The Bahamas collects an estimated 40% of its tax capacity

Bahamas Near Bottom At 40% 'Tax Capacity'

By NEIL HARTNELL
Tribune Business Editor
nhartnell@tribunemedia.net

Nassau, The Bahamas


The Bahamas is currently operating at just 40 per cent of its tax capacity, the Government’s US consultants have warned, ranking this nation near-bottom of 98 countries.

The Compass Lexecon report, which the Government leaned on heavily to produce its restructured 7.5 per cent Value-Added Tax (VAT), also strongly backed the Bahamian private sector’s calls for greater enforcement and compliance with the existing tax system, noting that only 40 per cent of real property tax bills are being paid.

“The IMF has estimated that The Bahamas collects only 40 per cent of its maximum attainable tax-to-GDP ratio as determined by the economic structure of the country, a metric on which it ranks 92nd out of 98 nations,” Compass Lexecon said.

“In comparison, Sweden and Denmark collect 98 per cent of their tax capacity.”

This will likely add fuel to ongoing private sector, and public, suggestions that if the Government were to get existing tax compliance levels up to international standards, and combine this with targeted spending cuts/restraint, there would be no need for Value-Added Tax (VAT) or any other new taxes.

Robert Myers, the Coalition for Responsible Taxation’s co-chair, yesterday told Tribune Business that The Bahamas’ tax compliance rates and ratios were “skewed” by the fact the collective $285 million in annual investment incentives is treated as revenue foregone.

But, acknowledging that compliance rates with the existing system were “still lower than they should be”, he added: “Some of that is due to the fact we have concessions, so concessions are factored in.

“Compliance does take a hit because of the concessions given out to the hotel industry and other investors. These concessions are counted as revenue, but hurt our compliance.

“It makes it difficult to say what the true compliance is, but it’s still low; lower than it should be,” Mr Myers added. “It does skew the numbers.”

The Government’s restructured 7.5 per cent VAT appears to be a model produced from the amalgamation of Compass Lexecon’s report with that produced by the two New Zealand consultants, Dr Don Brash and John Shewan.

The private sector’s efforts further buttressed these reports, and the lateness of the Government’s decision is further highlighted by the date on the final Compass Lexecon report - May 27 - the day before the 2014-2015 Budget announcement.   Returning to the poor compliance/enforcement theme, Compass Lexecon said: “At present, taxes in The Bahamas are regressive, inefficiently administered, and apply to a very narrow base.

“The Bahamas is not realising anywhere near its potential revenue on property taxes.  The Government presently exempts the first B$250,000 on owner-occupied housing and does not means test this exemption, while it also gives breaks to hotels, timeshares, and other tourist-related investments.

“In addition to having a narrow tax base, the Bahamian property tax is inconsistently applied.  Government property rolls have a coverage rate of about 70 per cent, and the Government receives payment on only 40 per cent of the property tax bills it issues.  Enforcement against non-compliance has been weak to non-existent.”

The Government has repeatedly pledged to address this issue, and Michael Halkitis, minister of state for finance, on Monday said another 1,000 properties had been added to the tax roll following the latest amnesty programme’s conclusion.

As for Customs, the Compass Lexecon report said it was investing $6.745 million over three years to re-engineer its business processes.

“Reforms include the development of a new computerised system for the processing of transactions, training for staff in the implementation of the new trade agreements, the introduction of a new K9 unit, and the enhancement of the existing marine unit,,” Compass Lexecon said.

“These measures are expected to improve enforcement capabilities, decrease fraudulent activities, and reduce the cost of collecting revenue by 15 per cent.”  To comply with World Trade Organisation (WTO) requirements, the Bahamas is looking to reduce the weighted average tariff rate to 10 per cent - a drop of 15 percentage points.

The US consultants also disclosed their belief that the original 15 per cent VAT model, and estimates that it would generate a net revenue increase equal to 2 per cent of GDP, “may not be necessary to put the Bahamian Budget on a sustainable trajectory”.

