Open letter to the Finance Minister on corporate tax cut
Dear Mr Minister,
It is no doubt that your government is doing everything conceivable to stimulate growth in every sector of the economy. Apparently, one of such stimulus packages is the tax reforms (tax cuts), introduced at the beginning of the 2017 fiscal year.
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Generally, academic and empirical evidence from various economies has established that cutting taxes will unleash investment and lead to higher incomes, more jobs and rapid growth. It is further refreshing to hear that your outfit is thoughtful of reducing corporate taxes for the 2018 fiscal year which in fact, will reduce the tax obligations on companies.
Mr Minister, there is also historical evidence which seems to support this classical ideology from numerous economies that corporate rate cut is a powerful pro-growth tax reform. Most notably was the Ronald Reagan tax cuts in the early 1980s, which led to massive economic boom in years later. However, there is also considerable less evidence that this cause-and-effect could apply at all times and in every environment. In the case of another tax cut by George William Bush between 2001-2003, there was absolute disappointment in growth.
Contrary to this assertion (tax cut), it is evidenced that Bill Clinton’s tax increase regime culminated in economic growth which was argued to surpass the post-gains of the Reagan tax cut regime. It is further evidence that the outcome of tax cut in most economies initially culminates into reduction of tax revenue.
In the case of the Ghanaian economy, it is also imperative to consider the historical antecedent to our tax cuts vis-à-vis our macro and micro economic environment. In retrospect, the Ghanaian tax system relies on a number of different types of tax to generate revenue. Our taxes are serialised into direct taxes (company taxes, individual taxes & other miscellaneous taxes) and indirect taxes (general taxes on goods and services, excises, customs and other import duties, taxes on exports, and petroleum related fund).
Over a 10-year period, revenue generated from direct taxes accounted for less than 46 per cent of total tax revenue collected in relation to indirect taxes. Out of this figure, it is interesting to note that since corporate tax rate was reduced from 32.5 percent in 2004 to 25 per cent in 2006 and remained constant till date, revenue generated from corporate taxes averaged 37 percent of all direct taxes as compared to tax revenue from individuals 47 per cent, others 19 per cent within the period under consideration.
Tax Cuts and the Economy
Mr Minister, it is a common belief that lower tax rate will give individuals and corporate institutions more after–tax income that could be used to invest in more goods and services, thereby increasing the demand-side argument to support tax reduction as an expansionary fiscal stimulus.
However, in a large body of academic research on this topical issue, it has been empirically established that tax reduction eventually reduces the general revenue projections of most governments and has failed to establish a direct relationship between tax cuts and economic growth in the medium term. In our case, I wasn’t surprised at all when your ministry had to review the 2017 revenue budget downwards as a result of your inability to meet half-year revenue targets in the midst of the mouth-watering fiscal stimuli provided for in the 2017 budget.
Tax cuts and Investments
It will interest you to know that corporate tax cuts have not always yielded its purpose because until an individual has enough money than they actually need, it will not impact on savings, as the cuts provide extra funds to meet already existent need. The theoretical implication of tax cuts is to reduce the flow of cash from households and businesses to government with the aim of improving domestic and industrial savings at the expense of government savings considering the indirect impact it has on improving government income in the long run.
This phenomenon is similar for businesses that are expected to use the tax saving for re-investment and capital maintenance but the implementation of these is subject to the various need of the business at the time and investment options available. This generally raises concerns as to the actual impact of this policy on tax cuts on the expected economic agents and the resultant output thereof. Some schools of thought argue that tax cuts are focused on producing a short-term sense of confidence by putting more money in people’s pocket in a way that did little to nothing for the future and actually harmed the economy.
Tax cuts will mean that portion of the government’s money will be sacrificed with the aim of increasing domestic savings and would have to be financed by alternative sources of finance. Given the finite nature of government revenue sources, it is consistent that the extra deficit to be caused by the tax cuts would be financed with borrowing.
The use of this policy will defer the negative impact of the policy to a future date when the country’s debt rating is so low that they affect the interest on debts and increase the government’s interest expense bill. Huge interest expenses will affect the general revenue balance of the consolidated fund in Ghana and hence investment, which in turn means less growth.
Historical information from the Ghanaian economy shows that as income tax rates were cut, budgetary deficits grew and savings rate trended downwards. One means of reducing this effect is to reduce government expenditure to meet the revenue cuts so as to control the deficit created. From the above historical data, it is clearly evident that revenue collected from corporate taxes increased from 2006 onwards when the rate was reduced to 25 per cent.
However; the economy did not experience relative consistent growth within this period. The country’s real GDP growth witnessed an increase of only three years within a 10-year period and reduced 14.2 per cent in 2011 to 3.3 per cent in 2016. Within the same period, payroll taxes (direct taxes) became an important source of revenue for the government and have consistently grown from 27 per cent in 2007 to 54 per cent in 2016, even though annual maximum tax rates were reduced and increased from 28 per cent in 2005 to 25 per cent from 2006 to date. Relatively, annual chargeable income also increases consistently over the period.
Interestingly, it’s also evidenced that the period under review (2006-2016), witnessed a consistent increase in Ghana’s debt to GDP from 31 percent in 2006 to 73.5 per cent in 2016. This is a clear indication of revenue deficiency in the government’s fiscal setup although other economic variables have been held constant in this regard. Lowering tax rates may also discourage investment as owners may be inefficient in allocating the gains from the tax savings on luxury goods and services rather reinvestment.
Recommendations
Mr Minister, I might not be able to say this in plain words but through this piece, it is my hope that considering the government’s numerous developmental and interventional programmes, the average Ghanaian is not expectant of excuses even though they will embrace any reform which will inure immensely to their benefit. In fact, further reduction in corporate taxes will surely stifle the government’s effort in meeting revenue targets and consequently lead to increasing the government’s debt portfolio to finance budget deficits.
