Crafting the optimal budget

As we head to the reading of the budget, I am sure that there are some serious considerations to be made by the crafters. This has been exacerbated by what has been happening globally recently, not least of which are the revised downward projection of the Jamaican economy by the IMF and the fact that Europe seems to be falling apart, with the UK and Spain going into a double dip recession, and countries like Holland and France facing some serious challenges.

In addition the last US employment numbers show that they are not yet fully recovered and China's economy has been slowing.

These considerations are things to seriously consider as we craft our already late 2012/13 budget. It is quite possible that we may not have an IMF agreement finalized by the time the budget is read. The recent attempts to raise funds from the capital markets is also indicative of the realization that the only way we are going to craft a credible budget is accept the fact that we have to increase the debt stock, as my view is (an always been) that raising taxes is only a certain way to further sink the economy.

The fact that Europe seems to be going into another round of recession should come as no surprise, and I remember in 2010 when the UK announced its fiscal austerity measures that both Ralston Hyman and I were on radio saying that it was the wrong way to go and it would only serve to contract the economy further. At the time also we said that the new taxes that were imposed on the Jamaican economy and the cut back in capital expenditure, would also contract the Jamaican economy.

Both situations are really just a classic example of pro and anti Keynesian arguments. As far as I am concerned Keynes has won again and the US, being cognizant of the argument Keynes made after the 1930s depression, was careful to stimulate the economy rather than apply harsh fiscal austerity measures. The result is that it is going to take Europe a very long time to recover from this mistake, and in the process they may have retired the Euro.

As we go into the 2012/13 budget, the lessons from Europe, the US, and our own recent experience is clear, as Timothy Geitner said, we cannot grow the economy by contracting government expenditure. This argument that the private sector will jump in and take up the slack is one of the most flawed arguments I have heard coming from persons who are supposed to know better. If we go back to Economics 101 it tells you that private firms are motivated by profit.

Where there is no aggregate demand the possibility of profits are reduced, so you will find a very cautious approach from new entrants into the market. Where there are new entrants they will mostly be from small and micro businesses, which means that the time it will take for private firms to the void (without government stimulus - or fiscal contraction) will be longer than is needed. Even in the US where new businesses have a more immediate impact they still needed the stimulus funds to get their economy growing, and even so it is just grinding along.

The argument against stimulus for Jamaica is that we are heavily indebted and we were not generating surpluses prior to the recession. That argument sounds good if one is writing a text book. But when you are talking about the livelihood of people and the worst recession in our lifetime, then text book arguments just don't cut it alone. We need to be practical. I mean if I owe money, and at the same time I am dying of hunger, do I postpone eating because in order to do so I have to borrow. Or do I borrow to satisfy my hunger, and keep from dying, and then by eating I will have the ability to consider how to deal with the debt.

The fact is that because we have impractically convinced ourselves that we could not afford new debt we ended up causing the economy to contract. And this inability to face reality has not helped us because we have ended up having to go to the capital markets anyway for new debt. So what was the purpose of the argument against expending the debt. What we have to understand is that when we contract fiscal expenditure, causing a contraction in the economy, all we end up doing is increasing the debt/GDP ratio anyway, as GDP is not growing and the debt grows by virtue of interest costs.

So as we go into the new budget, even though it is going to be very tempting to continue our old ways of taxing to close the fiscal gap, we must change the way we approach fiscal policy by focusing on expanding the economy rather than the narrow focus of just closing the fiscal gap. As an accountant I know what it must be like to be faced with a cash flow crisis and want to do everything to solve that crisis immediately. However, the approach should not be just to focus on an immediate cash solution to the detriment of the future development.

I do not expect that it will be easy for the government, assisted by the technocrats, to craft this budget, but we will need to change the way we think about the solutions and employ a more strategic long term view. Within the context of our social and economic structure we have done well to keep the ship afloat but it is time to start sailing and not just stay afloat.

In my view the solution to the fiscal crisis lies in solving the balance of payments problem as well as ensuring that capital infrastructure work continues. Luckily for us these two avenues are open to us immediately, and the ministers in charge have been speaking about the right things to be done and seem to be moving ahead with the implementation. These are the energy and transport and works ministers.

If Paulwell has his way and can implement a greater use of renewable energy at home and get competitiveness in energy distribution then we can significantly positively impact the balance of payments through lower oil imports.

If Dr Davies can get the transport system properly organized, which means less traffic congestion and a better alternative to private motor vehicles he can also positively impact the balance of payments. Additionally, if he can get the infrastructure project rolling then this will provide much needed stimulus to the economy.

