VAT model a recipe for disaster?
VAT on top of customs duties ‘a dangerous proposition’
Nassau, The Bahamas
Dissecting the 2014/2015 budget
The logical impact of the government’s new model for value-added tax (VAT) is that it would likely result in less consumer demand and therefore less spending, according to Professor Gilbert Morris, an economist, who chairs the Turks and Caicos Resort Owners Economic Council.
In response to strong opposition from the business community to the originally planned 15 percent VAT rate, Prime Minister Perry Christie announced in the House of Assembly last Wednesday that VAT will now be implemented at a rate of 7.5 percent on January 1, 2015 and customs duties will essentially remain unchanged.
The previous plan called for a lowering of customs duties and an implementation date of July 1, 2014.
According to the 2014/2015 budget, the government projects that it will collect more under the 7.5 percent model than it projected under the previous 15 percent model.
The government had projected to collect $200 million under its old VAT plan. It now says the 7.5 percent would result in a collection of $300 million.
While on the surface the 7.5 percent rate sounds more palatable than the 15 percent, the fact that there will now be very few exemptions and unchanged customs duties (at least in the near term) may not produce a more desirable outcome for businesses and consumers.
But it is a painful measure the government says makes more sense to bear than cataclysmic repercussions within two to three years in the absence of reforms.
Morris predicts the 7.5 percent on top of customs duties will lead to substantial burdens for consumers who must shoulder the weight of current costs along with the new tax.
“My understanding also is that mortgage arrears are very, very high and in that situation if you’re going to add 7.5 percent VAT you’re just piling another cost on top of things and what will happen, because as you know, businesses don’t pay taxes; they pass taxes on to the consumers.
“But the taxes won’t simply be the 7.5 percent. Whatever it costs businesses to comply with the tax, it would be more like 8.5 percent...all of that will be passed on to the consumer.
“Here’s what this does. Consumers may then, and this is a theoretical point, but the logical follow through is that consumers may consume less. The economy may shrink. Black markets may emerge.”
In his budget communication, the prime minister was non-committal on when customs duties will be lowered.
“Moving to a single rate of VAT, other than zero for exports, with very limited exemptions would enormously reduce the compliance costs of the private sector and the enforcement costs for the public sector,” he said.
“Based on the revenue performance of VAT early next year, the government may be in a position to consider tariff and excise reductions at the time of the 2015/2016 budget.
“More general tariff rebalancing, however, is still a requirement that will need to be implemented once The Bahamas concludes the ongoing WTO negotiations.”
But Morris told National Review the new model is simply not a welcomed proposition.
“Adding 7.5 percent to the consumer spending bill to me is a dangerous proposition because you’re just going to lump that, essentially with duties remaining unchanged,” he reiterated.
The 7.5 percent VAT will come as disposable income and savings for many Bahamians remain virtually non existent.
The following year, January 1, 2016, the government plans to introduce National Health Insurance, which is expected to be financed by way of a payroll tax. This will further stretch the incomes of many Bahamians.
As it relates to VAT, the government has not yet revealed what products or services would be exempted, but the prime minister stressed that these will be “limited”.
Christie said VAT exemptions are a costlier method of trying to help the poor, because more revenue is sacrificed to those who are not poor.
“Having the means to provide direct assistance to low-income families is thus a far more efficient mechanism than exempting necessities from VAT,” he said.
The government is introducing VAT in response to what it says is a critical need to act.
Christie announced that government debt at the end of 2013/2014 is projected at $5.1 billion, or 60 percent of GDP.
This is up from the projected 59.4 percent of GDP in last year’s budget.
At the end of 2013/2014, the GFS deficit is expected to stand at $462 million, or 5.4 percent of GDP.
That compares to the budget estimate of $443 million, or 5.1 percent of GDP.
To cover its projected shortfall in revenue in the coming fiscal period, the government plans to borrow $343 million, pushing to $1.5 billion its total borrowing since coming to office.
Public debt interest is draining around $260 million of the annual budget and would likely trend even higher if the government fails to act, Christie noted.
With our finances at such a critical point, few would doubt the need to act. Just what action the government ought to be taking is the point of contention.
Morris contends, “You can’t add costs to an economy which shrinks consumer demand and project higher income. That’s basic economics.
“It’s just not possible because you make no provision for the increased costs of goods for businesses that won’t be able to cope, for businesses that have to add costs. If someone has to hire an accountant and pay out a certain amount every month that’s one staff person gone.”
The prime minister said economic developments in 2013 have had very clear implications for the evolution of public finances this fiscal year.
In particular, the tepid rate of growth of our economy, along with weak consumer demand and imports, impacted recurrent revenues directly, he reported.
Christie also laid out a series of investment projects he said would have a beneficial impact on the Bahamian economy.
“We are diligently striving to strengthen the foundations of the economy to secure steady growth and private sector employment creation,” he said.
“In particular, we are continuing our push to develop new and expanding private sector investment projects across the breadth of the nation.”
But Morris sees no serious effort at transformative economic reform.
“I see all these governments across the Caribbean talking about tax reform and again, as I always say, it’s not that these people are any less smart than anybody else,” he said.
“They went to the same schools with the people whose countries are doing very well, but they are stuck in a system and have adopted the priorities and prerogatives of that system, and appear to advance all that that system permits.
“A first-year economic student would not come with a concept of tax reform except it was embedded in economic reform, and so when I see governments of the Caribbean talking about tax reform and merely adding taxes this is a rather sad occurrence, unfortunate occurrence.”
Morris added, “Economic reform would reveal where that $300 million is going, whether it’s waste, whether there are outstanding taxes that you ought to have collected that you didn’t collect, what the reasons are for not collecting them, and it may be well in excess of the $300 million that you are about to add in taxes to the economy.
“So, the government has the power to tax and the power to impose penalties when people don’t pay taxes, but governments are refusing even to look at their own incompetence, the inability to collect taxes, and instead of reviewing those policies through economic reform and taking responsibility for them, they’re coming out with additional new taxes to make up the shortfall.
“This produces a sense and a habit of aversion in people because eventually people will begin to say why should I pay any more taxes?”
“They’re just going to waste it anyway, so people lose faith. They begin to resent the taxing power of the government and they lose faith in the judicious decision making of the government to spend tax dollars wisely.”
Christie claimed, however, that the government is addressing “deficiencies” in its “grossly deficient” system of tax administration.
But these reforms have clearly done little to change the course of public finances.
Morris is far from impressed.
“We should have had a comprehensive economic review and comprehensive economic reform and that would have revealed where our true direction should be,” he said.
“The Bahamas does not need another tax.”
June 02, 2014