There may be very little that people agree upon in The Bahamas, particularly when it comes to the three-letter word "tax."

Despite a consensus that nobody likes paying, there is general recognition that somebody must if government and all the services it provides are not to collapse.

And there is equal recognition that Bahamian dependence on stamp taxes and customs is fraught with vulnerability to both economic cycles and massive abuse, through direct avoidance or through sloppiness and apathy at the collection point. Corruption also

certainly finds a place in there.

About that point, consensus ends. There is wide variance on what kind of reformed tax should be applied, ranging from some form of user fees to value-added tax, collected by sellers of goods and services. Anything but the dreaded income tax.

Several dozen countries use some form of VAT, theoretically a tax on final consumption in the home market, collected at every stage of production and distribution.

The United States has been toying with a VAT to replace its corporate tax and it is recommended by the International Money Fund as one of the solutions to the Bahamian tax debate.

But not everybody thinks VAT is a good idea.

On a technical economic level, it has much to recommend it. The tax is built into the prices of goods and services and thus is rebatable at the border on exports, according to world trade law. Another advantage is that it does not fall on saving or investment. Against these advantages, however, are some very powerful disadvantages.

According to the U.S. Centre for National Policy Analysis and think tanks that examined VAT before introduction in Canada and New Zealand, it doesn't make much sense to impose a VAT at a low rate. Startup and compliance costs eat up a high percentage of revenue and therefore the rate would have to at least justify the cost of imposing it.

A second problem is that a comprehensive VAT can be very regressive. That is, it would take proportionally more out of the pockets of the poor than the rich. The U.S. centre said that though over a lifetime the tax would be proportional to income, there is no question

that the poor would pay more taxes under a VAT.

In most countries, efforts to relieve the poor involve exemptions. Usually, food and medical services are exempt, but in some, a large number of other goods and services are exempted as well. This erodes the tax base, requiring higher rates to achieve needed revenue, and greatly increases the complexity of the tax, thereby increasing the compliance cost yet again.

This all leads to the biggest problem with a VAT, its tendency to ratchet up.

When European countries, led by Britain, imposed VATs in the 1960s, most had rates

around 10 per cent. Today the average is about 18 per cent, according to the Organisation for Economic Development and Cooperation. It proved too easy for governments to piggyback on inflation and raise VAT rates as prices were rising anyway. People did not

notice the tax increases hidden in the price of goods and services. Consequently, the VAT proved to be a massive money machine that fueled a vast increase in taxation in every country that adopted it.

An OECD report last year showed the overall tax burden in Europe at 42 per cent of gross domestic product, compared with 30 per cent in the U.S. Before the VAT came along, U.S. and European tax burdens were comparable.

Politically VAT is a much more palatable solution than some others, but in the long run it's going to be at least as hard on Bahamian wallets as the alternatives.

Government services inevitably cost huge amounts of money. There's no way around that. The best solution remains prudence with expenditure rather than playing politics at the revenue end of things.

Posted Friday 12 September, 2003