It’s Time for a Solidarity Tax
Last month, Peru’s President Martin Vizcarra proposed a Solidarity Tax to mitigate the economic impact of the COVID-19 pandemic. The proposed solidarity tax would be temporarily imposed on wealthy and super-rich Peruvians earning more than US$3,000 a month. The tax authorities are expected to raise 300 million soles (US$88 million) per month in additional revenue from the solidarity tax.
Targeted at the wealthier sections of society whose livelihoods have been less disrupted by government-enforced lockdown restrictions, the proposed solidarity tax is inspired by the principle of solidarity. “It important for those who have the most to show solidarity with those who have the least,”[1] said Mr. Vizcarra. He is seeking permission from Congress to make fast track changes in tax laws to implement the proposed solidarity tax on wealthier income brackets.
Peru was among the first in the region to impose nationwide restrictions on people’s movement, starting March 15. Despite more than 50 days under nationwide lockdown and considerable public support to “flatten the curve,” Peru has the second-highest number of confirmed cases and deaths in Latin America, next to Brazil. As of May 11, 2020, there were more than 67,000 confirmed cases and 1,889 deaths from COVID-19 in Peru, with a total population of 32 million.
Solidarity Tax: A Simple but Potent Idea
While exact details of the tax proposal are eagerly awaited, the idea behind solidarity tax is straightforward but potent: the affluent Peruvians should shoulder a larger share of the economic burden of addressing the COVID-19 pandemic and its economic fallout. The Vizcarra administration has launched a massive fiscal stimulus package worth $26 billion (equivalent to 12 percent of the country’s gross domestic product) to support millions of jobless citizens and the mining sector affected by the COVID-19 lockdown. Other than Peru, no country in Latin America has enacted a fiscal stimulus equivalent to 12 percent of its GDP.
The proposed solidarity tax is a small step towards filling the massive fiscal holes created by the COVID-19 pandemic. Peru’s fiscal deficit is likely to widen to 8 percent of GDP this year due to a fall in tax revenues and a sharp contraction in economic activity. In addition to solidarity tax, Peru is also seeking an $11 billion loan from the IMF under a two-year Flexible Credit Line after successfully issuing $3 billion in US dollar-denominated bonds in international capital markets in Mid-April. These myriad domestic and international resource mobilization initiatives are directed at raising additional funds for the battle against the COVID-19 pandemic.
In response to the COVID-19 pandemic, Colombia also introduced a three-month solidarity tax, which shall remain in force during May-July 2020, on public servants with a monthly salary of over 10 million pesos ($2,500).
Taxing the Rich Gaining Traction
As COVID-19 has an unprecedented impact on people and economies across the world, policymakers, tax officials, and other stakeholders in advanced and emerging economies are exploring new revenue-raising measures to fund public expenditures on relief and recovery programs. These include fine-tuning the existing taxes as well as introducing new taxes (such as solidarity and wealth taxes) targeted at the super-rich and high earners.
Even prior to COVID-19, the Democratic presidential candidate hopeful Senator Elizabeth Warren and Senator Bernie Sanders proposed wealth taxes to reduce income and wealth inequality in the US. By adding new momentum to such tax proposals, the COVID-19 pandemic has re-ignited policy and academic discussions on raising revenues through new wealth and inheritance taxes, financial transaction taxes, besides reforming the international tax regime.
In Latin America, the idea of a wealth tax is not new as Argentina, Colombia and Uruguay are already implementing such taxes with different rates. Brazil, Colombia, and Argentina have implemented taxes on banking and financial transactions in the past. It is worth noting that growing interest in solidarity and wealth taxes is part of a broader framework of implementing progressive tax policies.
Understandably, some Latin American governments may be hesitant to implement solidarity and wealth taxes for ideological or political economy reasons. Nevertheless, solidarity and wealth taxes are increasingly gaining traction as the region’s tax systems are biased towards indirect taxes and place the low tax burden on the rich, thereby increasing wealth concentration and income inequality.
As noted by Brenden O’Boyle, debates over new tax measures targeting the ultra-wealthy and high earners have begun in at least nine countries across the Latin American region since March 2020.[2] In Brazil, Bolivia, Chile, Ecuador, and Paraguay, such tax proposals have been put forward by opposition parties and candidates. It is too early to predict the outcome of these initiatives, but the exploratory work to estimate the tax potential has already begun.
