This is the first in a series of Daily Post analyses, examining differing views on how to raise government revenues.

Calculating the right tax level is extremely hard. Any money you take in tax is money that doesn’t get spent on other things. But without tax, government has no money to spend on social programmes and service delivery. So if we want new infrastructure projects, better schools and hospitals, then we need more revenues. Somebody’s got to pay.

The question is: who pays, and how much?

People who advocate against income tax argue that increasing the VAT is not only the simplest solution, it’s the one that stands up best to a cost-benefit analysis.

Martin St Hilaire is president of the Vanuatu Financial Centres Association, a private sector group. In an exclusive interview with the Daly Post, he laid out the case for using the VAT to address the country’s rising revenue requirements.

“As an accountant and auditor,” he says, “I would be fine” with a new income tax. “I’d make more money because people’s accounting would be more complicated.”

“But I just don’t think it’s the best answer,” he adds.

A report prepared for the Chamber of Commerce claims that it could cost businesses an average of 70 hours additional time spent complying with a more complex tax regime than the current one.

Most businesses here use what’s known as cash accounting. In a nutshell, you count income from the moment you get paid, and you count outflows from the moment the money leaves your account. That keeps things pretty simple for small business owners.

But if an income tax were put in place, St Hilaire claims that most businesses would have to move to an accrual model. Under accrual accounting, you count income from the moment a deal is done, even if you don’t actually receive payment right away.

Likewise with expenses. You count your expenses from the moment you get the bill, rather than when you actually pay it.

This may not seem like a big deal, but St Hilaire claims that this added time and expense comes at a cost.

Time spent keeping track of what you owe the government is time lost managing other aspects of your business. For small businesses with tight margins, this can make a big difference, he says.

St Hilaire also claims that an income tax costs more to the government to administer. The VCCI report adds fuel to this argument, claiming that “Experts agree that income taxes are generally easier to plan and avoid compared to VAT.”

Others agree that a straight up salary tax would likely result in the vast majority of permanent employees being shifted to contract work in order to avoid paying.

St Hilaire insists that there’s more to it than just that. “Income tax is really a rich country’s tool.” There has to be a large enough base of wealthy people for a progressive income tax to be a significant revenue generator, he says.

Vanuatu’s employment base is too small to support significant income tax revenues, he says. The Vanuatu National Provident Fund had fewer than 25,000 active members at the end of 2011 (the last date for which statistics are available). “That includes my gardener and my housegirl,” says St Hilaire with a smile. “We can’t expect them to pay much income tax.”

He claims that the people who will be penalised most are those whom we need the most. The VCCI report states: “At 6.8 mean years of schooling Vanuatu sits lower than both the global average (8.2 years) and the average in East Asia and the Pacific region (8.6 years) making intellectual capital a particularly scarce resource.”

“There is a local elite of highly skilled professionals here,” says St Hilaire, but it’s inevitable that some skills and disciplines are under-represented or even missing. A country as small as Vanuatu has no choice but to seek these skills beyond its borders.

Every home team imports a few ringers, he says.

A professional thinking about working in Vanuatu is going to be asking how much of his salary stays in his pocket at the end of the day. So if he’s hit with a 20% income tax, for example, the extra money is going to come from the employer. And the employer is going to pass on that additional cost to the customer.

How is that different from a rise in the VAT rate? Both kinds of tax have a stifling effect on the economy, he admits. But the VAT is simpler, and the base is broader, he says. Even people in the informal economy pay into it eventually, when they pay for transport or goods in a store, for example.

St Hilaire accepts that poor people carry a heavier burden under consumption taxes. Because their income is smaller, the relative amount they pay is higher. When someone is hovering near the poverty line, this can make a crucial difference.

Asked if a VAT increase will be sufficient to get us over the impending cash flow crisis when a number of big ticket debts come onto the public books in 2019, St Hilaire suggests that institutional lenders are likely to be flexible if it becomes evident that the government cannot meet its obligations.

In response to a question concerning the disagreement between VCCI’s forecasts and the governments’, he expresses frustration that the private sector has yet to see what numbers the government is using. “If they would share them with us, maybe we could have a better conversation. Maybe they’d change my mind.”

A decision by the Council of Ministers on whether to proceed with a draft revenue reform plan was delayed again yesterday. It’s unlikely now that action will be taken before August.

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