VAT and its implication for the Bahamas and the Bahamian economy
by: Zhivargo Laing, Former State Minister of Finance
The Bahamas.
... ... My talk today will seek to answer five questions, namely:
1. What is V.A.T.?
2. How does it operate?
3. Why is it an issue in The Bahamas at this time?
4. What is likely to happen?
5. What should happen?
What is a V.A.T.?
Briefly, it is a tax on goods and services at each stage of production and distribution. As its name implies, it is a tax on each increase in value as goods and services are produced and distributed.
More specifically, and here I have the European Unionâ s website to thank for what I regard as a succinct set of specifics, a Value Added Tax is:
• Charged on wide range of goods and services, commercial activities;
• A consumption tax because the final consumer ultimately pays the tax; we will get into this a little bit more later;
• Not a charge on businesses, which will become clear as we move along;
• Charged as a percentage of price, which means that the actual tax burden is visible at each stage in the production and distribution chain.
• Collected in pieces, through an invoice credit payback system or by partial payments where taxable persons (i.e., VAT-registered businesses) deduct from the VAT they have collected the amount of tax they have paid to other taxable persons on purchases for their business activities, which make it neutral or places no charge on businesses, as I alluded to earlier.
• Paid to the government by the seller of the goods, who is the â taxable person,â but it is actually paid by the buyer to the seller as part of the price. It is thus an indirect tax.
You would have heard me mention â taxable personâ several, in which case I am referring to any individual, partnership, company or trading entity that supplies taxable goods and services as a business. In many instances, however, if that business has an annual turnover that is less than a certain minimum, a VAT is not levied on its sales, it is VAT exempt.
Generally speaking, there is no VAT charged on exported goods since it is already paid on the inputs of the good for export. However, VAT is paid on imported goods as means of ensuring that they do not have a price advantage over goods produced locally.
The Bahamas, of course, is a predominantly service based economy; not manufacturing based economy. So, if implemented, a VAT would be applied on many services. So the lawyer, doctor, electrician, carpenter, etc. might all be subject to a VAT on their services. Here again though, it is not their businesses that will be ultimately charged if they had to pay a VAT in the course of producing that service, as they would be able to deduct any VAT paid. It is the consumer who would ultimately pay the VAT, just as is the case with a sales tax. Quite naturally, VAT on services can be fraught with complexities, especially in multi-jurisdictions, where place of supply issues arise; but we need not bother with that here.
Typically, there are a range of services that may be exempt from VAT, including financial services, insurance, health services, social services, education, cultural, leasing of property and the sale of property services.
In some jurisdictions, there may be several VAT rates, including a standard rate, a reduced and a zero rate. Zero rates might apply to such things as food, books, childrenâ s clothes, public transport, etc.
Some 130 countries apply a VAT and the rates can range between five percent and 25 percent from country to country. There is no VAT charged in the United States of America but President Obama did propose the implementation of one which was met with fierce opposition from conservative politicians in the U.S. In the Caribbean countries that have a VAT include Barbados (17.5), Guyana (16 percent) Saint Kitts and Nevis (17 percent) and Trinidad and Tobago (15 percent).
Why have so many countries adopted the VAT, why are so many more considering it and why VAT over sales tax? There are a number of reasons, including the fact:
• Governments needed more revenue which was not being supplied by their predominantly income and sales tax systems;
• Governments found that their tax bases needed to be broadened in order to collect greater revenue; and
• Value Added Tax broadens that base while producing a neutral tax for businesses but a self-policing system through the invoice credit payback system that a sales tax could not provide;
Time does not permit me to get into an extensive discussion on the arguments given by some against a VAT. However, briefly stated, they include the following:
• It is complicated to implement, especially in a service based economy; this notwithstanding, it is in most territories in the world and others are seeking to implement;
• It is regressive, as is the sales tax and customs duty, and IT IS;
• Problems for businesses in adapting to VAT that include time, paperwork, difficulty reclaiming funds and issues with how the VAT applies to unique supplies.
Why is VAT being considered today?
It has been known for some time that The Bahamas could not indefinitely fund the State enterprise with its existing tax sources. Our economy is, conservatively speaking, about 70 percent services and 30 percent goods, yet the Government raises about 70 percent of its revenue from 30 percent of the economy. Some 40 percent plus of Government revenue comes from taxing imports into the country, that is goods brought into the country from overseas.
A growing state with increasing cost of operations cannot continue to look to the narrowest segment of its economy to pay for the bulk of the cost. This was combined with the growing recognition that you cannot run deficits indefinitely without at some point paying a high price. Thus the need arose to look for alternative sources of funding. This effort was launched in 1995 when the Government asked the International Monetary Fund to explore the issue with it.
