Paying it Down

Three different scenarios show how Vanuatu’s debt to revenue ratio plays out between 2015 and 2030. If we take on more expensive EXIM loans, we could be in deep trouble, but only if we stop borrowing right now can be drop the debt load quickly. And that’s not going to happen. So new revenues are needed.

IMF 2015

This is part two in a series of Daily Post analyses, examining differing views on how to raise government revenues. This article makes the argument for an income tax.

The question of whether or not to impose some form of income tax ultimately comes down to how you calculate the government’s future spending needs.

One thing that everyone agrees on is that we’ve taken on a lot of debt in a very little time. Between 2010 and 2016, Vanuatu’s external public debt load more than doubled. It’s going to rise sharply in the coming years, as the grace period for a number of large loans reaches an end.

In an article in the July edition of the Vanuatu Business Review, one financial expert said, “there could be severe debt servicing issues.” The amount of money we’ve borrowed isn’t the problem, so much as the speed with which we took on the new loads.

In 2019, we’re going to see a spike in our debt service payments, which means that the country “does have a potential cash flow issue. Unless the revenue base expands [through] new initiatives or fast economic growth, there could be a problem.”

The recently released VCCI tax strategy report suggests that an increase in VAT, coupled with smarter spending and the sale of state assets, will be enough to address any additional revenue needs the country might have.

Government models aren’t so optimistic.

Details are frustratingly sparse, because the draft tax reform plan has not yet been approved. Officials are reduced to talking in generalities.

But one thing is abundantly clear: Officials are willing to pull more than one economic lever in order to make sure we weather the coming financial storm. They appreciate that a VAT-only solution might be simpler and less costly to implement, but they argue that the result is a short-term bump in revenues that quickly levels out, creating a plateau.

Asset sales, too, are a one-time benefit. Fiji was roundly criticised for overstating the benefits of asset divestment in their 2014 pre-election budget. Many said they used one-time income to hide a recurring shortfall.

The list of Vanuatu’s development challenges is dauntingly long. Health and education loom largest, and already we’re spending servicing our external debt than we are on both of them combined.

If the government is going to achieve even a simple goal such as joining every single school to the e-Gov network, it will need billions of vatu. Assuming even a modest implementation, the cost per location would be roughly VT 5 million per location. With nearly 500 schools, even the basic capital costs are equal to nearly 60% of the recurring education budget. And that’s ignoring operating expenses, replacement costs and programme development to actually use the services.

That’s just one example out of dozens of plans that are on the table today.

Income taxes are more complex to administer. Nobody doubts that. They do add to what’s known as ‘deadweight’ costs—that is, the time lost in uproductive labour such as filling out tax forms.

They also create perverse incentives. Tax avoidance—the perfectly legal practice of not paying more tax than one has to—is a common tactic wherever corporate or personal income taxes exist.

Officials admit that a salary tax, for example, is probably unworkable. Employers would just switch their staff to contract work. And that would set off the same vicious cycle of regulation and avoidance that makes the tax code of most developed countries indecipherable to non-experts.

But a corporate income tax, with appropriate thresholds to protect vulnerable businesses, might be enough to fill some of the revenue gap. It’s conceivable that annual revenue increases of as much as VT5-6 billion might result within two years.

That number could grow to VT7 or 8 billion if the country’s development plans take off and the economy grows rapidly.

At the end of the day, imposing an income tax is gambling on prosperity.

At the end of 2011, the VNPF had nearly 3,500 active companies on its rolls. That number is certainly higher now, and the bet is that it will rise significantly as upgraded wharves, roads and airports come online. The very same roads, wharves and airports that these taxes will be paying for.

Vanuatu’s development is a bootstrapping problem. We need to lift ourselves up using mostly our own strength. When we spend large sums on infrastructure, we hope to entice even larger amounts of investor spending on hotels, resorts, business facilities and the like.

If the gambit works, then we’ll see a surge in growth. That growth will be sufficient to keep an income tax from cutting off the economy’s oxygen supply.

That’s the logic anyway.

There are dozens of different tax permutations available to us. But putting nuance aside for a moment, we have three main options: VAT Only. VAT Plus Income Tax. Income Tax Plus VAT Reduction.

VAT Only won’t be enough, according to government models. Plus, it’s a regressive tax—it punishes the poor more than the rich.

Income Tax Only isn’t really an option. Dropping the VAT to a lower rate might be popular with consumers, but it might not generate enough new spending to offset the lost revenues.

If we accept the current thinking at Treasury, the question becomes: increase the VAT by how much, and what kind of income tax to impose?

The question can’t be answered just yet. We have to wait and see if the proposed revenue reform plan is going to get past the Council of Ministers; and then we’ll be able to get down to brass tacks.

The business community is champing at the bit to begin the dialogue.

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