The Tribune

By Richard Coulson

Value Added Tax (VAT), as presented in the recently-published Government White Paper, is fine as far as it goes. The various administrative measures described in the White Paper seem well-designed to implement VAT with the minimum compliance difficulties. However, VAT by itself does not go nearly far enough in bringing the highly-publicised ‘tax reform’ to the Bahamas.

The White Paper itself states three objectives of tax reform:

• Secure an adequate revenue base to support modern governance.
  
• Create a tax structure that promotes economic efficiency and strong economic growth.
• Make the tax system more equitable.

Consider these point by point. In point one, the phrase “modern governance” is a polite way of saying that in our modern world Government must provide an ever-increasing range of services to the public. Social services that were unheard of 50 years ago – food stamps, aid to disadvantaged children, free medical care, mortgage relief, subsidised housing, wider education, public broadcasting – are now taken as a matter of course, and every year we can be sure that more such services will be added.

They may be socially desirable or simply extravagant, but inevitably they will require higher Government expenditures, and as night follows day that means more revenue must be raised for the public purse.

But public officials repeatedly soft-soap us by telling us that imposition of VAT will be ‘tax neutral’. It will be matched by reductions in import duties, Business License fees and excise taxes, so that there will be no actual increase in the tax burden. If that is so, how can VAT make any contribution towards increasing the Government’s total current revenue? In short, VAT will do nothing towards attaining objective number one.

In point two, yes, “economic efficiency” will be encouraged by VAT, since it will reduce our dependence on import duties. The existence of these charges on virtually every imported item represents our principal obstacle to joining the World Trade Organisation (WTO) and other regional trade agreements. Our membership will not be accepted as long as we impose across-the-board tariffs that make imports unnaturally expensive, thus discouraging trade from other nations. Specific protective measures can be negotiated to encourage certain local industries, such as the production of bottled water, but these must be the exception rather than the rule, and can often be imposed as quotas rather than as ad valorem financial charges.

The reduction or elimination of import duties in favour of VAT should also benefit all local businesses who import big-ticket items that can be slow movers, such as automobiles, furniture and kitchen appliances. At present, the tax is paid at the front of the sales cycle immediately upon import, impacting cash flow and requiring excess capital to be tied up while the goods are held as inventory. Yet VAT taxes will be paid only with the sales ticket to the final buyer.

On point three, achieving a more “equitable” tax system, we do not see that VAT will make any real contribution. Just like import duties or excise taxes, VAT is a tax on transactions - in effect, a consumption tax. It is well established that, even with exempt items such as basic food-stuffs, a consumption tax has a greater impact on the poorer segments of society, taking a greater portion of the income of an hourly-paid laborer than the upper tier earners.

We can be sure that the 15 per cent VAT charge on fees levied by a lawyer, doctor or accountant will be passed on directly to the consumer of these services, and will not impact the income of the professional provider. Of course, VAT will not apply at all to the salaried compensation of senior bankers or corporate officers, or to dividends received by a business owner.

In other words, VAT will not in any way challenge our present inequity of taxing the poor while leaving the rich virtually tax free. We do not in any way criticise the high earnings of our professionals and executives, which are fully justified as due compensation in a capitalist economy operating under free market principles. But we do not believe it smacks of socialism to argue that a reasonable portion of these earnings should be paid into the public Treasury, as a direct contribution to the cost of governance.

This can only be accomplished by some form of income tax, a concept that has been anathema in the Bahamas and is summarily rejected in the White Paper. Relying on various studies of taxing methodologies, mainly in Europe, the White Paper bluntly concludes that “the principal drawback of income tax is that it acts as a disincentive to work effort and entrepreneurship”.

We challenge this statement as a highly misleading description of experience in the real world, whatever the surveys may suggest. Would anyone claim that entrepreneurship and risk-taking in the famed Silicon Valley have been seriously restricted by US federal personal income tax rates? Did Mark Zuckerberg worry about a tax “disincentive” in creating Facebook?

Income tax is now imposed by virtually every modern country active in the international economy. Occasionally, a country goes too far, as when after World War II the left-wing UK government raised the marginal rate to 90 per cent and drove entrepreneurs out of the county. But these excesses are always corrected by competitive factors, and at present the maximum rate rarely exceeds 50 per cent, often mitigated by adjustments that reduce the effective rate very substantially. The US system, with a marginal rate up to 39 per cent, provides a minimum threshold and various deductions that exempt a substantial portion of citizens from paying any personal income tax.

Two smaller countries, Panama and Singapore, with economies more similar to the Bahamas, are thriving despite imposing income tax. In Panama, income under $11,000 is exempt from tax, and the marginal rate of 15 per cent applies to income up to $50,000, with 25 per cent over that amount. Similar thresholds, probably at higher levels, could be set in the Bahamas to assure exemption for low earners and fair, non–confiscatory, rates for the more affluent taxpayers. As an offshore financial centre that caters to the establishment of local companies with foreign-source income, Panama exempts these companies from its tax regime. The same type of exemption could be set here, so that we would retain the attraction for our International Business Companies.

Of course, many details would remain to be worked out – not only the specific percentage rates, but what deductions to allow for such items as mortgage payments and charitable contributions; whether withholding should by applied by companies to salaries and dividends; and whether capital gains should be taxed at separate rates. But all these points could be resolved once the Government takes the basic decision to tax income.

The White Paper raises another objection to personal income tax: it would lead to “onerous compliance burdens for individual taxpayers”. We point out that every year, millions of American citizens file income tax returns with little difficulty – and certainly the Bahamas system could be much simpler to understand than the US Internal Revenue Code and the standard forms used by American taxpayers. In any event, many of our low earners, people unaccustomed to keeping financial records, would fall below the threshold of even the minimum income tax, and would not need to comply with filing requirements. We might have rare cases of wealthy Bahamian taxpayers with complex financial affairs and tax questions needing resolution, but here, just as in the US, these individuals can afford to retain an accountant to advise them and even prepare their returns. Yes, filing a personal tax return would be an additional responsibility for reasonably affluent Bahamians, but hardly an “onerous burden”.

In any event, this responsibility is simply the base-line duty of citizens who expect to receive the services provided by a modern Government. It is difficult to see how revenues can be provided for these services without imposing income tax if, as has been indicated, VAT will not increase total revenues but will merely match the reductions in import duties and excise taxes.

We have plenty of other disincentives to entrepreneurship, in the form of bureaucratic red-tape and over-regulatio. These are far greater obstacles to risk-taking than a reasonable level of income tax.