Saturday, December 26, 2009

No new taxes: a better alternative

As usual in Jamaica we consume ourselves with arguments around the wrong alternative. So instead of discussing the real issues that will carry the country forward we end up being caught up in the political and social spins on the various issues.

The fact is that the recent discussions re the tax package, as to how much burden the rich or poor should bear, is really a redundant argument. Empirical evidence and logic show that you can't help the rich by burdening the poor and similarly you can't help the poor by crucifying the rich. The latter is supported by the rich taking up the offer of "five flights a day to Miami in the 1970s" and the former supported by the recent decimation of the US consumer in 2007/8, which caused economic declines, and a worldwide global recession.

Poor and rich suffer together
Economics does not distinguish between rich and poor, like politics, and is concerned with things like total money in circulation and the multiplier effect. I don't remember, limited as my knowledge is, looking in any economics book and reading about whether to burden the rich versus the poor. So once again politics takes the forefront in Jamaica, in the face of a worsening economy.

My argument has always been, and continues to be, that any new taxes within the context of an already declining Jamaican economy are more likely to shrink the economy and lead to lower tax revenues rather than increase it. This of course assumes that the other two arguments forwarded holds, that is (1) no new debt; and (2) reduced government expenditure.

It is only logical that if an economy is stagnant or declining (that is no real growth from production) at say $1 Billion, there is no new input in it from loans or other external funds, and in addition taxes are taken from the economy, then logically the economy must shrink. So we can verify this by assuming the following:

The table clearly shows that without any growth in the economy, if money is taken out then the size of the economy will contract and subsequently the tax collections will decrease, instead of the intended effect of increasing revenue.

This I think is borne out by Jamaica's fiscal numbers over the years. Looking at the fiscal numbers between 2003/4 to 2008/9, the government has increased taxes every year for a total tax increase over the period of $115 Billion. Over the same period the total new debt was $232 Billion, and was the only reason why the economy managed to grow, and also the only reason why the government was able to collect the increased taxes. So it stands to reason that if there is to be any increased economic activity or even a maintenance of the current economic activity, then the only way is for new loans to be introduced into the system.

Replacing higher cost debt
One way that the government is correctly doing so is by replacing the higher -cost debt with lower-cost debt. That again is another argument and I don't think it will have the effect intended for other reasons, but I will not get into that here.

On the other hand if the rate of taxation were to be reduced by 2%, at a multiplier effect of 4, then the government could in fact collect marginally more tax than is currently the case. This could be further increased if through fiscal policy, crime falls bureaucracy is addressed thus allowing the multiplier effect to increase.

The logical conclusion then is that the way to find ourselves easing out of this vicious downward spiral is to (1) withdraw the government influence on the economy in the form of taxes and the bureaucracy; and (2) improve the multiplier effect by introducing fiscal measures that will increase confidence and the economic outlook.

So the argument that we have been having over the past week on whether to tax the poor or rich is really based in politics rather than economics, as proper economic policy dictates that in times of recession less taxes and increased stimulus is needed as promoted by Maynard Keynes. This theory has been successfully used in the recent recession.

So my view is that what is needed is not new taxes but a stimulation to the economy, and a restructuring of the bureaucracy and fiscal policies to engender the much needed paradigm shift. Unless that is done then I am almost certain that we will be speaking about the same issues next year, only from a worse vantage point. A year ago I had told all who criticised me for saying we need to look at restructuring the cash flows re the debt that we would be talking from a worse position a year later.Need I say more?

Poor customer service continues
A few months ago I wrote an article about poor customer service, and this seems to be growing worse. It seems as if this has escalated with the harder economic times. Only a few months ago I had experiences with two listed companies calling me about money I did not owe them, only to apologise and say that their systems had messed up.

Just this week Scotiabank, who I have a mortgage with called me on three different occasions to say that I had missed a payment. This was after a similar incident about two months ago. One lady even insisted that I (the customer) was wrong, wasting my time for five minutes and refusing to hang up when I told her she would have to call back as I was in a meeting. Well, she didn't call back but I had to call someone and tell them to stop wasting my time. Again the excuse is that the system was not working properly. Similarly NCB wrote to me a few months ago to say I owed them for a card they had sent me, which I had not requested and I had never accepted or used. They also blamed the systems.

Poor Jamaicans. We are let down not only by our governments over the decades but also by the poor customer service from various institutions. I long to see the day when the Jamaican citizen is put first.

Friday, December 18, 2009

Jamaica's opportunity

At the time of writing this column, I, like every other Jamaican, am waiting to see what tax package the government delivers and the final outcome of the IMF negotiations. Both these issues have been on the tongues of everyone except the dead in Jamaica.

