Local News>The 2008/09 Budget - A review Financial Gleaner

Minister Audley Shaw's 2008/09 Budget presentation in Parliament last Thursday was the first by a Jamaica Labour Party (JLP) administration in 20 years.

Much expectation accompanied the change in administration with the Jamaican public anxious to see delivery on pre-election promises and implementation of measures to stimulate economic growth and development.

In light of Jamaica's current fiscal situation, the options open to the Government in the short-term are relatively limited.

Further, the Government has had to contend with the effects on Jamaica's small open economy of spiralling oil and commodity prices, the sub-prime mortgage crisis, US recessionary fears, et cetera.

The 2008/09 Expenditure Estimates (totalling $489.5 billion) were tabled in Parliament on March 27, 2008.

The minister subsequently outlined how this would be financed in his presentation on April 10.

Our observations below will focus on some of the fundamental assumptions on which the budget is predicated and our perception of the effectiveness of the announced fiscal measures.

We also comment briefly on how we feel that the budget process could be adjusted to facilitate greater certainty among the population as to what may be expected in the medium term.

KEY ASSUMPTIONS/PROJECTIONS

Real GDP Growth: Jamaica achieved real GDP growth of only 0.9 per cent in FY 2007/08, versus the three per cent projected by the previous administration. The Government has projected real GDP growth of three per cent for FY 2008/09, triple the rate achieved in 2007/08.

This is to be viewed against a slowdown in economic activity over the past several months due undoubtedly to the vagaries of the weather following Hurricane Dean last August.

Ominously, it is now accepted that the United States, our major trading partner, is experiencing a recession, only the third since 1990. The same factors that are contributing to the global slowdown, record high oil prices, rising commodity prices and the fallout from the sub-prime crisis will work against the realisation of the growth target.

The minister recognises these challenges but asserts that, "The correlation between Jamaica's economic performance and the US business cycle has not been strong and the sources of the main financial flows, tourism and remittances have become less sensitive to these business cycles."

This sounds similar to the experience of major Latin American economies, which feel that they may have 'decoupled' themselves from the United States, having achieved growth averaging five per cent per annum since 2004 (Economist April 12-16). This would also be supported by the technical assessment available to the minister.

Inflation: The 2008/09 Budget is predicated on an inflation rate of 10 per cent for the fiscal year. The Government has also assumed that inflation will fall to 8.0 per cent in FY 2009/10 and seven per cent in FY 2010/11. The inflation rate in FY 2007/08 was 19.7 per cent (target was seven per cent).

Against the background of increasing oil prices and other factors mentioned above, it is difficult to insulate Jamaica from the global price pressures in the present economic environment, thereby making our likely inflation levels harder to predict.

Fiscal deficit/GDP: The country performed worse than budgeted in FY 2007/08 with expenditures exceeding revenues (that is, a fiscal deficit) by J$37.639 billion. This was over J$2.5 billion greater than budgeted.

The previous administration set a target of balancing the budget by 2005/06 but this proved to be unrealistic. We recorded a fiscal deficit of 3.3 per cent in that year and this worsened to 5.3 per cent of GDP in the following year.

In 2007/08, the deficit fell to 4.7 per cent of GDP. This administration has again set a target of balancing the nation's budget by 2010/11 with an initial target deficit of 4.5 per cent for FY 2008/09.

Obviously, success in this regard will be dependent on significant improvements in revenue flows, to be buoyed by the predicted growth in the economy and significantly increased tax compliance. We comment further below on our perspectives on the effectiveness of the major revenue measures.

Jamaica's mounting debt burden: Jamaica's national debt passed the one-trillion-dollar mark without much fanfare towards the end of FY 2007/08.

The country's debt to GDP ratio declined, however, to 126.1 per cent (from 132.4 per cent in FY 2006/07).

The Government announced the target of a 100 per cent debt to GDP ratio by 2010/11.

FY 2008/09 interest costs are projected to increase by 19.5 per cent over FY 2007/08 levels.

The effect of this is that interest payments will represent nearly 41 cents of every dollar of recurrent expenditure incurred.

Debt service costs (being interest plus principal repayments) are expected to increase by 25.1 per cent and will represent approximately 54 cents of every dollar spent by the Government.

This is driven by increased borrowings, higher interest rates as well as the depreciation of the Jamaican dollar particularly since Euro and US dollar obligations comprise 21 per cent and 73 per cent, respectively, of the nation's external debt.

THE BUDGET PROCESS

Some years ago, the previous finance minister had undertaken to change the process to facilitate greater input from the Parliament and wider society in the development of the revenue proposals.

This we recall was after major controversy surrounding amendments to the General Consumption Tax regime some years ago, which resulted in the reversal of many of the initiatives that had been announced.

We recommend that this process of greater involvement of stakeholders in the budget process be revisited and adopted.

We also believe that the Government should adopt a system of rolling budgets, whereby broad targets would be fixed over (say) a five year time frame. Each year, an additional year would be added to the programme as the previous year is removed. This would facilitate greater certainty amongst stakeholders, particularly businesses which need certainty in order to plan their affairs. It would also demonstrate in more concrete terms, the mechanism through which Government intends to meet its medium term targets and objectives.

REVENUE MEASURES

Revenue targets: The revenue budget calls for a 20 per cent increase in tax revenues to $262.7 billion, requiring new taxes of about $3 billion. Given the measures that have been announced and the impact of the relatively high rate of inflation that we have been experiencing over the past several months, we believe that this is attainable.

Administrative reforms: "We are going to deal with the issue of compliance and we are going to deal with it in a serious way … " is how Minister Shaw introduced the discussion on improving compliance systems.

