One year after the last salary and scale adjustment to the government employees was made the government proposed the long-awaited amendment to the employee tax schedule this week. Following the leaks on social media a few months ago, debates surfaced as to what this amendment entails to employees and their purchasing power by extension. Now with all rumors aside, the current amendment, which would be implemented next month, is something that is stirring another round of debates, writes Asrat Seyoum.
Short of expectations
Arguably, the two most powerful ministerial positions in the Ethiopian government next to the Prime Minister have always been the Minister of Foreign Affairs and Minister of Finance. Accordingly, these positions have always grabbed attention at every major ministerial reshuffle. Perhaps fitting this character, only handful individuals have filled these positions during the past 25 years. This stands at a stark contrast to the other ministries whose stewardship changed hands more frequently. Most notably, two names were almost synonymous to these two positions in the past two decades.
As far as the Ministry of Foreign Affairs is concerned, it is the veteran Seyoum Mesfin who had defined the role of chief diplomat in Ethiopia serving on the same position for a period of 19 years (1991-2010). Equivalent to that is another long serving politician who had been Minister of Finance for 21 years—Sufian Ahmed. Under Sufian’s tenure, the Ministry oversaw an economy which has experienced one of the sharpest changes in the world. From one devastating war to another the country was able to grow by double-digits and grab the attention of the international community.
Under the banner of economic development and finance, Sufian led two strategic aspects of the Ethiopian economy: garnering economic assistance from abroad and leading the often ambitious and highly expansionary fiscal policy of the nation. As such, the government has always relied on increased spending of the public sector to fuel the ongoing growth and Sufian knew to keep it together.
When it was finally announced that it was time for the longest serving finance minister to leave the position, tension was high as to who will fill his shoes. Apparently, it was Abdulaziz Ahmed, formerly vice-president of the Oromia Regional State, and someone with no experience as line minister, who assumed the responsibility. Abdulaziz took his position in October 2015, the start of the fiscal year in the Ethiopia calendar.
So, in a milestone event, last week, Abdulaziz delivered his first budget speech to the House of People’s Representatives (HPR), the first person other than Sufian to do so in manner of two decades. Abdulaziz looks to be carrying over the expansionary tradition in its budget proposal for 2016/17 fiscal year. By presenting a spending of 274 billion birr, a sharp 50 billion over and above last year’s spending Abdulaziz signaled his resolve to conduct his fiscal policy much like his predecessor.
One of the highlights of this year’s budget speech, however, was the long-awaited amendment to the income tax schedule. This amendment was rumored to be in the works for more than three years now. According to the Finance Minister, the amendment goes much deeper than a revision on the income tax schedule. “An exhaustive overhaul of both the tax administration policy and the income tax proclamation has been drafted and it is expected to enter into force by next year,” Abdulaziz told MPs on Tuesday.
Meanwhile, the proposed amendment to the employee income tax schedule and the tax schedule for rental income surfaced on the social media on the same day. In retrospect, this was not the first time when the new schedules were rumored to have surfaced on social media. It is not also the first time when it trended quite high on the social media platform. By the time, Abdulaziz delivered his speech and proposed the budget for the next fiscal year, a number of social media commentators have already made up their minds about the proposed amendment.
In all fairness, the focal point of the income tax schedule was the minimum threshold income. The threshold defines the cut-off income level below which all income will be exempted from taxation. And this level was 150 birr for very long time. As far as the threshold is concerned, the earlier figure released on social media was not that far off. Anyway, the new schedule had the threshold at 585 birr, a 435 birr rise from its level at this moment. On the other end of the table is a monthly salary of 10,833 birr, above which a flat rate 35 percent is directly applicable. In between, there are four income brackets each varying in size and the applicable rate of taxation.
Immediately after the minimum threshold level comes in the income bracket, which ranges between 586 to 1650 birr monthly income, is subject to 10 percent taxation rate and it is the smallest in size when one considers salary range. As one goes up the income ladder, the next bracket will be 1,651 to 3,146 birr with a taxation rate of 15 percent applicable for all incomes falling in this bracket. This bracket is successively broader than its predecessor. Still further, one finds income brackets 3,146 to 5,195 and 5,196 to 7758, with tax rates of 20 and 25 percent, respectively, and still each getting wider than the last one. These brackets include income levels which were classified as high income categories under the previous tax schedule (above 5,000). The last income bracket is 7759 to 10833 with 30 percent rate and yet exhibiting broader a range in the bracket.
Similarly, the income earned from rent is also subject to new schedule with minimum taxable threshold lingering at annual rental income of 7,000 birr. On the other hand, a yearly income of 130,000 birr is set to be the maximum that can be earned form rent and hence anything above that would be subject to 36 percent taxation.
