Samuel Mapuranga
“The realisation of The Transitional Stabilisation Programme short-term quick-wins for the economy will be underpinned by adoption of, and strict adherence to, macroeconomic stabilisation policies that require painful trade-off, and sacrifice.” These were the words of Zimbabwe’s Finance Minister Prof Mthuli Ncube at the presentation of The Transitional Stabilisation Programme (TSP), Zimbabwe’s economic recovery roadmap in the capital last week. Perhaps it was my first year Introductory Economics high school course that first piqued my interest in taxation policy, eventually leading to a career dedicated to helping Zimbabweans navigate the complexities of our tax system while trying to understand the policy rationale behind our myriad tax rules and regulations.
One of the economics lessons I learnt early on is that governments essentially have two choices when it comes to managing budget: cutting spending or raising taxes. But what if raising taxes actually leads to lower tax revenues? That possibility was not covered in our first year class but seems to be playing out right here or might occur in Zimbabwe.
Ncube’s decision to raise the Intermediate Money Transfer Tax from 5 cents per transaction to 2 cents per every dollar transacted was like a bomb dropped on an already ailing economy only supported by a few individuals in formal employment. The former chief economist and vice president at the African Development Bank (AfDB), announced a series of measures to reform and revive the economy, and put the nation on the path to steady growth however, the statement failed to stir the market. The minister later on released a communique clarifying on the application of the tax and stated that the tax applies on transactions of $10 and above with an upper limit of $10 000. This implies that transfers above $500 000 attract a flat tax of $10 000. In addition to that, a number of exemptions were made chief among the list, the transfer of funds on purchase and sale of equities, a move regarded as a way to cushion investors. Despite these exemptions, the tax measure being part of fiscal consolidation encountered severe resistance, amid huge public outcry. This measure is likely to yield a third of the tax revenue because of public resistance. The policy could suffer what is known as behavioural response as fierce public resistance continues from a country already battling with cash shortage and inflation.
The field of behavioural economics brings psychology into traditional economic theory to help us understand why people sometimes make irrational decisions and why their behaviours sometimes do not necessarily follow the predictions of traditional economic theory. Research suggest that, in developing countries, the taxes base of direct taxes is constrained by a large informal sector hence the minister’s move to tax both domestic and international transactions will attract a wider tax base including the informal market. However, irked by the economic meltdown faced by the country the move encountered severe criticism from both formal and informal sectors of the economy.
The country is in a serious debt estimated to be $16.9 billion. Domestic debt accrued through issuance of Treasury Bills (TBs) remains a challenge to stir the economy. Hence adding public displeasure and discontentment among Zimbabweans. Following three decades of economic meltdown under President Robert Mugabe’s disastrous rule, the government has been still struggling to collect tax revenue. By 2017, rampant corruption involving tax evasion, illegal tax credits, and theft of government tax revenue had left public finances in shambles. At home, the government is still struggling to honor its obligations to public servants and pensioners, even though salaries and pensions are still very low. What is needed is a broader tax base, better compliance and stricter enforcement.
In order to succeed in this measure, Ncube will need sweeping tax reforms across board. These include but not limited to; having a clear mandate, securing high – level political commitment and buy –in from all stakeholders, simplifying the tax system and curb exemptions, introduce comprehensive tax administration reforms, management, governance and human resources reforms, enhanced audit and verification program and smart use of information management systems. It clearly shows that large tax revenue mobilization can be achieved and sustained.
Although reforms must be tailored to individual circumstances, it can be seen that: tax reform requires first and foremost a broad social and political commitment; it rests on broad-based strategies that recognize that what and whom to tax should go hand in hand with how to tax; and it should be developed with the longer view in mind. For years, it has been long-argued by various economists that a government is only able to raise taxes so high above the rate itself creates a psychological barrier to work such that reduced economic activity by those (high) income earners leads to a reduction in tax revenues. In 1966 the Carter Royal Commission Report on Taxation suggested that, even though a governments revenue needs may call for a higher rate, once the rate reaches 50 percent, it begins to threaten productive efforts. Economists strongly believe that there is a psychological barrier to greater effort when the state can take more than one half of the potential again. As such high marginal tax has an adverse effect on the decision to work.
When the tax was introduced, many commentators warned that both high and low-income earners would react to the hike by reducing their earned income or engaging in “tax avoidance”. Higher tax may encourage shifting taxable income to different forms, times and jurisdictions. High rates may not only negatively affect the economy, but they may add little to, or, even reduce government revenues. Economists argue that, this is a paramount factor likely to affect the tax hike and lower the government budgeted and while the minister had budgeted for a $2.6 billion a year, this might yield approximately $1.2 billion and $1.4 billion lower than his budget. Furthermore, the erosion of the national personal taxable income base will affect other units as well since all share the same taxable base. Consumers are likely to find ways to dodge certain units where it seems possible or default.
Impact on other variables
An automatic increase of tax revenue generated by a larger tax base is welcomed to the public balance, reducing the deficit or even producing a surplus and that will be a dream come true for the Minister. However, an intentional increase of the tax rate would instead reduce the disposable income of households. Both consumption and savings will go down, unless other dynamics are taking place at the same time.
