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?