Individual income tax as an instrument for income redistribution in the republic of Kazakhstan

Individual income tax is an integral part of a government tax system that should fulfill both fiscal function and solve the social-economic problems of a country. A tax system should develop the economy and its subjects (entities), balance public and private interests, create an effective system of social guarantees for the population, help to reduce significant gaps between the level of consumption of the richest and the poorest groups, which have been formed over the past two decades.

I. Analysis of the development of taxation on individuals in the Republic of Kazakhstan

According to the Tax Code of the Republic of Kazakhstan (further “RK”) individual income tax has been calculated with 10% flat rate since January 1, 2007. A progressive rate of taxation was used up to that time From January 1, 2001 to January 1, 2007 a taxpayer's income imposed for the tax year was collected at the rates presented in Table 1.

Table 1. Rate of individual income tax in the RK for the period From January 1, 2001 to January 1, 2007

At the same time the income of employees, taxed at the source of payment that does not exceed 12 times of the minimum wage according to the Law of the Republic of Kazakhstan "On Republican Budget" within one financial year is subject to a tax at the rate of "0%". Under the condition that the average income of an employee during the quarter does not exceed the minimum wage.

The progressive scale of rates on individual income tax was abolished by the Law of the Republic of Kazakhstan "On Adopting Amendments and Additions to Some Legislative Acts of the Republic of Kazakhstan on Issues of Taxation," July 7, 2006 № 177-III ZRK. From January 1, 2007 was replaced by the single flat tax rate at 10% for everybody. Legislators of the Tax Code also presented such innovation, as the liberalization of the tax legislation in Kazakhstan and its improvement for all taxpayers. In this case, one of the reasons to introduce a flat rate tax was to facilitate the removal of citizens' incomes from the shadow economy. At that time, some large employers criticized the legislators, because it meant an actual tax increase from 5 to 10% for the vast majority of employees.

In 2010 there were opinions in Kazakhstan that in order to implement the principle of tax equity it was necessary to return to a progressive rate. The proposed bill has the scale of 10, 15 and 20%. As of today, a decision has been taken to postpone the adoption of the bill until 2013.

II. Analysis of the effectiveness of the introduction of a flat tax

As noted above, since January 1, 2007 in Kazakhstan a progressive scale of taxation on individuals has been replaced by the single income flat tax rate of 10%. The question remains if this tax reform has been effective.

Yuriy Gorodnichenko, Jorge Martinez Vazquez, Klara Sabirianova Peter, conducted a study using a database survey of households in Russia [1]. They concluded that the adoption of a uniform tariff rate of income tax does not lead to significant increase in tax revenues, as originally anticipated, because its impact on productivity, according to the analysis, is relatively small. However, the above researchers argue that if the economy is plagued by ubiquitous tax evasion, as it was in Russia uniform tariff rate may lead to a significant increase in total tax revenues through increasing voluntary compliance. In addition, in the course of their research they found out that the most significant reduction of tax evasion was among taxpayers who have experienced a significant reduction in tax rates once a flat rate of personal income tax was introduced.

Our analysis, conducted using data provided by the Tax Committee of the RK {2}, has shown a growth of receipts of revenues from individual tax income during the period from 2002 to 2010.

The Graph 1. Dynamics of growth of public revenues from individual income tax and an average nominal wage in 2002-2010

Introduction of a flat taxation skale

*Done by the authors using the data of the Tax Committee of the Ministry of Finance of RK and Statistics Agency

In Graph 1 we can see that since the moment of the introduction of a flat scale of taxation (2007) there was no sharp increase in tax collection. Most likely, the growth was caused by growth of nominal wages in the country. Having correlated two indices, we have found that close direct relation occurs (Graph 2).

Graph 2. Relation between state income from Individual Income Tax and an average nominal wage

Revenue to the state budget from Individual Income Tax, thousand KZT

* Done by the authors using the data of Tax Committee of the Ministry of Finance of RK and Statistics

However, here one can also see that if the change of the scheme of taxation effects the collection of taxes and the withdrawal out of shadow of wages fund of Kazakh companies since 2007 to a large extent. It was reasonable to observe growth of tax collection rates. In addition, a multiple regression coefficient equal to 0.96 suggests that the increase in revenue to the state budget for the period was 96% due to changes in average nominal wages.

Graph 3 shows that the index of revenues from the IIT to the state budget (in % for previous year) from 2005 to 2007. This was higher than the growth of wages since 2007. The rate of increase revenue dropped sharply. Such sharp decline is likely due to the economic crisis in the country.