“Furthermore, immediate implementation of a VAT at this rate would substantially reduce economic growth over the short and medium terms, which would result in even higher unemployment,” Compass Lexecon said.

“In combination with other fiscal reforms, a VAT raising less revenue than initially proposed - in the range of 1 per cent of GDP in incremental revenue rather than over 2 per cent - should be sufficient to address the long-term fiscal challenge, and would be substantially less of a drag on short-term economic growth and employment.”

The US consultants said this pointed to the option ultimately chosen by the Government - VAT in the range of 5-10 per cent - with the “greater flexibility” to increase this if more revenue was needed.

Compass Lexecon said that with VAT raising revenue equivalent to 1 per cent of GDP from 2015-2016 onwards, debt would start to fall by one percentage point, growing to almost a two percentage point drop the following fiscal year. “But, this is only the case if all other deficit reduction measures are fully implemented and achieve the targeted savings, and the economy grows as expected,” Compass Lexecon said.

“Notably, the most recent IMF projection shows debt-to-GDP falling by smaller amounts than in the Government’s official projections.  The IMF’s pessimism largely results from the IMF assuming that the Government’s other revenue measures (like property tax reform) raise significantly less than the government projects.

“In sum, the target is achievable based on the Government’s current projections and without a VAT of 15 per cent, but there is a real risk that the extant measures discussed so far prove insufficient in achieving the fiscal targets and a higher VAT will be needed.”
June 04, 2014

Tribune 242

...we examine the experience of Barbados in its transition to value added tax (VAT) ...and look at how we can apply those lessons to The Bahamas ...Finally, we present an argument for why the tax discussion should ultimately be extended to include modest corporate taxes

Value added tax, part 2

CFAL Economic View

Nassau, The Bahamas

Last week we examined the need for a new tax system in The Bahamas and gave an example of how value added tax, or VAT, would be calculated in practice.  In this article we examine the experience of Barbados in its transition to VAT and look at how we can apply those lessons to The Bahamas.  Finally, we present an argument for why the tax discussion should ultimately be extended to include modest corporate taxes.

In an excellent article recently published in The Tribune titled “Barbados’s Lessons for The Bahamas over VAT”, Dr. Nikolaos Karagiannis of Winston-Salem State University presented a detailed overview of the process that took our southern Caribbean neighbor to its new tax system.

VAT was introduced in Barbados at the beginning of 1997 at a standard rate of 15 percent (it has since been raised to 17.5 percent).  Among the reasons cited for its choosing to implement VAT was to reduce the complexity of the country’s indirect tax system and to reduce the high level of duties and taxes on imported goods.

Serious discussions on tax reform began in earnest when Barbados underwent stabilization and structural adjustment under the International Monetary Fund (IMF) in 1991.  In order to coordinate the extensive work of implementing a VAT, Barbados established a VAT Implementation Unit (VIU) in 1993.  In January 1994, it entered a technical cooperation agreement with the Inter-American Development Bank (IDB).  Under the agreement, loans were allocated for the design of the VAT system and to bolster the Customs and Excise Department.

When the Owen Arthur administration came to office in 1994, the implementation of VAT was postponed to mid-1996 while research continued on estimating the impact of the tax on revenues, prices and the productive sectors.

The VIU started public relations outreach programs in May 1995, including the release of pamphlets and booklets, targeting four main target audiences: the private sector (retailers, manufacturers, importers and managers); the government sector agencies involved in the administration of the system; members of the general public (consumers) and finally the school system.  The VIU presented at workshops, seminars, as well as via television and radio to further educate the public and business community.  The major features of the new act were passed by the Barbados House of Assembly in September 1996 with effect on January 1, 1997.

The Bahamian context

Will Bahamians comply with a new and seemingly complicated tax?  Many are skeptical that we can effectively get companies and individuals to forward the correct amount of tax to the government when we struggle to collect existing property taxes.  As reported numerous times before, our government is owed some $400 million in past due property taxes according to the auditor general; much of that amount will probably never be recovered.

