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Treasury’s medical tax credit plan: Squeezing blood from a stone

01 August 2011 Robert W Vivian, University of the Witwatersrand

The National Treasury recently published a raft of amendments to the tax legislation for comment, including a new plan for the taxation medical services, which introduces the idea of tax credits. The medical tax credits proposal, as we will discover in th

Tax should be levied in terms of simple general principles as part of the rule of law. There should be no need to introduce amendments year after year. Yet, the taxation of medical services, in recent years, has been undergoing annual changes.

These never-ending changes simply distort the system ever-further away from the simple general principles. In fact, in the end, sight of the general principles is lost. This is the current situation.

The reasoning behind the changes

The reason for these amendments is clear: ever-increasing government expenditure requires ever-increasing taxes. This was pointed out a long time ago in what is now called Wagner’s Law: government expenditure will always rise.

AHG Wagner (1835-1917), the author of what is now known as Wagner’s Law, said that government activities will always expand. This expansion will drive an increase in government expenditure and the result is ever-increasing taxation. Government expenditure will always outstrip tax revenues and thus taxes will always increase.

One can contrast this view with that expressed by our current Minister of Finance when he was the Receiver of Revenue: if everyone paid their taxes, taxes would decrease. According to Wagner’s Law, taxes do not decrease, they always increase.

In fact, taxes eventually exceed what can be levied by the application of the simple legitimate general principles of taxation. At this point, the taxing capacity of a country is exceeded and government must resort to other forms of taxes, which fall outside the legitimate simple tax principles and, in fact, violate these. This phase is captured by the adage: “squeezing blood out of a stone”. South Africa is at this phase. In Africa, when this phase is exhausted, governments simply resort to printing money, which is what happened in Zimbabwe.

The taxation of medical expenses in the medical tax credits proposal is one of these “blood out of stone” proposals.

Legitimate system

There is a legitimate method of dealing with all expenses, including medical expenses.

All taxes should be dealt with in terms of the general principles of taxation, which are not new - they were set out hundreds of years ago by the father of modern economics Adam Smith. I explained these in detail in an article published in the South African Journal of Economics 2006 74 (1) entitled ‘Equality and Personal Income Tax - The Classical Economists and The Katz Commission’.

Legitimate taxation is simple enough. Tax is levied on taxable income which is: gross income less deductions for the necessities of life.

Medical expenses are, of course, a part of the necessities of life. So the legitimate method of dealing with medical expenses is simple enough: all medical expenses, contributions and out-of-pocket expenses are deductible as necessities of life from gross income to arrive at the taxable income. The tax payable is arrived at by applying the effective tax rate to taxable income. This is how it should be done.

National Treasury’s proposals

National Treasury’s proposal can be contrasted with this legitimate method of dealing with medical expenses.

The first proposal, which is the only proposal considered in the article, deals with contributions to medical schemes. These contributions are expenses which are a necessity of life. Thus, the taxpayer’s gross income should be reduced to the full extent of the contributions made to medical schemes to arrive at the taxpayer’s taxable income. But this is not what the Treasury is proposing.

The National Treasury proposed granting tax credits as detailed in Table 1.

Table 1 Proposed tax credits
 
Tax credits
 
pm
pa
Member
R 216
R 2 592
First dependant
R 216
R 2 592
Each dependant thereafter
R 144
R 1 728
3rd dependant
R 144
R 1 728
Total
R 720
R 8 640

These amounts are fixed and independent of actual contributions paid by the taxpayer or the income of the taxpayer. These are also tax credits and not deductions.

Structural issues

The proposal cuts across a number of existing structural matters the tax system.

Firstly, the South African tax system uniquely treats each taxpayer independently i.e. the family is no longer treated as the tax unit. This proposal quite correctly allows the taxpayer who makes the contribution for other members of the family to have a reduced tax liability, since the taxpayer is, in fact, making the payment.

For example, if the husband is paying the medical contributions for himself, his wife and two children, the husband will get a tax credit of R8 640. He gets the credit whether his wife is working or not, and even if she refunds him her contribution. The amount she gives him does not form part of his income. He thus gets the credit even if he is not in fact paying her contribution.

As pointed out, this is correct. The issue is the fact that, although correct, this is an exception to the rule. The same principle should be applied to all necessities of life, but is not. For example, if one spouse is not working and the other spouse pays to support him or her, why are those costs not also allowable to reduce the single breadwinner’s tax liability? Why are medical contributions the one exception? It should be the rule and not the exception! Nevertheless, making the exception distorts the structure of the existing system, even if the existing system is wrong.

Secondly, the next issue that arises is: Why a tax credit and not a deduction or a rebate? This, again, is an exception to the rule. Why now introduce a mixed system of deductions, rebates and credits?

The difference between deductions and tax credits is illustrated below.

Deductions

• Taxable income = Gross income - Deductions for the necessities of life (general) – Deductions (medical).
• Tax payable = effective rate of taxation multiplied by taxable income.

Currently the deductions for medical contributions are capped at R27 840 for a husband, wife and two children combination.

Tax credits

• Taxable income = Gross income - Deductions (general).
• Tax payable = [effective rate of taxation] multiplied by [Gross income - Deductions (general)] - medical tax credits.

When tax credits are applied, there are no deductions for medical expenses. The tax credits are fixed at R8 640 and independent of the taxpayer’s income or effective tax rate.

In setting the level of the tax credits, no reference is made to the actual contributions to medical schemes. I estimate the costs of a husband, wife and two children to be around R50 000 per year, far more than the currently capped deductions of R27 840 or tax credits of R8 640. It is thus not surprising that no mention is made of actual contributions. At best, the remission on taxation is a fraction of the actual medical costs. A taxpayer who pays R50 000 per annum for medical contributions currently only gets a reduction of R27 840 or 55% of the actual cost, or R8 640 as a tax credit. At an effective tax rate of 30%, the R50 000 translates into a required tax credit of R15 000 instead of the actual value of R8 640.

A third issue is that medical services now have their own tax system. Tax is not levied in terms of general principles. By nature this violates the general principles of taxation and the rule of law.

Impact on the fiscus

The other interesting aspect of this, and indeed a multitude of other documents produced by government departments on taxation, is the statement that a “remission” constitutes a cost to the fiscus.

In this case, Treasury’s report concludes with the statement that the credits represent “a total fiscal cost of R16.7bn”. That is nonsense. This view implies that all income earned in the country belongs to the government and if the government lets the taxpayer keep anything to live on, the amounts which they are privileged to keep are a cost to the government!

The age of wage slaves

Unfortunately, this view is now commonly held by all government officials. It can, however, only be true if all people in South Africa were wage slaves and every cent they earn belongs to their master, the government.

Amounts deducted for the necessities of life are in no sense whatsoever a cost to the government! In fact, the proposed tax credits for medical expenses are a mere fraction of what they should be, which simply highlights the reality that government is now indeed trying to “squeeze blood from a stone”.

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