Friday, November 28, 2008

The Flat Tax in Iraq: Much Ado About Nothing—So Far

May 6, 2004

By Alvin Rabushka


Supporters and opponents of the flat tax have spilled considerable ink debating the merits of a 15% flat tax on personal income in Iraq that was implemented on January 1, 2004. Supporters of the idea believe that what’s good for the Coalition Provisional Authority (CPA) goose in Iraq is good enough for the U.S. Congressional gander. Opponents criticize the low 15% flat tax as a giveaway to the rich. Both groups, in the bard’s words, make “much ado about nothing,” at least so far.

It is instructive to examine the 2004 budget of the Republic of Iraq, which is posted on the CPA’s web site. Estimates in the draft October 2003 budget for calendar year 2004 projected oil revenue of New Iraqi Dinars (NID) 18,000 billion, or US$11.96 billion, constituting 93.5% of total revenue. (US$1=NID 1,505 in October 2003.) The share of revenue for 2005 and 2006 was projected at 96.4% and 97.7% respectively.

Other sources of revenue in 2004 include the reconstruction levy (NID 450 billion), the 15% personal income tax, or PIT (NID 15 billion), a 15% corporate income tax, or CIT (NID 30 billion), interest income (NID 15 billion), transfers from state-owned enterprises, or SOEs (NID 562.5 billion), user fees (NID 96.3 billion), and other taxes and charges (NID 90 billion). The reconstruction levy is a 5% charge on all goods, except humanitarian goods, imported into Iraq from January 1, 2004, to expire after two years.

The draft budget noted that the 15% PIT rate, a reduction from the previous top 75% rate, would encourage compliance and reward effort. The CIT rate of 15% applies to the profits of both domestic and foreign companies operating in Iraq. Transfers were projected for only a handful of the nearly two hundred state-owned enterprises. User fees and charges are to cover vehicle registration, emergency services, passport fees, higher education course fees, court fees, social security rental income, with flight overpass fees, entry fees to cultural institutions, consultancy fees, and sales of statistical publications added later. The remaining category of other taxes includes a 15% excise tax on alcohol and tobacco, a 10% tax on 4 and 5 star hotel accommodation and restaurants, a real estate transfer tax, and other smaller taxes including those collected by regional governments.

The 15% PIT was projected to rise from NID 15 billion in 2004 to NID 45 billion in 2005 and NID 90 billion in 2006. The share of total revenue to be contributed from the PIT is 0.078% in 2004, 0.16% in 2005, rising to 0.30% in 2005. The projected rise in the 15% CIT is from NID 30 billion to NID 75 billion and NID 150 billion over the same period, constituting 0.16%, 0.26%, and 0.30% respectively of total revenue.

Due to a marked improvement in fiscal circumstances over the original October 2003 budget, the Ministry of Finance issued revisions to the 2004 budget on April 10, 2004. It identified greater than expected net capital inflows of Iraqi Dinars (ID) 750 billion and additional revenue from all other sources of ID 2,470.3 billion. (US$1=ID 1,476 on April 10, 2004.) The first increase is due largely to a lower-than expected need for central bank reserves, which has reserves exceeding ID 2,250 billion. Given the appreciation of the Iraqi Dinar, no requirement for greater reserves is foreseen, permitting the cancellation of an ID 1,350 billion transfer from the budget to the Central Bank. Transfers of assets from abroad (ID 300 billion from Jordan) also added to the net figure, which was reduced by a shift of ID 900 billion in refunds from the oil-for-food program from 2004 to the 2003 budget.

The second increase of ID 2,470 billion is due largely to higher oil prices, generating an extra ID 3,262.9 billion. Partially offsetting higher oil revenues are a reduction of ID 277.5 billion in the reconstruction levy due to its late implementation, the postponement of the CIT for the year, a 50% cut in estimated PIT receipts of ID 7.5 billion, a reduction of ID 562.5 billion in transfers from SOEs, and reduced receipts from excise and land taxes. Anticipated receipts of ID 7.5 billion in PIT revenue will underwrite a mere 0.02% of projected expenditure of ID 29,889.8 billion in 2004 (which is higher by ID 9,756.3 billion than in the October 2003 draft budget due to a higher starting balance in uncommitted funds from the previous year).

Oil revenues in 2004 are estimated on the basis of a gradual fall in net oil price to US$21 (ID 31,000) a barrel in June 2004, assuming production of 1.9 million barrels per day by the end of the year. Higher prices and greater exports would generate a notable increase in net revenue. In early May 2004, the price of top quality crude oil reached about $40 a barrel with Iraqi oil exports exceeding April’s estimates. If prices for the year average well above $21 a barrel and exports exceed 1.9 million barrels a day, it is likely that PIT revenue will contribute in the neighborhood of 0.01% of total revenue.

It is a stretch, as many have done, to credit or criticize a 15% flat tax based on its negligible role for some time to come in generating revenue or stimulating economic activity. It remains to be seen if even ID 7.5 billion will be collected in 2004, or if any effort is made to enforce compliance. PIT revenue amounting to one or two-hundredths of one percent of total revenues is hardly a topic about which to crow or complain. Paul Krugman, please take note!

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