THE IMPACT OF AN INCREASE IN TAX RATE ON THE MAURITIAN ECONOMY?

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THE IMPACT OF AN INCREASE IN TAX RATE ON THE MAURITIAN ECONOMY?

CHAPTER 2: LITERATURE REVIEW

2.1 Taxation

According to the World Bank (2007, p. 237), taxes represent the major source of revenue for the government as it provide finance for the financial and economic development of the country. Taxation in its most essential form is based on the notion that individual citizens "sign" a contract that gives moral legitimacy to a governing body, (Nikhil Sonnad,seeker of nuance, May 2012). Cooley, tax lawyer 2010 defines taxation “as the process or means by which the sovereign, through its law-making body, raises income to defray the necessary expenses of government”. Malcolm, tax law 2010 explains that “taxation is the power vested in the legislature to impose burdens or charges upon persons and property for the purpose of raising revenue for public purposes”. Revenues of the central government include taxes and other compulsory transfers imposed by central government units, property income derived from the ownership of assets, sales of goods and services, social contributions, interest, fines, penalties and forfeits and voluntary transfers received from non-government (IMF, 2009 p. 12). However, if tax rates change, it will bring an effect on the economy whether positive effect or negative effect. According to an article published on fed 2014 by the National Bureau of Economic Research, the Tax changes have very large effects: an exogenous tax increase of 1 percent of GDP lowers real GDP by roughly 2 to 3 percent. The simple correlation between taxation and economic activity shows that, on average, when economic activity rises more rapidly, tax revenues also are rising more rapidly.

It clearly indicates that most of the government revenues come from taxation; this can be supported from the chart below given in the KPMG Budget highlights 2014:

2.2 Economy of Mauritius

According to the index of Economic Freedom, Mauritius’s economic freedom score is 76.5, making its economy the 8th freest in the 2014 Index. Its overall score is 0.4 point lower than last year, with declines in investment freedom, property rights, and business freedom that outweigh improvements in labour freedom, freedom from corruption, and monetary freedom. Mauritius is ranked 1st out of 46 countries in the Sub-Saharan Africa region.

The Mauritian economy has remained resilient in spite of the recession in the euro area that has weakened its external demand. At 3.3% in 2012, the real gross domestic product (GDP) growth rate remained positive although it continues to ease after growth rates of 3.8% and 4.2% in 2011 and 2010 respectively. Growth was anchored by strong performances in the financial services, information and communications technology (ICT) and seafood sectors. The 2013 outlook is positive, but may be tempered by downside risks if external demand remains timid. Growth is projected at 3.8% and 4.2% for 2013 and 2014, respectively, driven by continued expansion in the financial services, ICT and seafood sectors. The Cost Price Index (CPI) inflation steadily declined from 6.5% in 2011 to 4.1% in 2012 as the base effects were absorbed and global prices trended downward. As risks to growth outweighed price stability challenges the Key Repo Rate (KRR) was cut by 50basis points to 4.9% in March2012, (African Economic Outlook, sept 2013)

The Gross Domestic Product (GDP) in Mauritius is expected to grow 3.20 percent in 2013 from the previous year. GDP Annual Growth Rate in Mauritius is reported by the Central Statistics Office, Mauritius. From 2001 until 2013, Mauritius GDP Annual Growth Rate averaged 3.9 Percent reaching an all-time high of 9.8 Percent in March of 2003 and a record low of -0.8 Percent in March of 2005. Mauritius is one of the most successful economies in Africa and one with the highest GDP per capita. The country’s success is a result of trade led development supported by exports of textiles, sugar and tourism. In recent years, Mauritius was able to attract foreign direct investment due to its skilled labour force and good infrastructure, (Trading Economics, 2013). Below is a chart from the statistics of Mauritius, showing the GDP Growth rate:

Mauritius GDP Annual Growth Rate

2.3 Theoretical Review (The effect of taxes on the economy)

Advocates of tax cuts claim that a reduction in the tax rate will lead to increased economic growth and prosperity. Others claim that if we reduce taxes, almost all of the benefits will go to the rich, as those are the ones who pay the most taxes. What does economic theory suggest about the relationship between economic growth and taxation? (Mike Moffatt)

Taxes affecting the economy are:

  • VAT

Mauritius’s VAT system is considered highly efficient by international comparison; including comparison to Small Island, which by their nature demonstrates high VAT efficiency, (By James Y. Yao, IMF 2005). An increase in the VAT rate is not a free lunch, (Julie Parker 2012). VAT increase is often seen as the ‘best of a bad bunch of alternatives. Indirect taxes, such as VAT, are less distortionary than direct taxes, such as income taxes. Direct taxes encourage saving as opposed to consumption spending. Indirect taxes are impossible to avoid since all of the population pays VAT. As such, VAT is perhaps the most efficient means of collecting large amounts of tax revenue and cases of VAT rates falling are rare.

http://www.euromoneycountryrisk.com/Documents/37726253-E805-4178-8A9A-2174276856BC/wiki/b78f4543-dfdb-4f13-a9e8-a38177e890a8.JPG

  • VAT on Consumptions

In this chapter, mentions will be made on literatures on the effect of VAT on consumptions.

