THE ABACO CHAMBER OF COMMERCE
MARSH HARBOUR, ABACO

29TH JANUARY, 2004
 

Mr. President, Executives and members of The Abaco Chamber of Commerce, Distinguished Guests, Ladies and Gentlemen.
 I am honoured to have this opportunity to finally accept your kind invitation to address such an important and in the context of The Bahamas, such a timely topic as, “Tax Alternatives under Trade Liberalization”.  Generally speaking, as countries participate more and more in international trade, there is a growing consensus that in order to receive the full benefits of trade, there is a need for a “level playing field”.  In other words, if each participant in the process is to add-value to its respective economy, then each must remove any barriers which tend to restrict the movement of goods and services between countries.  Trade barriers could take the form of high tariff rates, such as we find here in The Bahamas or, non-tariff rates such as import licences or excessive administrative red-tape which are sometimes used against exporters.

Although the concept of trade liberalization consists of many elements including transparency, standardization, harmonization of laws and practices among other things, market access or issues involving border taxes or customs duties tend to dominate the discussion and accordingly, that issue would be the main focus of our discussion today.

In The Bahamas, not unlike other countries, we are faced with the problem of raising sufficient revenue to meet the growing needs of the state for the purposes of education health, security, public infrastructure and debt management services to name a few.  More importantly, all Governments of The Bahamas, including the current administration has made it clear that there will be no taxes levied on income or capital nor would a tax regime be introduced that would adversely affect the competitiveness of our financial services sector.

In these circumstances therefore, any attempt to alter or change our tax regime to comply with the dictates of trade liberalization, has some built-in restrictions for The Bahamas.

Given the above, in the discussion of Tax Alternatives for The Bahamian Economy, I should like to first briefly examine the existing tax structure and touch on some perceived weaknesses in that structure; next, I should like to comment on certain influences including proposed free-trade agreements which are having some impact on the need to introduce an alternative tax regime.  Following that, I should like to examine briefly, some of the alternative tax options and lastly, spend some time discussing one of the options which has been recommended to the Government and the rationale for that recommendation.

Existing Structure and the Need for Change
During the period when The Bahamas was a colony of the United Kingdom, revenue was collected from a limited range of items including customs duties; port wharf and harbor dues; licence fees and government utilities charges.  Even then the majority of revenue was derived from the imposition of taxes on international trade.  In other words, the application of a tariff or customs duties on imports and export.  Today, some 200 plus years later and in the context of the 2003/04 Revenue Budget of approximately $1 billion, 46% of that amount is collected from Customs Duties and Excise Taxes; another 23% is derived from Stamp Duties and about 9% comes from Tourism taxes.  The remaining 30% is received from the other sixteen or so revenue items including real property, motor vehicle and gaming taxes.  This over-reliance on international trade taxes for government revenue poses certain risks for the Government; some of which became clearly evident following the events of September, 11th, 2001.  Immediately after the terrorist events in New York, tourism travel to The Bahamas declined by almost 20% and similarly, the level of imported goods dropped by almost $300 million.  In a similar, but predictable fashion, Government revenue was adversely impacted and the surpluses on the recurrent budget which were experienced in previous years quickly became deficits and a source of concern to both the domestic and the international community including the IMF.

The slowdown in the economy also posed a risk to the domestic financial sector and the monetary policy response to that risk was for the Central Bank to restrict bank credit in order to preserve a healthy level of foreign reserves which had declined by $140 million.  Ironically, in The Bahamas, good monetary policy could sometimes translate into bad fiscal policy.  The slowdown in credit gave rise to a slowdown in imports and consequently, a drop in Government revenue receipts.  As expected, Government expenditure continued to rise resulting in budget deficits of $147 million and $154 million in the two years following the 9/11 event.  What became clear was that the existing tax regime is inadequate for a modern Bahamas.  Revenue growth is significantly slower than the growth in expenditure.

Another weakness of the existing tax-structure is, according to tax theory, its regressive nature.  That is, it tends to impact more heavily on low-income households than it does on upper-income brackets.  It is assumed that lower-income families spend virtually all their income on consumption and therefore pay a disproportionately larger share of import duties than others.  It should also be noted that the existing tax structure tends to penalize small and large businesses by forcing them to tie up a considerable amount of their cash-flow in inventory even before the first sale is made.  And lastly, circumvention, non-compliance and non-payment seem to be the order of the day under the existing system.