Graph 3. Growth rate of revenues from IIT and the average nominal wage in Kazakhstan from 2001-2010

Thus, studying the data provided by the Tax Committee of the Ministry of Finance, we can make a preliminary conclusion that the goal set by the developers of a flat rate of taxation - the increase of income from IIT to the budget and the withdrawal of shadow wages was not achieved. We interviewed 15 experts in the field of taxation, finance and manufacture. All respondents were inclined to believe that the flat rate of taxation is extremely beneficial for companies from the point of view of simplicity of tax payments. Some regarded the transition to a flat rate of taxation as a reduction of the tax burden on business.

The financial director of an industrial company (wine products) explained, "As our company produces excisable products, we always show all income legally. Transition to flat rate of taxation for our company resulted in a reduction of taxes, as now we have to pay less tax from our salary fund. For example, we employ a technologist, whose market salary is $1000 (after payment of all taxes and deductions) that is, the costs of the company on this employee will be: $ 1000 plus 10% income tax plus 10% pension plus all social security tax. Until 2007 a scheme might be 1000 + 15 (20) % + 10% + social tax.

Naturally the rate has been decreased and the company's costs and the cost of its products have decreased. Now there is no need to hide all sorts of bonuses, etc. The tax changes are of no significance for those enterprises that pay wages under the table that is completely shady. "

Maksat Aldeshev, – Deputy Director General for Economy and Development LLP KazInterСom appraised the situation, "I think they have to pay even more because of the calculation of IIT has become easier. It has become difficult to “pull out cash” (because of tax audits), so it's easier to pay wages officially. I have not seen a single company over the past 5 years that would pay salaries under the table. Apparently, there are still companies who do not show wages officially, but it is actually easier and cheaper to pay taxes for the majority of them than to pay the salaries under the table, “pull out” cash and still pay a percentage to offices which are cashing money."

A general manager of a research firm said, "Yes, this scale is much easier to calculate taxes for accountants and employees themselves. In addition, as the percentage of tax burden for the higher income groups has been reduced, it has positively influenced the output of wages from the shadow economy. Companies are interested in a single tax. In percentage terms, everyone pays the same – only 10%. It's fairly easy to calculate and is doable from the psychological point of view. It is easier to pay 10% of salary, rather than 15 or 20%".

A chief accountant of a large trading company said, "After the introduction of a simplified calculation in our holding, the salary remained hidden and only in 2009, when the risk of cashing the money increased, we were forced to report the salary. Our leaders do not think of the complexity of the calculation, they are interested only in saving money on taxes.”

We can make a conclusion that the withdrawal of a significant part of the salaries from the shadow economy in Kazakhstan has occurred, but it was most likely not due to the reform of taxation but due to the improvement of tax administration in the country. The introduction of a unified tax rate on individuals in 2007 led to the increased tax burden on the poorest part of the population (since for them the tax was increased from 5 to 10%) and to the decrease of those whose salaries were above 150,000 tenge. This enabled companies to withdraw higher salaries from the “shadow”, to simplify financial schemes, and decrease expenses.

III. Can individual income tax be used as a mechanism for redistribution of income in the Republic of Kazakhstan?

The report of the OECD, «Unequal Growth: Income Distribution and Poverty in OECD Countries" for 2008, shows that in the vast majority of countries income inequality has been growing at least since the mid 1980s. Recently, the sharp rise has been note din Canada and Germany, and a decline in Mexico, Greece and Britain. In developed countries governments collect more taxes and spent more to compensate the rising trend of inequality. The redistributive effect of public expenditures has weakened the growth of poverty in the decade from the mid 1980s to the mid 1990s, but increased poverty in the subsequent decade, as the benefits became less focused on the poor [3].

Free market economies can often result in increased wealth by individuals and consequently, in income inequality, which can be mitigated by the government in a process of redistribution [4]. Many western economists believe that progressive taxation coupled with universal guaranteed social security benefits plays a role in income redistribution. However, such a transfer may entail negative effects, the so-called “fairness and efficiency” compromise (Alston et al, 1992; Kearl et al, 1979; Ricketts and Shoesmith, 1992). But, despite the fact that many scientists and politicians lean towards a redistribution of income, a controversy arises regarding the mechanisms of these distributions. Disputes include questions such as: how to determine the optimal level of distribution, whether the current level of real redistribution is above or below the optimal level, and which specific redistributive mechanisms are the most effective.

