Too Austere?

Keith Collister continues the discussion on whether Jamaica’s IMF programme is overly harsh


Sunday, May 18, 2014    

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IN assessing whether Jamaica's IMF programme is overly austere, one is not arguing for "stimulus", nor does one just want Government to spend more, increasing the level of macroeconomic uncertainty in a country as indebted as Jamaica.

Instead, the first need is for a "fiscal cushion" to allow a growth-inducing tax reform. The 1986 comprehensive tax reform led to a near doubling of revenues over a three to four-year period, in the process wiping out the fiscal deficit. The reform was actually modelled as revenue neutral, and although it reduced tax rates sharply overall, the end result was a large increase in tax revenue, both through helping to encourage much faster growth over the period of a little under five per cent, and through sharply reducing incentives for evasion.

It is noteworthy that although the issue of incentives was discussed (and fully understood) in the 1980s tax reform committee, the then incentive regime was left alone. Indeed, a very large part of the faster economic growth of the period occurred because of the rapid expansion of export industries under incentive, namely textiles (807), tourism (largely all-inclusive) and bauxite. The argument, however, is not that the then incentive regime was perfect, but simply that it was used effectively in that period to increase the rate of economic growth.

Chapter 25 of the final report on "Jamaica Tax Reform" in the 1980s edited by lead consultant Professor Roy Bahl is entitled "Integrating tax policy, Industrial Policy and Trade Policy in Jamaica" by economist Carl Shoup. Unfortunately, this integration is something Jamaica clearly still needs to do thirty years on, although a start was made with the recent reform of the incentive regime, at the price of some complexity, itself mainly due to the total lack of a fiscal cushion. Shoup argued that "A much simpler tax incentive is a low rate of income tax, coupled with virtually no tax preferences", observing that Hong Kong had been the most notable example of this approach, and that it implies a no-targeting industrial policy.

A hybrid of this strategy was used by Ireland in the 1980s, meaning a 10 per cent corporate tax rate on manufacturing and internationally traded services, which, due to European Union pressure, was replaced by an across the board 12.5 per cent corporate tax rate in 2003. Indeed, a recent Economist magazine article noted "But throughout the crisis (2007-2008) the Irish Government refused to shift on one issue; the 12.5 per cent tax rate on corporate profits that has helped the country become a big draw for American companies....Without the presence of those foreign companies the Irish recession would have been worse."

The whole issue can be summed up in the words of the 1980s committee now deceased Chairman, Roy Collister, as "The need for incentives simply means the corporate tax rate is too high". In short, the current argument that incentives overall are somehow responsible for Jamaica's poor rate of economic growth over the past two decades through the misallocation of capital is simply wrong, and that therefore the focus of the economic reform programme so far in front loading the issue was at best misconceived. Instead, the problem is that for decades, Jamaica has overall had an overly high rate of corporate tax, and then used tax "preferences" or incentives to allow it to still attract foreign capital to an economy that was highly uncompetitive. Instead, as Price Waterhouse tax partner Brian Denning has observed, "Jamaica should give up just enough tax to attract the required foreign investment".

Furthermore, the whole issue of the negative impact of targeting specific sectors for preferences is overblown, as a small economy such as Jamaica is only going to have a limited number of sectors in which it can be globally competitive. If we had a joined up government, a very proactive investment agency with a proper budget searching for new industries globally, and the ability to change laws quickly, Jamaica could still "target", as other countries such as Singapore have done very successfully. The real problem is a continued failure of administrative capacity and focus, which is what really biases one towards a low tax solution such as those of Hong Kong or Ireland, as it doesn't really require the other things to be successful, although of course they are still very helpful.

Currently, however, a key part of our austerity programme is to restrict "tax expenditures" (treating them as actual revenue foregone), and the IMF has almost completely tied Jamaica's hands with respect to new incentives. The best way of putting this is a comment on the issue by one of Ireland's leading economists, Dermot O'Brien, in 2003 "The income tax foregone argument is rubbish, as most of the industries would not have been here in the first place without a low corporate tax rate".

The government's very difficult problem with tax reform is that they have been required to make an enormous fiscal adjustment over the one-year life of the IMF programme (really over two years, as they were preparing for the programme from the May 2012 budget) moving from a primary surplus of just under 3per cent of GDP in 2012 to 7.5 per cent of GDP in 2014. This overly sharp adjustment has effectively destroyed any concept of the type of comprehensive tax reform that would have been growth- inducing, as instead the government has been scrambling to find sectors to tax to meet the primary surplus target, further discouraging local and foreign investment.

The need for further tax "policy measures" in the last budget, on top of the other measures already taken in a still very depressed economy, is what finally destroyed the coherence of Finance Minister Peter Phillips' budget, in addition to the lack of consultation. Instead, the IMF should have allowed a fiscal cushion for a growth- inducing tax reform that would ultimately have been revenue positive. A fiscal cushion is key in the political economy of balancing winners and losers rather than having every sector treating the process simply as a zero sum game of "tax him not me". Based on the 1980s experience, it would have paid for itself many times over. On this and many other issues, it is now time for a "fresh look" at the overall IMF programme to begin. Next week we will continue to review what such a "fresh look" should look like.





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