We have been taught in school that the objectives of a tax are to raise government revenue, discourage the consumption of certain types of goods, and most of all to redistribute income and wealth. Government needs to raise revenue so that it can achieve its development objectives, and finance the services to be provided to the public and in the form of public goods, like roads, bridges, airports and ports. Some types of goods like alcohol, cigarettes, and environmentally harmful products are taxed heavily in order to discourage people from using or consuming such goods. Redistribution of income and wealth among the population is an important objective of taxation, as the government collects a higher percentage or a higher amount of money from the rich, and provides social-security benefits or subsidies to the poor, so that the income gap between the rich and the poor can be narrowed.
An efficient and effective tax system in trying to achieve those objectives mentioned above, also should be targeting to maximize social welfare by having the optimal tax structure. If the government’s fiscal policy ignores the concept of ‘optimal tax’, it can actually harm the aggregate production efficiency of the economy. In other words, if the government is careless and over-burdens the businesses by ‘over-taxing’, it can actually decrease the economic activities or production, leading to lower tax revenue over the medium to longer term. Hence, in order to increase the government revenue in the shorter-term we should not be recklessly increasing the tax rates or playing with the tax system.
Prior to the introduction of GST on general goods and services, we had the import tax or the import duties, which required the importer to pay a certain percentage of the value of the goods to Customs as duty, before even the goods are being cleared or sold to the customers. We replaced the import duties with GST, so that importer will not be paying any tax to the government before selling a product. When the customer buys the product, tax is paid and the seller collects it, pays it to the government. We have seen that total government tax revenue has actually increased, and increased significantly since the tax reforms brought in 2011. Has it hurt the aggregate production efficiency? In some areas yes. And with the proposed new changes to the tax rates, it may hurt even more. In the short term it can increase the government revenue, however, in the longer term it can do more harm, as total production may fall, and so can the total tax revenue in the medium term.
The issue of Withholding Tax (WHT) needs special mention, as I have been tackling this issue from the business side, both in my own business and also others whom I am advising. Under Section 6 and 7 of Business Profit Tax (BPT) Law, businesses are required to pay 10% of all the payments made to any foreign party for business services obtained. The total amount of revenue raised through WHT comes to about 3% of total tax revenue of the State. It may be a huge burden for some individual companies to pay tax on the company’s expenditure paid to a foreign company, and at the same time pay tax on the net profit of the company. Most of the time, the foreign company will not allow to deduct the 10% tax from their payments. Hence, individual companies may face bankruptcy or incur a loss that threatens the continuity of the business. Had the government removed the WHT from the law and let go of the 3% revenue, many individual companies will benefit from it, and actually be paying more than 3% collectively as Business Profit Tax and GST.
Then comes the issue of Bed Tax. High-end resorts sell rooms for as high as $2,000 per night, and still pays $8 to the government. It’s just 0.4% of the room rate. However, a guest house selling a room for $50 per night also pays $8 per night as bed tax, but which is 16% of the room rate. Of course, it’s the guest who bears the tax. But for Tom Cruise who comes to ‘One & Only’, $2,008 plus GST may not be much for a night. However, for Markuss who is from a lower income level, even $58 plus GST may be too much for a night, especially, comparing this price to the same standard rooms in other countries. Most of all, considering the fact that Bed tax is very ‘unfair’ as both the rich and the poor pay the same amount, makes the tax regressive in nature. For this reason, it cannot be considered as part of an optimal tax structure.
GST on the other hand is more equitable, as a certain percentage is paid on the room rate and other prices, and those with higher incomes and who pays more for their services, will pay more as tax. At present, GST rate for tourism sector is 8%. Most of the resorts, hotels, and guest houses will also include service charge (normally 5-10%) in their prices, and add on GST. With this, guests will be paying more than 18% on top of the prices quoted for room and other services. If we increase the GST rate to 12%, with service charge, guests will be paying 23% more on top of the quoted prices. And if we continue charging bed tax that’s an additional $16 per night for a couple, and makes it 39% in addition to room rate. In the case of hotels in Colombo, it comes to about 26% with service charge and taxes. Which means, with bed tax, and GST of 12%, our tourism product will lose competitiveness, and may actually lead to Maldives becoming less attractive to tourists; especially mid-market tourists. In that case, total national income and total tax revenue may decrease over the medium and longer term. So, the tax rate or tax system should not be played as we wish, so as to increase short-term revenues. It has to be carefully analyzed, its impacts identified, its optimal level determined, so that social welfare is maximized.