Note: this is the second part in a series of posts on Tax and, more specifically, the draft Zimbabwean Income Tax bill. The preceding posts:
- Tax-oh-no-mics 101: the Zimbabwean Lesson – in which Zimbabwe experiences hyperinflation, dollarises, engages in diamond trade, and the Government runs out of money.
How Governments Finance Themselves*
*Whenever I talk about tax, I bring this point up, so forgive me if I’m repeating myself.
Governments basically have four ways in which to “get” money in order to finance their spending:
- Normal Tax Collection (the equivalent of an individual’s salary)
- Domestic Borrowing (the equivalent of an individual borrowing money from his parents)
- Foreign Borrowing (the equivalent of an individual borrowing money from a bank)
- Money-Supply Inflation (there is no individual equivalent really…)
Unless you’re Qatar. In which case, you have a fifth (and much more awesome) way: State-owned Companies. Traditionally, large state-owned enterprises are a bit of a fail, because they’re run in the same way that government is run: high on staff, low on efficiency, big on budget. But when your state-owned enterprise is making its money off foreigners, and it’s run properly, they’re a win. I mean – who doesn’t want a government that is capable of funding itself efficiently?
PS: “efficiently” is the most important part of that statement.
How a Government Finances Itself After Hyperinflation
Here’s the problem:
- Normal Tax Collection: the economy is back to being only a fledgling. And government size, unfortunately, had grown to match the magnitude of the economy prior to its inflationary crisis; but unlike the economy, the government departments have not downsized. So even if tax collection normalised, there just wouldn’t be enough money raised to cover what’s needed.
- Domestic Borrowings: see point above about fledgling economy. There is no one in the country to borrow from. Although there will be attempts: like forcing banks to hold higher reserves in government bonds; and imposing overly-extensive credit terms on domestic suppliers of goods to government.
- International Borrowings: you must be joking.
- Money-Supply Inflation: requires a country to have its own currency – which it won’t have after hyperinflation.
This is usually the moment that Foreign Aid steps in to try and help. But there are always conditions attached to Foreign Aid – and certainly in Zimbabwe’s case, there is a strong sense of pride in not-being-dictated-to by anyone that isn’t Zimbabwean. Or Chinese.
And it’s around this time that the out-of-the-box strategies emerge: seizure and re-sale of mineral assets, attempts to nationalise key industries, austerity-style spending cuts in education and healthcare, dramatic customs tariffs, exploitation of existing tax law…
Certainly in the Zimbabwean case (and in the cases of most of the Latin American countries), these things happen in combination. But at some point, tax code reform becomes a priority. And to be clear, this is not just a government rhetoric exercise, nor is it power-mongering by any particular governing party: traditional economic fundamentals practically demand it.
A Layman’s Guide to Expanding the Tax Base*
*Tax base – what a government can charge tax on.
Step 1: make more people liable to pay tax.
Every Income Tax Act defines who/what is subject to tax in a given jurisdiction. And usually, somewhere in this, there is a “residency” definition. Watch out for this residency definition (the subject of the next post).
Step 2: make more types of income subject to tax.
When you hear people talk about source-based VS residence-based taxation systems, it’s this step they’re concerned about (the subject of the post after next).
Step 3: disallow more types of expenses from the calculation of tax.
This is where the Zimbabwean Income Tax bill (or, at least, the interpretation of it) gets a little wild (this will be post number 5).
Step 4: increase tax rates.
The step that first comes to mind when we talk about “expanding the tax base” – but it’s usually the least step, and the least effective. And it’s not always about changing the tax rates: it can also mean changing what will be taxed as capital and what will be taxed as income (and that’ll be the subject of post number 6).