Abstract
This paper is primarily concerned with the revenue and tax efficiency effects of adjustments to marginal tax rates on individual income as an instrument of possible tax reform. The hypothesis is that changes to marginal rates affect not only the revenue base, but also tax efficiency and the optimum level of taxes that supports economic growth. Using an optimal revenue-maximising rate (based on Laffer analysis), the elasticity of taxable income is derived with respect to marginal tax rates for each taxable-income category. These elasticities are then used to quantify the impact of changes in marginal rates on the revenue base and tax efficiency using a microsimulation (MS) tax model. In this first paper on the research results, much attention is paid to the structure of the model and the way in which the database has been compiled. The model allows for the dissemination of individual taxpayers by income groups, gender, educational level, age group, etc. Simulations include a scenario with higher marginal rates which is also more progressive (as in the 1998/1999 fiscal year), in which case tax revenue increases but the increase is overshadowed by a more than proportional decrease in tax efficiency as measured by its deadweight loss. On the other hand, a lowering of marginal rates (to bring South Africa’s marginal rates more in line with those of its peers) improves tax efficiency but also results in a substantial revenue loss. The estimated optimal individual tax to gross domestic product (GDP) ratio in order to maximise economic growth (6.7 per cent) shows a strong response to changes in marginal rates, and the results from this research indicate that a lowering of marginal rates would also move the actual ratio closer to its optimum level. Thus, the trade-off between revenue collected and tax efficiency should be carefully monitored when personal income tax reform is being considered.
Highlights
A vast body of literature exists arguing the features of an efficient tax regime and tax reform measures to improve on tax efficiency and collection
The results show that such a lowering in rates to levels on a par with those of South Africa’s peers has the potential to lead to improved levels of efficiency with the tax burden equal to, or even below, the optimal tax/gross domestic product (GDP) ratio from an economic-growth point of view
With less progressive marginal tax rates, the personal income tax (PIT)/GDP ratio declines to 5.6, which is less than the optimal tax ratio, and it can be assumed that such a policy reform would stimulate economic growth and thereby expand the revenue base to compensate for the first-round loss in revenue
Summary
A vast body of literature exists arguing the features of an efficient tax regime and tax reform measures to improve on tax efficiency and collection. A brief overview of the historic development of income tax reform in South Africa since the change in government in 1994 shows that the number of income bands was limited to nine and that individuals were taxed at a minimum and a maximum marginal rate of 17 and 43 per cent, respectively. At the time, they were taxed differently on marital and gender status.
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