In the midst of the current crisis, one should not be surprised if some governments introduce higher taxes on the rich in the form of a solidarity tax or a wealth tax as they are struggling with a “scissors effect” of decreasing tax revenues due to sudden stop in economic activity and rising expenditure due to a higher demand for health, social protection, and welfare services.
India Looks the Other Way
India desperately needs solidarity and wealth taxes to boost direct tax revenues that would decline drastically this year due to lockdown and social distancing measures implemented in response to COVID-19. In late-March, the government announced an economic package of $22 bn (amounting to 0.8% of GDP) that is grossly inadequate to support a $2.9 trillion economy and to protect 1.3 billion people from coronavirus.
On May 12, a second economic package was announced, which amounts to nearly 10 percent of India’s GDP. While we await finer details of the second package, preliminary analysis shows that it includes the first economic package and a slew of credit guarantees and liquidity enhancing measures that do not qualify as fiscal stimulus.
Given the magnitude of humanitarian and economic disaster in India, the government should not worry about fiscal deficit numbers. This is the right time to abandon fiscal fundamentalism as India badly needs a strong fiscal stimulus to mitigate the COVID-19 shocks.
The Modi government has not yet unveiled its plans to boost revenue collection from direct taxes. There is no denying that India has the potential of greater domestic resource mobilization by imposing wealth, inheritance, and estate taxes, in addition to raising the income tax slab for the super-rich.
India is a land of many paradoxes. While India is still home to 180 million poor people, the country has the world’s fastest-growing population of millionaires. According to a report by Credit Suisse Research Institute, there are 7,59,000 dollar millionaires in India.[3] The report further notes that dollar millionaires in India could number 1.2 million in 2024.[4] According to Hurun Global Rich List 2020, India occupies the third position globally (after China and the US) with 137 dollar billionaires.[5]
In 2016, the Modi government abolished the wealth tax introduced way back in 1957. The wealth tax was replaced with an extra 2 percent surcharge on the super-rich individuals with a taxable income of over Rs 10 million. In the 2019-20 Union Budget, the Finance Minister proposed enhancing the super-rich’s surcharge but soon withdrew it. Last year, the government slashed the maximum corporate tax rate from 30 percent to 22 percent. The revenue foregone on reduction in corporate tax would be Rs 1.45 trillion annually, not an insignificant amount.
Despite experiencing higher growth rates over the past two decades, India’s tax-GDP ratio is abysmally low primarily due to low direct tax base, parallel economy, and unorganized sectors of the economy. India’s tax-GDP ratio (excluding states’ share in taxes) was 10.9 percent in 2019, far lower than the average OECD ratio of 34 percent. According to official statistics, only 14.6 million individuals (less than 2 percent of the population) paid income tax in India las year.[6] On the other hand, indirect taxes (such as excise taxes) impose a greater burden on poor people, thereby aggravating the already high degree of inequality in India. In recent years, there have been frequent demands to reform India’s regressive tax system and to make it more equitable.
In the wake of the COVID-19 crisis, a group of over 50 serving tax officials belonging to the Indian Revenue Service Association (IRSA) prepared and submitted a policy paper titled, “Fiscal Options and Response to Covid-19 Epidemic,”[7] to the Central Board of Direct Taxes (CBTD). The policy paper contains recommendations to mobilize additional revenue in the short and medium-term without burdening poor and low-income people. The recommendations include enhancing income tax rate to 40 percent for those earning over Rs 10 million; re-introduction of wealth tax for those with a net wealth of Rs 50 million; a one-time COVID-19 cess of 4 percent on taxable income of over Rs 1 million; and increasing the surcharge on foreign companies operating in India.
