Mon | Aug 21, 2017

Peter-John Gordon | Promise kept or not?

Published:Sunday | May 15, 2016 | 5:00 AM
Peter-John Gordon
Audley Shaw in Parliament last Thursday. Regarding the new tax regime, economist Peter-John Gordon asks, "The question is, will this higher take-home pay be able to buy more or less than consumers were able to buy before the tax giveback/increasesd indirect tax change?"
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Finance Minister Audley Shaw made a presentation in the Parliament on May 12, 2016 titled 'Partnership for Economic Growth', in which he outlined the Government's tax programme for the year 2015-16. Minister Shaw had economic growth as his 'guiding star'. The minister announced that tax revenue would be $44.7 billion, while loans would amount to $89.4 billion (20% of tax inflows). This demonstrates that Jamaica is still heavily dependent on loans.

Mr Shaw made the common mistake of highlighting the trade deficit with Trinidad and Tobago (J$13.2 billion). The more important news is that the current account deficit has improved to 2.2% of GDP during 2015-16 from 7.1% a year earlier. I am almost sure that Mr Shaw runs a deficit with his barber. What is important is not a balanced trade with every person (country) with which you trade, but an overall collective balance with all your trading partners.

The minister also announced that the FINSAC report would be completed. Hopefully, this report will help in understanding all 83 banking crises in 79 countries between 1990 and 2007 as reported by the IMF. These crises were similar to what happened in Jamaica.

What was of interest to Jamaicans was not issues of international economics or financial crises that occurred two decades ago. The interest was on the Government's tax policy. Mr Shaw declared, "We consider a shift from direct to indirect taxes to be an obvious policy to consider and implement. In arriving at this conclusion, we availed ourselves of the plethora of research. One such paper offers the conclusion that the structure of taxation is probably more important than the level of taxation." Mr Shaw is, therefore, aware of a very sound bit of economic thinking.

No doubt this realisation led to the removal from the original proposal made on the campaign trail of the most insidious provision of multiple thresholds dependent on level of income. The original proposal was to have persons earning under $1.5 million exempt from income tax, while having persons earning between $1.5 million and $5 million tied to a threshold of $592,800 and a tax rate of 25%, while persons earning above $5 million would have zero threshold and a tax rate of 25%.

This was a dangerous proposal. It appeared appealing but would have created very serious incentive problems. This was akin to an artist designing a building without knowledge of architecture. Mr Shaw said the objective is to ultimately replace direct taxation with indirect taxation. If we decide to move from driving on the left to driving on the right, we cannot approach it in a gradual way in which trucks first shift and then later cars. The country has been spared an economic catastrophe by the removal of that part of the plan.

 

MOST UNFORTUNATE

 

The plan to be implemented has the same threshold for everyone, $1 million, and the reintroduction of a progressive income tax system, with a rate of 25% for those earning under $6 million and 30% for those earning $6 million or above. It is most unfortunate that the country has returned to a progressive tax system. We abandoned this system years ago because it complicates tax administration and can be very distortionary. Economic theory tells us that a uniform tax rate is the most efficient.

Many persons view the government like a household: If you increase expenditure here, you can simply cut it someplace else, or if you reduce one source of income, you can simply make it up from another. This is a fallacy.

When a household moves its spending or income activities, there are no second or third rounds to consider. With the Government, things are different. Mr Shaw accepts this, for he says, "Simply put, taxation affects what choices we make at the individual and company level and, ultimately, the rate of growth in the economy."

The JLP, on the campaign trail, indicated that it would not have to introduce a tax package to finance raising of the income tax threshold. The Government of Jamaica has had to introduce a tax package to finance this venture. The tax giveback is to cost $12.5 billion for the first tranche. The Government has introduced a tax package of $13.8 billion. So the tax giveback results in the Jamaican people paying more, not less, in taxes.

For the most part, the additional taxes have been placed on items that are not very responsive to price movements - petrol, fuel and cigarettes - so additional taxes on these items are not likely to distort their consumption too much, thus providing a dependable source of taxes for the Government. International travel might prove to be more responsive to price movements. Since some of this tax is to be paid by tourists, it will be interesting to observe the result of this tax on tourism.

Fuel and petrol taxes are likely to have a great pass-through effect on other prices. A petrol tax will affect not only the motorist at the gas pump, but all transportation, i.e., bus and taxi fares, and the cost of moving goods around. A fuel tax will cause the prices of all goods and services to spike. And though the Jamaica Public Service Company will be spared SCT on heavy fuel oil, the new SCT on LNG will likely have implications for electricity rates.

There is a concept in economics known as money illusion. A person whose income is doubled might think that he is better off. However, if prices are also doubled, he is no better off than he was before. If prices more than double, he is actually worse off than he was before.

 

TAKE-HOME PAY VALUE

 

Everyone who sees a higher take-home pay will rejoice. The question is, will this higher take-home pay be able to buy more or less than consumers were able to buy before the tax giveback/increased indirect tax change? Some people might be able to do better, depending on what they buy. With certainty, the poorest in the society will be made worse off. These are people who were already below the tax threshold and who will receive no 'tax relief' but who will face the rounds of price increases to follow - transport, supermarket, etc.

Mr Shaw declared that people are better able to decide how to spend their money and so the Government should leave money in the people's pockets so that they can make their decisions. This is a call made in many countries. It is never used to advocate indirect versus direct taxation; rather, it is used to advocate (a) lower taxes in exchange for lower levels of services provided by the government; instead of (b) higher taxes in exchange for higher levels of government-provided services.

Increasing indirect taxes, as has been done, will introduce some distortions, i.e., it might force people to change their spending patterns. It would be interesting to know what leads to Mr Shaw's confidence that these distortions will be growth inducing.

Moving to a pure indirect tax regime might make tax evasion harder but it increases the burden on the most vulnerable, the poor and pensioners. The currency of politics is perception. Money illusion is a great political ally. In economics, experience transforms perception into rational expectations. In short order, people will know if they are, in fact, better off by this change.

- Peter-John Gordon is a lecturer in the Department of Economics, UWI, Mona. Email feedback to columns@gleanerjm.com and pjmgordon@hotmail.com.