2014 Budget: Tax cuts or more govt spending

via 2014 Budget: Tax cutsor more govt spending | The Financial Gazette 14 Nov 2013

The Minister of Finance has delayed the announcement of the 2014 national budget after claiming that he needs more time to consult. This is because the 2014 budget comes at a time when the country has just gone through a landmark plebiscite that had many promises.

At the same time the economy is facing numerous challenges that are threatening the recovery momentum that began in 2009. The Finance Minister therefore faces a monumental task of balancing citizenry expectations, reviving the economy and raising the necessary funding.

With monetary policy reduced to largely bank supervision in the multicurrency environment, the Finance Minister lacks the quick fix of “quantitative easing” that is being applied in big economies like the United States and Japan to stave economic depression.

The government will have to rely on fiscal policy to meet the competing needs. Fiscal tools available to change the economic performance in the country include taxes, government expenditure and transfer payments.
Keynesian theory suggests that in times of economic downturn, a discretionary (expansionary) fiscal policy should be adopted. A discretionary fiscal policy would include tax cuts, increasing government expenditure and increasing transfer payments.

Theory favours increased government expenditure over tax cuts on the assumption that the marginal propensity to consume is less than 100 percent. In other words an increase in government expenditure is expected to have a direct impact on aggregate demand whilst the impact of tax cuts depends on the savings rate of an economy.

Where the savings rate is say 25 percent then only 75 percent of the tax cut benefit will impact aggregate demand as beneficiaries are assumed to conserve the balance through savings. In Zimbabwe the savings rate is around 10 percent implying that tax cuts will result in an increase in consumption by about 90 percent.

So should the Finance Minister reduce tax rates to increase consumption and eventual aggregate demand by 90 percent or just retain the tax rates and increase government expenditure? Over the past few years national budgets have been associated with changes in income tax brackets and other concessions meant to cushion the working population.

Expectations are high that the upcoming budget will result in movement of the tax free income and bonus thresholds. The expectations are necessitated in part by the fact that the majority of workers in the country are earning below the poverty datum line (PDL) which stood at US$505,21 in September 2013.

Government recently conceded that civil servants should be awarded salary increments that take the lowest paid civil servant to the PDL. If this move is to be effective it means either the lowest salary for civil servants has to be pegged at US$505.21 with the tax free threshold increased to at least the same figure or the least paid civil servant will have to earn a gross salary of at least US$580,28. Given that not all employers will be able to increase their employee’s salaries to the PDL, the fairest move by government would be to raise the tax-free threshold to the PDL.

The dilemma facing government is that it will need to fund the salary increase for civil servants from tax revenues whilst at the same time it is expected to earn less from income taxes owing to the lifted tax brackets.
A comparison of the local income tax rates and those in other Southern African Development Community countries shows that Zimbabwe income tax remains on the higher side.

The lowest income tax rate in Zimbabwe of 20 percent is above the sample average of 17 percent and the highest income tax rate of 45 percent also exceeds the sample average of 31 percent.
Mauritius has a flat income tax rate of 15 percent for income above US$1,358 per month while Angola has income tax rates from as low as five percent to a high of only 17 percent. The tax free threshold in Zimbabwe is also less than half the sample average of US$547 per month and only compares to Angola whose tax free income is US$259.

Government may therefore be forced to follow the theoretically unfavourable route of upping the tax free threshold (a form of tax cuts) in order to improve the livelihood of the citizens who are living below the PDL. This will also be in line with the recently launched Zimbabwe Agenda for Sustainable Socio-Economic Transformation (Zim Asset).
Zim Asset is meant to achieve social equity and poverty eradication amongst other key objectives.

To eradicate poverty government will also be expected to increase transfer payments to the needy through programmes such as Basic Education Assistance Module, student grants and other social benefits (e.g. free health).
Given that government needs to implement a discretionary fiscal policy, it will be undesirable to increase government revenue through additional taxes or increasing the current taxes.
Government will have to look at increasing its non tax revenues or widen the tax base.

Government can increase its non tax revenue by eliminating loopholes that have seen contributions from the diamond sector being minimal. Government, through ZMDC owns significant stakes in some of the diamond mining firms and it should get its fair share of the diamond profits.

Given the relatively low value of rough diamonds, government should also invite investors to invest in diamond polishing so as to extract more value from exporting processed diamonds.
The government can also try to improve efficiencies in companies that it owns so as to be able to get dividends at the end of the day rather than finance losses made.
The tax base can be widened by ensuring that those in informal employment or informal businesses are made part of the formal sector. The informal sector is contributing significantly to the country’s gross domestic product but it has not been easy for government to collect revenue from the sector.

The government should also strengthen border controls to limit smuggling of imported goods which prejudice the state of duty revenue.