And while in the limelight are primarily questions of increasing inequities in the distribution of labor income, which can be improved through progressive taxation of income, many people say that income inequality is less significant than inequality in capital distribution (Bartels, 2008, Keister, 2000, Smith, 2001 and Wolff 1995). The economic argument that a very high level of wealth and capital inequality can cause the reduction of volume of production is less popular. In accordance with this last argument, in the case of wealth distribution there is no conflict between fairness and efficiency.

Nevertheless, the system of taxation of individual income has to stimulate economic activity, which has a direct impact on economic growth in the country. In many countries for these purposes a progressive tax rates of individual income is applied.

While in the West there is a concept of fiscal integrity of a minimum level of income per person needed for a living wage. The essence of such a minimum is to allow each taxpayer to restore adequately their potential and potential members of his or her family from his or her income, and in addition to this amount to oblige him to pay income tax. Government does not claim to such revenue of its citizens [5]. For example, taxpayers with low incomes are free from income tax. In Luxembourg and Austria the zero rates is applied for income up to $1000 a month, in the USA- up to $700, in Ireland - up to 600, in France - up to $ 500.

Director of the Institute of Financial and Tax Law, Doctor of Juridical Science E.V. Porokhov says that Kazakhstan has already overtook and left behind the West by the prices of goods (works, services) of public consumption and by the value of human life (as a process), but it is still lagging behind by social and fiscal guarantees of providing this life [5].

In Kazakhstan, the taxation is the combination of all individual income (both earned and unearned) and their levying the rate. However, in order to apply the principle of efficiency and fairness, the tax rate should differentiate between sources of income. For example, Prokhorov proposes to differentiate: 1) Income taxed at the source of payment. 2) Income under an employment contract 3) Property income, and 4) Dividend income and income of certain categories of individuals (lawyers, notaries, individual entrepreneurs).

Considering the issues of income inequality and redistribution mechanisms, many Western economists suggest that the redistribution of wealth through progressive taxation of property is more effective than the progressive taxation of income from employment (Bartels, 2008, Keister, 2000, Smith, 2001 and Wolff 1995). The economic argument that a very high level of wealth and capital inequality can cause a reduction of volume of production is less popular. In accordance with this last argument, in the case of wealth distribution there is no conflict between fairness and efficiency.

Nevertheless, a system of taxation of individual income has to stimulate economic activity, which has a direct impact on economic growth in the country. In most countries around the world for these purposes a progressive tax rates of individual income is applied.

Also it should be noted that "income of individual occupations (creative, intellectual) requires preliminary long-term investment in advanced education and skills rather than routine monotonous work" [5]. Therefore, in respect of such professions a special tax clause in fixing rates of taxation of their incomes should be made.

If Kazakhstan wants a professional, well-educated population, it should stimulate citizens' zeal for education and nurture in them respect for science and vocational education, including through taxation. The President of Kazakhstan Nursultan Nazarbayev in his speeches repeatedly stressed that one of the main objectives of the national “Project Intellectual Nation – 2020" is to bring up a new generation in Kazakhstan and transform Kazakhstan into a country with competitive human capital Accordingly, the government should create the necessary conditions to support increased human capital through tax policy.

The deputy of Mazhylis of the Parliament of the Republic of Kazakhstan, President of the Finance and Budget Committee, and Doctor of Economic Sciences, Professor G. Karagusova m noted the existence of high taxes in Kazakhstan and the absence of deduction system for an individual: ”First it is necessary to provide a system of deductions for the individual, in order to create conditions for his/her development as an educated, healthy and law-abiding citizen of the state». Many Western researchers hold this point of view as well.

James A. Yunker (2010) in his article «Capital Wealth Taxation as a Potential Remedy for Excessive Capital Wealth Inequality» argues, that social services, such as education and health are distributed more equally than income. Thus, when we include education and health into a wider view of economic resources it reduces inequality. However it will lead to insignificant changes in the rating of countries. Consumer taxes extend inequality, but not so much as calculation of social services which narrows it.

A progressive scale of taxation has economic grounding and is applied in many countries. There are few examples of flat scale of taxation, currently about 29 countries in the world use such wealth taxation scheme of individuals’ income. These include as examples Russia, Estonia, Lithuania, Latvia, and Romania. Nearly all the countries OECD and countries of Asia apply a progressive scale of taxation or its analogue. For instance, in France taxation is 56%, in the USA 15-35%, in Germany 15-45%, in China 5-45%, Czech Republic – 15-32%, and Poland – 19-50%.