Certain social groups can be hurt by taxation (both in total level and through specifically hideous taxes, especially if recently introduced) to the effect of changing their electoral behaviour and support anti-tax parties and policymakers. Taxation remedies for (or exacerbates) unbalances between desired aggregate investment and savings. By taxing the rich, and more in general people with large savings, and spend in public goods conducive to private investment (or directly productive public investments), the government spurs modernization and GDP growth. However, in certain business cycle conditions, and if public investment is highly irrational and wasteful, the opposite result is achieved, by depressing private entrepreneurship and social pain. The latter is likely to occur in Zimbabwe.
Important Support Policies and Macroeconomic Factors
Economists believe that policies or macroeconomic fundamentals play a mitigating role when fiscal consolidation is needed. These policies may include the monetary stance, the urgency for the fiscal consolidation and its composition, degree of exchange rate flexibility, the size of external buffers, and the degree of trade integration of the economy. Against this backdrop, Ncube needs to urgently address these issues.
Firstly, there is need for a more accommodating monetary policy stance however, the contractionary effects of fiscal consolidation will be smaller because of our current higher debt levels. Secondly, a more exchange rate flexibility can lessen the negative impact of fiscal consolidation on economic activity. This is because in a more flexible exchange rate regime, monetary policy is less constrained by fiscal policy, and in the context of a fiscal consolidation it does not need to contract the monetary policy stance, as would be the case in a more rigid exchange rate arrangement. The main obstacle for the government’s plan is the non-availability of reserves, to this the main leeway would be to pin survival hopes on the US$500mln loan.
Currently, macroeconomic credibility has forced the parallel market rate to soar. Currency black market has thrived, with notes pegged 1:1 to the dollar selling at $1 to 3.20 bond notes on the parallel market with signs of economic melt-down. The immediate course of action is to float the exchange rate and let the USD dollar become the core currency. The Reserve Bank of Zimbabwe (RBZ) insists the bond note option has greatly assisted the economy, especially in boosting exports. However, maintain the bond notes as a currency at 1:1 rate is now unsustainable.
Gross Domestic Product Dynamics
In macroeconomic terms GDP dynamics is a major determinant of tax revenue. The higher the GDP, the larger the tax base, the higher the tax revenue. Hence it became clear that the move to rebase the economy data was a calculated strategy. This was a sign to show a wider and large tax base and a way to appeal to foreign investors. Finance minister announced that Zimbabwe’s economy was $25 billion after data rebasing a move described as “an exercise in deception” by economist John Robertson. While rebasing is one way to boost growth and has become a growing trend among African countries as it provides a clear picture of an economy’s size; and gives updated figures. This in turn enables the government to better evaluate their fiscal position and potential revenue basis while providing investors with more accurate information on which to base their investment decisions.
However, in order to curtail the free-fall economy, the government has to immediately float the FX rate and in less than two months, prices will stabilises at new levels as fixing exchange rate creates an irrational crisis of expectation. Fiscal consolidations if implemented well can achieve desired results. The composition of fiscal consolidation also matters as cutting capital expenditures is much costlier in terms of output than cutting current expenditures or raising revenue.
It is believed that since increasing revenue is less costly in terms of output, consolidation through revenue mobilization is preferable to cutting expenditures, especially public investment. Furthermore, increasing revenue through domestic revenue mobilization can yield substantial returns by allowing for addressing the country’s social and infrastructure gaps. Apart from that, increasing revenue mobilization can be growth enhancing and there is scope to boost public revenue through the expansion of tax base. However, increases in revenue mobilization may be difficult to implement quickly, creating a need to adjust spending in the short term.
The Finance Minister hinted that cutting current expenditure will not be preferred as the first choice measure as its costlier and tantamount to cutting investment but here, too, composition matters. Options include streamlining expenditures by containing the wage bill in oversized public sectors, and eliminating highly regressive and poorly targeted fuel subsidies in favour of targeted social spending. In particular, the government needs to remove all subsidies for fuel, grains and edible oils. Current spending cuts are likely to have social costs and hence need to be designed in conjunction with social protection schemes and the preservation of crucial social spending on health and education which is none-existent in the current prevailing environment. Cutting capital expenditures, which arguably tends to encounter the least resistance, should be the last option and limited to items that have a limited impact on domestic activity (for example, those with a large import component) and long-term economic growth, or in cases where the scaling-up of investment has taken place and consolidation is urgent. In addition, capital expenditures could be stream- lined following a quality-based prioritization of projects, as fiscal multipliers are smaller where spending efficiency is low. There is also need for complementary policies which can play an important mitigating role in fiscal consolidation.
Speaking at Chatham House on Monday, Prof Ncube advised that the government wage bill is currently 18% of GDP and he would like to bring it down to 10% a clear sign of giving fiscal consolidation support through expenditure re-orientation. In addition to that a more accommodative monetary policy and a greater exchange rate flexibility wherever possible, and greater openness to trade may play a mitigating role. In the long run, the government will strive to build external buffers in the form of international reserves. Feedback: smapuranga15@gmail.com or twitter: @Sa_miiM