Given the observations outlined earlier on our current tax system, it may be generally concluded that it is overly concentrated on international trade and not sufficiently directed at domestic sources of taxation.  It is extremely sensitive to international events and adversely affected by domestic monetary policy.  It is both cyclical and regressive and despite its ease of collection, the applicable customs duties are often avoided and evaded by an increasingly large segment of our society.

Taxation and the Proposed Free Trade Arrangements
Import Tariffs or Customs duties are said to produce trade distortions because they favour or protect local production while at the same time, discriminate against imported goods.  Tariff regimes are regarded as barriers to trade and therefore all international trade agreements, whether regional, hemispheric or global, contain provisions for the elimination of tariffs over a specific period of time.

As you are all aware, The Bahamas currently has observer status in the World Trade Organization (WTO) and has submitted the first draft of its accession report with a view towards full membership in the not too distant future.  We are also actively engaged in negotiations for the free Trade Area of the Americas (The FTAA) and are in the process of making a  determination with regard to our status in the Caribbean Single Market and Economy (CSME).

In all cases, participation in any one of these arrangements would require The Bahamas to re-examine the existing tax regime particularly as it relates to the tariff structure or the level of Customs and stamp duties applied to imported goods.  Indeed, the main obligations of these agreements require participants to adopt non-discriminatory and transparent procedures in the conduct of trade within the group.  Indeed, even if The Bahamas elects not to participate in any of the trade arrangements, there is, in my opinion, still a need to seriously consider reforming our tax regime in order to expand the tax base, reduce economic distortions and ultimately, stabilize public finances.

Any new tax regime, to be successful, must be broadly acceptable to the public; it should provide the same or more revenue as the system it is replacing, it must be seen to be equitable, it should approach economic neutrality, that is, it should not attempt to re-distribute income from one group to another, and lastly, it should be administratively easy to collect.

While attempting to achieve the proper balance among the broad objectives I have just outlined, the new or reformed tax regime must yield sufficient revenue to replace the combined total of customs and stamp duties which are applied at the rate of 35% and 7% or a total of 42% on the value of all imported goods.

It should be noted at this point that the total annual revenue taken in by the Government is approximately $1 billion which translates to about 20% of Gross Domestic Product (GDP) and is among the lowest tax jurisdictions in the Caribbean region.  Of that total, the yield from customs duties and stamp duties is approximately $550 million and that is the amount that would have to be replaced in the event that a new tax regime is introduced in The Bahamas.

In this connection, we have received technical advice from international institutions and I should like to share with you some alternative tax options with a brief commentary on the applicability and efficiency of the tax option to local conditions.

It should be noted also, that all of the options considered are essentially an attempt to shift the tax base more towards domestic consumption.  Other taxes such as real property tax, business licence fees and selected excise taxes are expected to remain in place.

Alternative Tax Options
When reviewing alternative tax options for The Bahamas against the existing policy background of no taxes on income or capital, there are at least three types of taxes which immediately suggest themselves given the structure of our economy.  These are a sales tax, a payroll tax, or a value added tax (VAT) which is sometimes referred to as a Goods and Services Tax (GST).  Sales Taxes are conceptually straightforward in that a levy of five to seven percent could be applied on gross sales of every registered tax-paying unit.  If the gross-turnover in The Bahamas is anywhere in the region of our total annual imports, then the yield from a sales tax would, in all probability, fall far short of the $550 million needed to replace customs and stamp duties.  Moreover, it is quite likely that small businesses, say with turnovers of $50,000 or less would have to be exempted because of the difficulties with collections and the disproportionately high cost of administration that would be imposed upon them.