In Mauritius, tax based on consumptions is known as VAT. Boulanger [no date, p.2] defined consumption as any activity involving the selection, purchase, use and disposition of goods and services by individuals and groups to meet one or several needs or aspirations Consumption taxes are mainly divided into two types. One is general consumption taxes, which are imposed on an extensive range of goods and services. They are usually VATs. The other is excise taxes, which are imposed on specific goods and services like alcoholic drinks, tobacco, and gasoline. There are several characteristics to notice in general consumption taxes. First, it is often said that general consumption taxes are better for economic growth than income taxes because of their effect on savings and on labour supply, (Bumpei Miki, working paper series June 2011, No.297).

In their book, Jain and Khanna (2009, p.372) mentioned that “classical economists believed that taxation system should not affect economic activities like consumption, production and distribution. As against this, modern economists believe that taxation system influences main economic activities like consumption, production and distribution by influencing aggregate demand and supply.” They concluded that “taxes have a significant effect on consumption. Because of taxation, purchasing power of the tax payer goes down.

  • Businesses

Businesses in Mauritius are taxed on taxable profits which are known as corporate tax on a flat rate of 15%. High taxes will have a negative impact on businesses. According to Drs. Robert Carroll and Gerald Prante Ernst & Young LLP July 2012, increase in tax rates will result in fewer jobs, less investment, and lower wages, specifically; he finds that the higher tax rates will have significant adverse economic effects in the long-run: lowering output, employment, investment, the capital stock.

  • Imports

Tax on imports is imposed by MRA under the customs (imports, exports and others) at the rate of 15%. Imports in Mauritius increased to 41967 MUR Billion in the third quarter of 2013 from 38640 MUR Billion in the second quarter of 2013. Imports in Mauritius are reported by the Central Statistics Office, Mauritius. Imports in Mauritius averaged 16711.39 MUR Billion from 1985 until 2013, reaching an all-time high of 44748 MUR Billion in the fourth quarter of 2012 and a record low of 1755 MUR Billion in the first quarter of 1985. Mauritius’ main imports are: oil, manufactured goods, capital equipment and food. Mauritius’ main import partners are: India, China, South Africa and France, (trading Economics)

  • Unemployment

Unemployment Rate in Mauritius decreased to 7.76 percent in the third quarter of 2013 from 8.18 percent in the second quarter of 2013. Unemployment Rate in Mauritius is reported by the Central Statistics Office, Mauritius. Unemployment Rate in Mauritius averaged 7.61 Percent from 1983 until 2013, reaching an all-time high of 19.70 Percent in the fourth quarter of 1983 and a record low of 2.70 Percent in the fourth quarter of 1991. In Mauritius, the unemployment rate measures the number of people actively looking for a job as a percentage of the labour force, (Trading economics). According to mike kimel sept 2010, the usual argument of taxes and unemployment is that the lower the taxes on businesses, the more money they keep and pump back into, well, doing business, and thus, the more people they end up hiring. However, Kanuk 2011 stated that increase or decreases the tax rates for every bracket; this too will have a limited impact on unemployment.

  • Government Spending

Government depends a lot on taxes as it is the main revenues for the government. Taxes fund government operations that range from the provision of collective services (military and police services, courts, roads, etc.) to a variety of transfer payments that are aimed at stabilizing economic activity (unemployment insurance and earned income credits) and reducing poverty. When governments increase their spending, crowding out can occur – government spending reduces available funds and increases the cost of capital, leading many businesses to abandon expansion projects. Likewise, when a government spends in excess of receipts (a deficit) and must borrow funds to finance that deficit, crowding out can occur, (Stephen Simpson)

http://www.pwc.com/mu/en/budget/budget2014/assets/government-spending.jpg

2.4 Conclusion

Finally, it can be concluded that tax form part of an important factor in the economy of Mauritius as it can be seen from the chart about the main revenue of mtius. In mtius, there is a flat tax rate of 15% for all income tax, corporate tax and VAT. The economy of the island is stable with an economic growth of 3.5%. Because of the flat tax rates, the island is attracting more foreign investment as there is no capital gain tax implemented on investment. Mauritius is becoming a business hub for investors and with the invent of double tax relief, it has encourage foreign investments in the country. However, if the tax rates increases, there will be a slowdown in the economic growth, businesses might shut down and this may lead to unemployment and this to inflation and this to economic crisis. Therefore, as Mauritius is among the developing countries, which generates on a small economic scale, the idea of increasing tax rates will need to be well analysed.


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