Taxing for growth

Claude Clarke, Guest Columnist

All serious politicians desire to leave a positive legacy behind them. Prime Minister Portia Simpson Miller and Finance Minister Peter Phillips are no different. My guess is that Portia fervently hopes her legacy will be one of having lifted the poor out of poverty. Peter, I believe, would love to be remembered as the person who put Jamaica on the road to economic recovery and stability.

By now they both would have recognised that the legacies they hope for cannot be realised unless the country is extricated from the economic bog in which it has been mired for the last two decades. It should also now be clear that the economic programme accompanying the International Monetary Fund's (IMF) Extended Fund Facility cannot provide the foundation on which the desired growth can be built. The prime minister and the finance minister might also have come to recognise that it is they who must construct the framework for organising our economic assets to increase the country's productive output and generate economic growth.

Jamaica's enormous debt of almost one and a half times the size of our economy desperately needed the rescue of the IMF. But the seemingly generous US$2-billion Fund-led bailout package is not designed to create economic growth. It is structured to reduce and service debt. The IMF has done what it believes will serve the interest of Jamaica's creditors. And the Government has so far been an obedient facilitator.

But is the Government doing everything it should to serve the interests of the Jamaican people? Is it doing what is necessary, not only to stop the decline of the economy, but to grow it? Is it increasing the economy's capacity to provide opportunity for the economic fulfilment of the Jamaican people? Now we see that even the IMF itself is recognising what some of us have been pointing out all along: the Government needs a strategy to grow the economy.

So far, the only discernible objective of Government's fiscal policy has been to maximise tax revenues and minimise spending, with the aim of extracting 7.5 per cent of GDP to pay down the country's debt. It believes that if it can do this, it can meet the IMF's target of reducing the debt to 96 per cent of GDP.

After two quarters, the targets are being met. But there are still many rivers to cross. And without economic growth, the task will become increasingly arduous, the economic pain increasingly burdensome, and the contracting economy ever less capable of supporting the debt-servicing programme.

One must acknowledge the Government's incapacity to finance the country's economic expansion. But in making this concession, we cannot ignore the Government's ability to employ the even more powerful development tool of fiscal policy. This tool gives Government the power to construct an economic infrastructure within which entrepreneurship and capital would be induced to flow into productive activities and generate the growth the economy needs.

FISCAL INITIATIVES

The Omnibus Incentives legislation presented to Parliament recently is the first opportunity we have had to assess whether the Government knows what is needed to produce growth. The legislation was expected to contain fiscal initiatives that would bring capital to production and improve the viability of production in the economy.

However, while the legislation contains worthwhile steps towards streamlining and rationalising the tax code and increasing transparency in the application of tax incentives, it provides no incentives for capital to be invested in production.

Instead, it has specifically rejected the notion that production should be specially incentivised and has embraced a guiding principle of 'levelling the playing field' for all business activities. In doing so, it ignores the logic that equal treatment can become the means of locking in place an already distorted pattern of capital allocation. Jamaica's capital is now allocated in a manner inimical to production, which has resulted in the failure of our economy to grow for decades. The purpose of tax reform should, therefore, be to actively fix that misallocation and create an investment landscape more favourable to production.

Productive enterprises are playing in a field already tilted in favour of providers of domestic services. The risks are unequal. So are the capital requirements. For most manufacturers, plant and machinery, raw material inventory, in-process and finished product stocks and customer credit impose a financing burden many times greater than is borne by any provider of domestic services.

All goods and export services produced in Jamaica must compete with the world's goods and services. Domestic services operate in their own parochial cocoon, sometimes in oligopolies and monopolies. Export activities, which must operate in someone else's backyard, demand greater effort and resources than most other business activities. Because of the intensely competitive overseas environment, exports often yield lower-than-normal profits.

Yet it is production and exports that must be increased if the economy is to grow and create the value needed to uplift the economic circumstances of the Jamaican people. The country benefits from exports with incremental foreign-exchange earnings. And it is not difficult to see the advantage of producing goods that would otherwise have to be imported. But as clear as this is, the new legislation does not reflect this fact and does not do enough to improve the prospects for the profitable employment of capital in production compared to its alternative uses.

The objective of 'levelling the playing field', which underpins the legislation, is an ideal that may well be useful for an already-developed economy. But for a country that lags at the back of the pack of the world in economic competitiveness and growth, it could be a major retardant to development.

The old system of incentives is clearly outdated and badly in need of overhaul. But the removal of taxes and fees from the primary inputs to production, as welcome as it is, is hardly likely to move the investment needle towards production. It is less an incentive than it is the correction of an unjustified and self-defeating burden.

Trinidad's manufacturing surge was propelled by extremely generous tax credits given for investments in machinery and special incentives for overseas advertising and promotion. These are some of the kinds of incentives that can attract capital to the purpose of production and should be a central part of Government's tax-reform programme.

I also believe large amounts of capital would be attracted to production, if instead of reducing the corporate income tax (CIT) to 25 per cent across the board, the opportunity was provided for companies to reduce their tax rate to 15 per cent through tax credits earned on investments made in any productive or export services business. The reduction of the CIT for all unregulated companies to 25 per cent is not an incentive to invest in anything, let alone production and export services.

A level taxation playing field that does not promote production and export services over domestic services is a luxury that a poor country desperate for jobs and growth cannot afford.

Of the nearly $600-billion capitalisation of the companies listed on the Jamaica Stock Exchange at the end of 2012, less than 10 per cent can be attributed to productive activities. Less than eight per cent of the profits of the top 20 companies on the combined exchange are earned by organisations whose principal business is production or export services. How will this new level playing field change this anti-production imbalance?

ECONOMIC VALUE

If Jamaica is to begin producing economic value sufficient to provide the growth the country needs, the objective of economic policy must be to attract more investment capital to production and export services; enough that the bias against businesses involved in producing goods and export services can be reversed.

The Government's decision to discontinue the junior stock exchange is evidence that it does not understand this imperative.

The Jamaica Stock Exchange's twin objectives of the Junior Market were, on the one hand, to bring equity capital to smaller, newer and probably smarter and nimbler enterprises; and, on the other, to make small investors more comfortable and willing to invest in businesses they do not control. How will those objectives be met now that the end of the exchange has been decreed?

As a facility to stimulate economic development, the junior stock exchange is not perfect. In fact, a valid criticism is that it is not sufficiently skewed towards productive enterprises. However, production and export services companies represent almost 60 per cent of its 2012 market capitalisation and it has attracted hundreds of new and small investors to the market, largely for the benefit of small to medium-size enterprises.

The twin goals of putting Jamaica on a path of sustained economic growth and giving the poor of our land the hope of a better life hang squarely on Government's ability to design policies that will attract investments and entrepreneurial talent to production. A constructive tax code is the key. The Omnibus Incentives Legislation, as it is currently constituted, cannot open that door.

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