However, the reality may prove to be less problematic: only persons/businesses of the size and capability to adhere to good record-keeping (as measured by annual gross sales) will be included in the VAT system.  Around the Caribbean region, this minimum threshold is TT$200,000 in Trinidad and Tobago (approx. US$30,000), JM$144,000 in Jamaica (approx. US$2,000) and BD$80,000 in Barbados (US$40,000).  Given the higher average per capital GDP of The Bahamas, one can reasonably anticipate that our exemption threshold will be much higher than the rest of the Caribbean.

The Barbadian government was equally concerned with tax avoidance and evasion.  Only those traders who were registered, and who displayed a certificate of registration, were legally authorized to charge VAT on the taxable goods and services they were selling.  On the other hand, those traders who were not registered were paying VAT on the goods they were buying, but were not legally authorized to charge VAT on the goods they were selling, thereby squeezing their profits.

No doubt Bahamian business culture will need to be transformed.  Compared to Barbados, which already had a strong tax framework and a history of paying taxes, this nation is starting from the opposite spectrum in terms of tax familiarity and compliance.  The principle challenge for the business community will be record keeping; many companies will need to hire book-keepers or accountants while upgrading their point of sales or POS systems.  Ultimately we will need to force compliance by tying it to the renewal of business licenses, alongside rigorous and impartial execution of the law by the newly created tax authority.

The move forward

As the Bahamian economy is a predominantly services-driven one, the real challenge for our policymakers is to introduce a VAT system that can achieve economic, fiscal, social and developmental objectives, while avoiding any adverse effects on tourism and financial services.  As one example, VAT in Barbados was applied at a concessionary rate of 7.5 percent (now 8.75 percent) on accommodation in hotels, inns and guest houses.  The government will need to decide very carefully which goods and services would be zero-rated and therefore exempted to make sure that VAT is neither regressive, nor penalizing those who are at the lowest levels of income.

Beyond VAT, how do we get the greatest mileage out of the many tax information exchange agreements, or TIEAs, that our jurisdiction has signed?  One of the stated goals of the Bahamian financial services industry is to see companies locate their head and subsidiary offices within our shores.

Would that be an easier sell if we had a tax regime that allowed foreign companies to offset taxes paid in our jurisdiction when repatriating income?  For example, Barbados has a number of double taxation agreements, or DTAs, that are extremely favorable for certain types of investors.  These agreements promote cross border trade, avoid double taxation and prevent tax evasion.

As a result of its 2000 DTA treaty with China, Barbados has emerged as the leading jurisdiction for offshore wholly foreign owned enterprise (WFOE) holding companies in China.  Under existing law, payments of dividends by a WFOE to its foreign owners are free of Chinese withholding tax.  Payments of interest to foreign lenders are subject to withholding at 20 percent, typically reduced to 10 percent under applicable tax treaties.  However, where a taxpayer qualifies for benefits under the Barbados-China treaty, the tax rates are reduced to five percent for dividends and 10 percent for interest.

The Bahamas should be able to compete in this space with the proper tax structure.  The current tax debate is an ideal time to examine the merits of corporate tax as a boost to our competitive advantage in an era where being a zero-tax country is now a liability.  This would allow the Bahamas to obtain tax income from foreign companies operating here at modest rates of 1.5 percent to 2.5 percent without increasing their overall tax burden since, by the DTA, the tax would be shared by our treasury and that of the home country.

Even as we move to a new tax system, we stress that the government will still need to be vigilant in controlling its spending and getting its fiscal house in order. This is one reason why the so-called Tea Party in the United States is so adamantly against any form of tax increases, including any overhaul of the tax code which increases efficiency and as a consequence increases collection.  Instead, it feels the need to “starve the beast”, as governments’ natural inclination is to spend more than whatever revenue it takes in.