The arguments for progressive taxation include: reduction of the income gap between rich and poor, and equalalization of social services for people with low and high income.

In countries of the CIS a progressive scale of taxation was in use prior to the beginning of the 21th century. In 2001 Russia transitioned to a flat scale of taxation; followed by Ukraine, Georgia, Kazakhstan, Kirgizstan and Belorussia. They were then joined by Bulgaria, Rumania, Slovakia, and Chernogoria. It is necessary to stress that a flat scale of taxation is presented in the countries with a lower developed economy and weak administrative taxation.

Currently the necessity of progressive taxation is being lead by Kazakhstan and Russia. There are numerous reasons for this, but the main argument in favor of progressive individual income tax lies in the principle of social justice. In other words, those who get more income may, to some extent, carry more tax load and be of more use to their society than the one with low income.

A bill with 10, 15 and 20% tax rate has been prepared in Kazakhstan. According to the State Center of Pensions Payment, 98% of the working population receives a salary which does not exceed 350 thousand tenge per month. Thus, according to officials, the proposed taxation threshold is wide enough to not affect the vast majority of the population. It can be assumed that with the introduction of new tax rates, the change would concern only 2% of individuals whose salary exceeds a threshold of progressive taxation. In this case their salary would be taxed in steps – a part of their salary at 10%, a part at 15 %, and a part at 20%. According to the data provided by the State fund on payment of pensions, out of 5.3 million addressees of pensions, only 101 thousand people received a salary over 350 thousand tenge and, accordingly, fall under the proposed progressive scale. From people of the given category more than half (about 66 thousand) have incomes up to 600 thousand tenge, and their tax increase, by calculations of experts, will increase by 2.1%.

Thus, only 8.6 thousand individuals receive an income more than 1 million tenge per month. To implement this in a population ranging in size of incomes of 100 thousand, the richest receive the incomes equal to cumulative incomes of 2.5 million people receiving small wages. That is 100 thousand people earn 25 times more than 2.5 million. Certainly, these figures visually reflect the large inequality in income distribution in the country. But we shouldn't forget that until now, despite a flat scale, not all the income from earning on the black market is included. It is necessary to consider that employers pay at their own expense from the same wage fund of employees of the social tax at the rate of 11%, plus each worker pays 10 % as obligatory pension insurance. In totality we can speak about rather high taxation of individual incomes. «Therefore to the employer with workers at increase of tax loading from one and the same economic object of taxation there is a point to think over, and there is always the a way to come to agreement» [5].

Disputes on efficiency and fairness of a flat scale of taxation will continue, but I will argue that the transition to a uniform rate of income tax in 2007 was a process of simplification of the tax system that made it in this area simple, clear and accessible to the majority of taxpayersth. In such a situation a person can accurately count how much he or she earns and how much he or she will pay in taxes. Under a weak tax administration it is very difficult to state that a progressive scale will lead to increases in tax collection. An open declaration of incomes is rare in Kazakhstan and the reliability and accuracy of tax payment is an extremely difficult and labor-consuming problem.

Even now under the current "simple" scheme of individual income and property taxation, part of it remains uncollected.

Finally, the introduction of a progressive tax rate on individuals at this stage of economic development in Kazakhstan is untimely and ineffective. It is unlikely to improve budget revenues, reduce inequalities in income, or stimulate the development of enterprises.

REFERENCES

1. Gorodnichenko, Y., Vazquez, J. M., Sabirianova, K. P. Myth and Reality of Flat Tax Reform: Micro Estimates of Tax Evasion Response and Welfare Effects in Russia, (June 2009), The Journal of Political Economy, Vol. 117, No. 3, 504-554

2. Incomings of taxes and payments to the State Budget and National fund. In Tax Committee Ministry of Finance of the Republic of Kazakhstan Retrieved May 14, 2011, from http://www.salyk. kz/ ru/ nk /statistika/Pages/di.aspx

3. Growing Unequal?: Income Distribution and Poverty in OECD Countries. from http://www.oecd.org/ bookshop/

4. James A. Y. Capital wealth taxation as a potential remedy for excessive capital wealth inequality, (Fall 2010), Journal of Post Keynesian Economics, Vol. 33, No. 1, 83-104

5. Porokhov E. We still lag behind the social and fiscal guarantees to provide the life. December 3, 2010, from http://loto.zakon.kz/ 192172 - v- socialnykh – i - nalogovykh-garantijakh. html