U.S. study looked at VAT with ‘attendant tax cuts’
By ALISON LOWE
Guardian Business Editor
A range of “attendant tax cuts” were assumed to accompany the implementation of value-added tax (VAT) when it was recommended by U.S. economists commissioned by the government to examine the best possible approach to tax reform, Guardian Business has learned.
In addition, the economists, Compass Lexecon, also supported the contention of groups such as the Coalition for Responsible Taxation and others when they recommended that the government must strengthen the existing tax system, particularly the administration of real property tax, as a key component of its overall reform plan.
In an email exchange with Guardian Business, David Kamin, an adjunct professor at New York University’s School of Law and a key participant in the formulation of the study produced by the government, discussed the objectives, assumptions and findings of the study, which the government has pointed to as further support of its plans to introduce VAT.
Kamin confirmed that the group found value-added tax (VAT) to be the preferred method of tax for The Bahamas, proposing a combination of VAT and a varying range of tax cuts in order for the government to raise a level of revenue that would not choke off economic activity.
He said: “We analyzed what revenue should be generated by the VAT in combination with related tax cuts. Here, we warned that there’s a balance between 1) the long-term revenue needs of the government and positive long-term economic impact of deficit reduction, and 2) the short-term negative impact that fiscal consolidation is likely to have on the economy.
“We then analyzed the VAT and attendant tax cuts producing 1) over two percent of GDP (like the government proposed last year); 2) 1.5 percent of GDP, and one percent of GDP.
“In striking this balance between long-term revenue needs and the short-run impact on the economy, we recommended a VAT and attendant tax cuts that would produce less revenue on net than the government had proposed last year - consistent with a VAT rate in the range of five to 10 percent (depending on the breadth of the base and size of related tax cuts). And, we further recommended that this be backed up with a fiscal rule to bolster credibility.”
On Wednesday, during the Budget Communication 2014/2015, the prime minister announced that the government is planning to implement VAT on January 1, 2015, at a rate of 7.5 percent, with “much fewer exemptions” than initially proposed, and no “wide-scale duty reductions”.
The decision to offer fewer exemptions has won applause from the business community, who felt it would make administration of the VAT more simple, as suggested by New Zealand experts Don Brash and John Shewan, but the announcement that there will be few duty reductions has been more controversial.
Coalition co-chair Gowon Bowe has argued that findings of the study commissioned by the private sector grouping suggest there will not be a “radical” price spike under a VAT with few duty reductions, while some retailers and the president of the Bahamas Contractors Association fear a major knock to consumer demand from the plan.
As to what duty reductions were assumed under a VAT with 7.5 percent if the revenue target was to be achieved, Kamin said: “We were not asked to calculate (and didn’t calculate) the duty reductions that would be consistent with our recommended net revenue target for a VAT with a 7.5 percent rate. Since both the potential breadth of the VAT tax base and the duty reductions were shifting as our report was developed, we focused our recommendations on the net revenue that we believed appropriate.”
When selecting VAT as the preferred method of taxation for The Bahamas, Kamin noted that what is involved in administering a VAT, as opposed to other taxes, was of particular relevance to the consultants. Kamin is a specialist in tax law and policy; he served as adviser, to Peter Orszag, director of the U.S. Office of Management and Budget, and helped to formulate policy for President Obama’s first two budgets.
“The study considered whether the current tax system in The Bahamas was in need of reform, concluding that it is and that a VAT should be adopted in light of The Bahamas’ significant revenue needs, the expectations of the markets and the current relatively narrow and inefficient tax base,” he said.
“In arriving at this conclusion, we looked at a number of different alternatives, including payroll taxes, corporate income taxes, individual income taxes and the VAT. Based on what is known of these different tax systems, we concluded that a VAT is superior in terms of efficiency and, especially, administrability as compared to these alternatives.
“We also recommended that The Bahamas endeavor to strengthen parts of its existing tax system, like the property tax. To be clear, this analysis considered the effects of these taxes in terms of efficiency, fairness and administrability.”
Prime Minister Perry Christie spoke of the Compass Lexecon report during his presentation on the Budget 2014/2015 last Wednesday. He noted the group’s favoring of the VAT, as well as how the study also concluded that the government implement a fiscal rule to bolster its “credibility” in the budgeting process. However, Christie said that the government determined that such a rule, which would require the government to legislate a maximum debt to GDP and minimum annual level of reduction in the debt to GDP ratio removed a level of “adaptability” that the government sees as important to its ability to make financial decisions going forward.
Meanwhile, contacted for comment on the government’s proposed tax plan, New Zealand tax expert Don Brash said that he and Shewan were “very pleased” to hear that it appears that the government may have elected to pursue the “low rate/ few exemptions” VAT model they recommended during their recent visit to The Bahamas, but declined to comment on the government’s decision to do so while largely retaining duty rates at the current levels.
June 02, 2014