VAT the solution
On Monday, former Prime Minister Owen Arthur addressed the monthly business luncheon of the Grand Bahama Chamber of Commerce on the topic “The Value Added Tax, its impact on the Bahamas: a Caribbean perspective”.
In light of current economic situation in Barbados and the rest of the region, we have decided to publish the full text of this address over the next few days in the hope it will stimulate further discussion on how Caribbean people can better confront the challenges.
Following is the second instalment.
First, VAT is intended to be a broad based tax, levied at multiple stages of production, with the crucial essential feature that taxes on input will be credited against taxes on output.
It is in that capacity intended to be designed to ensure that the final base of the tax is consumption. In this regard deliberate provision is being made to shield exports and investments from the incidence of the VAT in a bid to use it, as elsewhere, as an instrument to promote greater efficiency and competitiveness in the domestic economy.
In conformity with best practice elsewhere, there is a clear commitment to use the invoice credit/method which should both help to discourage fraudulent reporting for tax purposes, and to more deeply embed proper accounting practices as a widespread feature of the Bahamian business community.
The concepts of exempt supplies and zero rating which are intended to be applied in the Bahamas are in keeping with the ordinary and widespread meaning of the terms as applied to the tax regime internationally. So too is the proposal to set a sales threshold to exclude much of the genuinely small businesses of Bahamas from the incidence of the tax.
Among its design features, there seems to be the intention to provide the VAT with a broad base, since there is intended provision for only a very narrow range of zero rated and exempt activities.
Another important proposed design feature is for a standard rate of 15%, and a lower rate of 10 per cent for the tourism industry, with a view to making the tax easy to administer while at the same time benefitting the leading sector of the economy.
In addition, some of the purposes that clearly seem to have motivated the proposal to introduce the VAT, such as the prevention of cascading, which are given expression in the proposed design of the VAT, are to be found almost everywhere the VAT is applied.
In the case of Bahamas, there is a very special issue that has to be explicitly taken into account in the design of this VAT. Like the VAT elsewhere it has, for purposes of administration, to have a relatively simple structure, with only two rates, few exemptions and a relatively high threshold.
It is intended to replace a tax regime characterized by very high rates of import duties. There is at the same time no intention to introduce taxes on income or corporation taxes as exists in other jurisdictions in the Caribbean.
The resulting new tax regime will therefore only succeed in generating an equivalent amount of revenue to that which it replaces if great care is first taken to accurately estimate, and then even greater discipline is exercised in maintaining the proposed broad base.
To be precise, the introduction of a VAT in the Bahamas will broaden the tax base especially by bringing a number of activities, particularly services into the tax net.
But in so far as income and profits will continue to be free of taxes, the overall tax base against which revenue is raised in the Bahamas will be smaller, in relative terms, that that of other CARICOM countries which have a VAT as well as taxes on income.
The proposed rate of the VAT in the Bahamas will be the same as in most other Caribbean countries. With the proposed lowering of the rates of import duties, a VAT at the standard 15 per cent rate will only serve its revenue generating objectives if discipline is exercised to maintain its base that it is given to begin with.
The size of the base will be such a critical determinant of the eventual impact of the VAT in the Bahamas that two essential actions need to be carried out before the new tax is introduced.
The first relates to the need for the conduct of appropriate studies and simulations to gauge and to measure the proposed base, and to derive estimates of the likely impact of proposed design features of the new tax on prices, revenues and the productive sectors.
The Barbados experience emphasises that this necessary research is a vital first step which must be mastered to ensure that the best decisions about the design features of the tax are made on the basis of the very best information.
Initially, decisions were intended to be made in Barbados regarding the VAT based on two reports of 1992 and 1993 which were basically baseline studies and which proposed a tax with single rate of 15 per cent to replace the taxes to be abolished.
On coming to office in 1994, the administration I led decided to defer the date for the implementation of the VAT to enable a more intensive study to be undertaken to simulate the VAT empirically and scientifically, and to derive better estimates of its likely impact on the productive sectors, prices and on revenue.
The scope of the research that had to be undertaken in both the private and public sectors proved to be formidable. The research however yielded the empirical evidence which supported the structure and design of the VAT that was eventually introduced in 1997.
Secondly, the successful introduction and operation of a Value Added Tax require high levels of compliance. To deal with this, a very special challenge has to be recognised and mastered. The challenge is that the VAT is intended to simplify the tax system; but it is itself a complex tax to design and to administer.
To address this challenge, no effort should be spared to design and to have in place a fully competent VAT implementation unit before the VAT is introduced. In addition, the most comprehensive public relations outreach programme has to be undertaken to address the specific and legitimate concerns of the main target stakeholders and to solicit and secure their support for an initiative which carries its own intrinsic complications.
The drafting of the legislation for the VAT also has to draw from best practice. In particular, drafts have to make the subject of extensive discussion and refinement and the legitimate concerns of stakeholders have to be embraced and reflected in the Bill to be presented to Parliament to secure strong stakeholder sense of ownership of the new tax.
A systematic effort also has to be made to deal with the registration of those liable to pay the tax, and to iron out the transitional problems which are sure to arise as one tax regime is replaced by another.
One major transitional issue is sure to concern the procedures that are put in to be in place to enable businesses to manage inventories as one tax regime is replaced by another.
The point in all of this is that no matter how sound may be the reasons for the introduction of a VAT, and no matter how perfect its features are in their conceptual design, the success of the new tax will depend on the strength and sensitivity surrounding the planning and administration of its introduction.
In the Bahamas, as elsewhere, where the introduction a VAT is accompanied by the abolition of a member of pre-existing taxes and the reduction of the rates of some that are allowed to remain in place, I cannot overemphasise how important it is to establish and prove the base of the tax before making adjustments.
A VAT on a large base that yields more revenue than required can always be adjusted and right-sized. But it is almost politically impossible to start with too narrow a base and to hope thereafter to expand it.
The case of Barbados and Belize is very instructive in this regard since the two countries introduced a VAT at virtually the same time.
The Government of Belize started with a tax with a base characterised by many exemptions. It could not meet the revenue or other requirements. The subsequent effort to attempt to broaden the base by reducing the number of exemptions brought the VAT into disrepute and led to its abolition.
In the case of Barbados, we started with as broad a base as possible and I gave the commitment to the public to review it after sufficient empirical evidence existed that the tax could get the job done in relation to the raising of revenue and its beneficial effects on the economy.
The VAT in Barbados was intended to yield the same revenue as the taxes it replaced. It yielded significantly more. Its yield and buoyancy having been established and verified, the fine tuning of the scope of its base was subsequently undertaken.