Options for PIT indexation

Project Active from to State and Tax

This report evaluates the need for and effect of personal income tax indexation in Rwanda, including an assessment of the effect of changing the number of tax brackets. Using data from social security declarations lodged with the Rwanda Social Security Board (RSSB), this report focuses on the effect of PIT on total tax return in addition to changes in the net income distribution.

Tax brackets need to be adjusted to reflect changes in inflation over the years. This can be done in a discretionary way, where the decision to change tax brackets is a political one. Alternatively, governments can use automatic indexation to ensure tax brackets are adjusted appropriately. The choice of a suitable index measure depends on the purpose of indexation- maintain governmental tax revenues as a proportion of national income or hold constant the real purchasing power of federal revenues. This report argues in favour of income indexation for Rwanda.

The data shows that almost 90% of all income tax revenue in Rwanda comes from individuals with an income much higher than the top bracket. In this case, indexation would have little effect on increasing government revenue. The authors argue that instead of focusing on inflation, the government of Rwanda should focus on real growth. At the same time, they stress on the importance of economic incentives and the effect that over taxing the rich might have on the behaviour of high earners and on total tax revenue.