Referring to Barbados one last time, that country has a 17.5 percent VAT, 20 percent to 35 percent personal income taxes, 12.5 percent withholding on income and dividends, 15 percent to 25 percent local corporate taxes and import taxes on vehicles, spirits, tobacco and petroleum products. Nevertheless, they still had a 2010/2011 central government deficit of 8.5 percent of GDP and total government debt over 110 percent of GDP.  Clearly, getting the tax policy right is still only one side of the government’s fiscal equation.

CFAL is a sister company of The Nassau Guardian under the AF Holdings Ltd. umbrella.  CFAL provides investment management, research, brokerage and pension services.  For comments, please contact CFAL at: column@cfal.com

Jul 11, 2012

Value added tax, part 1

thenassauguardian

...the need for a new tax system in The Bahamas ...Value added tax, or VAT, has emerged as the frontrunner to supplement or completely replace the Bahamian system of customs duties

Value added tax, part 1

By CFAL Economic View

Nassau, The Bahamas

Much has been written in the press recently on the need for a new tax system in The Bahamas.  Value added tax, or VAT, has emerged as the frontrunner to supplement or completely replace our system of customs duties.

In this first of a two-part article, we will examine why we need to change our tax regime in the first place, give an example of how VAT taxes work in practice and describe the basic structures that will be needed by both the government and private sector to make VAT work.

Next week we will highlight Barbados’ experience in moving to a VAT system in the late-1990s and continue with a discussion of the challenges and opportunities of moving to a similar system here in The Bahamas.

Finally, we will review other tax methods that can potentially raise government revenues and increase competitiveness for a key segment of our economy, financial services.

So why all the fuss over taxes?   Quite simply, our government’s spending is outpacing our tax revenue by a greater and greater amount, especially since the recession of 2008.   In other words, we have been running increasingly large government deficits and borrowing the difference.  According to the Central Bank, our deficit has increased from $182m in fiscal year 2006/2007, hitting $361m in 2008/2009 and is now estimated to be over $550m for 2012/2013.

As former Central Bank governor and Minister of State for Finance James Smith remarked in a recent article, this revenue gap now appears “structural” in nature, meaning it will not correct itself on its own through normal reduced spending or increased collection of the existing taxes on the books.

What ultimately is needed is a concerted effort to either cut public spending, raise more revenue or some combination of the two.   Both Moody’s and the International Monetary Fund (IMF) have warned that our growing financial deficit at approximately 4.7 percent of GDP is unsustainable.   Central Bank statistics show that government debt has ballooned from $3 billion in 2007, or about 31 percent of GDP, to over $4.3 billion in 2011, or 53 percent of GDP.

Studies have shown that as debt approaches 60 percent of GDP, the need to service that debt and pay the interest begins to slow the growth rate of the economy.   With official unemployment at almost 16 percent and over 40,000 people unemployed, the last thing The Bahamas needs is to have its already anemic growth rate slow even further.

So what is wrong with our current tax system based on customs duties?   Most obviously, it is not providing the government with the revenue it needs to support current expenditure (of course, this could also be framed as a government spending problem – more on this next week).   According to the CIA World Factbook, The Bahamas ranks 167th out of 210 countries in terms of tax revenues paid to the government as a percentage of GDP.

Our government takes in about 19 percent in taxes versus the global average of 29 percent.   By comparison, Jamaica takes 27 percent, Barbados 28 percent, Trinidad & Tobago 34 percent, Canada 39 percent, Brazil 40 percent and most of Europe between 40 percent and 60 percent.   The United States, with the largest economy in the world, takes a tax haul of 15 percent of GDP, highlighting the “fiscal space” it still has to address in contrast to Europe which is looking increasingly “maxed out”.  It is clear that we are lightly-taxed in this country by global standards.

Secondly, by putting most of the tax burden on imports, our tax base is fairly narrow and completely leaves out our dominant service-based economy.   It also requires merchants to pay their taxes upfront, prior to making the final sale to consumers, thereby tying up capital unnecessarily.