Nevertheless, a concept that remains elusive is how the new schedule especially the minimum and upper thresholds are meant to benefit lower income brackets from carrying heavy tax burdens. This becomes a bit complicated as one explores how the net gains from the new tax schedule fares in the current market. For instance, sample monthly incomes of 700, 2,000, 3,400, 6,000 and 10,000 birr and the net gains in the form of increase in the disposable income reveals the ambiguity as to which income bracket gets the biggest benefits.
For the 700 income earner the older income schedule implies 57.5 birr total tax returns monthly and a net disposable income of 642. 5 birr. However, as per the new schedule, the net tax return for this income earner would be around 11.5 birr, a net reduction of 46 birr in taxes. Similarly, the 2,000 and 3,400 income earners would get net benefit of 124.5 and 233.25 birr.
Meanwhile, for 6,000 birr income earner, which was included in the 35 percent taxation band in the previous schedule, the benefit goes higher up to 495.5 birr. Under the old schedule 6,000 birr income earner was expected to pay 1437.5 birr and the amendment brings this down to 942 birr.
For the 10,000 birr income level tax return of 2837.5 is reduced to 2045.1 offering a net tax relief of 783.4 birr. Meanwhile, for income levels above 10,833 birr the net gains accruing to the taxpayer is an equal amount of 825.05 birr.
Now, if one tries to test the hypothesis that the new schedule offers tax relief particularly to lower income brackets, the result would be confusing at best. Using the sample monthly salaries which were mentioned above, the net relief of 46 birr for 700 birr income earner is no discernable way better than benefit that accrues to the say the 10,000 or 6,000 birr income earners. Simply considering what these net gains mean to the different income levels mentioned in the above illustration would bring this confusion to life. For instance, 46 birr net tax relief for 700 birr income earner amount to freeing up 6.57 percent of the gross salary.
Meanwhile, a 495.5 birr net tax relief to the 6,000 birr income earner is equivalent to 8.26 percent of gross salary and 783.4 birr net relief for 10,000 income earner is also around 7.8 percent of the gross income. Here, it is clear that the net gains from the new tax amendment is far more superior for the relatively higher income categories there by contradicting the initial intentions of amendment.
The structure of the proposed income schedule aside, the level of the new threshold income looks to be far more debatable, if the discussion on social media is something to go by. In fact, the better question here is if there is any underlying logic to setting the minimum income tax threshold around the world and Ethiopia in particular.
Sadly, the answer to this question is not definitive. According to Costentinos Berhe (PhD), a lecturer at graduate school of AAU, the minimum threshold income is usually associated with the level of inflation and exchange rate in a particular country. He argues that adjusting the threshold would require estimating the impact of inflation and currency exchange rate on the standard of living. In country like Ethiopia, it is probably best guess work than a reliable market survey since the economic data by itself is not reliable, Constentinos contends.
As to the theoretical foundation and the definition of the minimum threshold income, there are a number of assertions which are brought to the table. While some define the threshold to be a mere measure minimum wage amount that a labor force is legally mandated to earn from employment others say that minimum threshold and minimum wage are quite different entities. Although the two macroeconomic variables are similar in giving due consideration to the standard of living and minimum amount that wage earners need to sustain life, the overwhelming majority argue as to the divergence of the two.
According to an explanation Zemedeneh Nigatu, Managing Partner of Ernst and Young Ethiopia, gave to The Reporter in 2012, the minimum wage legislation is meant to protect workers in labor negotiations while the minimum threshold is about offering tax relief to lower earners and shifting heavy tax burdens.
Meanwhile, other economists assert that minimum threshold should be less or equal to minimum wage level since it is by definition the bare minimum that is needed to survive and be able to generate income. In a way, this amount of income needed what is required to produce the income that is subjected to taxation. Some even draw parallel between the business and employees in a sense that expenses that are spared by businesses to produce the revenue, which is exempted (deductable) from corporate profit taxation, is equivalent in concept to the minimum threshold income that is exempted from taxation.
According to Constentinos, the global experience in setting the threshold income level is such that a special macroeconomic measure called the cost of living index is estimated periodically to help adjust the threshold. The cost of living index is a sort of measure that goes deeper into consumer’s standard of living than the standard consumer price index. Although Costentinos admits that measuring living standard and utility of consumers could be difficult in Ethiopia, it is instrumental in informing such decisions.
On the side of the consumer, the limit of the amendment in terms of reflecting the real cost of living on the ground is not as worrying as the impact that might follow the amendment. For some, the net impact could easily be nullified or even worse consumers could end up being worse off than they are right now if the amendment triggers an increase in the price of basic consumer goods. The fear is not without reason, according to experts. It has become customary these days to see a disproportionate increase in level of prices in Ethiopia in the aftermath of such amendments.
Nevertheless, what most agree is on the fact that both minimum threshold and regular wages has to keep with fast changing cost of living and inflation. To this effect they argue for indexation of such variable to assure the meaningfulness of the impact to the consumer and also as a policy instrument.