Taxation refers to the compulsory transfer of resources from the private individuals, institutions or groups to the public sector. Taxation can be classified under two types: direct and indirect taxation. Taxes that are levied directly upon wealth, income and capital gains are called direct taxes. Indirect taxes are those, which are additionally charged on prices or on the quantity of goods sold.
Official documents issued by the Maltese authorities give four main objectives to taxation in Malta.
> Ensure an adequate and regular flow of revenue to government
> To be adjusted in light of Malta’s relation with European Union
> To stimulate saving and capital formation as well as direct investment and personal efforts into productive channels.
> To ensure that financial burdens be borne by those most able to carry them.
Since Malta gained independence, we have experienced various changes in taxation policies, both on the income and expenditure side. In fact the affects of taxation can be divided under two main categories. These are the Micro and Macro affects. According to microeconomic theory, tax changes affect a person’s willingness to supply effort. This happens because taxation affects the relative price of work and leisure. The Macroeconomic theory states that changes in taxation have impacts on consumption and saving-investment decisions, in turn affecting total revenue collection. In order to see how tax burden is influenced today one has to consider the taxation history of the country. This is so since taxation is not a static event. The following are the main events in the taxation history of Malta.
The government needed a type of taxation that managed to collect revenue for the government over time. For this reason in 1973 the PAYE, -(Pay-as-you-earn) income and the Provisional Tax (PT) were introduced. In 1977, there was a reduction in the company tax rate of 5%. With the election of the Nationalist party in 1987 the government modified certain regulation in the income tax structure. The 2%, 5% and 7% marginal tax rates for married couples and the 2% for the unmarried taxpayer were abolished.
In 1991 the maximum marginal income tax rates were lowered from 65% to 35%. At this point it was also possible to opt for a separate income tax assessment. This was important since it encouraged married females to participate formally in the labour force. Another modification was introduced on the company tax rate where this rate was adjusted to be equal to the highest marginal personal income tax rate of 35%. In this way the government eliminated the possibility of avoiding tax liabilities through company profit. In the last budget the income tax rates for the married were revised.
Value added tax (Vat) was introduced in 1995, substituting to a great extent, customs duties. In 1996 a final withholding tax of 15 % was introduced on part-time work and the income tax system was integrated with the Children’s allowance transfer scheme. In the same year there was a change in government administration. This brought an alteration of the tax system. In fact VAT was replaced by a Customs and Excise tax system. This system consisted of a 5% Excise tax on products a 5% Excise on services and a 15% Excise tax on imports. In 1998 a new Final Settlement system (FSS) substituted the traditional PAYE tax collection system. The FSS is a system where each employee’s pay accordingly, leaving no amount owing or owed to government at the end of the year. This system was introduced in order to relieve the Inland Revenue Department from the burden of processing future tax revenue arrears.
If we look at the figures of revenue from income tax, we can observe that it remained stable throughout the years, reaching a peak in the late seventies and decreasing at a moderate pace after. National insurance contribution varied in the range of 30 – 37% of total revenue. This can be seen in Appendix 1. In the nineties there was increased importance of licenses, taxes and fines. On the other hand, revenue from Customs and Excise, which was significant in the eighties and in the seventies, began to lose its share in the early nineties. In fact as we see in Appendix 1 Customs and Excise collapsed to 8% in the mid-nineties, when VAT replaced it. In our analysis we don’t have the figures for the later years where we suppose that the removal of Vat in 1997 would have increased Customs and Excise values for the years following until the Introduction of VAT that was brought in the last election when the Nationalist party was appointed.
We can observe a graph showing the total revenue collected in taxation in the following country.
The graph shows the continuous growth in total tax revenue collected by the government from 1971 to 1995.
In order to analyse the tax burden in Malta we have to be able to analyse if the Maltese economy is overtaxed or not. If we therefore speak of overtaxed economy we are implying that there exists an “optimal’ tax. This tax can be used as a yardstick for reasons of comparison. In 1945 an economist named Clarke attempted to determine this rate. Together with Keynes, Clarke suggested that when total taxation exceeded 25 % of Gross Domestic Product (GDP), ‘ damaging pressures’ would follow. So we can explain this 25 % as the limit that an economy is able to support.
This concept of having a limit, after which ‘damaging pressures’ may crop up, is also found in the Laffer curve. Arthur Laffer derived this in the 1970’s. The relationship that he focused was the one between tax revenue and tax rates. This can be shown in the figure below.
The principal rationale underlying the Laffer curve, is that the optimal tax rate is that rate which maximizes tax revenue for the state. This is point M in the diagram. Below the optimal tax rate, an increase in the tax rate increase tax revenue, whereas above the optimal tax rate, an increase in the tax rate reduces tax revenue. This happens since higher rates discourage productive efforts. Being derived intertemporally, the Laffer curve assumes that the optimal tax rate is consistent overtime, and that such optimal tax rate corresponds to a maximum level of tax revenue, which is also by implication consistent over time. The optimal tax rate corresponds to a particular level of GDP that is consistent over time. However we know that a developing economy tends to grow over time. In fact the economy is continuously subject to trade cycle fluctuations, which influence the overall performance of the economy. This shows that the Laffer curve could be considered being a simplistic approach.
During the period 1960-1980, research of the Maltese scenario has suggested that the tax rate index and tax revenue were positively related and upward moving. If we transfer this analysis to the “Laffer curve” analysis we can say that the, Maltese economy was still below the maximum rate M. Therefore according to theory a rise in tax rates could yield additional revenues. In an analysis on the data of the Organization for Cooperation and Development (OECD), Michael Beenstock extrapolated a linear function, correlating the average tax rate and the GNP per head. In this way we can compare Malta’s past tax indices with those for Europe. In 1976, According to these calculations, Malta obtained a 26% rate of tax. The actual rate was 24 %. This means that tax rate was 2 points below the OECD average. From these results we can say that Malta’s tax rate was considered to be fair from an international point of view.
In order to judge critically the overall tax burden in Malta there exists mainly two methods. The first method refers to a time serious analysis. This method consists of acquiring data from the Maltese scenario and making an intertemporal analysis using statistical techniques known as regression analysis. The other method consists of an international comparison. In this case one can also use regression techniques in order to derive an internationally equivalent tax rate for the Maltese economy for the year 1994.
A country’s tax burden is estimated by dividing the total amount of taxes paid by the GDP, that is, (sigma) sigma taxes /GDP). If we consider the international tax structure, studies have indicated the existence of a progressive element. This means that richer countries pay proportionally more tax than the less well-off (Delia 1982). So we can fit a regression line relating a country’s tax burden to its GDP per capita, using data for different countries. The countries chosen are OECD countries. The following data for the OECD countries is shown below.