Therefore, if we can broaden the tax base we can tax everyone at a lower rate and still provide the government with the revenue it needs to help balance the books and even start paying down its debt.

A final reason for changing our tax system is the fact that The Bahamas has entered into a number of international trade agreements, including the Economic Partnership Agreement, or EPA, with Europe.   Moreover, the current administration continues to work towards full membership for The Bahamas in the World Trade Organization, or WTO.   Our high rates of duties will most likely be viewed as a barrier to trade by these bodies, forcing us to either reduce them or eliminate those tariffs completely.   So the clock is already ticking – The Bahamas’ EPA obligations with Europe require us to reduce tariffs on EU imports by 2014.

What is VAT?

So what exactly is a value added tax?   VAT is a consumption-based tax, much like a sales tax, but it is collected “in pieces” along the production chain.   It is estimated that over 70 percent of the world’s population live in countries which apply VAT.

Unlike customs duties, it is applied on all sales, including goods and services.   VAT tax rates generally vary between 10 percent and 20 percent and the final rate selected for The Bahamas would depend on how much revenue needs to be raised to replace other taxes as well as to close the deficits mentioned earlier.

Let us look at an example of how VAT actually works, taken from The Atlantic Magazine, May 2010.   Consider a loaf of bread you buy in a grocery store for a dollar.   You have a farmer, a baker, and a supermarket along the production chain.   Finally, let’s set the VAT rate at 10 percent:

1. The farmer grows the wheat and sells it to the baker for 20 cents.   The VAT is two cents.   The baker pays the farmer 22 cents, and the farmer sends two cents in VAT to the government.

2. The baker makes a loaf and sells it to the supermarket for 60 cents.   The VAT is six cents.   The supermarket pays the baker 66 cents, of which six cents is VAT.   The baker sends the government four cents, which is the six cents in VAT on the bread sale less a two cent credit from the government for the VAT he paid when he bought the wheat.

3. The store sells the loaf to me for a dollar which costs me $1.10, including tax.   The store sends the government four cents total – the 10 cents it collected in VAT on its sales, minus the six cents it paid to the baker in VAT, which it gets back in a credit.   In total, the government gets two cents from the farmer, four cents from baker, and four cents from the store.   That equals 10 cents on a final sale of a dollar for a 10 percent VAT.

If that sounds overly complicated, you might be asking yourself why not simply add a sales tax on the final transaction?   Believe it or not, it is easier to collect VAT than a sales tax because of these various stages and built-in paperwork along the chain.

A retail sales tax would have been very easy to avoid because there’s no counterparty to the transaction besides the end consumer.

Look at the baker in the VAT.   The baker may want to avoid paying the VAT to the government but he knows the grocery store will report the purchase in order to claim its VAT credit.   If it is paying attention, the government should be able to go to the baker and say “you forgot to report your 60 cents of sales and six cents of VAT which you owe”.

That mechanism represents the system of checks and balances within the VAT system.   A lot of research suggests that sales taxes are difficult to enforce when you get to rates above six to 10 percent because people find ways around them, such as under-invoicing or unreported cash sales that occur under the table.

From the example above, it is clear that the introduction of a VAT system will require significant changes on the part of the government, as well as from the private sector, which would be forced to assume the role of tax collector.

Government would need to address organizational issues such as setting up a separate VAT or Tax Office, staffing requirements and training, deciding how much lead-in time is necessary and informing the general public of the transition.

Companies involved with VAT administration will face significant invoicing and bookkeeping requirements, will have to coordinate filing and payment requirements and will ultimately be subject to VAT audits, refunds and penalties.

Next week we will look at the Barbados experience with implementing VAT and the lessons learned for The Bahamas.   We will also make the argument for why a modest corporate tax should be included in the discussion.

• CFAL is a sister company of The Nassau Guardian under the AF Holdings Ltd. umbrella.   CFAL provides investment management, research, brokerage and pension services.   For comments, please contact CFAL at: column@cfal.com

Jul 04, 2012

Value added tax, part 2

thenassauguardian