Tax reform: antecedents, opportunities and challenges

Colin Bullock, Guest columnist

The desirable characteristics of a system of taxation are generally cited as simplicity (easy to pay and collect), transparency (clarity as to who actually pays a tax that is levied), efficiency (minimisation of impact on the distribution of expenditure), horizontal equity (people 'equally well off' pay the same), vertical equity (better-off people pay more) and flexibility (adaptability to changed circumstances). There is a tendency to see efficiency (allowing free operation of market forces) as automatically enhancing economic growth, but the role of taxation on saving and investment ought to be explicitly considered in developing countries.

When we speak of tax reform, we refer to reform of the structure of the tax system (what types of taxes are levied, the structure of the rates (differentials and exemptions), who pays the different types of taxes, and the social and economic impact of the different types of taxes. This is to be differentiated from reform of the system of tax administration, which has more to do with reform of the institutional and administrative organisation of the tax-collection process and the procedural format for the payment of taxes (eg tax offices and e-payment methods, simplifying forms and untangling bureaucracy). There is some overlap in so far as a simplification of the system of tax rates facilitates understanding, enhances compliance and may discourage tax avoidance (within the law) and evasion (outside the law).

Tax Reform in the 1980s

Jamaica last undertook comprehensive tax reform in the 1980s. Those of us who are old enough remember another world where there was a complicated system of exemptions for 'non-cash' benefits and where the major selling point of life insurance was the tax relief it offered. (Incidentally, life-insurance sales accelerated after that 'benefit' was eliminated and the product was sold for risk management and long-term saving). In that world also, there was no general consumption tax (GCT) and the revenue was heavily dependent on a more complicated system of income tax, with tax rates increasing for higher bands of income.

The reform in the 1980s included the elimination of the complex system of income-tax credits, introduced GCT, unified the personal income tax (PIT) rate at 25 per cent, and cemented the corporate income tax rate at 33¹/³ per cent. GCT has operated with a wide range of zero-rated and exempt items, there are concessional import-duty rates and an extensive set of tax incentives (some going back to the 1950s), ostensibly, in support of investment, employment and economic growth.

The system emerging from the 1980s has continued in its essential form to the present day. Adjustments, often in response to pressing revenue needs, have been ad hoc and incremental. This is reflected increases in GCT rates in steps from 10-17.5 per cent, and the periodic revisiting of sin taxes (alcohol and cigarettes), driving (driver's and motor-vehicle licences, fuel, and motor-vehicle imports). At the same time, the extensive system of incentives and exemptions (both in production and consumption) has remained resistant to change.

Tax Policy Review Committee (2004)

The thrust towards new, comprehensive tax reform emerged in the transition to the new millennium. Towards this end, the then Government commissioned a study by Professors Bahl and Wallace that provided analytical research for the Tax Policy Review (Matalon) Committee Report (2004). Bahl and Wallace found that because of incentives and exemptions (costing 60 per cent of the revenue actually collected in 2002-03), and selective tax administration (including discretionary waivers), the tax base was too narrow. These factors also led to horizontal inequalities. In a similar vein, they found the system with its multiplicity of property tax and GCT rates and border charges (customs and stamp duty, GCT, special consumption tax and customs user fees) overly complicated (therefore susceptible to corruption).

Bahl and Wallace, endorsed by the Tax Policy Review Committee, posit that a flat-rate value-added tax (GCT) is more likely than income tax to widen the tax net, and less likely to create distortions in people's choices between work and leisure and between different types of expenditure. Accordingly, the main thrust of the recommendations of the committee is to rely more heavily on GCT (preferably a single rate without exceptions) and less heavily on income tax. The increased reliance on GCT could come from higher rates (already increased) and/or from eliminating 'compensation' for higher GCT rates and elimination of exceptions (for basic foods, etc.) would be provided through increasing the income tax threshold (the income level below which no income tax is paid), unifying and lowering the PIT and CIT rates, and a special 'social fund' to compensate lower-income earners for the loss of protection from eliminating GCT exceptions on basic foods.

