Personal Income Tax reform to secure the South African revenue base using a micro-simulation tax model

Abstract

The purpose of the study is to analyse tax reform measures to secure the tax revenue base, in particular the personal income tax structure of South Africa. The main objectives are: firstly, to identify personal income tax reform interventions so as to align the personal income tax structure in South Africa with international best practices. Secondly, the impact of tax reforms on revenue collection, given optimal economic growth levels, is determined. Thirdly, to determine the best tax reform scenario which could minimise the individual tax burden and maximise its efficiency. Lastly, the impact of the suggested tax reforms on fairness as a principle of a good tax system is evaluated. A static micro-simulation model is developed from survey data and used to simulate the proposed tax reforms. Different tax reforms were selected from a study of international tax reform trends and an analysis of the South African personal income tax structure. The literature provides clear margins for the structuring of tax bands and threshold margins. Tax elasticities are estimated in order to explain the methodology for determining the impact of tax reforms. These elasticities include the elasticities for determining the progressiveness of the PIT structure, determining the deadweight loss (tax efficiency) and also to determine the optimal levels of taxes and economic growth and revenue maximisation. The different tax reform scenarios take the economy closer to or further away from optimum growth and optimum revenue. The results show that as far as marginal rates are concerned, a lowering in rates to levels on par with South Africa’s peers offers potential for improved levels of efficiency with the tax burden equal to or even below the optimal tax ratio from an economic growth point of view. Although such a ratio is below the optimal revenue ratio the results suggest that the loss in revenue could be minimised over time through a resultant increase in productivity and economic growth. By adjusting the non-taxable thresholds and taxable income bands according to the algorithm defined in the best practice scenario, more taxpayers will be included into the tax net but with a net decrease in tax liability. As a result the tax/GDP level also declines to a level below the optimal growth level but tax efficiency increases. The resultant loss in revenue will have to be recouped through increases in other than individual income taxes but improved levels of tax morality because of the lower margins for each tax band and increased productivity might also contribute to increased revenue performance. The tax structure is also more progressive which contributes towards the “fairness” of the tax regime. Regarding tax expenditure reforms, the analysis shows that medical tax credits offer a more equitable form of relief than medical deductions which substantiate this kind of reform as already implemented by government and which is to be fully phased in over the next couple of years. Tax liability is slightly lower in the case of medical credits compared to medical deductions but the difference is only marginal as far as net revenue and optimal growth and efficiency is concerned. However, a medical credit which increases disposable income at the lower end of the scale and discriminates against higher income groups also improves progressiveness of the tax regime and therefore the fairness thereof accordingly. Finally, the demographic impact of the suggested reforms also shows some important trends. Better education improves skills levels which seems to be positively correlated to taxable income levels. As far as age is concerned, the analysis shows that a substantial number of taxpayers in the categories below the age of 24 and above 65 fall within the lower taxable income groups. Those are also the most vulnerable groups from a subsistence point of view. Thus, tax reform that specifically improves their levels of disposable income should be prioritised in order to address equity and fairness as objectives for a “good” tax structure.