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The legal and economic implications of Value Added Tax

Anyone watching the news or reading the newspapers in the past few months would have heard some elements of the government’s planned implementation of Value Added Tax (VAT). The private sector has mounted opposition to the introduction of VAT and some have raised concerns whether VAT is the best taxation regime to wrestle the gloomy state of the national finances. It should be stated at the outset that VAT is widely employed and recognized in many developed countries as an appropriate model for modern tax collection.

With the publication of the White Paper and the Value Added Tax Bill, there is no doubt that the introduction of VAT is a major and radical policy shift in our post-independence fiscal management. If introduced, it will amount to the alteration of an archaic taxation regime that has been in place from the colonial days. It too will have the distinction of modernizing our approach to taxation matters and hopefully will signal a new paradigm in the collection and allocation of the state’s finances. The planned introduction of VAT has major consequences for The Bahamas and therefore it is vitally critical for members of the public to be informed and engaged in the consultative process. Given these realities, it is imperative for the public dialogue to be analytical, informative and frank.

VAT is generally considered a complex and robust tax. Although VAT is not the most progressive of taxation methods, it is viewed as having vast benefits in a multi-tax regime principally because it is a consumption tax. VAT is similar to retail (or sales) tax but is collected in smaller increments throughout the production or service delivery process. Its method of collection does not allow the “full” tax to be paid by the final consumer. The tax is collected by all entities providing taxable goods and services and is imposed on sales to all purchasers. It allows for a set-off of a business’ VAT liability from that of the amount paid for the purchase of the goods and services delivered to the consumer. It has a net-like-effect in the calculation of the total VAT liability owed to the government.

There is need for further explanation and discussion as to whether the “Bahamian” design of VAT will be based on a broad consumption base by an inclusion of all forms of government services. There must also be further consideration to whether there will be neutrality between public and private sector provision of goods and services. Additionally, deliberation must also be given to whether VAT will employ a credit-invoice method and if there is value in the imposition of the intended multi-rate as opposed to a single uniform rate. There has not been sufficient discussion about the increased administrative burden it will place on businesses and the government and whether the rate(s) will be high enough to raise sufficient revenue to accomplish the tax reform measures. These are weighty matters that require broad consultation and public education so that the implementation is progressive and seamless.

Further, special consideration must be given to small businesses and those entities which carry out non-commercial services in light of the added costs associated with VAT compliance. At present, the definitions of “business” and “taxable activity” in the Bill are broad enough to include some charitable and religious services and possibly certain non-commercial government services. Although the Bill exempts services relating to religious and charitable functions, all ancillary services may not be exempt. This was the experience in the United Kingdom (for example) where children’s clothing had a zero rate VAT but some items in that category was still not exempt (i.e. a basic t-shirt versus one with embellishments!).

It is interesting that the Bill seeks to create a distinction in the taxes collected from goods and services for local and international consumption. This approach questions whether our present economic model justifies such a division given the limited tax-payer base. We also must examine whether there is any merit in retaining the payment of licence fees in the port area in Grand Bahama under the Hawksbill Creek Agreement if VAT is to create a broad base tax regime. Emphasis must also be directed at ensuring that poor Bahamians are not unduly saddled with a greater taxation burden. In this regard, the Bill provides exempt status for certain basic food items and services. The question is whether the identified exempted goods is adequate to provide the required protection for the poor and marginalized. It must be noted that some critical services are not subject to zero exemption, albeit they are heavily utilized by the poor.

There are clear advantages if VAT’s application is broad based and levied as a single rate. It should stimulate economic efficiency and can also increase consumer’s choice. It can also have the effect of allowing consumers to properly and wisely allocate resources in a democratic fashion.

The rationale for the exemption of financial services and international transactions requires further public explanation. The intent may have been to blindly continue the decades’ old “protectionism” of foreign Banks and financial service providers. For local Banks and financial services providers that are majority owned by Bahamians who cater to a predominant foreign clientele, no exemption should apply. Similarly, foreign banks and financial institutions, whose shareholders are predominantly non-Bahamians and whose control is outside the geographical waters of the Bahamas, should not enjoy exempt status. These matters should be further reviewed within the context of whether VAT will be a barrier to the further expansion of the Bahamian financial services sector and the overall economic growth across all sectors.