Another consideration was the fact that with the creation of the World Trade Organization, to which every Caribbean country belonged having joined at the time of the creation of the organization in 1995, would eventually mean The Bahamas had to look at reducing its dependence on customs duty for revenue if it hoped to belong to that international trading system on day. Talks of a Free Trade Area of the Americas to be negotiated also played a role in this consideration.
Study launched into new tax opportunities, namely sales tax and VAT because of the challenge of imposing income tax in our offshore finance environment that was extremely sensitive to such issues.
Many years of inquiry by IMF and IDB and Ministry of Finance has taken place but a concrete written first proposal was developed in 2008/9. This technical proposal is the basis of the existing proposal.
It is a live issue today because in the wake of the Great Recession and its impact on The Bahamasâ fiscal position, the imperative for increased revenue is even greater.
The Government needs cash and it needs it badly. The proposition on the table is to produce a VAT by July 2014, next year.
What is likely to happen?
One of two things is likely to happen: (i) delay of the proposed implementation date and uncertainty as to a future date; or (ii) implementation within proposal date with numerous headaches in doing so. We could all be surprised and have a painless implementation of the VAT.
What Should Happen?
The Value Added Tax proposition on the table today is, for the most part, a technocratic proposal. It does not have the benefit of broad academic consideration or input.
It also lacks commercial consideration, as serious study, thought and consideration by the entrepreneurial community of The Bahamas, including the professional supportive communities of accountants, lawyers, economists and financial experts is lacking.
The proposal does not have, as far as I can assess, a current economic impact study to form the basis of any genuine analysis of revenue need medium to long term or spending and fiscal targets medium to long term.
Such a study would also have concluded what, for the medium to the long term, should be the appropriate tax system for The Bahamas, meaning that we should determine what taxes should exist in the modern Bahamas and which should be eliminated. Doing this would mean that we have a vision for the economic and commercial life of The Bahamas and what fiscal system would best support the realization of that vision.
It certainly has not yet been given an organized public education process and deliberation. This means that the community it remains largely an uncertainty to most of the public.
The proposal also lacks important details, especially as it relates to its implementation, though I do believe that the rudiments for such details were emerging as a consequence of certain legislative, administrative and technological reforms undertaken over the last six years and some are alluded to in the paper itself.
Tourism and financial services, along with their ancillary supportive services, account for more than 60 percent of our economy. Applying a VAT to these internationally competitive sectors with their major impact on our economy must be approached with caution. It is not clear whether the proposal on the table has carefully analyzed this situation and therefore has accounted for the implications of the VAT to them and the economy as a whole.
What we know about the VAT proposal from a white paper on tax reform issued on 13 February of this year include the following:
The Government's objectives are:
• To secure an adequate revenue base in support of modern governance;
• To establish a tax structure that promotes economic efficiency and stronger economic growth; and
• To make the tax system more equitable.
These are laudable objectives but the implementation of a VAT alone, even when combined with a congruent reduction in customs duty will not achieve these objectives. Reform of the tax system itself that results in a structure supportive of these objectives is necessary.
The aim is to introduce the VAT on 1 July 2014 at a rate of 15 percent.
The Government should rethink this.
Firstly, I think that the date is not doable, certainly not to achieve the best results. However, more importantly, I believe that we should step back and see the tax reform exercise more fundamentally and profoundly.
Many of the considerations that drove us to look at our tax system with jaundiced eyes have faded. In particular, our offshore finance centre has seen revolutionary changes in the international regulatory environment in which it operates.
The timidity that it once had to issues of no or low taxes and even secrecy has matured in some ways. We can, as a mature nation, take account of our needs as a state and the cost of financing those needs, and consider our vision for a dynamic, robust and growing economy and the commercial opportunities that exist to realize that vision, and develop a tax structure that suits us.
In other words, rather than be driven, lets drive our reform to do for us what we wish to do for ourselves within the context of the global environment in which we exist and are likely to exist. We should aim for reforms and should do them sooner rather than later but let us do our best and most considered reforms, so that we can look back at them and be proud of what we did for us.
There will be a reducing of both import duties and excise tax rates and elimination of the business license tax (but require a minimal annual business license fee) and the elimination of hotel occupancy taxes (which will be substituted with VAT). As a part of a considered tax reform process, these could have merits but cannot be fully known without that more complete picture in place.
