Thursday, April 05, 2012

The importance of correct tax reform

As we are approaching the completion of the white paper for tax reform it is very important that we understand the importance of getting the tax reform process correct. When this administration came to power in December 2011, Minister Davies said shortly after that the administration would extend the timeline for the tax reform agenda, as it was very important to ensure that proper consideration was given to the process. I totally agreed with him, because the green paper I felt would not have provided us with the necessary impetus for any long-term benefit, rather just delivering temporary fiscal space, which is how we have approached tax policy in this country for a long time.

In fact the last time any significant effort was made to use tax policy to positively affect the economy was in the mid-1980s. Every other time we have changed tax policy has been to provide additional revenue for the fiscal accounts, at the expense of the economy.

In fact I believe that we have become so accustomed to thinking about the government accounts even before the economy, that the private sector when making proposals about taxation measures always seem to be more concerned with maintaining or improving government finances than the economy. This while they seek to eke out some benefit for the private sector, by apparently not upsetting the government's voracious and never-ending appetite for taxes.

This is demonstrated in the fact that the latest private sector proposal seems overly concerned with providing the government coffers with an additional $7 Billion, in the hope that the government will allow some of the much needed reform as outlined in the proposal.

This I think is the main problem with how we approach, not only tax reform, but economic solutions. Our primary focus on the fiscal accounts, to the detriment of the wider economy, always gets us into a worse fiscal situation. The evidence is there for all to see and analyse.

So as we prepare to finalise the tax reform white paper, we must ascertain what objective we are trying to achieve through tax reform. Will we continue to focus on the fiscal accounts, and try to pull more money from the economy to fill the significant fiscal gap we face, or will we be bold enough to apply apropriate measures that will lead to economic development and a better long-term fiscal situation? This is what countries like the US did by reducing the tax rate in order to allow for greater economic activity. We will not be able to approach it in the same way, as we have other social issues that would prevent maximum value, but our approach must be in that direction.

Our approach to tax reform should include measures to ensure that there is greater growth in the economy. If we have this as our objective then we can look at the various proposals and determine how the economy will benefit from their implementation. I will address some of the major proposals.

The first thing is the matter of the expansion of the GCT on basic items, while at the same time lowering the rate across the board and having a more targeted welfare system. This to me seems like a logical argument, as currently most of the benefit from the exempted items goes to the higher income group which has the ability to spend more than the lower income group. If we are able to better target these benefits to the lower income group then it does make sense to go with this proposal, as it will mean that, contrary to the emotional responses, more money will get into the hands of the poor. The key to this is to ensure that we have an efficient means of targeting the benefits to the poor.

The second proposal of lowering the corporate tax rate to 15 per cent, for most companies, is a desirable objective, in my view. However, it is more important to ensure that rate reductions happen first with the PAYE group, as the propensity to spend is greater in this group, which will have a more positive effect on the economy. If we therefore need to phase the reform proposals, as I think is the prudent thing to do, then I would marginally reduce the corporate tax rate (to maybe 25 per cent), while having a much steeper reduction in the PAYE rate.

This takes me to the proposal to increase the GCT rate for the tourism sector. One of the challenges here is that there needs to be further consultation with the hotel sector, in order to do some simulation on how this would affect their own viability and the economy. It is important to consider this carefully as the hotel industry is extremely important to the economy as a whole and any attempt to increase the GCT rate that negatively affects the sector could have a devastating impact on our foreign exchange earnings, which could be hard to reverse.

One other proposal, which I would not agree with, is to remove the 50 per cent tax break for the companies that list on the Junior Stock Exchange, for the second five years of their listing. If you think about it, this is a small price to pay for the benefit of formalisation and increased employment that arises from the listings.

My own view is that we need to eventually move to a regime of consumption taxes and totally eliminate direct taxation, as this will cause a greater multiplier effect of money in the economy and also is less of an administrative burden for the tax authorities. The argument against consumption tax is that it is a regressive tax on the poor. While this may be so, correct tax reform will lead to greater income from a more vibrant economy, and coupled with a more efficient welfare distribution method, this will outweigh the negatives of moving to an entirely consumption-based tax system.

Whatever we decide to do, we must be guided by the principle of economic stimulation, rather than the usual narrow focus on the fiscal accounts. Getting it wrong again, as we did with the recent tax packages, could have a devastating effect on the economy. Are we capable of making the needed bold decisions?


Anonymous said...

Good article. However, I do not agree that companies listed on the Junior Market should be given tax incentives. The primary reason should be to get capital. This is no equitable. It makes other similar companies, not listed, to be less competitive.
The reduction in the CIT rate to 15% is to make non listed more competitive. If the incentives for Junior market is be remained then, I would agree with the PSWG recommendation for the reduction in the CIT rate to 15%. The principle is for companies to reinvest the tax savings, which would lead to expansion and increase employment.

In effect what proponents of the Junior Market is saying, is that CIT should be abolished or tax on businesses. In that, as soon as they stop paying CIT they are now able to make huge profits and can now expend their businesses.
I think the country cannot afford to give tax holidays to profitable companies.

What would be the situation if all the profitable medium size companies get listed.

It is a bad policy to reward companies to seek capital, this in effect is penalizing struggling companies are not in a position to get listed

Ralston said...

Good Day Dennis
Your support for incentives to the Junior market and the tourist sector seems to contradict your original views on waivers and incentives published by the Observer on the 23 Sept 2011.There you had indicated that Govt should do away with the system of waivers and incentives ,Your article indicated as follows .( Goverment cannot continue to seek to create pivate sector jobs by giving incentives If an incentive is required to start a business or create jobs then it means the business is not competitive and does not make good economic sense.Govt stimulus should instead come from infrastructure work ),Thier is some merit to your point ,however it does not take note of the fact that we are members of a Common Market all members were required to provide fiscal incentive to thier manufactuers(See Caricom Fiscal Incentive Scheme 1973 ).Barbados St Lucia, Antigua Trinidad Guyana etc all have this fiscal incentive Jamaica instead went with discretionary waivers (A polictical choice of 70s which now haunts us) If we are to do away with these incentives then we must first remove ourselves from this Common Market so as not to put our workers and manufactuers at a disadvantage as we could no longer fairly compete. Take note also that in 1962 Singapore unemployment was at 13% A UN Survey Mission visited the country and suggested that they focus on Labour intesive industry using incentives ,This was done and resulted in the formation of a Economic Development Board and an Economic Incentive Act was passed to provide incentives to fuel this growth. A conerstone of Singapore success is the succesful use of fiscal incentives which they still use to this day. Interesting to note also that by 1973 Singapore had labour shortages Incentives are not bad policies but poorly managed and you will not get the results you want.The best way to cross a river is to follow the man that has crossed it before instead of the one that has only read about crossing it.....Selah

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