The committee anticipated that the adoption of its proposals would not only be simpler, fairer and less distortionary, but that there would also be encouragement of growth-enhancing economic activity. For example, they posited that generally lower tax rates with everybody paying could be more supportive of economic activity than a complex system of different rates and several legal and discretionary exemptions. In what may have influenced recommendations in the Planning Institute of Jamaica's recent Growth-Inducement Strategy and the new revenue measures in the Budget, they recommended lowering of property tax and property-transfer rates (including inheritance), and elimination of stamp duty and tax on the transfer of securities. The committee also recommended elimination of taxes on distributed profits (dividends) and a reduction in the CIT rate. There was some ambivalence about the incentive system, ending with a recommendation for further study. The committee also recommended the modification and simplification of the tax regime on importation of motor vehicles, but as neither a revenue nor growth-enhancement measure.

The recommendations of the committee have been implemented only selectively, often in response to revenue needs without reference to any grand design of equity, simplicity, fairness and economic growth. For example, GCT rates have been increased, but exceptions (in the face of protest) have not been removed. The income-tax threshold has been increased, but so far, the CIT has not been adjusted. In the recent budget, stamp duty, transfer taxes and taxes on new car imports have been addressed, but this does not constitute comprehensive tax reform within a unifying philosophy. This is now to be addressed by the tabling of the Green Paper on comprehensive tax reform

Challenges and Overarching Ideals of Reform

The assessment of the current proposals for comprehensive tax reform will be complicated by the reality of the macroeconomic circumstances in which the country exists. Jamaica is a highly indebted economy that has been experiencing anaemic and negative growth. The macroeconomic programme from 2010 had not taken full cognisance of the impact of unavoidable fiscal constraint on economic growth and the impact of weak growth on limiting revenue and its capacity to reduce the fiscal deficit. In this context, tightly constrained fiscal expenditure has to be carefully allocated to enhance its capacity for economic growth.

The focus of fiscal adjustment has rested disproportionately on the role of public expenditure in enhancing growth. With that focus, taxation has been seen as a means of financing necessary expenditure rather than as an equally important independent means of enhancing economic efficiency, social equity and economic growth. The limitations of seeing taxation merely as a means of financing expenditure have been cruelly exposed over the last several years. With the exception of the tax on the value of fuel, several initiatives, including increased GCT rates, tax amnesties and the recent tax on spirits, have failed to meet expectations in a static economy.

It is then timely to consider the implementation of comprehensive tax reform with objectives including the enhancement of revenue-inducing economic growth. Much of the Budget presentation, despite the Jamaica Development Infrastructure Programme and significant reduction of domestic interest rates, located economic recovery in external economic circumstance (tourism and mining) and the attraction of foreign investment. To realise both desired domestic and foreign-direct investment, however, it is essential that gains in monetary stabilisation be enhanced by a growth-friendly tax system as well as significantly improved security and accelerated productivity enhancement.

Comprehensive tax reform is never an easy undertaking. Multiple objectives and interests are often conflicting. Using GCT to widen the tax net or minimise the distortion of the pattern of spending and resource utilisation may mean that lower-income individuals pay a disproportionate share of their income in taxes (recognised by the Tax Reform Committee). The reduction of CIT to facilitate investment may disproportionately benefit wealthier individuals unless the tax net is effectively widened.

Given these multiple and potentially conflicting objectives, the proposed process of consultation is appropriate. Reform, however, means that there will be winners and losers; consultation will not make everybody (equally) happy. It is important, therefore, that the reform is driven by, and defined within, a clearly stated, overarching philosophy against which the final result may be assessed and defended.

Colin F. Bullock is a lecturer in the Department of Economics, UWI, Mona. Email feedback to columns@gleanerjm.com and colbul3@gmail.com.