There will be a limit to become a VAT Registrant of $50,000 turnover per annum, meaning that about 3,798 businesses will qualify as VAT Registrants. At this rate, the revenue potential to the Government will be around $200 million. If we return to pre-2008 GFS deficits, this new revenue could totally eliminate our deficit, if the government enjoys levels of growth seen in that period and controls increase in spending, which, I admit is a tall order for governments. If we maintain post-2008 GFS deficits, this new revenue will still mean GFS deficits of $300 - $400 million, if all else remains equal; and that would not be sustainable or acceptable.
In keeping with what happens in other jurisdictions, it is proposed that financial services, agriculture and fisheries, social& community services, health and education and leases on land and residential buildings will all be tax exempt sectors. Nothing unusual there!
There are other details in the paper about the administrative procedures proposed for the VAT, but I do not have the time to comment on them.
Freeport
Any consideration of new tax implementation in The Bahamas has to take account to legal and economic privileges enjoyed by Freeport through the Hawksbill Creek Agreement. Let me say here that I have looked at the issue and while I do have some initial thoughts, I am not prepared to draw any specific conclusions at this time. However, I will say that just as it ought to be the case with all taxes imposed by the Government, the imposition of a VAT must not proceed without definitively considering its legality and appropriateness for Freeport in light of The Hawksbill Creek Agreement. No one, least of all the economic hard pressed businesses and people of Freeport, and Grand Bahama, need a legal battle or economic issue that pushes their misfortunes further. I will speak to this issue following upon my further study of this matter, however.
Conclusion
We are discussion VAT implementation because there is a glaring reality confronting The Bahamas, which is that its income cannot pay for its operations. It has not done so from The Bahamas became an independent nation. We have run deficits and financed those deficits with borrowings since 1974, when we ran a deficit of some $33 million. Incidentally, we had a surplus of about $3 million the year before that, the last such surplus seen on total budget performance.
In the wake of the crippling effects of the global recession of 2008 and the strain it put on the revenue of the government, our deficit spending has reached extraordinary levels, which is unsustainable, especially in light of the modest growth seen both in terms of the worldâ s economy and our domestic economy so dependent on it. The Government needs money to pay for its expenses and it needs money badly. That is why VAT is being discussed with the sense of urgency that it is being discussed today. In 1995 when the issue first arose, it was being discussed as a planning function; today is itâ s a practical issue of money.
Bahamians must embrace the realities of our present moment and those that relate to our moments going forward. A country is community to which all citizens and residents belong. There is a cost to operating a country. If it is operated efficiently, the cost is not as high as when it is operated inefficiently. However, operated, the cost exists and it must be paid by its citizens through taxes. If the governors drive up the cost through decisions regarded as good or bad, the cost exists and must be paid for by the citizens. If you want to punish those who drive up cost through waste or bad decisions, then do that at election time but know that the cost still has to be paid by the citizens.
A country can borrow to cover its deficits for a long time, for decades and decades. It can even do so increasing its debt to GDP ratio to extraordinary levels, above 100 percent, but the price to pay for this is reduced ability to afford products and services (education, infrastructure, technology, etc.) that could lend to a more prosperous, efficient and peaceful state. Minimizing deficit spending is good government policy, especially in times of economic growth.
Our present tax system is not serving our needs well. It needs to be reformed. We need to eliminate some taxes, to introduce some new taxes and ensure that that at the end of the exercise, we have a tax system that meets the revenue needs of an efficient Bahamian state and supports the ability of the commercial sector of that state to do what it does best, create, grow and conduct business resulting in good jobs and good income. A VAT has the potential to fit into this kind of a scenario.
In office, we certainly looked at implementing it and if returned to office would have given it early consideration. However, we would have also given it broad consideration in the context of the wider reforms to our tax system that we were already undertaking. Consistent with this was changes to our business license regime, real property tax reform efforts, the proposed creation of the Tax Administration Department, reforms to the Tax Administration and Audit Act, a new framework for support small and medium size business through SMEDA, the modernization of customs laws and department, etc. If we step back and approach this issue with the maturity, intelligence and integrity that it deserves, we could do wonders to help The Bahamas realize its greater potential."
The Freeport News
The Ministry of Finance (MOF) released the draft Value Added Tax (VAT) Bill, draft Value Added Tax Regulations 2013 and Guide to VAT legislation. This release follows weeks of clamor and demand by various stakeholders. In the days ahead, it is expected that the public discourse on this crucial component of our tax reform program will intensify as we begin to decipher the documents and properly assess the impact it will have on The Bahamas and Bahamians.