Now that the Free National Movement (FNM) has been unceremoniously kicked out of office, and Prime Minister Philip Brave Davis has appointed his Cabinet — deciding to take the important finance portfolio — he will find mounting pressure to deliver on the big-ticket campaign promise of reducing value-added tax (VAT) from the 12 percent it was increased to in 2018, to 10 percent.
The pledge was made no doubt with the full awareness of how the Minnis administration’s decision to increase VAT from 7.5 percent to 12 early in its term led to a dramatic depletion in public trust, which was never regained.
There is no evidence the VAT reduction proposed by the Progressive Liberal Party (PLP) would have any dramatic impact on people’s personal economic circumstances, but a failure to fulfill the promise would likely be damaging to the new administration.
Davis can expect to get the question often from reporters: “When will you reduce VAT?”
On the weekend, his response to that was that his administration will fulfill that pledge “once the dust settles”.
PLPs remain understandably elated at the recent election victory but there is no honeymoon for the new administration.
As one observer recently put to us: “The couple is now fighting in hushed tones. Later, they will get louder after the nosey neighbors start whispering.”
It won’t take long for many Bahamians to start getting antsy, as many are still hurting, and will be looking to government to create an environment for better days ahead.
The new administration inherits a very bad situation.
But repeatedly telling the people how poorly your predecessors managed our fiscal affairs would not temper the high expectations set by the PLP, which told voters it has the formula to stabilize our finances and grow the national economy.
The tasks ahead are daunting.
Shambles
Our fiscal house is in shambles.
The fiscal deficit widened at the end of the 2020-2021 fiscal year to $1.3 billion, from $811.7 million in the previous year.
This outcome was largely due to the economic impact of the COVID-19 pandemic and related expanded social welfare initiatives, the Ministry of Finance reported.
The Davis administration has promised “an immediate, full assessment of the true state of the country’s finances”.
We would not be surprised if the minister of finance does not soon report to us that the fiscal situation is much worse than the PLP had imagined.
Brace for it.
When it came to office in 2012, the Christie administration immediately borrowed $504 million, blaming the FNM government for mismanagement of public funds and pointing to the over-budget New Providence Road Improvement Project (NPRIP) for the country’s “fiscal deterioration” during the previous five years.
Its borrowing binge continued over its entire term.
It also collected $1.14 billion in VAT in the first two years of the new tax, but struggled to adequately account for how it was used.
This led to widespread corruption claims and a rapid erosion of trust. The PLP left office with many pledges unfulfilled, claiming it had to reorder priorities given the dire fiscal situation it met upon assuming office.
Similarly, when the Minnis-led FNM took power in 2017, then-Deputy Prime Minister and Minister of Finance Peter Turnquest told Parliament in most chilling tones that the fiscal situation was “far bleaker” than anyone could have imagined, and the Christie administration had left “the cupboard bare”.
Turnquest said $400 million was needed to satisfy expenditure for the previous year, while $322,462,707 million was being borrowed for the 2017-2018 fiscal year, bringing borrowing to $722.4 million.
Borrowing has piled on at an alarming pace since then.
Gross borrowing for 2020-2021 totaled $3.075 billion.
Government debt at the end of June 2021 was $9.9 billion, 86.3 percent of GDP.
Though we are a ways off from the presentation of a new budget, we expect Davis to give Parliament an early indication of what he met when he sat in the chair and cracked open the books.
The news will not be good, given what the previous administration has already reported.
The question is how much worse will we be told things actually are.
This would not take away from demands Davis will face to deliver on his promised VAT cut, which the PLP has already said would be reviewed after 12 months.
“The 12-month marker will give us enough time and enough empirical evidence to demonstrate whether that rate must continue to be 10,” said PLP Deputy Leader Chester Cooper, when he was shadow minister of finance.
Notwithstanding the PLP’s position that a VAT slash would be beneficial in the long run as it would spur activity in the domestic economy, a VAT cut right now would be an incredibly risky proposition.
