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Withdrawal tax is perfect - almost

Published:Sunday | April 27, 2014 | 12:00 AM
Minister of Finance and Planning, Dr Peter Phillips (second right), making his presentation during the opening of the 2014-15 Budget Debate in the House of Representatives on Thursday, April 17.-File

The Government of Jamaica (and, by extension, the Jamaican people) has a huge debt burden, which is approximately 140 per cent of GDP. This debt arose because in past years, the Jamaican people have been living above their means, i.e., the Government spent more money than it earned. This was occasioned by the Government dispensing 'free' services (some of which unfortunately still exists) and losses incurred by public enterprises, among other reasons.

This debt can only be repaired by the Government spending less than it earns in the current period and for some considerable time into the future. The Jamaican people will have to live below their means until the debt is repaid. The Government's main source of earning is taxation, so for a considerable period to come, the amount of taxes collected will have to be more than government expenditure. The Government will have to cut expenditure and/or raise taxes.

Calls for the trimming of the Cabinet and/or consultants in the public service are really only of psychological value and little moment to the real dollars and cents. It is inevitable that taxes will have to be increased, as unpalatable as this might be to some people. Before discussing the withdrawal tax, we first seek to establish some broad principles.


All taxes are paid from income. Without income, there can be no taxes. The argument that income is being double-taxed by the withdrawal tax is correct, but is nothing new. GCT paid by consumers is paid out of income, which was (supposed to have been) already taxed.

Unfortunately, probably for political saleability, the minister of finance declared that the tax on withdrawals was not on consumers, but on the banks. Every first-year economics student is confronted with the question, 'Who pays the tax?' Initial naivety leads to the answer that consumers do. These students soon discover that taxes are shared between firms and consumers, and it really does not matter who put the cheque in the mail to the Government.

GCT is not a tax solely on consumers; a portion of it is paid by firms. How the tax is shared between firms and consumers depends on the relative elasticities of demand and supply, i.e., on which group, consumers, or firms responds more to a change in price. If consumers respond more, firms will have to absorb a larger share of the tax. If a tax is placed on vacations in Negril, the hotels there would be forced to absorb a large share of the tax since consumers could easily vacation in Montego Bay, Ocho Rios, elsewhere, or just stay home. If a tax was imposed on toothpaste, most of this tax would be borne by consumers as they have little alternative.

Taxation is used for two main purposes with very different expectations. One is to alter the behaviour of the taxpayer, and the other is to raise revenue for the Government. A tax might be imposed on alcohol and tobacco to discourage their use because it is felt that they create harm. Such a tax would be considered successful if it did not raise a cent in revenue but caused no one to use these products.

A tax meant to raise revenue for the Government would be successful if it did not cause people to alter their consumption too much, which would result in a large amount of money being raised from the tax. The withdrawal tax is meant to raise money.

There should not be any confusion between bank fees and a tax. Bank fees are part of the cost recovery/profit maximisation strategy of banks. Taxes are meant for the Government.

The ideal tax for the purpose of raising revenue should be broad-based, difficult to avoid, and efficient. There are two types of efficiency to consider here: The first is that the levy should not cause taxpayers to lose more than the Government gains, and this occurs when the tax does not alter their behaviour. Second, the tax must be easy and, therefore, cost little to collect. If there were a gate that everyone had to pass through, collecting taxes there would be a good idea - it would be broad-based, no one could avoid the tax, and it would be easy to collect. We could think of the financial system as such a gate since most persons do deal with financial institutions.

army of enforcers

Collecting taxes through withdrawals will catch people who find ways to avoid paying income taxes and GCT. The GCT regime is complex because there are different rates applied to different products, so an army of enforcers has to be employed to make sure that the right rates are being applied to the right products. A larger army is required to verify incomes. This army of tax collectors is non-productive in an economic sense. They do not contribute to growing the economic pie, merely to distributing it.

Readers old enough will recall the effort of the Government of the 1970s in making cornmeal available cheaply in an attempt to protect the poor, but later discovered that much of the cornmeal purchased was by the rich to feed their dogs. Selectively trying to apply different prices (taxes) is costly and cumbersome. The withdrawal tax does not need an army of enforcers to collect it. There are fewer than 100 financial institutions from which to collect, compared with thousands of retail outlets from which GCT is collected.

Because the tax is so widespread, its rate can be very low. Low rates do not lead to large changes in behaviour, so the withdrawal tax satisfies the non-distortionary efficiency condition. If the tax from passing through our proverbial gate is low, this will not affect the number of times people choose to pass through it. Even if the financial institutions all colluded and were able to force the entire withdrawal tax on to the consumers, it is relatively small, and I predict that it would have no appreciable impact on people's behaviour.

Unfortunately, the withdrawal tax, as announced by the minister of finance, is regressive. A regressive tax is one where higher-income people pay a lower tax rate, even if they do pay more money in taxes than poorer persons. The tax rate on withdrawals up to $1 million is 0.1 per cent, yet for withdrawals over $20 million, it is 0.05 per cent, half the rate of the lower group.

Peter-John Gordon is a lecturer in the Department of Economics, UWI.Email feedback to and