSFBS contributions Tax No ceiling(b) 3. HEART Tax Total emoluments of any employer whose monthly payroll exceeds J$14,444© Emoluments, net of NIS and 4. NHT CSFBS contributions Contribution No ceiling(d)
1. CSFBS Contribution
4%
NA
NA
NA
Yes
2% NA 2%
3% 3% 3%
Gross earnings No ceiling NA
2% NA 3%
No No Yes
Gross earnings No ceiling Gross earnings up to J$500,000
5. NIS Contribution
Gross emoluments up to J$500,000(e)
2.5%
2.5%
5%
Yes
Source:Table 5 Alm and Wallace(2004)
(a)The NIS and CSFBS are deducted from earnings before earnings for the individual income tax(IIT). (b)The base is similar to the IIT.(c) Base is similar to the income tax.(d) base is similar to the IIT.(e) Earnings >$500,00 bear no tax.
28
29
Appendix 2: The Burden of Jamaican Income Taxes and Contributions,2003 Educat Income Payroll ion Decile Paye Taxes HEART NHT NIS Tax CSFBS Interest Dividend
Corporate. Tax
Property Tax
Total Total Direct Taxes Tax
1 2 3 4 5 6 7 8 9 10
0 0 1.19 3 3.83 4.84 6.12 7.33 9.85 11.59
6.54 7.82 7.07 6.71 7.12 7.39 7.46 7.54 7.9 7.56
1.04 2.65 2.27 0.99 1.01 1.04 1.04 0.97 0.89 0.81
1.77 1.68 1.56 1.83 1.94 2.01 2.04 2.04 2.19 2.29
1.81 1.76 1.62 1.89 2 2.07 2.11 2.12 2.16 1.55
1.76 1.67 1.54 1.81 1.92 1.99 2.03 2.04 2.15 2.24
0.16 0.06 0.08 0.19 0.25 0.28 0.24 0.37 0.51 0.67
1.78 0.91 0.87 1.18 0.88 1.1 3.07 2.42 1.3 1.85
0.05 0.02 0.02 0.03 0.02 0.03 0.08 0.07 0.03 0.06
1.98 1.42 0.71 0.69 0.62 0.78 1.51 1.31 1.16 2.34
0.64 0.69 0.61 0.62 0.59 0.54 0.37 0.34 0.36 0.36
17.53 18.68 17.54 18.94 20.18 22.07 26.07 26.55 28.5 31.32
11.0 10.9 10.5 12.2 13.1 14.7 18.6 19.0 20.6 23.8
Source:Wallace et al (2004)
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Appendix 3: Statutory Tax Incidence of the Payroll Taxes and Contributions: Combined Marginal Tax Rates PAYE-Private Sector Worker PAYE-Public Sector Worker Employee Share Employee Plus Employee Share Employee Plus Only Employer Share Only Employer Share Income Marginal Tax Rate Average Tax Rate Marginal Tax Rate Average Tax Rate Marginal Tax Rate Average Tax Rate Marginal Tax Rate Average Tax Rate
Self-employed Individual Marginal Average Tax Rate Tax Rate
J$50,000 0.065 0.065 0.18 100,000 0.065 0.065 0.18 200,000 0.065 0.065 0.18 300,000 0.065 0.065 0.18 400,000 0.065 0.065 0.18 500,000 0.065 0.065 0.18 600,000 0.04 0.061 0.13 700,000 0.04 0.058 0.13 800,000 0.04 0.056 0.13 900,000 0.04 0.054 0.13 1,000,000 0.04 0.053 0.13 Source:Alm and Wallace (2004:Table 13)
0.18 0.18 0.18 0.18 0.18 0.18 0.172 0.166 0.161 0.158 0.155
0.105 0.105 0.105 0.105 0.105 0.105 0.08 0.08 0.08 0.08 0.08
0.105 0.105 0.105 0.105 0.105 0.105 0.101 0.098 0.096 0.094 0.093
0.22 0.22 0.22 0.22 0.22 0.22 0.17 0.17 0.17 0.17 0.17
0.22 0.22 0.22 0.22 0.22 0.22 0.212 0.206 0.201 0.198 0.195
0.10 0.10 0.10 0.10 0.10 0.10 0.05 0.05 0.05 0.05 0.05
0.10 0.10 0.10 0.10 0.10 0.10 0.092 0.087 0.081 0.078 0.075
31
Figure 2:Tax Rates for Individuals With and Without Allowances and the Difference Plus the impact of the Post Budget Changes for Commissions and Gratuities.(Source:The emolumnets Survey 2002)
30
25
20
Percentages
15
10
5
0 < $50,000 50,000-100,000 100,000120,432 120,432150,000 150,000250,000 250,000500,000 500,0001,000,000 1 – 5 million Greater than 5 million
Income Groups
Tax Rates without Allowance Difference 1 Tax Rates with Allowance Difference 2
32
Appendix 4: Sampling Methodology. The microsimulation model was based on the emoluments sample survey conducted at the site of firms in calendar year 2001. In addition, information was gathered on the first full payment period in May in order to establish a population base (Emoluments Survey 2001). Detailed information with respect to emoluments and wages were collected on the five wage based programs and taxes. These were The Education Tax, The Human Employment and Resources Training Trust Fund (HEART), The National Insurance Scheme (NIS), the National Housing Trust (NHT) and the Civil Service services Family benefits Scheme (CSFBS).
The sample design was based on the 7,500 PAYE returns of firms and a multistage method was used. Firms were stratified into four groups and at this stage the size of firms was not known. A set of firms was randomly and unevenly selected within each stratum. An additional stratum was selected to generate government employees. If a firm within a stratum could not be identified a supplementary random listing was supplied for that stratum. The second stage was to select a sample of employees from each firm, with the size being dependent on the number of employees in the firm. At the stage
33
5,631 employees arising from 177 firms and 20 government agencies were chosen.
The Table below sets out the number of firms selected in the sample and the actual number chosen.
Table III: Distribution Sample of Firms and Actual Firms Chosen. PAYE Paid More than $50M $10 up to 50$M $1M up to $10M Under $1M Government (81,000) employees Total 7,500 208 No of Firms 47 154 1,012 6,287 Sample Size 10 31 101 66 Actual 7 24 88 58 20 197
The systematic method was used to determine the number of employees to be sampled as follows:
More than 50 employees 10 to 49 employees Less than 10 employees
20% (but not more than 200) 50% 100%
34
A specifics payment period was chosen for the basis of computing wages to avoid double counting. In addition, an unbalanced stratified sample was used to determine the weights for each employee based on each subgroup in order to determine the population
The weighting formula for each employee was as follows:
W
1 No of firms in sub group sample No of employees in firm sample , where Pf ; Pe Pf * Pe No of firms in sub group No of employees in firms
Where Pf is the probability that the firm is drawn and Pe is the probability that the employee is drawn.
The microsimulation model was developed based on the sample distribution of PAYE workers and was updated after 2001 to reflect inflation and the distribution of emoluments.
35
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