The Tribune

This article was originally published in October 2004 - the last time there was serious talk about changing the Bahamian tax system.

Large-scale taxation to finance a growing public sector is a 20th century phenomenon. These days – except perhaps in the Bahamas - the big debate is about cutting taxes, reining in spending and making government more effective.

In the face of ever-bigger government and ever-rising rising taxes, Margaret Thatcher and Ronald Reagan managed to turn the political tide in the 1980s. They argued (convincingly, it turned out) that social idealism could not be achieved without market economics.

So today’s debate no longer pits socialism against capitalism. Rather, it is about the role of the state, with one side favouring a more active and interventionist central government and the other seeking devolution and divestment. The trick is to achieve the right balance based on prevailing circumstances.

Both Reagan and Thatcher cut taxes. And one of the economists who drafted Reagan’s landmark tax law in 1986 (which brought top income tax rates down from 50 to 28 per cent) was a guest at a seminar on Bahamian tax reform staged by the Chamber of Commerce last week.

At the British Colonial Hilton, Dr Charles McClure of Stanford University’s Hoover Institution told Bahamians to seek a bipartisan consensus on tax reform and to keep any new system as simple as possible.

He was here because for the first time in modern history we are contemplating big changes to our economic system - changes that will have far-reaching consequences for all of us.

Most other countries have a slew of personal and corporate income taxes, consumption taxes, property taxes and excise taxes, as well as payroll taxes. But our revenue system is more akin to that of America’s at the turn of the last century. It relies on import duties for half the government’s billion-dollar income. The rest comes from fees and property taxes, and there is a small payroll tax for National Insurance - but many Bahamians avoid paying all of these.

State Finance Minister James Smith acknowledges that this relatively low tax regime has let the Bahamas avoid complex administrative problems while providing “reasonable” revenues to finance essential public services. We have, after all, a very small population.

But, at the seminar, College of the Bahamas lecturer Olivia Saunders questioned the sustainability of this model: “the cost of...government is only going to rise...the present fiscal regime is inadequate and has been for some time. (Our) fiscal position...since 1980 has been one of perennial deficits.

“Fiscal reform cannot be divorced from economic reform,” she added. “These times require us to leave the past where it is; to craft an effective and accommodating government; to foster entrepreneurship; and be open to creative and innovative thinking.”

Well that, of course, is the big fat question: Exactly how are we to achieve economic growth along with an effective and accommodating government. Merely by coughing up more taxes for the public sector to waste on bread and circuses, as some recommend, or by doing a little creative and innovative thinking for a change?

According to the World Bank, a growing private sector is the only sustainable way to achieve poverty reduction and higher standards of living. But along with this must come empowerment – giving poor people wider access to affordable, better quality services and infrastructure.

“A better investment climate provides better opportunities for poor people, whereas an empowered population provides a more efficient and productive labour force for firms,” the World Bank says. “It is not just good for firms but good for society as a whole.”

But as Financial Times commentator Martin Wolf put it, “In far too many poor countries, the law’s delays and the insolence of office prevent desperately needed improvements in economic performance.”

In other words, governmental failure is the main obstacle to growth. If contracts and property rights are weakly enforced, if regulations are burdensome and inefficient, if corruption and crime are tolerated and if public infrastructure is unreliable, the cost to business can be much more than what is typically paid in taxes.

Barriers to competition are also obstacles, the World Bank says: “Even though individual firms typically prefer less competition, all the evidence shows that this is actually key to driving productivity improvement and growth in the long-term...firms that face stronger competitive pressure are more than 50 per cent more likely to innovate in various forms...we see that as a truly integral part of the investment climate.”

The evidence also shows that a difficult investment climate tends to handicap small firms and the informal economy most. So by dealing with these issues, governments can provide more benefits to small business and micro-entrepreneurs like street vendors and market workers.

The credibility and trustworthiness of government are big factors in achieving results. When governments pass laws that aren’t implemented or enforced, it’s not surprising that people don’t take their policies and actions seriously.

Improving the delivery of key public services is crucial for progress, the Bank says. And more spending by itself won’t do it. We can see clear evidence of this in our own heavily-funded state education system, which produces unemployable school leavers.

