Tuesday, September 30, 2003

Process re-engineering needed

The Finance ministry’s recent job freeze announcement is a clear indication that the government is either strapped for cash or is projecting difficulties. Either way the move is a welcome as it suggests government’s intention to meet its budget deficit target. This must not, however, be seen as the end all as it is only the beginning of the needed procedural reorganization. The government must now take this opportunity to implement the next step of process and personnel rationalization.

Process re-engineering
With that said though, the solution is not as simple as cutting jobs or remuneration as that could easily prove to be a counter productive move. Immediate cost savings cannot be interpreted as productivity or efficiency gains. For example, one could eliminate a process or person with a high value added and therefore destroy future income potential although ensuring short term cost savings. Because of this possibility the government must embark on a proper process re-engineering exercise to ensure the greatest advantages. They could in fact conclude that in order to earn the desired income they need to spend more.

It is clear that there have been initiatives to improve government’s service delivery as interactions with front line government staff are a lot more palatable. This experience is however not where it should be because of the procedures and systems that are still in place. This is the area of greatest opportunity for service improvement and reduction of waste.

Unproductive time
To illustrate this I would like to cite a recent experience I had with renewing my driver’s license. I arrived at the Constant Spring collectorate at about 10 AM and was met by a very courteous gentleman who enquired about the purpose of my visit and provided the form for me to complete. He then took the form from me, stamped and signed it and directed me to the cashier. Up to that point I felt obligated to pay for the renewal because of the refreshing service. He then directed me to the driver’s license renewal section. On arriving there, I noticed a gathering of persons who were obviously waiting to complete their renewal. The frustration was obvious on their faces and I immediately began to wonder what went wrong between the reception / cashier area and the twenty seconds it took me to get to the renewal section.

I turned in my old driver’s license along with the receipt and was told to wait for a picture to be taken. I waited for approximately 40 minutes before being called and then took the picture. I did not wait for the license as an earlier discussion revealed that it would take at least another 40 minute unproductive wait.

It occurred to me that there were some 50 persons there at the time, who were waiting for approximately 1.5 hours each, which equates to 75 hours of unproductive time. It is therefore quite possible that up to 400 hours of idle time could have been spent in that particular section on that single day. If we assume that this day was unusual and only 2/3 of that time is lost per day this still translates to 1,340 hours per week of unproductive time being wasted on the renewal of drivers’ licenses at one collectorate. If the relevant information is included for various collectorates and other sections then the number of unproductive hours lost to inefficient systems is tremendous. Is it any wonder then that the country’s productivity is so low? This means that Jamaica has to produce more per labour hour during the productive times than international competitors. The implication for businesses is that they have to pay a higher rate per output even though the rate per hour may be less than our global competitors. Simply put Jamaicans are working more for less.

Alternate process
In contrast to the present system I made some quick observations about what could be introduced to reduce this problem. I had no problem with the persons as they seemed courteous and customer driven. An improved system could easily be implemented as illustrated below, with no significant investments.

On paying the renewal fee the cashier should have taken all relevant information and a unique number be generated for that receipt. That number would be transferred electronically to the renewal section and would also act as the service number. The renewal section would have two processing sections, one for taking photographs and the other for printing and delivering the finished driver’s license, instead of the one area that does everything. They would still use the same office space but divide it into two sections. This division of labour would have been more susceptible to handling transaction volumes.

You would then hand in your receipt and wait to take the photograph. All the information would have been entered at the cashier and so would not have to be re-entered as is currently being done. When your receipt number is input then your picture would be taken and applied to the template that comes up. The fact that a re-entry would not be done would save approximately five minutes.

Instead of someone calling out your name, there would be a number service system that would be wall mounted and persons would proceed in that order as it changes. This would save another five minutes of persons leaving their desks to go and call out a person’s name. It would also improve the delivery efficiency.

On taking your picture you would then go to the next door where you would pick up your license. This would result in the greatest time savings as I observed that the same persons calling out names were the same ones taking the pictures and printing the license. The process of switching between tasks is itself time consuming as well as the fact that multi-tasking is not as efficient as a concentration on one process. If one more person was added to the process then there could be at least two persons dedicated to printing with the current three taking pictures. This would save at least 20 minutes per transaction.