It must also be recognized that unlike other nations that have employed VAT, the national conversation is not centered on the introduction of VAT in conjunction with the harmonisation of income or capital gains taxes. This means that our approach should be fundamentally different to that of the United Kingdom and New Zealand (and other OECD countries). The primary focus should be to attain the greatest potential for overall revenue generation by taxing goods and services enjoyed by all consumers, particularly those who may repatriate savings and profits to onshore or other offshore jurisdictions without the payment of taxes under the present structure.

Our present taxation regime is unitary and based on fixed rates for business licenses and customs duties. Even within this simple system of taxation, noncompliance is remarkably high. It is also true that no matter the taxation method or model, tax evasion is inevitable. In the USA, income tax evasion is projected at between 18-20 percent. It is possible that in The Bahamas the rate of tax evasion is at the higher threshold of 40% for customs duties, real property tax and business licenses. The government hopefully has built into its revenue projections and analysis a reasonable percentage for tax evasion, as VAT will not likely put an end to the culture of tax noncompliance. In fact, it may be arguable that tax evasion may be simplified and enlarged with the introduction of VAT as it may lend to counterfeit inputs and “ghost” transactions. The United Kingdom pegs its tax evasion for VAT to around 13% and in OECD countries it is around 18% on average. The experience of the developed economies is that VAT is more prone to evasion when more categories of goods and services are excluded and multiple rates are utilized. There are other valuable experiences and lessons that we must take stock of and seek to find creative ways to eliminate in the Bahamian roll-out of VAT.

Thus far the debate on the new tax has placed too little emphasis on the relationship between VAT and the growth of government spending. Assuming that the government is able to raise more revenue with VAT it must not be a panacea for an exponential increase in government spending and the expansion of government noncommercial services. The fact that there is a need for a more modern approach to taxation demands that the government similarly creates a legislative frame that ties government spending to the total amount of taxes actually collected in any fiscal period. There must be dual responsibility and accountability on the tax payer and the government in the collection, allocation and spending of the tax dollars.

Bahamians fully understand that the government requires a broader tax regime to meet the growing demands of the society. Bahamians are also in tune with the culture of non-tax compliance, which is across all economic classes. Thus far the debate is glaringly and intellectually hypocritical by the failure or refusal to discuss all of the other available options for tax-credit expansion. There is a need therefore for the policy makers to engage in a larger purposeful discussion about taxation (period) and the best measures to increase taxes, albeit in a grueling recession. The debate must also focus on the “new” measures and methods that must be introduced to improve tax collection. There is no denying that presently the government is doing a lousy job in collecting real property tax and in the assessment and collection of customs duties and business licence fees. Just as the present system allows for tax evasion, one hopes that the culture of a few paying the tax bill will not remain a staple of our fiscal discipline and management.

Governments are elected to lead. But they are also elected to govern responsibly, sensibly and fairly. There is no fairness in a taxation model that will drive people into poverty and create a further burden on those who are not able to meet the basic needs of human existence. The Bahamian people are duty bound to reject any taxation regime that favours over-taxing the poor or that creates a windfall for those who can afford to pay more.

The Honorable Prime Minister was correct when he suggested that the government should slow down the process. At present there remains too many unanswered questions, and too many other viable options that require public explanation as to why they cannot be employed to fix the nation’s fiscal crisis. It is therefore incumbent on the government to change the conversation and to review all options, inclusive of a payroll tax, to assess and determine if there are other robust models which can be implemented to assist in the expansion of the tax base. The government must also lead by example and must demonstrate to the public that it recognizes that it must reduce waste, foolish and extravagant expenditure and poor fiscal planning. It can lead by recognizing the constitutional provisions on the size of Cabinet and by creating a more lean, responsive and progressive public sector.

There is much merit in a simple and easy to understand taxation regime that better aids in tax compliance.

The government should revisit its overall taxation strategy and devise a plan that fits well within the nation’s future needs and achieves our international competitiveness. The fact is that there can be no new taxation regime without an engaging public dialogue. Leadership on these matters demands a pragmatic approach to the nation’s daunting fiscal challenges and the full engagement of the Bahamian people. The process must be transparent, intellectual in its analyses and focused on improving the quality of the tax-product (VAT or a viable alternative).


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