Whither tax reform?

Peter-John Gordon, Guest Columnist

CHARLES JOHNSTON'S article in The Sunday Gleaner of July 31, titled 'Smart tax-policy reform' demonstrates why tax reform is such a difficult objective to achieve. Everyone agrees that there should be tax reform, but everyone has a different idea of what that tax reform should look like.

I will assume (naively, no doubt) that these irreconcilable differences are driven, not primarily by self-interest, but more by ignorance. Every business person deeply believes that what is good for his firm or his sector is, by extension, good for the economy, if not the society. This position is not surprising, but it is simply not true.

Simplification of the tax code is not an end in itself, but rather a means of satisfying two important objectives. The first is efficiency. Efficiency means getting the most you can from the least amount of resources. For a factory, this means getting the maximum amount of output from the least amount of inputs - labour, raw materials, electricity etc. In the context of tax collection, efficiency means using the least amount of resources per dollar of taxes collected. The more complex is the tax code, the more highly skilled persons and time are required to ensure that each taxpayer is paying the correct amount of taxes. Given that tax collection is a non-productive activity (it does nothing to grow the economy) this puts additional pressure to ensure that as few resources as possible are devoted to it.

Minimising distortions in the economy

The second objective of a simplified tax code is to minimise distortions in the economy. Ideally, the tax code should not cause resources to move from areas where they would logically be directed, to other areas. Johnston is calling for a tax reform which "supports the country's productive sectors, agriculture and manufacturing ...". He also points out that other countries "have selected sectors they wish to protect, and have exercised their right to do so". It appears that 'supporting' a sector and 'protecting' a sector could be used interchangeably.

What is wrong with this line of reasoning? First of all, when a sector is protected, what is it protected from? Many would argue from foreign competitors, but this is not so. It is protected from other players in the domestic economy. Johnston recognises this when he says, "the Government of Jamaica needs to decide whether it is more important to support the country's productive sectors ... or its trading sectors". Some local players must thrive at the expense, not of foreigners but other local players. Johnston could easily have said that the Government of Jamaica needs to decide whether it is more important for consumers to receive lower prices or selected businesses to prosper. The arguments that protection of domestic firms results in domestic consumers paying higher prices are well known.

What is not readily recognised is that protection of some domestic firms actually retards the development of other domestic firms. A few years ago, there was a big debate about whether or not Jamaica should allow the importation of bananas. The only reason why such a debate arose in the first place was that foreign bananas were cheaper than local bananas. Many voices called for the protection of the local banana industry and the jobs which it provided. What these voiced failed to acknowledge is that forcing Jamaicans to pay more for bananas retarded the growth of the banana-chip industry. Higher prices for bananas meant that the most crucial ingredient in the making of banana chips would cost more, which would reduce the prospects that domestically produced banana chips would be competitive either on the Jamaican or export markets. The banana industry was protected from the banana-chip industry. Jobs were maintained in the banana industry at the expense of jobs in the banana-chip industry. The growth of one industry does not mean that the economy grows.

Spending policy

Distortions can be caused not only by taxation policy, but also by the Government's spending policy. A few years ago, the Jamaica Manufacturing Association called for the Government to buy local, at a cost of up to 10 per cent more than imports. They pointed to the school textbook programme as a good place to exercise this policy. If the Government's textbook budget is fixed (and it is) and this policy is implemented this would mean 10 per cent fewer children would have the benefits of textbooks. Would supporting the local printing industry at a cost of 10 per cent fewer children being educated be in the national interest?

Which are the sectors/firms which receive 'protection' and which are the sectors which are aborted? Those which receive protection are usually those which are organised, have access to and influence with policymakers. In the language of economics, they spend a considerable amount of resources in "rent seeking". These resources are not utilised in creating anything, merely in affecting distribution. Some of the methods used are legal and some shady.

What is the difference between a company which contracts (or hopes to contract) with the Government making a contribution to a political party and a company making a political contribution hoping to affect tax policy? The size of the Government of Jamaica in relation to the size of the Jamaican economy, makes it impossible for any large company operating in Jamaica not to be involved with the Government at some level, whether the company is selling air conditioners, office furniture, medical supplies or almost anything.

The country, therefore, needs to seize every 'teachable moment' which arises to have an open discussion on political financing and its impact on the economy and society. Are we too polarised to have such a discussion?

Peter-John Gordon is senior lectuerer in the Department of Economics, University of the West Indies.