So we need to refocus this tax debate. It’s not just about raising more money. It’s about forcing government accountability and getting more value for our tax dollars, much of which is wasted on an inefficient public sector.

It’s time we spoke up to help set the agenda, because there already seems to be an official consensus for the introduction of a value-added tax within the next couple of years. VAT has been implemented in over 120 countries (including Britain, Canada, Barbados and several other Caribbean nations). It generates about a quarter of all tax revenue worldwide.

In calling for a more broad-based tax system when he opened last week’s Chamber seminar, Minister Smith argued that the government’s “persistent deficits” are caused by things we have no control over, like hurricanes and oil prices. A value-added tax would help to stabilise the government’s revenue stream.

Well, we do have one of the lowest tax burdens in the region – about 17 per cent of GDP compared to 30 per cent in Barbados (which has both income tax and VAT). In fact, we are one of only a very few states in the region without any corporate or personal income taxes. But that is part and parcel of our economic model, which relies on tourism and offshore finance.

And it is true that our indirect tax system is regressive – meaning it has more impact on the poor (although many items used more by the poor are lightly taxed). In contrast, property taxes are scaled to collect more from wealthier homeowners, but both rates and compliance are low.

And because we tax only goods in what is mostly a service economy, a lot of potential revenue is lost before we even start. By broadening the tax base to include services (which are used more by the wealthy) a VAT rate of only 15 per cent could generate more revenue than the current regime, be more progressive and provide other benefits.

“Tax reform, if done correctly, can lower the cost of doing business and induce the provision of greater quantities, quality and variety of products and services,” explained COB lecturer Dr Llewelyn Curling. “It can also promote greater competition, lower the cost of living, increase economic activity and business income; and finally - arriving full circle - it will increase government tax revenue while conforming to international trends in trade relations.”

According to Paolo Dos Santos, a tax advisor to the Caribbean Regional Technical Assistance Centre: “VAT is the way the region is moving. Reliance on tariffs is finished.”

Barbados is the main comparison cited by experts because its economy and population are similar to ours (about $5 billion in GDP and about 300,000 people). Today, Barbados is considered a stable economy, but In 1991 it was forced to take harsh measures by the International Monetary Fund.

Barbados’ problems in the 1980s were partly due to politically-motivated populist policies (the same kind our government likes). The depletion of foreign reserves was the most pressing problem in the crisis that developed. In other words, the country was unable to service its foreign debt. After the IMF structural adjustment package – which provided emergency loans once certain conditions were met - growth returned in the mid-1990s.

The IMF prescription included balance of payments support, radical cuts in government spending, deregulation, more taxes, a tight money policy, wage freezes and the sale of state assets (including hotels and telecoms).

This was surely not a pleasant task. But the main goal was to reduce the role of the state in shaping economic policy while relying more on the private sector to promote growth. At the same time, the process included the introduction of income tax in 1992 and a 15 per cent VAT in 1997.

Before we move to a new tax system we need a significant upgrade in the government’s ability to collect existing taxes. And if we get that - without making an effort to follow good fiscal management and improve the delivery of public services - we could simply be throwing good money after bad.

“The government has failed to privatise BATELCO even after huge expenditures and prolonged negotiations,” one analyst told Tough Call. “Furthermore, it has no plans to go beyond BATELCO. The IMF has recommended a reduction in waste and excessive staffing, but there is no evident move in this direction. Year after year the government simply borrows more money.”

And just making speeches about civil service productivity and transparency is not good enough. We need leadership to make some fundamental policy changes...including the way the government’s own members behave. Otherwise, who can take them seriously?

Meanwhile, Minister Smith says the government will listen carefully and do all the right things. But the key point is this: there is no good or bad decision on tax reform, as Mr Dos Santos said at last week’s seminar: “It all depends on what you want government to do and what returns you want from your tax investment.”

It is up to us to hold their feet to the fire, and make sure we get what we want – and not what they want by default. A tough call indeed.

• What do you think? Send comments to larry@tribunemedia.net or visit www.bahamapundit.com.