As one watched Prime Minister Golding and Finance Minister Audley Shaw in parliament on Thursday afternoon, it became clear that Jamaica’s day of economic reckoning has now truly arrived.

Amongst the breathtakingly tough tax measures announced were new taxes on electricity and gasoline, a 1per cent-point hike in the General Consumption Tax (GCT) to 17.5per cent, a reduction in the number of GCT exempt items and higher taxes on cigarettes. Overall, the government imposed a tax package designed to raise just under $22 billion, or approximately 2per cent of GDP on an annual basis.

The very small mercy is that this is just under half the over $10 billion in three months that was rumoured after the Prime Minister’s interview. The genesis for the latter number is the difference between the revenue underperformance of $17.8 billion below and the $7.2 billion reduction in expenditure for the first seven months.

In the period April to October, the Government collected $156.6 billion, or $17.8 billion less than the $174.4 billion projected for the period. Tax revenues over the same period were $140.7 billion, or $15.1 billion below the budget of $155.8 billion. This is only marginally above comparable tax revenues for the first seven months in 2008 of $135.6 billion. Without the imposition of a sizeable tax package in April, particularly the tax on gas, actual tax revenues would have been negative for the year to date compared with a similar period last year. This should be no surprise when the Jamaican economy is expected to decline by approximately 4 per cent in real terms this year. Moreover, tax revenues are falling in nearly every country across the world, automatically leading to wider fiscal deficits.

Expenditure of $235.5 billion between April to October was $7.2 billion below the budgeted figure of $242.7 billion, with programmes and capital expenditure below budget. The primary problem is that interest costs have increased a mammoth $50 billion from $125 billion last year to a revised $175 billion this year, or $16 billion above the original budgeted figure for interest costs for 2008/2009 of $159 billion.

This produced a fiscal deficit of $78.9 billion, approximately $10.6 billion higher than the $68.2 billion deficit budgeted for the period.

We can therefore see that the context for such a seemingly savage tax package, imposed on an already declining economy, is Jamaica’s unsustainable debt path, with Jamaica’s fiscal deficit likely to be at least double, around 10 to 11per cent of GDP ($110 to 120 billion) the 5.5 per cent originally projected.

The tax package appears to be one of the key elements of an IMF Stand-By Arrangement for U.S. $1.3 billion, and will no doubt be part of the letter of intent that the government is in the process of finalizing for IMF board approval early next year.

The issue of interest costs

It is important that Jamaicans understand that the tax package is only the beginning of the required fiscal correction. The heavy lifting of putting Jamaica on a sustainable debt path will have to occur through much lower interest rates. In my view, the eventual contribution of owners of capital and the financial sector needs to be at least double, between four to five per cent of GDP, the size of the tax package, at minimum reversing this years $50 billion increase in interest costs. This point appeared to be clearly understood by Prime Minister Golding, who referred specifically to a debt management strategy involving the fixed, high interest-rate domestic debt of between 16per cent and 25per cent.

The Prime Minister argued, correctly, that simply taxing the high-interest rate debt, to raise say $10 billion, is not good solution. Investors are interested in their after tax return, and would take that tax into account when pricing the bonds, causing interest rates to go up, when what Jamaica needs is for interest rates to fall sharply. If investors are now prepared to accept a lower after tax return due to the prospect of an IMF deal and limited alternatives (interest rates are effectively zero in the US, Canada and the UK), the correct response would be to drive interest rates down faster, benefiting not just the Ministry of Finance but hard pressed Jamaican borrowers generally. Over the course of a year, just the two per cent cut in rates announced by the Bank of Jamaica during Minister Shaw’s speech would save the Jamaican government approximately $8 billion. Another half percent interest rate cut would save the full $10 billion that it was suggested should be raised from an additional tax on interest over the course of a year.

Other proposed measures included the divestment of non-core assets including Air Jamaica and the government’s stake in Jamalco, and the proposed freezing of public sector wages.

One extremely legitimate concern is whether the tax package was properly structured, with such a heavy emphasis on consumption, particularly of items consumed by the poor. Combining an increase in the GCT rate, with a major reduction in the number of GCT exempt items, requires extremely strong and effective expenditure programmes to help the weakest in society.

Another concern is why the refinancing programme was not able to be announced at the same time as the tax package.

In this context, it is absolutely imperative that the government put in place the strongest possible team of macroeconomic, tax and debt advisers immediately, and seek societal consensus through a partnership process on the tax package.