How not to collect Taxes

When Tony Blair became UK Prime Minister in 1997, the UK Tax Code numbered 4,998 pages. By the time Labour left office in 2010, the tax code had grown to a monstrous 11,520 pages. It is now such a nightmare that the current Chancellor George Osborne set up an Office of Tax Simplification to trim the damned thing (incidentally it submitted its interim report today). Last I checked it had managed to trim 100 pages from the code. 

I remember some years ago when I was working in an accounting firm and we used to have online seminars for 1 hour every other Wednesday. Basically each seminar was a short lesson and explanation on some, usually esoteric, provision in the tax code. One particular lesson I remember was on how doctors were supposed to charge their patients VAT for giving them insulin. If the doctor injected the insulin into the patient himself, the tax code specified that he was to charge VAT on top of the cost of the drug. If he simply handed over the insulin to the patient to go and administer themselves, then no VAT was to be charged. When you have stuff like this in a tax code, it’s easy to understand how it got to 11k pages. (The world’s fastest talker can speak 637 words per minute…feel free to guesstimate how long it will take him to read the entire tax code assuming 400 words per page).

What makes a tax code get so complex and unwieldy? In the case of the UK, you can easily trace it to Tony Blair’s campaign promise in September 1995 before Labour came into power when he famously said ‘We have no plan to increase taxes at all’. When a politician makes such a promise, you know there’s trouble. Essentially politicians like to spend money, especially other people’s money. It is also a useful way of winning votes. So did Tony Blair and Labour increase taxes? ‘Technically’ they didn’t. But they needed more revenue so all manner of additions were put into the tax code to catch revenues wherever they could. In other words, as a wise man once said, words are the currency of fools…the biggest mistake you can make is listening to what a politician says instead of what he actually does.

Across the pond in America, the situation isn’t much different. Increasing headline tax rates is politically unpalatable so the way around it for politicians is to create all sorts of traps in the tax code which then have the effect creating a monster that no one understands and the rich are able to navigate with the help of highly paid lawyers and accountants. It also creates distortions in the economy because companies now have an incentive to make investment decisions based on the tax implications and not necessarily whether it will deliver returns to shareholders.

 

The point of the above is to illustrate the point that when a country first starts to seriously collect taxes from its people, the smart money is on making it as simple as possible to ensure the tax base is as wide as possible. Indeed when the USA ratified the 16th Amendment in 1913 which formally gave the Federal Government powers to tax incomes, the first tax rate was set at around 3% for incomes up to $10,000. And from there it has grown to the 35% or thereabout that it is today.

Before discussing Nigeria’s tax code, imagine this scenario. Everyone knows Christians pay tithes on their incomes to the church at 10%. (The only dispute in some cases is whether to pay it on your gross or after tax income). Now you don’t even need an education to be able to compute your tithe. My 100yr old grandmother who never went to school has been a tither for as long as I remember. She calls it idamewa …anytime someone gives her money, no matter the amount; she is able to immediately set aside 10% of it for her tithe. 

Now imagine a church decided to make the tithe ‘progressive’ by introducing tithe percentages for different levels of income. So 10% of income up to N1m income and then say 12% for anything above N1m and up to say N5m. And then perhaps 15% on anything above that. You can imagine the kind of havoc this will cause among members of the congregation who are perhaps uneducated. You will also begin to witness ‘funny’ behaviour where for example someone earned N5, 000,500 leading to all kinds of palaver over the marginal tax rates for the N500 above the N5m threshold. Such a tither then has every incentive to declare his income just below the N5m to avoid the higher tithe and then perhaps ask God for forgiveness later. 

Furthermore, the business of tithing will then be taken out of the hands of people like my grandmother and create a whole new industry of tithe accountants who will help you ‘calculate’ your tithe and perhaps give you tips on how to ensure you pay the ‘correct’ amount of tithe i.e. less than you really ought to pay. 

The scenario I have described above with tithes is not much different from Nigeria’s ‘new’ Personal Income tax Act (PITA) that was signed into law by President Jonathan at the beginning of this year. It has six different tax bands as follows

First N300k taxed at 7%

Next N300k taxed at 11%

Next N500k taxed at 15%

Next N500k taxed at 19%

Next N1.6m taxed at 21%

Above N3.2m taxed at 24%

There are also all manner of allowances and deductions which further muddy the waters. In short, implicit in the tax code is a refusal to widen the tax base, something which we badly need to do so as to not just raise revenues but to get more people interested in the business of governance. This could have the effect of making corruption harder so perhaps it is deliberate.

What this tax code tells us is that it is almost impossible for anyone to calculate it correctly without the help of an accountant. Here in the UK, you have the option of simply entering in a simple list of your income and expenses online to HMRC and they will then work out your tax liability for you…provided you do this by a certain date in the year. This helps a significant section of the populace to comply with the tax laws without incurring the cost of an accountant. But to the best of my knowledge, this is not an option that is available in Nigeria.

This creates the classic scenario where it is cheaper and less of a headache to break the law especially as enforcement by the tax authorities is practically impossible. It is easy for the police to prosecute and jail murderers because the vast majority of the population of the populace are not killers. However, until such a time as there are public toilets all over the place in Lagos, it will be much more difficult to prosecute every man or woman who urinates on the streets. In other words, the best laws are the ones where the people comply without being forced giving the authorities the ‘magic’ of being in charge so long as law and order does not break down.

 

We know that we desperately need to raise more sustainable forms of revenues outside of crude oil to fund our development as a nation. We also know that we have a massive informal sector that runs into the trillions of naira every year. We know that the gap between government and this informal sector needs to be closed as best as we can. 

What we therefore need is a tax code that is as simple as possible that everyone understands thereby leading to a significant portion of the population voluntarily paying it. In so far as the govt confers some kind of rights on those who pay, making it an attractive proposition, the cost of enforcing against those who refuse to pay will be greatly reduced. We shouted ourselves hoarse at the beginning of this year over N1trn from fuel subsidy removal yet the evidence is that a simple tax code can raise multiples of that in a few short years for a serious government. 

At least we understand how the western countries with complex tax codes got to that point after starting simple. But what is Nigeria’s business with such a tax code that excludes the majority of the population in the name of having a fancy act that reads nice on paper?

 

So here’s my proposal – a flat tax of 10% on income. Everyone gets a minimum wage allowance before this tax kicks in. Absolutely no other deductions will be allowed.

So if you earn say N5m per annum, you deduct N216, 000 (minimum wage of N18k per month x 12) from this and tax the rest at 10%. So such a person will pay N478, 400 in taxes on his income (N5m – N216k x 10%) or just under N40k per month. 

Anyone who earns minimum wage or less will not need to pay any taxes. 

Once you can get between 50 – 60% of the population on the books as taxpayers, then you can start fiddling with the tax rates….this is inevitable because politicians will never be able to leave it alone. But the point is that we need to get people on the books first…that is the challenge we have now and not fancy tax allowances and bands.

Simplicity is the greatest sophistication. Always

 

FF

 

 

 

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