IMF makes suggestions on handling tax allowances and deductions
The fund has recommendedGovernment consider converting major allowances and some deductions into credits and eventually integrate the Consolidation Tax into the Personal Income Tax.
94. Individuals in Barbados are subject to a number of taxes, which typically take into account their ability to pay. As with many other countries, it uses progressive rate structures and individual allowances to address redistributive objectives. This chapter focuses on the individual income tax (PIT), and also briefly reviews charges under the National Insurance System (NIS).
95. Individuals are subject to PIT that has two rates on employment earnings.The basic rate of income tax is 17.5 per cent and the higher rate is 35 per cent.For 2013, the basic rate applies to the first BDS$35,000 of taxable income and the higher rate to taxable income in excess of this amount. This range of taxable incomes subject to the lower rate is new, having been raised from BDS$24,000 in two annual steps. The PIT is levied on resident individuals’ worldwide income and taxable income subject to the progressive rate structure includes wages and in-kind benefits, business income, pension income, and the value of benefits received under the NIS. The taxpaying unit is the individual; thus in particular working spouses file separately.
96. A “dual-income tax” approach is generally applied to incomes from nonbusiness capital.That is, separate flat schedules are applied to elements of capital income, and taxed at source to the extent possible. Interest and dividends paid from domestic sources are for the most part subject to flat withholding at source, at a 12.5 per cent, which are considered final taxes; otherwise the payments are taxable under the progressive structure.Residential rents are taxed under a different schedule, at a flat rate of 15 per cent. However, capital gains are not taxed.
97. There are a number of allowable expenses and special deductions that are subtracted from earnings in arriving at assessable income. These include contributions to employer-sponsored registered retirement plans and registered retirement savings plans (up to a limit dependent on income level); charitable contributions, travelling allowances for employees who are required to travel as part of their employment, and a special allowance for qualified non-nationals working in Barbados
98. A basic allowance of BDS$25,000 per year is exempt from PIT.Those taxpayers over age 60 are allowed a basic allowance of BDS$40,000. There is an allowance for each dependent child of BDS$1,000, up to a maximum of two children, and an additionalallowance of BDS$ 3,000 in the case of a spouse who has little or no independent income source.
99. Other important deductions are related to housing. Mortgage interest for owner- occupiers and home improvements are deductible up to a maximum of BDS$10,000 per year. Rental payments are also deductible for renters; the deduction limited to the smaller of 20 per cent of rent payments or BDS$3,000. There are in addition several programs introduced recently to encourage adopting energy-efficient and renewable-energy technologies.
100. In addition to income tax, resident individuals who have earned income in excess of BDS$50,000 are subject to a separate Consolidation Tax (CT) effective from September 2013.This is intended as a temporary tax, with a separate return appended to the PIT return and filed at the same time (the tax for 2013 was applied based on earnings in the last four months of the year). The base is gross income, minus itemized allowable expenses and travelling allowance. Tax rates rise with income, but the relevant tax rate applies to the entire tax base, not marginally as with the PIT. The rate structure is as follows:
101. A reverse tax credit is offered that is explicitly linked to the VAT and intended to offset to some extent any residual regressive elements in that tax. Individuals earning less than BDS$18,000 per year and BDS$1,500 per month (and thus having an income that falls below the basic personal allowance under the PIT) are entitled to a refundable credit of BDS$650. This credit was halved for 2013; previously the credit amount was BDS$1,300.
102. PIT is an important revenue source.Over the last five years it has raised on average revenue equivalent to 4.4 per cent of GDP (Appendix Table A1). It has risen significantly more than CIT over this period (although CIT consistently raised more revenue before 2009/10). For 2013, Consolidation Tax raised an additional 0.2 per cent of GDP.
103. Barbados’s lowest tax rate and highest tax rate are both higher than the average of the lowest and highest tax rates in the region (Table 14). The basic allowance is well within the range of others in the region, although it is the third highest in the region. Together, these tend to make the tax relatively progressive compared to the other regional individual income taxes.
