Tax reform, compliance will lift economy - Matalon

Below is an excerpt from PSOJ President Joseph M. Matalon's speech at an Incorporated Masterbuilders Association of Jamaica seminar last Wednesday.

One of the single greatest obstacles to tax reform, apart from political will, has been an approach by individual sectors of the economy to lobby for those policies that favour their own narrow interests, with little regard to the bigger picture issues of economic efficiency and social equity. The result has been a progressive narrowing of our tax base with consequently higher, uncompetitive rates of tax being applied to that base in order to meet the revenue demands of Government, and a total misalignment between our economic goals and the structure of our tax system.

Clearly a different approach is needed, one that recognises that a rising tide lifts all ships; and it is growth in our economy as a whole that will determine the growth prospects of our construction sector, or any other sector of the economy for that matter, by lifting employment levels and incomes and spurring productive investment that will increase effective demand for the services we provide.

Given the country's limited capacity to provide fiscal stimulus to the economy, and the fact that we have, correctly in my view, eschewed wide-scale monetary policy interventions, (read: high real interest rates), as a means of achieving macroeconomic stability, it should be apparent that one of the few policy levers left open to us is a thorough reform of the tax system aimed at creating a general tax regime that is competitive and which promotes economic growth.

It should be no surprise, therefore, that in its latest Country Memorandum, the World Bank suggests tax reform as a critical action to remove what it identifies as one of the primary "binding constraints" to economic growth in Jamaica. No surprise either that tax reform should be an issue of great concern both to the International Monetary Fund and the Inter-American Development Bank in their ongoing review of Jamaica's Medium-Term Economic Programme.

There are three critical questions that the current reform effort must answer. They are:

1. How will we deal with the vexed issue of tax incentives, tax holidays and waivers?

2. How can we address the disproportionate share of the burden of direct taxes on income that is borne by PAYE wage earners, and, in particular, those in the lower-income brackets?

3. We must ask ourselves whether we should continue to pursue social-welfare policy objectives through the blunt instrument that is tax policy?

In a recent article on the tax-reform process, tax expert Brian Denning noted, "Stakeholders within sectors which currently enjoy tax incentives (e.g. tourism, manufacturing, agriculture, export) will typically argue that they should continue to be incentivised and that this is critical to their survival. In contrast, stakeholders in non-incentivised sectors typically complain (with some merit) that they are consequently called upon to bear an excessive and disproportionate share of the overall tax burden in an effort to meet the tax revenue demands of the country."

Denning rightly points out, "Irrespective of one's views on incentives, the reality is that doing nothing is not an option. Jamaica has already committed to the World Trade Organisation to disband export-driven incentives for the goods-producing sector by 2015, with similar pressure anticipated in the future for exported services. If nothing is done, export activities will then revert to being fully taxable under the non-incentivised tax regime (which imposes taxes at relatively high levels)."

uniformly applied

We must move quickly to broaden our tax base as much as possible, with lower rates of tax uniformly applied across all goods and sectors of the economy, in tandem with the elimination of the existing bewildering web of incentives targeted at one sector or another. Not only would such a policy direction reduce distortions in economic incentives and the consequent misallocation of resources that have almost certainly stunted our economic growth, but it would also provide a much-simplified tax regime that is, therefore, easier to enforce and less prone to corruption.

Second, there is the question of how to provide greater equity in our system of taxation on personal income. As it now stands, a disproportionate share of the burden of such taxes is borne by PAYE wage earners, who suffer a marginal rate of tax of 25 per cent above an income tax threshold of J$441,000, or US$5,000 per annum, in addition to a myriad of payroll taxes at varying rates. Apart from the very low threshold above which income is taxed at the marginal rate, the fact that payroll taxes apply to income below the threshold means that taxpayers with lower incomes still face relatively high effective rates of taxation. This inequity is magnified by the fact of significant non-compliance on the part of self-employed taxpayers, who evade their obligation to contribute to the pot.

In the context of a comprehensive reform package, space must be found to redress this inequity by substantially raising the level above which income is subject to tax, and by incorporating one or more of the existing payroll taxes within the personal income tax system. Efforts must also be renewed to improve compliance among self-employed taxpayers, so that, over time, more income is brought into the net, and tax rates can be reduced to more competitive levels that increase incentives for work and foster greater productivity.

Finally, the question of whether we should continue to use the tax system to promote social-welfare objectives is a controversial and emotive one. Let us take the example of GCT exemptions that are granted in order to contain the retail prices of a wide range of basic foods and other so-called 'sensitive items' in the interest of protecting the poor and vulnerable in our society.

benefit to the poor

However, studies by our own Statistical and Planning Institutes have demonstrated, by reference to the consumption patterns of these products across the various income classes, that for every $100 of revenue that the Government gives up by exempting basic foods from GCT, only approximately $14 actually benefits the poorest 20 per cent of our population. In fact, the same studies estimate that the benefit of these exemptions to the wealthiest 20 per cent of the population amounts to $26 - incredibly, almost twice the level of benefit enjoyed by the poorest 20 per cent of the population!

If we truly are intent upon protecting the interests of the most vulnerable in our society, we would eliminate these exemptions, increasing the government's resources by the $100 of revenue that is now given up, and diverting substantially more than $14 of that revenue to expand earmarked expenditure programmes that can be more accurately targeted (via a new food-stamp programme, for example, or by expanding the scope of existing programmes like PATH), directly to those whom the policy is properly intended to benefit.

Not only would such a policy improve social outcomes, but it would also bring with it the benefits of uniformity and simplicity that would again aid enforcement efforts and reduce opportunities for corruption.

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