Edward Seaga's greatest economic achievement was the introduction of a flat tax


Sunday, June 23, 2019

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ON January 1st 1986, Prime Minister Edward Seaga, in his dual capacity as minister of finance, implemented one of the world's more successful tax reforms, nearly doubling tax revenues in just four years and making it possibly the most successful economic reform of his term in office.

What was called the Tax Structure Examination Project (TSEP) had commenced in July 1983 to develop a system of taxation that was consistent with the objectives of economic development, with a scope of work that was comprehensive and inclusive of direct and indirect taxes.

The project was carried out by a team of Americans and Jamaicans headed by Professor Roy Bahl of Syracuse University. It was financed substantially by United States Agency for International Development. Some 50 experts, specialists and consultants were involved in this massive, comprehensive project.

The best summary of this reform is from Seaga himself, who comments in his own autobiography, My Life and Leadership Volume 2 on the project, which is quoted below.

“Of special concern was the impact of the excessive and complex system of taxation which stymied personal and corporate earnings and profits.

“Individual income tax was assessed in the traditional manner, on a graduated scale, which increased the tax rates in a progressively higher band as incomes increased. These rates reached a tax band of as high as 57.5 per cent of taxable income, which was even more punitive since the income band to which this rate applied began at the pay level of weekly paid working-class taxpayers.

“As the graduated scale was applied to higher levels of income which increased with inflation, taxpayers used every device available to reduce their tax liability as much as possible. The most popular device was to load the pay package with non-tax-deductible allowances to minimise the wage and salary component in the package, thereby reducing the amount of tax on income.

Indeed, it was not unusual for pay packages to consist of 60 per cent taxable wage or salary, and 40 per cent tax-deductible allowances. Naturally the revenue suffered, as taxable income and tax receipts were effectively reduced.

“The recommendations of the tax structure project team radically changed the pattern of low salaries and high allowances by eliminating all but one allowance, housing. The income previously derived tax free from these allowances would now be substantially increased as taxable income. The consequence would be an unbearable increase in taxes due.

“Hence, the tax rate had to be substantially lowered to reduce the taxes due to a reasonable level. A new tax rate of 33.33 per cent was introduced. This was a very substantial reduction of the tax rate, compared to the previous high of 57.5 per cent — an achievement which stood out as a strong motivation to taxpayers.

A unique feature which was a special attraction was the assessment of the 33.33 per cent as a flat rate for all income brackets, instead of complex calculations on the graduated scale by which, as income grew, tax increased disproportionately. Further, tax liability could now be simplified. Instead of deduction of several credits and allowances in order to determine the tax due, a simple back-of-the-envelope calculation was now possible: deduct housing and tax threshold allowances and pay one third of the balance. This system of a flat rate existed in only a few countries.”

In fact, according to the final report, The Jamaican Tax Reform by Professor Roy Bahl, the fiscal deficit fell from 5.8 per cent in 1985 to 0.2 per cent in 1986 — so in its first year the reform was substantially revenue positive.

The years immediately after the reform also saw Jamaica's fastest period of economic growth from 1972 to date — at 5.2 per cent in 1987, with similar numbers even after the negative shock of Hurricane Gilbert.

The reform was extremely data-driven, with Seaga asking to review the numbers at every stage.

The approach emphasised simplicity, greater fairness, and mobilised much greater tax revenue — in part because it reduced the incentive for “income shifting” between corporate and personal taxation, and eliminated much of the incentives for evasion at the higher levels of income.

As the final report notes on page 23: “In Jamaica, the impact of the tax rate on effort may be of some consequence...” The response of “labour supply may be larger than thought, because Jamaican workers have options other than to accept the tax liability. They may remain within the PAYE sector and evade or avoid the payment of taxes, or they may migrate from the formal to the informal sector”.

Perhaps we can again leave the final evaluation to Seaga himself.

“The double benefit of lower tax rates and simple assessment was a big success.

“The reduction and simplification of the individual income and corporate tax systems…comprised the most far-reaching tax reforms ever accomplished to that time.”

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