The recent report issued by The Nassau Institute, written by Canadian PhD student David Godsell, has caused quite a stir. While it raised a few good points, such as questioning the feasibility of the timeline to implement the value-added tax (after all, July 1, 2014 is now a mere nine months away) and highlighting the need for government fiscal restraint, we found the paper to be poorly-researched, riddled with inaccuracies and ultimately not worthy to be considered a scholarly document.
In response to the report, the prime minister has urged the IMF and other similar agencies to speak to the benefits of the VAT tax system. We respectfully disagree; the government is at fault for a lackluster public information campaign and for not yet releasing the draft legislation or any specific details of which customs duties will be lowered and by how much. It is that 'informational vacuum' that has allowed so-called pundits and naysayers to proliferate and confuse an already complicated topic.
With respect to The Nassau Institute report, a key critique of this paper is the fact that it does not seem to recognize the starting point of the Bahamian tax regime or that VAT is primarily a partial replacement for existing customs duties. So to call VAT "a distortionary tax which affects the allocation of resources in a society" is neither here nor there - the same can be said of the current customs and excise taxes and indeed of all taxes.
Citing research that shows a tax increase of one percent of GDP lowers real GDP by roughly two to three percent, the author then goes on to surmise that by increasing overall tax revenues by two percent implies the Bahamian GDP would fall by between four and six percent. So extrapolating this he predicts GDP could decline from $8.04 billion to a range of $7.56 to $7.72 billion, a decline of $322 to $483 million.
This analysis is wrong on many levels. First, the research he cites refers to a cumulative decline over 10 quarters (two and a half years), not immediate. More importantly, he is mixing real and nominal figures - a four percent real decline over two years would be offset by two percent annual inflation, leaving nominal GDP unchanged. Furthermore, what has been conveniently excluded is that this same research report he cited shows that a tax increase specifically to deal with an inherited budget deficit (which is more akin to our current situation) actually increases real GDP by 1.4 percent after two quarters.
Mr. Godsell writes that "consumers will purchase less from VAT-affected vendors and will reallocate their income to VAT-free vendors" and "the informal market sector stands to gain the most from VAT adoption as Bahamian consumers reallocate their resources from VAT-affected sectors to VAT-free consumption". Who will these VAT-free vendors be?
Anything imported (which is most things) will be subject to VAT at the border and that cost will be built into the price for any vendors who are outside of the VAT system. This scenario may be more relevant for the services sectors but will all clients really leave the major law and accounting firms for a small practitioner? He goes on to state that "in the presence of a VAT the consumer will more often choose to substitute consumption with self-supply".
Really? Are we going to build our own TVs, make our own clothes and grow our own food? The section on the potential impact on labour is laughable. He writes, "VAT adoption leads to a dramatic decrease in purchasing power or real incomes.
Consequently, more people choose to engage in leisure activities or seek employment outside of The Bahamas rather than seek or continue employment at the now lower real wages." So we are to seriously believe that having less discretionary income will result in workers taking more time off, thereby earning even less?
And is he seriously predicting that some workers will actually leave The Bahamas and look for work in other countries? How many Bahamians really have both the means and opportunity to seek employment abroad? Economics 101 teaches us that consumption taxes don't distort labour supply incentives, income taxes do. A summary of the VAT's impact on government revenues can be found in table three on page 18 of the report. There is a glaring flaw in this calculation in that he is subtracting 40 percent of the "gross taxes assessed" as "refunds and rebates".
Without getting too technical, since this figure was already calculated on a reduced tax base of only 49 percent of GDP, which we assume already adjusts for the fact that some industries and items will be exempted or zero-rated, then the refunds and rebates within the VAT system are simply a timing issue and should net to zero across the whole economy.
Likewise, deducting 20 percent of the total potential tax collectible for non-compliance ($118 million) and 14 percent for fraud ($83 million) seems excessive. We could continue to highlight other inaccuracies in the report but we feel the point has been made. We strongly urge the government and its VAT implementation unit to earnestly begin the process of educating the Bahamian consumer on this momentous change to our tax system. o Kevin Burrows is the senior vice president at CFAL.
His primary role is to develop and oversee global asset class and fund manager research as well as new product development for both international and domestic clients. Kevin received a BA in economics from Yale University in 1993 (Cum Laude, Distinction) and a masters in finance from Cambridge University in 1997.
He holds both the Chartered Financial Analyst (CFA) and Chartered Alternative Investment Analyst (CAIA) designations and is a former president and current director of the CFA society of The Bahamas.
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