Friday, May 01, 2009

Tax as a developmental tool

The budget debate is currently underway, and as I write this the prime minister and Opposition leader have not yet made their contribution, and the minister of finance is to deliver his closing address.

This budget is no doubt by far one of the most difficult ones we have faced as far as I can remember. This time Jamaica has found it difficult to borrow its way out of our self-inflicted challenges, and all of this in the face of the worst global economic crisis since the end of World War II. Many of us, including myself, were not born then and this would therefore be the worst we have seen.

But what does that mean for Jamaicans? Even though the world has gone through good times, Jamaicans have always been asked to tighten their belts. Each year, the budget comes around we are always bracing for the high probability of more taxes. I can't remember a budget where there was a net give-back to the Jamaican taxpayer. The trend of Jamaican taxes, over the years, is always to ask Jamaicans to fork out more and more. And this is even as (i) we were borrowing more money every year and (ii) social services have been deteriorating fast. This has resulted in negative development for the country as a whole.

A cultural problem
The truth is that taxes in Jamaica for a very long time have been used as a means to plug a financing gap, and continue to fund an inefficient public sector bureaucracy. So even when many celebrated the implementation of the first MOU, I lamented its introduction as I saw it as another cover-up of the inefficiencies in the bureaucracy and a means to allow Government to continue on its merry way of spending more than it could afford to. This was only delaying the inevitable, and what they have done is place more burden on the people who they say they're trying to save.

What should have been done with regard to the MOU is that it should have been used as an opportunity to restructure the public sector, and allow for the transition of some of the workers out of the public sector into the private sector where they would have had much better earning power and the bureaucracy would have been more geared towards private sector productivity. But that was not to be, as consideration of finances by the government has not been about development but rather just a juggling of the books.

So because of our failure to implement financing policies as a support for broader development objectives, we have as a country found ourselves in the unenviable situation of having to contract the economy. This is simply because we have failed, when times were good, to generate any fiscal surpluses. So an analogy is that one would be earning exceptional income and fail to save in good times, choosing instead to spend it all on consumption. The result is that when times get bad there are no savings to fall back on, forcing one to cut back drastically on their lifestyle. In Jamaica, our culture does not encourage saving, like the Jews and Chinese, for example. Once we get a little money then everyone should know, as we have to drive the most expensive car and buy the most drinks at the bar.

I remember only last year going into a bank and meeting someone I have known for a while. Being courteous, I asked him how things were going, to which he answered 'very rough', as his payments from OLINT had ceased and he couldn't afford to properly maintain his Land Rover. I then suggested to him that he should sell his Land Rover, as it was fairly new, buy a cheaper car and invest the remainder of the money in his business. Of course, in true Jamaican style, he answered that if he sold his Land Rover it would affect his image. There endeth the conversation and I could see the fruitlessness in suggesting anything else. I hope he and his Land Rover are okay.

This is similar to the way that we have approached the national finances.

A move to consumption taxes
This is why I supported in principle the move to consumption taxes, as it influences consumption behaviour. What we need to do is use tax policy as an instrument for influencing productive and consumption behaviour. For example, we suffer primarily from spending more foreign exchange than we earn. What I would do then is use consumption taxes as a tool to encourage production and consumption of local goods and discourage consumption of imported goods. So if oil is the largest import value, then a tax on retail fuel consumption is the right move but should be complemented with (i) an efficient, disciplined, and safe public transportation system; and (ii) fares subsidised to encourage public transportation.

Similarly, tax incentives should be given to those investing in agriculture - primary and agro-processing production. The investment should have certain conditionalities such as large-scale production, where economies of scale can accrue.

The suggestion by Dr Davies for a surcharge on interest payments is consistent with the argument that the interest component of the budget needed to be looked at and some way found of alleviating the earlier cash flows, as this would create the fiscal space needed to ensure the economy does not contract significantly. The suggestion made by Dr Davies is however, more radical than anyone else would have thought as this would amount to a unilateral permanent impairment on the net earnings to debt holders. This is opposed to a temporary impairment in cash flows only, which would provide the debt holders with full restitution and also an economy that would have greater future earnings potential, assuming that the extra cash flow is used for development purposes.

I do not want anyone to think, however, that merely structuring tax policy around development objectives is the panacea we have been looking for. There is a lot more that needs to be done (as I explained in my book) such as dealing with crime and certain social and political issues.

One of the things I would change, if I had control of the process, is the format of the budget debates. The way the budget debates are structured has been with us for decades, even though the world has changed many times over during that time. I would adopt a structure that would help me to support my developmental objectives, while at the same time considering all options before finalising the budget. The way our budget is structured, it is cast before any serious consideration is given in the debates.

So I would first start with a discussion on the developmental targets. I would have the Government and Opposition spokespersons debate the developmental objectives, for all Jamaica to see. Next the government would look to determine what tasks are necessary to achieve the objectives, and place the most efficient structure and costs to each task. This would determine the expenditure requirements. I would then look at the revenue options, bearing in mind the negative effect on economic activity of taxes, and so any taxes being extracted should have a value added in excess of what it detracts from the economy. I would then allocate the revenue resources to the expenditure in order of priorities. This may mean an extended budget debate but at least we would get it right. These are just my very simple thoughts on making the budget debates relevant to development.

A failure to realise that taxes should be used as a tool for development, instead of just to raise more money, will mean that Jamaicans will be continually called on to fund a bureaucracy we will be less able to afford each year. The incremental result will be greater reductions in the real income of Jamaicans each year.

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