104. An aggregate picture of the nature of the PIT is given in Table 15.This is based on the 2013 returns. In 2013 taxable income overwhelmingly derived from employment and pension income (BDS$3,600 million); and personal, spousal and child allowance overwhelmingly dominated deductions from income (BDS$2,290 million). Other important income sources were National Insurance benefits (included under domestic investment and other income – BDS$ 69 million), income from foreign sources (BDS$70 million), and business income. Net residential rental income was relatively low, at about BDS$10 million.
105. The structure of the PIT has several positive elements, yet its progressivity could be strengthened.The dual rate structure is an appropriate way to generate more tax revenue while ensuring that the burden is shared more in accordance with individuals’ ability to pay. In addition, the basic allowance removes the lowest-income households from the tax net (and in some cases pays a negative tax in the form of the reverse tax credit). The nature of the distribution of PIT taxpayers, based on 2012 assessments, is given in Table 16. Fully 40 per cent of taxpayers, accounting for about 18 per cent of total income, pay no tax (and about half of these receive the reverse tax credit). In addition, the 18 per cent of taxpayers who fall into the upper, 35 per cent, tax bracket account for almost 75 per cent of taxable income, whereas they account for only about 46 per cent of employment income and 45 per cent of total income. The more than twice as many taxpayers in the lower tax bracket account for a slightly smaller share of employment income, 40 per cent, and a significantly smaller of total income, at 37 per cent. This group meanwhile accounts for 1⁄4 of taxable income. However, the picture misses that interest and dividends, which would tend to be concentrated within theset of higher-income households, are taxed separately at the flat, low 12.5 per cent rate; similarly capital gains, which are not taxed, would tend to accrue more to higher-income households. Residential rental income is also relatively lightly taxed; that income and business income would also exhibit a significantly higher degree of noncompliance than salary and pension incomes. All these factors work to reduce the effective progressivity of the individual income tax.
106. One measure that would raise further revenue, while increasing the progressivity of the tax, would be to convert the personal allowances to tax credits, calculated at the lower tax rate.Thus, the personal allowance of BDS$25,000 would become a credit against tax liability equal to BDS$4,375; similarly the child allowance would become a credit equal to BDS$175; and the spouse allowance would become a credit of BDS$525. Based on the income tax data from 2013 returns (Table 15), this move could raise additional revenue in the region of BDS$90 million, equivalent to more than one per cent of GDP.
107. Other deductions could similarly be converted to credits at the lower tax rate, or alternatively be eliminated.Another large deduction taken is for home improvements, including mortgage interest, to a maximum deduction of BDS$10,000. In 2013, total deductions were BDS$166 million, of which 70 per cent represented mortgage interest. This deduction would tend to benefit higher-income households. Converting to a credit wouldreduce this benefit. Going further, a strong case can be made for eliminating the preferential treatment of these expenditures, on the ground that implicit rental income arising from owner-occupied housing is not taxed under the income tax. Eliminating the deduction for home improvements would generate approximately BDS$40 million, equivalent to a little less than 1⁄2 per cent of GDP. A similar case, though less strong, could be made for converting or eliminating the deduction for residential rent paid.
108. Exempting capital gains from income tax reduces the fairness (vertical and horizontal) of the tax, its progressivity, and can introduce distortions. Capital gains would tend to be concentrated in higher-income households. In addition, there is a strong incentive to arrange affairs so that other types of highly-taxed income are converted to capital gains; for example, it is better to take the profit from a business in the form of an untaxed capital gain rather than in the form of (taxed) dividends. Over time, this weakness in the income tax should be addressed. There will be difficult administrative problems to be resolved in implementing this. One relatively easy place to begin is to bring realized capital gains on real property into the tax net. As with other elements of capital income, a flat, schedular approach would be appropriate, at a rate close to the current withholding tax rates on dividends and interest. For simplicity, the tax should apply only to gains accruing after some announced “valuation date”.