Jamaica is, I believe, at a significant crossroads, as what happens over the next six to twelve months will determine if we go down like the Titanic or rise like the phoenix from the ashes. It is, I think, the "last hurrah" for Jamaica, because if we mess up this time then there is a very low probability of turning back. And this is why all hands must be on deck and political expediency must take a back seat. It also means that the way in which we seek to crucify persons for the smallest of mistakes must stop because I guarantee you that as we seek to emerge from the mire we are in, mistakes will be made. What we need to ensure is that the mistakes are controllable and do not have a materially detrimental effect. We need to take a practical approach to it lest we find ourselves being a victim of our own criticisms.

A serious bind
There is no denying that the country is in a serious bind, and this will have a dramatic negative effect on the lives of many Jamaicans. But I really do believe that the present crisis provides us with a significant opportunity, as we are forced to face our reality as we are unable to postpone our challenges by going to the capital markets. In addition to this inability to beg or borrow our way out of the problem, there are some positive signs as shown in the significantly improved balance of payments, and more heartening for me, the way in which the police seem to have risen to the challenge of ridding the streets of indiscipline and stemming the tide of corruption within its ranks. The police leadership must be applauded for this, and I only hope that the courts can start to support them by dispensing with cases quickly.

One thing is certain: when we emerge from this present crisis we will be looking at a different Jamaica. In order for Jamaica's economy to properly adjust we will see business failures, as well as changed consumption patterns that will result in changed market behaviour. And there is nothing wrong with that if we are to move ahead, but any resistance to change will see a more painful and prolonged transition.

One of the changes will be to the government bureaucracy and in particular the fiscal accounts. Government has responded to the shortfall in revenues by announcing that new taxes will be announced, and no doubt the IMF may have had some hand in this. While the truth is that the government did not seem to have any other option, I don't think this will improve the fiscal situation much and could in fact cause it to worsen.

The fact is that taxes have been raised twice since the start of the current fiscal year, and the revenues continue to underperform. In addition the signs are evident that the retail sector is in trouble. The Bank of Jamaica has released data showing that the real value of money in circulation this Christmas is lower than last year. Real GDP is also down by 4 per cent and over 40,000 persons have lost jobs since the start of the year. There also has not been any increase in the salaries of public sector and many other workers. The fact is that purchasing power has fallen by approximately 20 to 25 per cent.

The world has learned from the 1930s recession that in a declining economy the only viable course of action is to increase government spending and reduce taxes. This course was not taken in the 1930s when we had the great depresiion.

Under performing revenues
As at October 2009 tax revenues have seen a real increase of approximately 3.68 per cent over October 2008, which means that government is already taking more money out of the economy, no doubt to primarily pay debt charges. In relation to the budget, however, tax revenues have under performed by approximately 10 per cent, indicating that the economy will not give up anymore taxes.

Increased taxes will have the effect of reducing the real purchasing power of an already fledgling consumer market. This will in turn lead to more conservatism around spending and result in lower profits for companies, which will face a stagflationary environment. This will result in lower company profits tax, which will see more businesses closing their doors resulting in lower employment or lower incomes. This in turn will lead to lower PAYE collections. Again, if more people see lower income levels (from reduced income or unemployment) then the result is lower consumption, which of course means lower GCT, SCT, and customs duty.

In addition to this, as government seeks to further reduce interest rates then a natural outcome will be lower tax collected on interest. Some have argued that government needs to increase tax on interest payments but that move itself will have a downside which could cause a more significant longer-term problem. The Prime Minister referred to this in his interview last weekend, when he said that this would result in persons seeking a higher interest rate to compensate for the increased tax. In addition to that, any taxes on interest, or profits, raises the question of uncertainty and risk for capital and therefore could see a resistance to invest risk capital, which is what is needed for economic development. So while this is an attractive offer, it could lead to a Tiger Woods-type backlash.

In the past the government was able to increase taxes successfully because it borrowed monies to support the economy and by doing so created a false sense of growth.

So the question is, if new taxes will cause the economy to compress and not improve the fiscal, and if the attractiveness of taxing interest or profits further is not recommended, then what options does the government have?

The first thing is that the public sector like businesses must accept that the environment has changed and they must adapt, or pull Jamaica down with it. A smaller and more efficient public sector is necessary if we are to move forward, but the bureaucratic and inflexible culture of the public sector does not provide me with much hope. The Prime Minister is making an attempt to make the change and I wish him well. At the same time this is happening the only real viable option for growth is to conclude the IMF agreement and allow for access to multilaterals for budgetary support. When this funding is accessed, however, it must be spent efficiently and not get caught up in the old ways of expenditure habits in an increasingly burdensome public sector.

Diamond in the rough
While all of this is happening it is critical that we applaud the efforts of our entrepreneurs. About two weeks ago I was given a brief tour of the development that is happening at the Wexford Hotel and was quite impressed. The new wing of suites and facilities for meetings is impressive in an environment that has not been very kind to the tourism industry. This investment shows a certain amount of confidence in the Jamaican economy and must be commended, and I would even go as far as to nominate it for Business Leader in 2010, even though I have no influence on the selection committee.