The current projected VAT for 2022-2023 is $993.5 million. A cut in the 12 percent top line rate would be equal to a 16.3 percent drop in the yield.
That would equate to a $162 million cut in revenue. It would have to be “paid for” by an increase in revenue elsewhere or by a corresponding cut in spending.
The PLP argues that the tax cut would pay for itself.
Prior to the election, Cooper, the now-deputy prime minister and minister of tourism, aviation and investments, contended that the economic principles suggest that lowering costs will increase demand. He said the government could increase revenue by $200 million.
He said the PLP is satisfied with the results of its modeling that showed that government revenue can increase even with the VAT slash.
“We are comfortable that there will be no reduction in revenue; in fact, we believe there will be an increase in the overall revenue. We believe that number to be in the $200 million range and you can take that to the bank,” Cooper said.
“Basic economic principles say the lower the price, the higher the demand. We want to drive economic activity, we want to increase demand in the economy.
“What we saw when the VAT rate increased, the chamber of commerce and business people across the country said they noticed a decline in sales. So, we always said the VAT hike was too fast too soon.”
A respected fiscal analyst, who spoke with us at the time without any expectation of attribution, said in response: “The notion that it can be made up by increased economic activity is bullocks of the first order. That is Reaganomics that says that tax cuts pay for themselves.
“To pay for that would need over $2 billion in increased economic activity. This kind of cut in a precarious fiscal situation will most certainly lead to immediate downgrades by the rating agencies.”
The Minnis administration took the same position.
After the PLP revealed its planned VAT cut earlier this year, then-Minister of State for Finance Kwasi Thompson accused the PLP of “rank-populist politicking”.
“The opposition’s plan would lead to a dramatic fall off in revenue likely in excess of $100 million during their proposed 12-month period, at a time when the country’s fiscal resources are under tremendous strain and the needs for government to support social and economic programs are even more pronounced,” said Thompson in a statement.
“The government cannot operate by trial and error. The 12-month period will only destabilize the economy causing the PLP to have no choice but to return VAT to 12 percent the following year or increasing to 15 percent. The country needs stability and consistency.”
Imagine the Davis administration following through and cutting VAT, then in a year increasing it once again. That would for sure be a nail or two in its political coffin.
If it announces that it cannot now follow through on its pledge because of the bare cupboard, that, too, would be a nail or two in its political coffin.
Unwise
So, what will the new government do? What should the new government do?
Noted Caribbean economist Marla Dukharan said last week the Davis administration’s plan to lower VAT “does not sound like a wise move”.
Dukharan explained the government must have a plan to make up the shortfall in revenue somewhere else if it carries out this promise.
She said whether the government was motivated to make the promise to lower VAT because it was politically expedient or to genuinely assist the Bahamian people in the midst of the country’s social and economic crises, additional revenue sources must be sought at the same time.
Before deciding when to pull the trigger on the VAT slash, the finance minister would need clear updated modeling that shows how the revenue will be made up.
It is not enough to fulfill a campaign promise while placing finances in an even more detrimental position, especially in light of another recent downgrade by Moody’s.
In its plan, released shortly before the September 16 general election, the PLP also promised “additional VAT relief” and said it will “transform the tax system to make it more equitable and progressive, and to encourage national growth and prosperity”.
In addition to its plan to cut VAT, the Davis administration has pledged to “prioritize increasing revenue”.
Davis and the PLP now have what they fought for — a chance to govern.
It is now showtime for them — time to start putting in place the plans they touted over the many months leading to the September 16 general election.
If their plans — like the pledge to cut VAT — fall short in stabilizing finances and growing the economy, the fallout for the country would be more significant than what the PLP would no doubt face at the polls when that time comes once again.
Though we are not incredibly hopeful that their stated formula will improve our fiscal fortunes in any significant way, we wish them well as they confront the monumental tasks at hand.
The post The tax cut gamble appeared first on The Nassau Guardian.
source https://thenassauguardian.com/the-tax-cut-gamble/
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