Underscoring the importance of taxing the rich Indians, the policy paper states: “In times like these, the so-called “super-rich” have a higher obligation towards ensuring the larger public good. This is for multiple reasons – they enjoy a higher capacity to pay with significantly higher levels of disposable incomes compared with the rest, they have a higher stake in ensuring the economy springs back into action, and their current levels of wealth itself is a product of the social contract between the state and its citizens. Most high-income earners still have the luxury of working from home, and the wealthy can fall back upon their wealth to cope with the temporary shock. In view of several European economists, taxing the wealthy would be the most ‘progressive fiscal tool’, as wealth is far more concentrated than income and consumption.”[8]
It is unfortunate that rather than further deliberating on policy recommendations, the CBTD issued charge sheets to three office bearers of IRSA and divested them of official responsibilities for going public with their personal views, on the pretext of violating conduct rules.[9]
The Fiscal Response to COVID-19
Although fiscal stimulus measures vary in size and design across countries, the overarching goal of stimulus measures is to provide temporary support to households and businesses most affected by the pandemic. Unlike developed economies that enacted swift and sizeable fiscal support measures in response to the COVID-19 pandemic, only a few emerging market and developing economies (EMDEs) announced large fiscal stimulus packages. The high public debt, coupled with the tightening of global financial conditions, constrains the space for fiscal stimulus in many EMDEs. Also, one cannot overlook the fact that the pandemic erupted at a time when many EMDEs were already facing severe financial stress.
Nevertheless, the COVID-19 crisis would widen the fiscal deficit in all major EMDEs. The increased government spending and fall in tax revenues would inevitably push the fiscal deficit to record levels. There can hardly be any country in the world that would not run a higher fiscal deficit this year. The fiscal deficits in major advanced and emerging economies would be much wider than witnessed in the aftermath of the 2008 global financial crisis.
In the present scenario, any attempt to cut back government expenditure to rein in fiscal deficit would undermine economic recovery efforts. To support vulnerable households and businesses, governments need to explore new and innovative ways to mobilize additional financial resources that can provide governments with increased resources for addressing the economic impact of COVID-19 pandemic. Given the gravity of the current crisis, solidarity and wealth taxes could be viable financing tools to quickly mobilize revenues for additional public spending for COVID-19 relief and recovery measures.
The Underlying Rationale
There are several justifications for the adoption of solidarity and wealth taxes to mitigate the economic shocks of COVID-19, some of which are summarized below:
Firstly, tax revenues are expected to remain subdued over the next two years due to a slowdown in economic activity. In particular, the loss in tax revenues would be severe for those EMDEs that depend significantly on commodities and natural resources for government and export revenues. The fall in tax revenues would also be substantial in economies that rely heavily on trade and tourism or serve as a part of global value chains.
A steep drop in consumption would decrease consumption tax revenues, which are the most critical source of government revenue for many EMDEs.
Secondly, increased expenditure for healthcare and social spending would require substantial increases in financial resources. In the wake of COVID-19, governments across the world are enhancing spending on public health, social protection, and economic relief programs. As a result, their fiscal positions are under considerable pressure, particularly of EMDEs that generally have weak health infrastructure and lack social safety nets to protect the poor.
Thirdly, it is clear that economic recovery would be mostly dependent on the effectiveness of public health and economic responses. Economies that would adopt strong stimulus and enforce social distancing policies would recover quickly from the COVID-19-induced recession.
Fourthly, although the political fallout of the COVID-19 pandemic remains to be seen, the rise in hunger, unemployment, and poverty would fuel widespread protests and civil unrest in many poor and developing countries. Even before the COVID-19 outbreak, large-scale public demonstrations in Chile, Colombia, and Ecuador demanded better social safety nets and public services. The ILO has recently estimated that the COVID-19 outbreak and resulting lockdowns threaten the livelihoods of 1.6 billion workers in the informal economy – nearly half of the global workforce.[10] To avoid potential political risks arising from COVID-19, the incumbent governments need to mobilize resources to provide basic means of survival to the poor and vulnerable populations.
Fifthly, taxes on wealth, estate, and inheritance are the most effective policy tools to reduce inequalities. Specifically targeted only at super-wealthy, such taxes redistribute wealth in addition to raising revenue for public spending.
Lastly, there are historical precedents for taxing the rich at higher rates in times of wars, natural disasters, and epidemics. The COVID-19 is a once-in-a-lifetime epidemic and poses an existential threat to humanity.
No Silver Bullets
While supporting the idea of solidarity and wealth taxes, we are not suggesting that these taxes alone would mobilize trillions of dollars needed to address the humanitarian and economic impacts of COVID-19 pandemic.
There is no one-size-fits-all solution. The design and implementation of solidarity and wealth taxes should reflect country-specific economic and institutional circumstances. The tax authorities should design these taxes in such a manner that maximizes revenue and minimizes the scope for evasion. Admittedly, the scope of tax evasion is far greater in Peru, Brazil, and other Latin American countries where the super-wealthy park bulk of their wealth abroad.
