The Tribune

By NEIL HARTNELL

Tribune Business Editor

nhartnell@tribunemedia.net

Value-Added Tax (VAT) may exacerbate the ‘brain drain’ of the most skilled and talented Bahamians, a newly-unveiled study has warned, while potentially reducing consumer consumption by up to 15 per cent.

A report commissioned by the Nassau Institute economic think-tank, and written by a former Canadian Revenue Agency auditor, also warned that besides reducing living standards and consumer purchasing power, VAT was likely to drive Bahamians towards the informal or ‘black’ economy.

The study by David Godsell, titled ‘The Economic Consequences of the VAT for the Bahamas’, warns that the proposed 15 per cent tax, which is set to be introduced on July 1 next year, will inevitably increase the cost of goods and services.

Without a corresponding rise in wages, the report said: “VAT adoption leads to a dramatic decrease in purchasing power, or real incomes.

“Consequently, more people choose to engage in leisure activities or seek employment outside of the Bahamas, rather than seek or continue employment at the now lower real wages. As a result, the labour pool is diminished.”

And, further analysing the consequences, the Nassau Institute study warned: “Widely available unskilled labour will bear the full brunt of the wage reduction, while skilled, non-expendable labour may be able to negotiate wage increases.

“Furthermore, due to the anticipated decline in business turnover, the demand for labour will decline. An important implication is that because both the supply and demand for labour declines, the unemployment rate may remain constant. The reality, however, is that fewer people are employed.”

That is a sober message for a country and government desperately seeking to create jobs,, stimulate the private sector and reduce the current 13.7 per cent unemployment rate.

“Due to the diminished supply of labour resulting from the labour market, employers will face greater hardships in attracting qualified labour,” the study continued.

“In addition to higher search costs for the best employees, firms may be pressed by non-expendable staff to increases salaries to compensate for employee purchasing power forfeited due to VAT adoption.”

Focusing on VAT’s impact on consumer spending and consumption, the Nassau Institute study said retailers would “face the greatest consequential decline in revenues”.

An International Monetary Fund (IMF) study, the report said, found that when Ireland increased its VAT rate from 10 per cent to 18 per cent, private consumption levels fell by 7.1 per cent.

And with others suggesting a 1 per cent increase in VAT rates corresponded to a 1 per cent reduction in consumption, the Nassau Institute report added: “Consequently, we can infer that consumption may decline by up to 15 per cent upon adoption of a 15 per cent VAT.

“It is important to note that a VAT will not only decrease purchasing power and thereby the purchases made by Bahamian citizens, but it will also encourage Bahamians to purchase from exempt, zero-rated or informal market sectors instead of VAT-affected sectors.

“Consequently, VAT-affected retailers not only bear higher compliance costs, but also suffer declining sales due to a ‘poorer’ customer and because the ‘poorer’ customer chooses to allocate his or her resources in a market sector unencumbered with VAT,” the report added.

“A startling outcome of VAT adoption in a country with a large informal market sector is the incentive to reallocate resources from benign conventional goods and services to illicit, informal market goods and services.

“Along with the reallocation incentive, the reallocation itself puts conventional and complying retailers at a competitive disadvantage which can, in turn, force compliant firms to become non-compliant themselves.”

And the Nassau Institute report warned that VAT, and any extra revenues generated, were not necessarily going to reduce the Government’s annual $443 million Budget deficit.

“Governments adopting VAT, and especially governments in the Caribbean, do not have a strong track record of eliminating the Budget deficit after adopting VAT. Worldwide, the increase in funding has been tied not with deficit and debt reduction, but with government spending,” the study warned.

It added that the countries mentioned in the Government’s White Paper all had poor track records in this area. Budget deficits for 2012 ranged from 1 per cent of GDP in Trinidad to 7 per cent of GDP in Barbados, while St Kitts & Nevis had seen its deficit quintuple - from 1 per cent to 5 per cent - after VAT came in.

And the Nassau Institute study warned that ‘exempting’ financial services from VAT, as the Government plans to do, would create a ‘tax cascading’ effect.

“Tax cascading occurs when VAT paid is not refunded, and consequently it is passed through to the next firm in the chain of value creation, the client firm,” the study said.

“The client firm does not pay tax on financial services, though the fee for financial services, implicit or explicit, includes the VAT originally paid by the bank for expenses incurred in its value creation process.

“If the client firm provides a taxable service, the typical VAT is not only charged to the consumer, but VAT is applied to the VAT earlier paid for by the bank. Said differently, this chain of events leads to a tax on tax. This is known as tax cascading and is an expected outcome of exempting financial services.”

In other words, financial services prices to Bahamian consumers will increase.