So as we approach the budget reading we need to bear these things in mind to ensure our long term development.

Budget faces toughest fiscal crisis ever

IN a matter of weeks, we will see the 2012-13 budget revealed, amid a fiscal crisis that may be the toughest we have ever had to face. Economic growth is not going to be sufficient to bring in the revenues needed, expenditure (and in particular loan payments) will be higher than last year, and any move to seek further loans to close the gap (outside of the IMF or other multilaterals) will have a negative effect on interest and exchange rates.

With an IMF agreement in abeyance for over a year, you could surmise that any additional loans from that source could come with demands for significant structural reforms. Saying that we are stuck between a rock and a hard place is an understatement.

But is it any surprise? A few of us have been saying that the IMF agreement that was entered into in 2010 was not very practical and would lead to the contraction of the economy. I remember having this same conversation with someone the month after the IMF agreement came into force. I told him then that I would talk to him again in November 2010, and contrary to what he said, I was confident that the economy would contract. I have not seen him so I am unable to collect.

I would not like to be in the shoes of the finance minister or other Cabinet members; They must be kicking themselves about being accountable for this problem that they didn't immediately cause (I say immediately because all governments since the 1970s must take some responsibility for where we are today).

For the first time since I started commenting on the economy, I find it difficult to see a solution to our problems. Not only the fiscal problem, but more importantly the increasing balance of payments deficit, poorly functioning institutions, high levels of bureaucracy (the one shining example of what is needed is the tax administration of Jamaica, TAJ), relatively high levels of crime, and general indiscipline in the economy (e.g., a failure to enforce simple things like the Noise Abatement Act).

If you think about the fiscal and balance of payments challenges, you will get an idea of where I am going.

Some positive moves have been happening but these need to be implemented much faster if we are to have any hope. The first one is the energy policy being proposed by the energy minister, and in particular the push for renewable energy and competition in distribution. We are still going ahead with LNG, which is not going to be the panacea many expect. But if we get the other thing right, then even if the LNG project fails we will still be okay.

The clampdown by the transport ministry on the illegal taxis is commendable. Indiscipline and illegality must not be accommodated, even if some want to say that we are "boxing food out of peoples' mouth". This is a bold move that I commend the ministry for.

Similarly, the increase in police personnel dealing with road indiscipline generally, and trying to deal with organised crime. The commissioner and security minister must continue with this trend but we need to have greater urgency in the implementation. One thing I must comment on is that the month-to-month comparison of the murder rate is the right way to compare murder. The way we used to compare murders, by looking at the same quarter in consecutive years, is senseless. The only reason for doing that would be if what you are comparing is seasonal. Murders are not seasonal, so they should be compared on a continuum.

These initiatives will not be featured in the budget, but they are important things to do to solve the fiscal challenge, for without creating a proper social environment the economics will not work. This social issue is at the root of our anaemic IMF growth projections of one per cent for the next few years, and 1.5 per cent in 2017. I do not know why we should be surprised, though, as the IMF projections, for example, have us increasing oil as a percentage of GDP from 14 per cent to 14.5 per cent, thus ensuring we remain uncompetitive.

Another point is the narrow focus we have always had on the debt/GDP ratio. I hope that the great concern with this ratio is fading, as certainly the past two years should have illustrated that we cannot come out of our problems by just focusing on cutting expenditure and restructuring debt. To grow GDP in any significant way (in addition to dealing with the social issues) we will need to fund certain major infrastructure projects. Any attempt to impose additional taxes will shrink the economy further without achieving the targets.

We must look at projects like the highway development, Vernamfield aircraft maintenance facility, and upgrading of the ports to prepare ourselves to benefit from the expansion of the Panama Canal. Instead of removing the GCT on electricity, the revenues from this tax could provide a short-term boost to the balance of payments by funding a credit to tax-compliant individuals for setting up solar solutions at home.

It is only through making these bold decisions that we will see any long-term sustainable improvement in both our fiscal and trade situation.

Tax Compliance

Tax compliance is being touted as one of the ways to raise the needed revenues, and has been promoted as such for a few years now. I do not think that the tax is out there is, and we will spend more on enforcement than we will actually collect.

However, it is necessary for us to ensure as much compliance as possible and support the Tax Administration of Jamaica (TAJ) in its effort. The TAJ, has made significant strides in the transformation of the tax culture and the service delivery by tax departments. Other organisations need to follow this example.

We always seem to try to do things such as compliance the hard way. The easier way would be to move more towards consumption taxes, which are more difficult to avoid, rather than direct taxes.

