Tax reform: opportunity for development

Leona Helmsley, dubbed 'the queen of mean' by her critics, was more imprudent than wrong when she declared that "only the little people pay taxes".

It was no doubt unwise for a rich, socially privileged woman to consign the less fortunate to be the sole bearers of the burden of taxes. Nevertheless, her statement was as profoundly accurate as if it had been made by the most highly respected economics Nobel laureate.

Nobody likes taxes. As George Washington noted, "There have never been taxes created which are not inconvenient and unpleasant." Those with the opportunity to pass them on to others do so. They avoid or evade them, as Helmsley was convicted of doing, or try to pass them on in the prices they charge for goods and services, in order to protect the net income to which they believe they are entitled. At the end of the chain of shunted taxes stand the powerless poor, who have little or no opportunity to pass on to anyone else the taxes hidden in higher prices.

For decades, governments have tried to use taxes and subsidies to redistribute income, which by the normal practice of capitalism accrues at a disproportionate rate to the already wealthy. These efforts have not always had the desired redistributive results. The poor, in consuming almost all their income, bear a disproportionately high proportion of the tax burden in prices inflated by taxes passed on and further compounded at each stage of the distribution chain.

The challenge facing governments that want to boost the purchasing capacity of the poor is how to prevent the intended benefits of their actions from being diffused or diverted. In Jamaica, exempting items deemed to be consumed by the poor from GCT has been costly to the Treasury, but the benefits are also substantially enjoyed by the well off, who also consume those items. The needs of the poor would be more accurately targeted if, instead of exempting items, they were compensated for the amount of the tax by increasing their tax-free income threshold proportionately. For the unemployed, a similarly proportionate direct cash subsidy could be given.

By making all items subject to GCT, the overall rate could be reduced to as low as 10 per cent. With almost 42 per cent of sales now being GCT-exempt, the revenues, particularly with the increased compliance that a lower rate would likely attract, would exceed present levels and would perhaps be able to finance the direct subsidies to the poor. Removing the exemptions would also lead to greater simplicity, transparency and economy, and avoid the diffusion of benefits intended for the poor.

When I entered the Ministry of Industry and Commerce in 1989, the ministry's technocrats provided me with clear evidence that the bulk of the benefit of the very costly subsidy on cornmeal went to the well-fed dogs of the well-to-do. I also saw conclusive evidence that price controls often had the opposite effect. The price-control mechanism involved guaranteeing net profit margins and distribution quotas. The effect of this was to remove the distributors' and retailers' incentive to reduce costs and provide consumer satisfaction. I became convinced that fiscal arrangements designed to achieve worthy ends could easily fall prey to undesirable consequences greater than their intended benefits.

the Government's desire to use taxes and subsidies to help the poor is commendable. But it is of far greater importance for it to use these tools to foster and encourage economic development and growth, because that is the only basis on which people can be sustainably lifted out of poverty and the entire society put on a path to prosperity.

To achieve this, the Government must adopt four simple, core principles.

Generally, tax rates should be kept low to reduce the motivation to avoid or to evade them.

In higher tax brackets, avenues to reduce the effective tax rate by investing in job-creating and foreign exchange-earning production should be open.

As far as possible, tax exemptions and waivers should be eliminated or substantially reduced in order to improve transparency, minimise corruption and simplify collection.

Benefits intended for any social or economic group should be delivered directly to the intended beneficiaries.

Jamaica desperately needs investments in the productive areas of the economy, and we must, therefore, induce capital to invest in productive endeavours. For domestic capital, one way to accomplish this is to incorporate effective incentives for such investments within the tax code. A flat tax system, as currently exists in Jamaica, doesn't provide sufficient room for this, and is a most inappropriate basis of taxation for a country that needs to encourage its people to invest in development.

growth-generating activities

Unlike those at the low end of the economic scale, high-income earners consume only a small proportion of their income locally. The assumption that taxes missed at the income end are collected on the consumption side is, therefore, false. Given this reality, the objective of tax policy should be to provide attractive reasons for these high-income earners to invest and spend more of their income at home. With a progressive personal and corporate income-tax system, it would be possible to incentivise these better-off individuals to invest in growth-generating, job-creating, foreign exchange-earning activities.

The strategy should be to set the minimum personal and corporate tax rates on all incomes, including dividends, at 20 per cent, rising to a maximum of 35 per cent (the USA's top personal rate). Between the minimum and maximum rates, tax credits should be provided for investments made in productive, job-creating and foreign exchange-earning activities. This would be a powerful incentive for high-income earners to invest in the development of the economy.

Jamaica's economic performance has been a patchwork of successes and failures between periods and between sectors. The coordinated, uniform and sustained development experienced by successful economies has eluded us. Among the reasons for this is the fact that our tax code has been influenced substantially by interests motivated more by personal or corporate objectives than by national interest.

The most outstanding recent example is the successful lobby that removed taxes from corporate dividends. The action was promoted on the grounds that it would lead to increased investments, which would boost the economy. Neither the promised investments nor the economic boost has materialised, but the lost revenue and negative impact on the country's fiscal affairs have been painfully present.

Much older but equally ill-advised has been the use of extraordinarily high import duties to protect specific local industries or enterprises. Under this strategy, import duties and other charges of as much as 250 per cent are sometimes imposed to protect the local producer. While aiding the development and survival of industries that have significant economic and social value is an important part of the Government's role, ensuring that the cost of these actions does not outweigh the benefit is an even greater responsibility. When the protective import duty on an item is 250 per cent, the result is that both the imported and local product are sold at prices that closely track the higher-duty paid price, creating excessively high costs, compounded as they pass through the distribution chain.

cost-of-living impact

Because the items protected by these measures are invariably essential, these protective duties have a significant impact on the cost of living of the poor, and are a major contributor to inflation and to the country's uncompetitiveness. Direct subsidies to select industries that cannot compete with imports would be far better, as they would enable them to be competitive without imposing inflation and uncompetitiveness on the rest of the economy. Simply put, protective duties inflate prices; direct subsidies would keep them low.

The discretionary waivers, which have given the Government such angst, are substantially the result of these inflationary protective duties and would be rendered irrelevant if such high duties were replaced by direct subsidies.

The Government, with its power to tax and spend, has the most important tools necessary to stimulate and drive development. But it has largely failed to use them for this purpose. Where taxes should have been used as a scalpel to shape development, they have been wielded as an axe to hack value out of the economy. At the same time, expenditure has been directed largely to achieve maximum political gain.

Economic development will take place only when private resources are motivated to create real economic value. The judicious application of taxes and public expenditure can be used to make productive economic activity attractive and the consumption of domestic production appealing and, ultimately, foster growth and development. The fiscal regime that has retarded economic growth for so long must be changed, despite the fact that some sectors and firms have succeeded under it.

This change to a more development-focused tax code and fiscal arrangement must be made regardless of the revenue demands of the Government. Today, the Government is bloated, cumbersome and obstructive, and must not be encouraged to continue extracting taxes to feed its wasteful indulgences.

Taxes will always be seen as unpleasant and inconvenient, but given the right structure, they can be used to promote development rather than hinder it.

Claude Clarke is a businessman and minister of trade. Email feedback to columns@gleanerjm.com.