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F. A. Hayek said that “the curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.” It would be good to recognize our limits about what we imagine we can design. We cannot steer the economy. Or the labor market. Recognizing our limitations is a step in the right direction.
[ Taxes ]
Value Added Tax versus Import Duty
22 February 2004
There is an interesting debate underway regarding possible changes to the country's taxation system as a result of commitments the Bahamas may have to make in free trade negotiations.
Whatever changes are made to the current tax system, if it results in an increase in the level of taxation, the negative effect on economic growth will outweigh any positive benefits. The perception of the Bahamas as a "low tax" country has been a significant factor in attracting foreign investors. Furthermore, money taken from the private sector to maintain (and expand) government bureaucracies means less capital is available for private sector entrepreneurs.
Although the Ministry of Finance insists that no decision has been taken by the government to introduce VAT, it notes that the extra revenues generated by such a changeover could easily justify the sophisticated information management systems that would be required to operate it.
Preliminary research by the Nassau Institute shows that implementation of a Value-Added Tax will increase the tax burden on all Bahamians. Tax will be added to the prices of a wider range of goods and services after all duties and mark-ups are in place.
The following table shows the effects of a 35% tax rate on all imports and provides a clear example of the consequences of a VAT in terms of imported goods. However, this system will also be applied to services, meaning the cost of a haircut or a doctor's visit will increase by whatever VAT percentage is decided on. These calculations do not show the additional effect if VAT is added at different stages of bringing a product to the consumer, i.e. at the wholesale and retail levels. As the VAT would apply to both goods and services it may be lower than 35% as it covers a wider range of activities.
The calculations show that government revenue will increase, business profit will decline, and the retail cost of goods and services will rise. It is estimated that a VAT rate of at least 22% will be required to maintain existing revenue levels.
Duties Control Government Spending
An argument for retaining the current tax structure (based on tariffs on imported goods) is that it helps to control government spending by limiting the level of taxation to what consumers require. Unless the VAT rate is set constitutionally, there will be no corresponding limit on the level of taxation that the government may impose.
In other words, when the economy takes a downward spiral, revenues from duties decrease, so theoretically the government is forced to cut back on spending just as the population has to. With a VAT charged on both goods and services, government revenue will probably not be impacted as dramatically in a downturn, so public spending can, and undoubtedly will, continue unabated.
If you listen carefully enough you can hear the revenue department licking their chops as they salivate over the prospects of more money being extracted from Bahamian taxpayers.
VAT will be increased
Just as income taxes in other countries have tended to rise incrementally and consistently increased, the same will probably happen with VAT as the Bahamian government discovers it needs more money to fix the problems it has created and to pay for public sector jobs. The difference is, it will seem less painful with a one per cent increase in VAT across all categories, than a five per cent increase in a duty category, for example.
On the other hand, the government will not be able to so easily hide its taxation in retail prices. There are estimates that Bahamians are currently being taxed at a level of 40-45 per cent of income-when all the various (and often hidden) taxes and fees are added together. A VAT will be more transparent as consumers will be able to see clearly what portion of the product or service they are purchasing goes to support the weight of the government sector.
The Nassau Institute does not presume to recommend a tax system for the Bahamas. However, foreign investors are attracted by the country's "low tax" regime. If this advantage is seriously degraded, we will be left to compete in the single industry of tourism, where serious difficulties already exist in terms of the value offered for the high prices charged.
In the final analysis, we expect and demand a frank and open process to consider all the options on the table. Changes to our revenue system can impose huge new costs on the private sector, which may adversely affect economic stability.
Date: January 18, 2004.