Abstract:
This paper is primarily concerned with the revenue and tax efficiency effects of adjustments to marginal tax
rates on individual income as an instrument of possible tax reform. The hypothesis is that changes to
marginal rates affect not only the revenue base, but also tax efficiency and the optimum level of taxes that
supports economic growth. Using an optimal revenue-maximising rate (based on Laffer analysis), the
elasticity of taxable income is derived with respect to marginal tax rates for each taxable-income category.
These elasticities are then used to quantify the impact of changes in marginal rates on the revenue base
and tax efficiency using a microsimulation (MS) tax model. In this first paper on the research results, much
attention is paid to the structure of the model and the way in which the database has been compiled.
The model allows for the dissemination of individual taxpayers by income groups, gender, educational
level, age group, etc. Simulations include a scenario with higher marginal rates which is also more
progressive (as in the 1998/1999 fiscal year), in which case tax revenue increases but the increase is
overshadowed by a more than proportional decrease in tax efficiency as measured by its deadweight loss.
On the other hand, a lowering of marginal rates (to bring South Africa’s marginal rates more in line with
those of its peers) improves tax efficiency but also results in a substantial revenue loss. The estimated
optimal individual tax to gross domestic product (GDP) ratio in order to maximise economic growth (6.7 per
cent) shows a strong response to changes in marginal rates, and the results from this research indicate that
a lowering of marginal rates would also move the actual ratio closer to its optimum level. Thus, the trade-off
between revenue collected and tax efficiency should be carefully monitored when personal income tax
reform is being considered.
