By NEIL HARTNELL

Tribune Business Editor

nhartnell@tribunemedia.net

The Bahamas’ proposed Value-Added Tax (VAT) will merely act as an ‘income replacement’ for the Government, a former Barbadian prime minister warning yesterday that “discipline” will be key to preventing the tax base’s erosion by ‘special interests’.

Owen Arthur, in an address to the Grand Bahama Chamber of Commerce, said the Bahamas’ tax reforms would produce a different result to that enjoyed by other Caribbean countries, which had introduced corporate and income taxes concurrently with their VAT, and therefore seen a revenue increase.

Warning that tax base size was critical to VAT’s success, Mr Arthur said it was best to start with one that was large, as the experience of countries such as Belize showed it was “almost politically impossible” to expand the tax’s reach if the initial coverage was too small.

He urged the Government to resist, “as far as is practicable”, calls from various industries to become ‘zero-rated’ or attract a 0 per cent VAT rate, as this would undermine the tax base.

And he also warned the Government that VAT must be accompanied by “maintaining expenditure discipline”, as increased revenues could encourage profligacy and the impression “the state is flush with cash”.

Warning that VAT and other tax reforms, together with the Bahamas’ accession to full World Trade Organisation (WTO) membership, would “change the structure of the economy for ever”, Mr Arthur said tax reform was also “a necessary response” to the Christie administration’s fiscal crisis.

He echoed comments made previously by Michael Halkitis, minister of state for finance, who has argued that the Bahamas’ tax base is too narrow to meet the country’s demands for infrastructure and public services.

And, with the Bahamas’ national debt now over $5 billion, and fiscal deficits standing at more than $500 million, Mr Arthur agreed that tax reform was necessary to prevent this nation from suffering the fate 
“bedevilling” other Caribbean nations.

Acknowledging that tax reform was bound to generate controversy, Mr Arthur said “its successful introduction is not beyond the people of the Bahamas”, especially given that Barbados brought its version in under more challenging economic conditions in 1997.

“The scale of fiscal adjustment that was intended to be accomplished by the move to a VAT by Barbados far exceeded that now intended in the Bahamas,” the former Barbadian prime minister said.

“In Barbados, the VAT was used to replace 11 forms of indirect taxes, and 44 kinds of fees as a means of raising revenue.”

Praising the Christie administration’s VAT ‘White Paper’ as giving the Bahamas “a reasonable chance” to successfully pull off tax reform, Mr Arthur said the proposals seemed to largely conform to international best practices.

Yet, given that the Government did not plan to also implement income or corporate taxes, he warned: “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.

“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 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.”

Mr Arthur said Barbados’s VAT experience showed that studies estimating tax base size, and likely revenue yield, needed to be performed well in advance of the new tax’s implementation.

“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,” he warned.

Belize discovered this the hard way, finding that efforts to eliminate exemptions and increase the tax base, led to its collapse. Mr Arthur said his administration delayed VAT’s introduction, upon coming to office in 1994, to ensure the base was sized correctly.

And Mr Arthur also warned the Bahamas to “spare no effort” to create a VAT implementation unit, and engage in a comprehensive public relations exercise, to ensure reform was successful.

To cope with fears that VAT is regressive, and will “fall more heavily on the poor”, the former Barbados prime minister said this should be dealt with by ‘support programmes’ rather than exemptions.

He said Barbados created a Poverty Eradication Fund to lessen VAT’s effects, plus a Social Enterprise Investment Fund, plus a Reverse Tax Credit that allowed persons below a certain income level to receive a tax refund.

VAT’s “buoyancy” enabled Barbados to reduce its corporation tax from 40 to 25 per cent, and impose even lower taxes on small businesses. And key industries, such as tourism and financial services, received concessionary rates or were treated as export services.

However, Mr Arthur said Barbados’s experience was that the VAT base was weakened by ever increasing exemptions, “frustrating” the main goals.

He confessed he was guilty of this, allowing computer hardware and software to be ‘zero-rated’ to help Barbados develop an IT industry.

“The base of the VAT in Barbados has since then been further weakened by the introduction of a wider and wider range of zero-rated exemptions,” Mr Arthur said.

“It is to be expected that in the Bahamas there will be a similar clamour for any original base of the proposed VAT to be narrowed to support the perceived or expressed needs of sectors and groups.

“As far as practicable, this should be resisted.”

And the former Barbadian prime minister warned the Christie administration to maintain “expenditure discipline and control”, as other Caribbean countries had been forced to increase their VAT rates having failed to achieve this.

“It should also be borne in mind that the increase in the basic VAT rate to support the growth in expenditure can eventually prove to be counterproductive, for any tax that is set at too high a rate will suppress domestic demand and yield diminishing revenues,” Mr Arthur said.