Untaxed Minimum

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About a month or so ago, candidates of the political coalition Georgian Dream declared that – if elected to the Parliament – they would amend the Tax Code of Georgia to introduce the so-called “untaxed wage minimum.” According to them, the untaxed minimum amount would equal the subsistence minimum.

The idea itself is not new – such an arrangement exists in a number of countries more economically advanced than Georgia. Even Georgia practiced the untaxed minimum approach several years ago and it totaled GEL 9. Advocates of an untaxed wage minimum, as a rule, support their stance by arguing that it helps to alleviate the tax burden on the economically disadvantaged. Their argument is that, under the current Tax Code, the state seizes part of the wages of poor citizens in the form of income tax, but if an untaxed minimum amount were introduced then that disadvantaged segment of the society would be able to bring a bit more money home to their families.

At the level of rhetoric, the initiative looks humane indeed. Politically, it is advantageous as well. Yet, it is important to understand what negative consequences would ensue if this idea of an untaxed minimum were enacted.

The most frequently heard counterargument to the Georgian Dream coalition’s initiative is that the untaxed minimum would decrease budget revenues. Since some of the income of Georgian workers would be exempt from taxation, income tax revenues flowing into the state budget would necessarily be less than before. If the untaxed minimum is equalized with the subsistence minimum of GEL 155, the loss in income revenues for some 620,000 taxpaying workers would amount to some GEL 230 million annually.

That amount, of course, is not insignificant – it comprises approximately three percent of the total state budget. But that is a weak argument against an untaxed wage minimum. An increase or a decrease in budget revenues is simply not a good criterion for determining whether or not a particular policy is expedient to implement. Every government naturally prefers to have more money to spend, but that does not at all mean that the welfare of the population will increase or decrease proportional to any increase or decrease in the state budget. In general, the more money left to the private sector and the less spent by the state apparatus, the better it is overall for economic growth.

In reality, problems that arise with an untaxed wage minimum are not so much related to a decline in state revenues as they are to the disparate treatment of citizens by the state.

Establishing an untaxed minimum would create a tax loophole which employers would try to use to decrease the cost of human resources. For example, if a small or medium-size business pays each of its employees GEL 300 after taxes (and consequently pays GEL 75 in income taxes for each employee), introduction of an untaxed minimum (conventionally, GEL 155) would enable the business to “employ” formally twice as many people and to pay each GEL 150. The exempted income tax of GEL 75 per employee would be a gain to the employer. The problem with such a scheme is not a decrease in budget revenues, but its corrupt essence.

Creating such a loophole in the Tax Code – and, with it, the possibility to evade taxes – would most likely shift corruption to the public sector. That is because it would be up to state bureaucrats to decide which employers are trying to dodge taxes and which employers really need dozens of GEL-150-wage “employees.” In short, bureaucrats would have the power to decide who should be punished and who should not.

Such an inequity, where the state treats high-income citizens in one way and low-income citizens in another, is easily exploited by affluent citizens. The reason for that is simple – affluent citizens can afford to hire high-priced lawyers and accountants to maximize the benefit of legislative loopholes. Poor citizens have neither the requisite knowledge nor the time and resources for that. Even more importantly, the efforts of accountants and lawyers to help affluent clients evade taxes do nothing to improve the general welfare of the population.

It is also important to recognize that any state policy which means virtually seizing wealth from the rich and distributing it to the poor (the essence of the untaxed minimum is that affluent people finance state expenditures while poor people are not levied) cannot produce a desirable result.

A 2002 survey conducted by the Institute for Policy Innovation showed that – not once in forty years – did progressive taxation (which implies an increase in tax rates along with an increase in taxable income) produce the intended effect. During the period from 1957 to 1997, the share of income taxes paid by the richest ten percent of the population (measured against total income tax collected) rose by fifteen percent while the share of income (measured against total after-tax income) of the remaining ninety percent of the population declined by thirteen percent.

The main problem with introducing an untaxed wage minimum as a tax norm, however, is that it upsets the principle of equality before the law: a segment of the population will not pay income tax while the rest will pay. Such a legislative norm is discriminatory. Discrimination on the basis of income is no different from any other form of discrimination – be it by race, gender or religious belief. If we really want to ease the income tax burden for the poor, then we should decrease the income tax rate – but for all. That would be fair to everyone and contribute to employment too.

This article first appeared in Tabula Georgian Issue # 99, published 7 May 2012.

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