The other point about compliance is that the Government needs to understand that it is a two-way street, and that when they do not provide tax refunds in a timely manner to tax payers that they are also out of compliance.

The importance of correct tax reform

As we are approaching the completion of the white paper for tax reform it is very important that we understand the importance of getting the tax reform process correct. When this administration came to power in December 2011, Minister Davies said shortly after that the administration would extend the timeline for the tax reform agenda, as it was very important to ensure that proper consideration was given to the process. I totally agreed with him, because the green paper I felt would not have provided us with the necessary impetus for any long-term benefit, rather just delivering temporary fiscal space, which is how we have approached tax policy in this country for a long time.

In fact the last time any significant effort was made to use tax policy to positively affect the economy was in the mid-1980s. Every other time we have changed tax policy has been to provide additional revenue for the fiscal accounts, at the expense of the economy.

In fact I believe that we have become so accustomed to thinking about the government accounts even before the economy, that the private sector when making proposals about taxation measures always seem to be more concerned with maintaining or improving government finances than the economy. This while they seek to eke out some benefit for the private sector, by apparently not upsetting the government's voracious and never-ending appetite for taxes.

This is demonstrated in the fact that the latest private sector proposal seems overly concerned with providing the government coffers with an additional $7 Billion, in the hope that the government will allow some of the much needed reform as outlined in the proposal.

This I think is the main problem with how we approach, not only tax reform, but economic solutions. Our primary focus on the fiscal accounts, to the detriment of the wider economy, always gets us into a worse fiscal situation. The evidence is there for all to see and analyse.

So as we prepare to finalise the tax reform white paper, we must ascertain what objective we are trying to achieve through tax reform. Will we continue to focus on the fiscal accounts, and try to pull more money from the economy to fill the significant fiscal gap we face, or will we be bold enough to apply apropriate measures that will lead to economic development and a better long-term fiscal situation? This is what countries like the US did by reducing the tax rate in order to allow for greater economic activity. We will not be able to approach it in the same way, as we have other social issues that would prevent maximum value, but our approach must be in that direction.

Our approach to tax reform should include measures to ensure that there is greater growth in the economy. If we have this as our objective then we can look at the various proposals and determine how the economy will benefit from their implementation. I will address some of the major proposals.

The first thing is the matter of the expansion of the GCT on basic items, while at the same time lowering the rate across the board and having a more targeted welfare system. This to me seems like a logical argument, as currently most of the benefit from the exempted items goes to the higher income group which has the ability to spend more than the lower income group. If we are able to better target these benefits to the lower income group then it does make sense to go with this proposal, as it will mean that, contrary to the emotional responses, more money will get into the hands of the poor. The key to this is to ensure that we have an efficient means of targeting the benefits to the poor.

The second proposal of lowering the corporate tax rate to 15 per cent, for most companies, is a desirable objective, in my view. However, it is more important to ensure that rate reductions happen first with the PAYE group, as the propensity to spend is greater in this group, which will have a more positive effect on the economy. If we therefore need to phase the reform proposals, as I think is the prudent thing to do, then I would marginally reduce the corporate tax rate (to maybe 25 per cent), while having a much steeper reduction in the PAYE rate.

This takes me to the proposal to increase the GCT rate for the tourism sector. One of the challenges here is that there needs to be further consultation with the hotel sector, in order to do some simulation on how this would affect their own viability and the economy. It is important to consider this carefully as the hotel industry is extremely important to the economy as a whole and any attempt to increase the GCT rate that negatively affects the sector could have a devastating impact on our foreign exchange earnings, which could be hard to reverse.

One other proposal, which I would not agree with, is to remove the 50 per cent tax break for the companies that list on the Junior Stock Exchange, for the second five years of their listing. If you think about it, this is a small price to pay for the benefit of formalisation and increased employment that arises from the listings.

My own view is that we need to eventually move to a regime of consumption taxes and totally eliminate direct taxation, as this will cause a greater multiplier effect of money in the economy and also is less of an administrative burden for the tax authorities. The argument against consumption tax is that it is a regressive tax on the poor. While this may be so, correct tax reform will lead to greater income from a more vibrant economy, and coupled with a more efficient welfare distribution method, this will outweigh the negatives of moving to an entirely consumption-based tax system.

Whatever we decide to do, we must be guided by the principle of economic stimulation, rather than the usual narrow focus on the fiscal accounts. Getting it wrong again, as we did with the recent tax packages, could have a devastating effect on the economy. Are we capable of making the needed bold decisions?