Based on the preliminary observations made above savings of 30 to 40 minutes per transaction could be made by just adding a link between the systems and employing one or two more persons. On the other hand this would save the country approximately 890 hours per week or 46,454 hours per annum of unproductive time from one small section. It seems to me that any up front investment from improving this process would be worth it. Deeper analysis could improve this return on investment even further.

In concluding we need to understand that the move to save short term cash flows is just the beginning of the road and what is needed is a long hard look at the processes we are working with. The aim should always be long term rather than short term implications.

Tuesday, September 23, 2003

The Truth About the Gaming Tax

Since the introduction of the 15% winnings tax on lottery games there have been many representations re the reduction in income and the negative consequence this will have on the industry and future tax revenue inflows. Some have even said that the tax will cause current government intake to fall significantly.

Illegal Market
There is no doubt that revenue intake by the lottery companies have declined, which is estimated to approximate 40%. Anyone who understands the gaming market would have predicted this effect, as there is a significant illegal gaming market, which has no doubt become much more attractive to the player as odds increase relative to the legal game. After all the illegal operator does not pay any taxes and usually has much lower overheads. The payout can therefore be higher. Similarly the player will not have to pay any winnings tax from the illegal bounty. It is a given that the tax will contribute to the growth of the illegal gaming market. We also need to remember that the drop pan game already has an illegal structure in place that existed for decades before the legal game. It is therefore not difficult for players to move back to that structure.

Government Revenue
The government is aiming to raise an additional $1 Billion by introducing the tax, while some are saying that the government will in fact realize less because of the reduction in revenue. It has been suggested to me that the advisors do not understand the gaming market and are therefore projecting incorrectly. Is this actually so? The only way to answer this is to look at the numbers based on the current fall off in sales and the contributions made to the government coffers.

The table portrays the 2002 revenue and tax structure based on information released by the Betting Gaming & Lotteries Commission.

The table shows the payout percentages to the winner and the various government agencies. At the bottom is the weighted average payout percentages based on 2002 revenues. From this we can compute what the government intake was and what it will be with a 40% fall off in revenues.

The second table compares the taxes under the old and new systems assuming a 40% revenue decline. This illustrates that even with a 40% revenue reduction the government agencies will collect $200 Million more than in 2002. This will be significantly less than the $1 Billion projected but will still be greater than the intake before the tax. An additional 5% decline in sales would, however, result in the government raking in less than before the introduction of the tax.

The tax will also redistribute moneys from the productive private sector to the government. If for comparison purposes we assume that salaries and other direct compensation to vendors amount to 10%, then the revenue fall off will cause a steep decline in moneys available for employment, directly and to vendors. From international studies we can also assume a multiplier of three times for earnings from the industry, which means that the $1,191 Million would become $3,573 Million in earnings. After the tax we could see that reduced to $2,145.

Charities (CHASE) will also receive substantially less. This implies a need for further support of charities from government and the private sector. Routing these funds to charities via government will have administrative costs, meaning less per dollar reaching the charities. Direct payments will always be more efficient.

Impact on the Economy
The immediate negative impact includes reduced employment and business activities. Ultimately this may result in lower corporate tax collections. In this example taxes would reduce as potential earnings fall from $3.6 to $2.1 Billion.

This analysis shows that although the government will collect more direct taxes from gaming operations, the overall net tax collections may be less because of:
- Less PAYE from reduced employment;
- Less profits tax from reduced company income levels; and
- The move to illegal gaming will mean greater expenditure on enforcement.
In addition to these factors, there is also the consideration that potential investments may not be realized because of the change in the payback ratios and the uncertainty of the rules. Also, the tax could possibly cause a prolonged stagnation of the gaming market.

The question to be asked is, have we measured the opportunity cost of introducing the tax? The tax may have been a short term solution, but what is the medium to long term implication. Already the tax will not have the desired revenue effect because of the revenue fallout, and in fact will not add much more. Added to this there may be a significant indirect negative effect on other future cash flows. Have we done the right thing to introduce this tax? I guess at this point only time will tell.