Without listing all the measures that were announced, we feel that the following have the greatest potential for making meaningful adjustments to the effectiveness and efficiency of the system:

Tax amnesty: This measure has been presented by the minister as an avenue for alleviating the "stresses and strains" on taxpayers over recent years. He indicated that the tax amnesty will represent a waiver of interest and penalties, in respect of all tax types, once the principal sum owed is paid in full. If the arrears of principal are paid in full by June 30, 2008 the interest and penalties will be waived in full.

Thereafter the following levels of waiver of penalties and interest will apply:

31 July 2008 80%

31 August 2008 50%

30 September 2008 40%

31 October 31 2008 20%

It has the potential to facilitate an expansion of the tax net - 'bringing in the wolves'. The benefit could be greater than the mere collection of taxes that would otherwise not be paid, to the extent that it allows the Revenue Department to develop records on taxpayers who were not previously in the net and would not otherwise have been in the net.

The effectiveness of this measure will be dependent on the extent to which persons who do not take advantage of the opportunity are caught and penalised. It must be demonstrated that it is expensive to be non-compliant.

If it is not demonstrated that the monitoring and surveillance systems are in place to avoid the significant non-compliance that is now evident, persons including those who are presently compliant will not be inclined to enter/stay in the system and compliant persons will feel cheated.

We will need to await the enabling legislation to ascertain how a number of critical elements will work in practice (for example whether taxpayers with ongoing disputes will benefit).

Improvements in collection performance: From our perspective, the systems and resources (human and other) devoted to collection of taxes require substantial enhancement and have the potential to significantly improve the revenue performance. The extent of delinquency amongst some tax-payers (or non-taxpayers) speaks for itself and we feel that the reintroduction of the Revenue Protection Department (RPD) and the attack on corruption and fraud in the system are meaningful initiatives that could have a major positive effect. In this regard we feel that a more analytical approach (including more strategic use of the TRN) to identifying recalcitrant persons and a more focused and informed approach in pursuing them have the potential for yielding rich dividends for the revenue.

Dividends/removal of with-holding tax - effective January 1, 2009: The removal of withholding tax on dividends will be welcomed by most, in particular groups of companies which suffer the cash flow disadvantage when their subsidiaries pay the tax up to their holding companies. Many persons will interpret this as the outright removal of taxation on dividends, but this is not the intention from what the minister said. Local taxpayers are still expected to include the dividend income in their income tax returns and non-residents will continue to suffer withholding tax on dividends that they receive at the appropriate rates (25 per cent, 33.33 per cent or some lower treaty rate).

However, the new mechanism will reduce the tax-take from this source, since collecting at source is always more efficient than collecting from the final taxpayer, hence, the relative success of GCT and PAYE when compared to corporate income tax. This category is said to have been complying only at the level of 17 per cent in 2004. Government appears to recognise that there will be leakage in the new regime since it is making a provision for a tax cost of $130 million.

Ultimately, we must address the fact that the corporate tax rates are now too high when benchmarked against regional and international standards. From a position where the corporate tax rate was probably the lowest in Caricom in the mid 1980s, we are now amongst the highest.

With an effective overall tax rate of just over 50 per cent for profits earned by a company and distributed to individual shareholders (55 per cent if the dividends are paid up through a parent company), Jamaica's overall corporate tax rate is now higher than what obtains in our major CARICOM partners. In Trinidad the overall tax paid on company profits is only 25 per cent (for residents) and the comparable figure in Barbados is approximately 34 per cent.

Reduction in transfer tax & stamp duty - effective May 1, 2008: Transfer tax on property (land and securities such as shares) transfers is to be reduced to 6 per cent. This includes transfers on death and apparently capital distributions by a company.

The minister also announced that stamp duty on property transactions shall be reduced by one per cent from its current rate of 5.5 per cent to 4.5 per cent with effect from May 1, 2008.

The impediment to economic activity presented by these taxes is undoubted and was commented on extensively by the Matalon Committee which had recommended the removal of transfer tax on securities transactions, the reduction of the tax to five per cent on land transactions and the complete removal of the stamp duty. The previous Government had started the reform in this area by reducing transfer tax on death to 7.5 per cent.

This measure will undoubtedly encourage economic activity and must therefore be seen as going in the right direction.

Customs user fees - effective 1 July 2008: Manufacturers will be permitted to claim the Customs user fees (CUF) paid on machinery and equipment (only) used for production purposes as a tax credit. The credit is available in the following year of assessment. He did not indicate whether this credit will be available for refund if there is no tax to pay, but we hope that as a minimum, the legislation will permit the carry-forward of amounts not utilised in a particular year.

Again, this is another measure that will be welcomed by the manufacturing sector which opposed the imposition of the CUF when it was introduced in 2004, even if the sector was hoping for a complete removal of the fee.

Motor vehicle imports - changes to the tax regime effective May 1, 2008: The minister announced a reform of the GCT rate structure applied to motor vehicle imports.

The simplification of the rates applicable to motor vehicle imports will make the system more understandable, but the change will increase the overall tax on motor cars, hence the projected yield in revenues of $985 million, including the effects of tightening the duty concessions and the ban on damaged vehicles.

For example, a car with a 3000 cc engine which previously attracted GCT of 51.28 per cent will now attract SCT of 35 per cent, plus GCT of 16.5 per cent.

However, in imposing a Special Consumption tax in lieu of GCT, there is a compounding effect, since SCT forms part of the base in calculating GCT.

Furthermore, whereas part of the GCT paid on cars was recoverable if the car was used in a 'taxable activity', the SCT element will be totally unrecoverable.

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