The Payroll Tax has a certain amount of technical appeal insofar as the collection mechanism is already in place in the National Insurance scheme; any contribution which is compulsory is, by definition a tax.  Currently, employers and employees contribute 8.2% of the insurable wage up to a ceiling of about $21, 000.  A payroll tax designed specifically for The Bahamas could take the form of raising the ceiling from $21,000 to say $50,000 and applying a slightly higher rate say 10% and then, adding another category of say $50,000 to $250,000 at say, 12 ½ %.  Only employees could be required to pay the expanded range to avoid raising the level of unemployment and those under the $21,000 ceiling could be exempted.  At those rates, the yield would be roughly in the order of $200 million which again, is much too low to replace the revenue from customs and stamp duties.  Although this form of tax is more progressive, in that those who have the ability to pay would contribute more, it too closely resembles an income tax and is therefore unlikely to find much support in neither the public nor the private sectors.
On the surface, it would appear that neither sales tax nor a payroll tax would adequately replace customs and stamp duties in terms of the quantum of revenue needed.  Additionally, neither tax is likely to receive broad public support nor are they likely to be regarded as being equitable.

Most of the expert advice we have received on the matter of reforming our tax system have recommended, over time, the introduction of a value added tax (VAT).  It is argued that such a tax has been successfully implemented in numerous countries around the globe; the tax is consistent with WTO and FTAA requirements; the tax rate is likely to be considerably lower than existing customs and stamp duties because it would be levied on a wider range of goods and services; most of it could still be collected at the border by our existing Customs administration; it would certainly reduce the cost of living for Bahamian households and businesses; and it could make our tourism sector more competitive.
The Value Added Tax (VAT) or goods and Services Tax (GST)

VAT or GST
The value added tax is perhaps one of the most important developments in fiscal affairs over the past fifty years.  Today it is an important source of government revenue in over one hundred and twenty countries.  It is estimated that over 70% of the world’s population live in countries which apply the value added tax.

The Value Added Tax (VAT) is essentially a tax on consumption which is charged at all stages of production with a provision which permits businesses to offset the tax they have paid for goods and services against the tax they charge on the sale of their goods and services.  There are many variations of the VAT however there are some common characteristics to the tax.  For example, the VAT is not applicable for exported goods and services; some goods and services are exempted such as food, education, health and social and financial services as well as small businesses.  In the context of The Bahamas, a small business would probably be defined as having turnover of $50,000 or less per year.  Businesses with gross turnovers in excess of $50,000 would be required to register as tax payers and would be issued with a unique tax identification number similar to the national insurance number.

The tax rate for the VAT varies between 10% and 20% and the rate selected for The Bahamas would depend on how much revenue needs to be raised to replace the traditional taxes.  Any rate selected should be lower than the current rate of customs and stamp duties since the tax would now be applied over a broader range of goods and services, including areas that are currently untaxed.

If The Bahamas adopts a value added tax regime it must necessarily absorb some existing taxes into the VAT such as the hotel room tax and part of the business licence fee.  Consideration should also be given to retaining some of the existing excise taxes on gas, liquor, cigarettes et cetera.  Above all, some consideration would have to be given to lessening the burden on lower income households either by exemption or taxing at a reduced rate.  Capital investments are also generally exempted from the VAT.

If designed and implemented properly, a consumption tax such as the VAT could generally reduce the price level.  There would be a need for intensive training in both the public and private sectors.  And any business which currently meets the requirements for business licences should, with a little assistance, be put in a position to comply with the requirements of a VAT.   The Government of Barbados introduced a VAT in 1997 using a tax note of 15% and exempting businesses with turnovers of B$60,000.  In the first year of operations, the tax yield far exceeded the forecast.

Conclusion
Mr. President, I should like to conclude as I started by making the general observation that while our existing revenue system has served us well in the past, the time has come to critically review it to determine whether it meets the needs of a modern Bahamas.  It is widely accepted that the performance of a tax regime must be judged by more than the amount of revenue it yields.  It should be evaluated in terms of its efficiency and fairness in the process of raising revenue as well as the cost of administration and the cost to the taxpayer.  Expert studies have concluded that existing system of customs and stamp duties are distortionary and certainly not well structured for the development of local production nor increasing the efficiency of local commercial and industrial activities in the long term.  It would not be prudent to ignore those findings.  Indeed, we are duty-bound to consider seriously any sound technical advice which we receive.  And, it is in that spirit that the ministry is examining alternative tax regimes and I am most grateful to The Abaco Chamber of Commerce for affording me the opportunity to discuss some of them with you.

Thank you very much.
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