Friday, September 19, 2003

Pensions and inflation

There has been much talk recently about the expected inflationary outturn for 2003. The Bank of Jamaica expects that inflation will be in the region of 13%, higher than the single digit inflation projected at the start of the year. This should be of importance to persons who will reach pensionable age within the next ten years.

High inflation environment
In a high inflationary environment pensions are always significantly affected as happened during the period of the early nineties. Inflation has caused many pensioners to be bordering if not below the poverty line. Between 1990 and 2002, the Bank of Jamaica numbers show that we have had cumulative inflation of some 294 per cent, which was reigned in only by the single digit inflation from 1997 to 2002. There are not many persons that would have seen their wages keep pace with that type of inflation and thus their pension would also suffer, as it is tied to wages. In fact, in order to beat inflation, the pension investment would have had to be returning in excess of 22 per cent compounded during that period. Not many pension funds were consistently showing that sort of return.

The pension regulations in seeking to protect the investment, does place restrictions on the type of investments that the trustees can participate in. These are usually safe investments such as government paper and certain blue chip equities, which will not give the same return as riskier investments. With that said though, this is a good thing as if there were no such restrictions there may have been serious consequences resulting from the 1990s financial crisis, as many more pension funds may have been seriously eroded.

Credible inflation numbers
In a recent article Raymond Forrest questioned the credibility of the published inflation statistics. There has been some doubt surrounding what is included in the basket of goods used to measure inflation and whether it has been updated to reflect the current trends. I don’t know what the truth is but if the published numbers are in fact lower than the reality then this will only serve to hurt the pensioner further.

Pensions are usually tied to wages and annual increases usually guided by the officially published inflation statistics. In addition, if we are not honest with ourselves as to what the true inflation numbers are then this will lead to a false sense of security as to the expected returns from the pension investments.

Defined contribution versus defined benefit plans
There are basically two types of pension plans, defined contribution and defined benefit.

The defined contribution plan is where the amount of the pension contribution is set as a percentage of wages. The employer usually matches the amount put in by the employee up to ten per cent of salaries. On retiring the employee will receive actuarial payments equivalent to the contributions plus the returns based on the investment gains over the period. Under this plan the pension is not guaranteed and in fact could be nil if the proper investments were not made.

The defined benefit is where the employer will guarantee a payment amount on the retirement of the employee. The risk of any deficiencies in the pension plan is borne by the employer. This exposure is one reason why some companies will not consider this plan, as in a high inflationary and unpredictable environment it is difficult to project what the company’s exposure will be. The result is that the risk of inflation is left to the employee. In some industries with a naturally high turnover rate, this exposure is reduced as the persons leaving will create a surplus in the pension plan that can be used to offset any deficiencies in the future requirements.

International Accounting Standard (IAS) 19, which deals with Employee Benefits, clearly makes this distinction and requires separate accounting treatments for both types. One of the disadvantages of IAS 19 for companies with a defined benefit plan is that it requires an actuarial valuation to be done each year for the annual report. A recent discussion I had with a representative from a pension company informed me that a $100 million pension will cost anywhere between $300,000 and $500,000 to prepare a valuation. This is an added cost to the company and for that reason he said that some companies were moving away from the defined benefit plan. On the other hand the argument can be made that this valuation is necessary to protect the members and also provide accurate financial reporting, as without this disclosure a company could go belly up without adequately protecting the employees’ pension.

A high inflation model will therefore significantly affect pensioners as it did in the 1990s and create a wider disparity between the wage earner and the person with capital. The long run effect is that the quality of life will decrease for many and there will be a greater dependence on state resources.

Even with a low inflation model, however, employees need to understand that the more popular defined contribution plan will not allow them to replace their income on retirement. Companies must shoulder the responsibility of educating their employees about other methods of savings and so remove the reliance on pension plans.

Some of the issues surrounding pensions will also be addressed in the new regulations being introduced. In the final analysis though it is up to the individual to protect his/her future income by paying close attention to their pension funds and saving in other ways during their working life.