If carefully designed and used in conjunction with other taxes, solidarity and wealth taxes could mobilize substantial resources to tackle the COVID-19 pandemic.
Apart from taxes, EMDEs could also use other sources to finance public expenditures to combat the COVID-19 pandemic. These include borrowings from multilateral financial institutions such as IMF and World Bank (provided fiscal tightening measures are not imposed), issuing sovereign bonds in domestic and international capital markets (albeit at higher costs due to rising spreads), and monetary financing (or “printing money”).
The EMDE governments can choose an appropriate funding mix, but the fact remains that direct taxes can raise revenues fairly and efficiently to meet not only COVID-19-related costs but also to finance equitable and sustainable development over the long term.
Overhauling the Tax System
The unprecedented nature of COVID-19 offers a window of opportunity to make the tax systems more progressive at both national and international levels.
At the national level, governments should promote greater policy coherence and inter-sectoral coordination. The domestic tax policy should not be viewed in isolation from health, social care, trade, financial and monetary policies. Instead, tax policy should be closely aligned with a comprehensive development strategy aimed at achieving inclusive growth and sustainable development.
At the international level, taxation policy should be an integral part of a comprehensive policy response consisting of health, debt relief, aid, trade, and investment policies geared towards faster economic recovery from the COVID-19 crisis.
International cooperation is also essential to ensure that tax disputes should not escalate into trade wars. In a post-crisis world, the growing demands for implementing measures to ensure that multinational enterprises pay a minimum level of tax cannot be ignored. The time is ripe for taxing the digital economy.
On the corporate tax avoidance front, international initiatives such as OECD/G20 Base Erosion and Profit Shifting (BEPS) Project are underway, but they fall short of an inclusive multilateral approach to address weaknesses in the current global corporate tax regime.
To conclude, exceptional times call for exceptional measures. COVID-19 has dramatically changed the way people live and work. The post-COVID-19 world would be completely different from the pre-COVID-19 world.
As the world prepares to adjust to a “new normal,” policymakers need to deploy every financial tool at their disposal to the fullest to recover quickly and strongly from the COVID-19 crisis. Policymakers need to be reminded that the post-COVID-19 economic recovery should be green and inclusive. A green and inclusive recovery is not only desirable, but also necessary for building an inclusive, sustainable, and resilient future.
Endnotes
[1] Quoted in John Quigley, “Peru Plans ‘Solidarity’ Tax Measures as Virus Spending Grows,” April 24, 2020. Bloomberg News, Available at: https://news.bloombergtax.com/daily-tax-report-international/peru-plans-solidarity-tax-measures-as-virus-spending-grows-1.
[2] Brenden O’Boyle, “Latin America’s Plans to Tax the Rich,” Americas Quarterly, May 7, 2020. Available at: https://www.americasquarterly.org/article/latin-americas-plans-to-tax-the-rich/.
[3] Global Wealth Report 2019, Credit Suisse Research Institute, October 2019. Available at: https://www.credit-suisse.com/about-us/en/reports-research/global-wealth-report.html.
[4] Ibid.
[5] Hurun Global Rich List 2020, Hurun Research Institute, February 26, 2020. Available at: https://www.hurun.net/EN/Article/Details?num=775CEFAE8BF8.
[6] https://twitter.com/IncomeTaxIndia/status/1227890943564623872.
[7] Fiscal Options and Response to Covid-19 Epidemic – Recommendations of the Indian Revenue Service on Revenue Mobilization and Economic Impetus to fight COVID-19, Indian Revenue Service Association, April 23, 2020. Available at: https://taxguru.in/wp-content/uploads/2020/04/IRS-Tax-Team-FORCE-ideas.pdf.
[8] Ibid.
[9] “CBDT charge sheets 3 IRS officers involved in controversial tax report ‘FORCE’,” The Statesman, April 28, 2020. Available at: https://www.thestatesman.com/india/cbdt-charge-sheets-3-irs-officers-involved-controversial-tax-report-force-1502881736.html.
[10] International Labour Organization, “As job losses escalate, nearly half of global workforce at risk of losing livelihoods,” Press Release, 29 April 2020. Available at: https://www.ilo.org/global/about-the-ilo/newsroom/news/WCMS_743036/lang–en/index.htm.
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