109. The consolidation tax introduces an additional element of progressivity into the income tax.This arises from both the relatively high exemption level of BDS$50,000 and the progressive rate structure. Data on the tax for the four months of 2013 (and a straight- line extrapolation for 12 months) is presented in Table 17. About 24,000 taxpayers had a positive tax liability under the tax, from which it can be reasonably inferred, from Table 16, that taxpayers in the lower income tax bracket of 17 1⁄2 per cent had positive liability under the tax.On the basis of collections in the last four months of 2013, it is estimated that the tax will raise about BDS$32 million at an annual rate, 75 per cent of which will come from taxpayers with incomes over BDS$100,000; and with half of that coming from approximately 20 per cent of those taxpayers with incomes over BDS$ 100,000 who have incomes in excess of BDS$200,000.
110. It is significant that the consolidated tax begins to bite at approximately the income level where the National Insurance contributions are capped.The ceiling for 2014 for NIS is BDS$ 52,320 (see the next section), close to the consolidated tax exemption level of BDS$ 50,000. Thus, the consolidated tax can be seen to offset (only partially, as NIS contributions total 21.35 per cent, of which 10.1 is contributed by employees) the fall in average and marginal tax rates arising from the overall taxation on income, comprising NIS contributions and PIT, as incomes rise above BDS$ 50,000.
111. However the Consolidated Tax design has a severe weakness that will need to be addressed eventually if the tax is to remain as an additional progressive element of the income tax. The tax embodies very high marginal tax rates (much higher than 100 per cent) at the income levels where brackets change. This introduces severe distortions for taxpayers with incomes near the bracket changes points. To remove this distortion, the tax will likely need to be integrated directly into the rate structure for the PIT. One element of such integration may be the introduction of a third positive tax rate into the rate schedule of the PIT.
112. The income taxation of small businesses is complex, and should be simplified along with the simplification of small taxpayers under other taxes, especially the VAT.From Table 15 above, net business and property income declared on individual income tax returns totaled BDS$ 104.5 million, equivalent to about 11⁄2 per cent of GDP. Actual taxable could in fact be considerably less than this, as personal and family allowances and other deductions can still be taken against this. Many of these taxpayers would be small businesses, yet they face record keeping and reporting requirements similar to larger businesses. In addition high administrative costs to ensure compliance of these taxpayers further reduce the net social benefit of the application of the tax to them. For these reasons, it would be beneficial to design and introduce a simplified regime for small businesses that is easier toadminister and to comply with, while still raising some revenue for the budget. As discussed in Chapter 1 above, this simplified regime would apply to all businesses below the VAT registration threshold, and would replace both VAT and income tax.
113. Employed individuals between the ages of 16 and 65 must be insured under the National Insurance and Social Security Act. The current pensionable age is 66, with increases of six months each scheduled for 1 January 2014 and 1 January 2018, eventually raising the retirement age to 67.
114. Contributions are determined as a percentage of insurable earnings up to a maximum of BDS$4,360 per month.The total tax rate is 21.35 per cent of earnings, with the employee’s share being 10.1 percentage points. Self-employed individuals must also be insured, and they make contributions of 16.1 per cent of their earnings of up to the same maximum of BDS$4,360 per month.
115. One anomaly that arises is the differential (unfavorable) tax treatment of NIS contributions relative to contributions to registered retirement plans.Registered retirement plan contributions are deductible from income, in determining taxable income, up to a ceiling. Employee contributions to the NIS are not deductible (employer contributions are effectively deductible, since the employee is not required to declare them as income). However benefits under both plans are treated symmetrically under the income tax – both types of pension payments are taxed. The degree to which this introduces unfairness into the overall tax treatment of savings for retirement depends to a large degree on the extent to which there is a direct linkage between NIS contributions and the eventual pension benefit. The mission did not investigate this matter.
· Consider converting major allowances and some deductions into credits, determined using the lower tax rate. To simplify the tax, eliminate minor deductions and allowances, and convert others to credits.
· Eventually integrate the Consolidation Tax into the PIT, to remove the perverse incentives at bracket change points under the current tax.
· Introduce a tax on capital gains on real property transactions, at a rate approximating the current withholding tax rates on dividends and interest.
· Introduce a simplified regime for small businesses (those below the VAT threshold), replacing both VAT and income tax for these businesses.