The fiscal reform series: A deeper dive into VAT
The analysis of the best taxation model and the appropriate mix of taxes for The Bahamas is far from over as we await the final study commissioned by the government and the results of the work done by Oxford Economics – a global advisory firm engaged by the Coalition for Responsible Taxation (Coalition). It is encouraging to see that the government seems to have kept its promise to work with the private sector in the fiscal reform exercise.
While we await the findings of the referenced studies, it would be unrealistic to conclude that value-added tax (VAT) will not be a major component of the government’s fiscal reform program. It is a known fact that the issue of tax reform, in general, and the implementation of VAT, in particular, have been considered for several years and by multiple administrations. Hence, considerable work and analysis ought to have been conducted prior to the selection of VAT as an appropriate form of taxation, even though the general public is not privy to the specific details of such prior analysis. As the clock ticks and the plot thickens on the government’s fiscal adjustment agenda, we take a closer look at this form of taxation, what is being proposed and where we stand today.
The general nature and details of VAT
VAT is an indirect tax; that is, it is a form of tax that is collected by an intermediary on behalf of the government or revenue agency from persons (either individual or corporate) that bear the ultimate tax burden. In essence, the payer of the tax is often different from the ultimate bearer of an indirect tax. Indirect taxes are therefore also defined by the ability of the taxpayer to shift the tax burden.
It is noteworthy to state that the difference between direct taxes and indirect taxes was first discussed at length by Adam Smith, who is regarded as the father of modern economics. In his classic work, “An Inquiry into the Nature and Causes of the Wealth of Nations,” which is abbreviated as “The Wealth of Nations,” Smith articulated extensively the concept of indirect taxes and the impact on necessaries and luxuries, noting the similarities between indirect taxes and direct taxes with the former falling on the consumer, ultimately.
VAT is a consumption tax that is essentially levied on consumers and what they consume. A key objective of introducing VAT, as indicated by the government, is to broaden the tax base, and the choice of VAT is intended to achieve this as the country seeks to join the World Trade Organization (WTO), which requires the reduction of tariff rates. This goal is consistent with the general consensus among a number of economists and public finance experts that consumption tax should be planned with the widest base and positive rate possible.
The VAT rate and revenue
The white paper issued by the government in February 2013 suggested the implementation of VAT at a standard rate of 15 percent with a proposal to have a special rate of 10 percent, exempt supplies and zero-rated supplies. The draft VAT Bill and Regulations were consistent with the white paper in this regard. The export of goods and services are expected to be zero-rated which means that 0 percent VAT will be charged by the supplier and the VAT paid by the supplier can be recovered from the government.
It is proposed that basic food products, soap and laundry detergent, electricity and water supplies based on established thresholds will be exempt from VAT. Exempt services include, among others, insurance services, domestic financial services not provided for an explicit fee, medical services, education services, daycare and after-school care, domestic travel and services provided by a facility to persons in need of care.
It is important to state that companies offering exempt services or supplies will incur VAT on their inputs, but will not be able to directly charge their customers or consumers VAT; hence, their prices may be adjusted to compensate for the increase in the cost of production. It has been further proposed that a special (reduced) rate applies to a supply made in accordance with the regulations by a hotel or similar establishment registered and licensed by the Hotel Licensing Authority; this is presumably to minimize the corresponding impact on the tourism industry.
We know that the minister of finance has indicated that VAT will be introduced at a rate lower than the proposed 15 percent. However, numerous utterances from officials from the Ministry of Finance (MOF) have also made it clear that the choice of the initial rates was based on the revenue needs of the government. On the one hand, revenue from VAT on goods is intended to replace revenue lost from the reduction in tariff rates. On the other hand, VAT revenue derived from the service sector was expected to provide the government with approximately $200 million in additional revenue. In light of the foregoing, it is logical to conclude that a lower rate of VAT will reduce the expected revenue and the projections will need to be adjusted. Luckily, MOF officials have indicated that they have conducted multiple projections based on lower VAT rates.
A tale of VAT studies
By the end of the debate on VAT, there will have been at least four studies conducted by different stakeholders in The Bahamas to ascertain the impact and suitability of VAT for the country. The stakeholders in this regard include the government, the Coalition and the Nassau Institute. The conclusions of the first two studies were different and subject to much scrutiny as well as criticism.
It is a generally accepted notion that the conclusions of research and studies are sometimes skewed towards the client or financier of the study. This does not in any way diminish the credibility of the people carrying out the study, neither does it suggest their lack of professionalism. However, the nature of research is such that it depends on a range of data and variables which are analyzed based on the mandate of the individual or entity commissioning the study. In essence, it is very unlikely that the findings of Oxford Economics will totally favor the government’s proposals and go against the Coalition’s position. The same applies to the new study ordered by the government. In spite of this expected variance, when read in full, the details of both reports should be identical based on the reputation of the individuals conducting the studies and the fact that the same source data is being used.
The decision to introduce VAT at a lower rate has been welcomed by the private sector, although some remain vehemently opposed to this form of taxation. It is encouraging to see the relevant stakeholders come together to ensure that the best formula for fiscal reform success is implemented in The Bahamas with constructive debate on the proposed VAT regime being a major part of this process. It is incumbent upon all parties to be mindful of the four maxims highlighted by Adam Smith in relation to taxes in “The Wealth of Nations.” The maxims cover topics including the need for subjects of every state to contribute support to the government based on their abilities; the importance of certainty in relation to the time and manner of payment as well as the amount payable; the necessity of convenience to the taxpayer in remitting payment and the adoption of a philosophy that takes out or keeps out of the pockets of the people as little as possible over and above what it brings into the public treasury of the state.
Consumption tax is not a new phenomenon and has been implemented in several jurisdictions across the globe. While there has been considerable discourse on the experiences of other nations that have implemented VAT, Singapore and New Zealand have been touted as success stories in the introduction of VAT. Next week, we will take a look at these countries with a view to determining how we can benefit from their VAT implementation story and whether differences in our circumstances allow for a fair comparison.
• Arinthia S. Komolafe is an attorney-at-law. Comments on this article can be directed to firstname.lastname@example.org.
April 08, 2014