Choosing between the unpalatable and the disastrous
The famous American economist John Kenneth Galbraith once said "Politics is not the art of the possible. It is choosing between the unpalatable and the disastrous." Jamaica is not alone in facing these difficult choices, which are currently faced by Government's worldwide, particularly in Southern Europe. Indeed, Jamaica, and particularly its Minister's of Finance over the last four decades, have been faced with difficult choices before, and have chosen both the unpalatable and the disastrous at different times.
We are now again approaching a time for choices, namely whether we are going to satisfy the conditions necessary to achieve a new IMF agreement. If we do not manage to achieve a new agreement this quarter, for sure we will need one in the quarter afterwards (barring a very unlikely global upturn or massive Chinese investment) as if it goes beyond this time frame the outcome is almost certain to be disastrous.
In attempting to double the size of the primary surplus (meaning fiscal surplus excluding interest costs) from three to six per cent of GDP in the current fiscal year, the Jamaican government is targetting a fiscal adjustment of a similar magnitude to that of the so called "fiscal cliff" in the US, where allowing the Bush and other tax cuts to expire in 2013 (as is currently written into law) would raise taxes by three per cent on what is also still a weak economy. Nomura economist Richard Koo, based on his experience as one of Japan's leading economists, that such a contraction could reduce US GDP by three per cent or even more.
Koo notes that "under normal economic conditions fiscal consolidation can boost economic growth by lowering interest rates and therefore making it easier for the private sector to borrow and spend. But it is likely to have little impact with short-term rates already at zero and the ten year treasury trading at 1.8 per cent. This is because if companies were waiting for lower interest rates to undertake capital expenditures, they would already have done so while the rates were coming down to these low levels."
As their own "fiscal cliff" is a matter of grave concern to the Obama administration and Treasury in particular, a new Jamaican government with a massive political mandate may well have thought (despite some voices to the contrary) that a "friendly" US administration might "help" it in its negotiations with the IMF, encouraging easier terms, particularly concerning the level of upfront fiscal adjustment required to get an agreement.
However, this is apparently not to be, as currently, it appears that something very close to the original agreement of 2010 is being required by the IMF. In other words, the IMF believes it has an agreement with Jamaica, and not a particular administration. Moving from an estimate of the additional tax package required for an IMF agreement (over and above normal growth in tax revenues) of $7 billion to $12 billion, and finally to the nearly $25 billion in the budget inevitably destroyed the coherence of the planned tax reform.
This is because it has long been known, and was proven in the 1980's, that "good" tax reform requires a fiscal cushion. In the 1980's, the measure that allowed a good tax reform was the imposition of a withholding tax on interest. This was really an administrative measure, as investors were already liable for the tax, but it was very effective with very low administrative costs borne effectively by the banks and not the government.
The only measure with a similar, or even higher (near 100 per cent) level of effectiveness would be a tax on gas, charged before it got into the distribution system, and therefore capturing the estimated 40 per cent of the economy operating outside of the formal economy.
One of the criticisms of such a proposal is that it would be inflationary, and indeed, immediately following the budget the Bank of Jamaica Governor raised his full year inflation target to 10 to 12 per cent due to the expected impact of the tax increases on items such as food. However, the latest figure of 1.5 per cent for the March to June quarter is less than half his three to five per cent "revised" forecast for second quarter inflation. Encouragingly, this is in line with the latest inflation expectations survey of businesses conducted by Statin for the Bank of Jamaica, where expectations for calendar year inflation fell from 8.3 per cent in March to 8.1 per cent in May. Whilst the survey, conducted between April and May, may not have fully captured the impact of the budget, and recent exchange rate weakness, it undoubtedly reflects the view of businesses that it is extremely difficult to raise prices without losing business in our depressed economy.
The opportunity, even necessity, for such a tax reform is still there, however. For the sake of argument, the IMF may not believe that the tax measures announced in the budget will manage to double the primary surplus, and instead may discount them so heavily that the primary surplus is only projected to increase to between four and 4.5 per cent of GDP. This places a premium on those taxes that can be collected with certainty rather than reducing economic activity and therefore tax collection, making effective tax measures far less costly to the economy if the goal is to reach an agreement with the IMF as quickly as possible.
Just one concrete example of how this works is that of a businessman in the “informal” sector driving a large car (possibly bought from someone in the public sector with a concession) or even “facilitated” at the point of entry into Jamaica, compared with the average man riding a bicycle or taking public transport
The informal businessman should pay more in gas tax, with part of the tax money gained used to subsidise public transport. One might even use some of the revenue gained to try to formalise the informal taxis on which so many Jamaicans depend for their alternative to public transport, many of whom in any case pay “informal” taxes to other “authorities”.