Fiscal Strategy (P.44/2005): amendment (P.44/2005 Amd.) - comments

STATES OF JERSEY

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FISCAL STRATEGY (P.44/2005): AMENDMENT (P.44/2005  AMD.) – COMMENTS

Presented to the States on 19th April 2005 by the Finance and Economics Committee

STATES GREFFE

COMMENTS

1 In t r oduction

1. A  n  amendment to paragraph  (a)(i)  of the  Finance  and  Economics Committee's  Fiscal Strategy (P.44/2005) was lodged by Senator S.Syvreton 15th March2005.Paragraph (a)(i) of P.44/2005 outlines the  Committee's proposals for  a  broad based  Goods and Services Tax  (GST) taken  from  the

recommendations of its independent consultants Crown Agents.[1]

2. In the amendment's report it isclaimed that "Sales taxes are highly regressive and impinge upon those least  able  to  afford  them". The  amendment seeks to remedy this  by  excluding  from  the  tax  basic foodstuffs, children's clothing, medical services and products and books and newspapers. It is also claimed that "the few simple exemptionsought not to create any additional expenses or manpower requirement".
3. T h e problem is that the facts donotsupportthese claims. This comment will show that a broad-based GSTisnothighlyregressive, the exclusions listed are notsimpleand, if adopted,would significantly increase the cost of administration and compliance.
4. T h e reportalso recognises that "a financial cost will exist in respect of the revenue foregone if the amendments are approved". This pointisaddressed in section  2 and the claims in the amendment are addressed in sections 3 to6.

2 "  the revenue foregone"

1. M e mbers will recall that the projected revenue from the broadbasedGST is £45  million. CrownAgents have estimated that the revenue that wouldbe foregone if the amendments were approvedwouldbe over £5 million pounds before allowing for anyextra administration costs (see section  6)and loss due to non- compliance (see section  2.2). With the extra administration costsalonethe revenue foregone would be

over £5.6  million.[2]

2. C r ownAgents stress that basedon international experience there would bean additional shortfall in revenue directly as a result of non-compliance. They regard the opportunities that would be introduced for non-complianceasthemost damaging aspectof the proposed exclusions. It is impossible to forecast the additional revenue shortfall with any accuracy but thelevel would belinkedtoexcludingcertaintypes of supply. From the amendment'slistof exclusions food most certainly would havethebiggestimpact but all would be problematic.
3. T h e amendment offers no specific or detailed measures torecoupthe lost revenue,other than to vaguely suggest a "variety of progressive taxes targeted at those who could afford them most".[3]

3 " S a les taxes are highly regressive"

1. T h is is simply not the case.There are views that they arenot regressive at all.  Indeed the International Monetary Fundhas stated: "A single positive rate of VAT applied to the broadest possible baseis

essentially a proportional tax on consumption"[4].

2. N o netheless CrownAgentsdescribe their prototype broad based Goods andServicesTax with a 3% rate as having a slight regressivity. They demonstrate this in Table 1 which shows the effect on Island

households by comparing the expenditure on GST for each quintile[5]. The table then compares that regressivity with the tax if it were amended as proposed.

Table 1   G S T  as a percentage of household expenditure by quintile

Group 1 Group 2 Group 3 Group 4 Group 5

Broad Based (3% rate) 2.5% 2.5% 2.4% 2.4% 2.4%

Amendment (3% rate) 1.9% 1.9% 1.9% 2.0% 2.1% Source: Crown Agents

3. A l ternatively, Table 2 uses incometax return data,withinlimitationsofthe available data, toshow the impact  on taxpayers in each quintile  as  a  percentage  of income. This shows that  even  with  the amendment's exclusions thereis a very slight regressivity.

Table 2   G S T  as a percentage of taxpayer income by quintile

Group 1 Group 2 Group 3 Group 4 Group 5 Broad Based (3% rate) 2.2% 2.0% 1.9% 1.9% 1.9% Amendment (3% rate) 1.7% 1.6% 1.6% 1.6% 1.6%

Source: Crown Agents

4. T a bles 1 and 2 clearly show that the regressivity of the Crown Agents' broad basedGST is soslightasto be negligible – it certainly cannotbe termed highlyregressive.
5. T h e amendmentseeks to mitigate its claimed high regressivity byexcluding a numberofitems from the tax,  but  again  the tables  illustrate  that  the  effect  of the  exclusions  is so small as  to  be virtually insignificant.
6. T h e amendment'sreport makes itclear that thepurposeof the exclusions is to alleviate the impact of the tax on the less well-off. Itisworthexaminingwhat that impact is onthehouseholds in the quintiles. Table  3 shows that the actual benefit that wouldbe derived from the exclusions is extremelylow,infact the lowestincomehouseholds would only benefit by £80 per year.Incashtermsthehouseholds that would benefit mostarethose in the highest income quintile.

Table 3   E f fe c t on household expenditure by quintile

Rate Group 1 Group 2 Group 3 Group 4 Group 5 Broad-based 3%

Proportion of

untaxed

household 12% 15% 17% 17% 16% expenditure

Amendment 3%

Proportion of

untaxed

34% 33% 33% 31% 28% household

expenditure

Annual decrease in GST

£80 £119 £148 £168 £217 borne

Source: Crown Agents

4 " S a les taxes impinge upon those least able to afford them."

1. T a ble 3 clearly shows that the amendment's exclusions would not achieve much relief at all for the lower paid.
2. C r ownAgents have commentedon the useof exclusions to the tax as a means of helping theless well off and say: "In our view, an income support scheme is by far the best way of alleviating the impact on the

lower paid, rather than complicating the system with exemptions, etc."[6]

3. T h e Committee fully endorses this view and has consistently said that the impactofanynewtaxeson those on lowerincomeswouldhave to be relieved by the new IncomeSupportscheme.TheEmployment and Social Security Committeeisdue to lodge its proposalsfor the IncomeSupportSchemeon26th April.
4. T h e Finance andEconomics Committee fully recognise and support the need to protect those in our community who are vulnerable andhastakengreatcaretoensure that its overall tax package is fairand progressive.

5 "  the few simple exemptions"

1. T h e amendment proposes to exclude basic foodstuffs,children'sclothing, medical servicesand products and books and newspapers. Its report describes these proposed exclusions as "simple exemptions" whereas the opposite is the case and they are generally viewedas the most complex to define. (On a technical pointwhentheseitems are nottaxedin other countries they are zero-rated' as opposed to being

made exempt').[7]

2. O n thefaceofitbasic foodstuffs seems a reasonable exclusion from the tax, howeveritisuniversally accepted that they are themostcomplextypeof goods to define. In the U.K. there are morerules, procedures, rulings and staff dedicated tothe application ofVATonfoodstuffs than any other goods or service. Thereasons are obviouswhen thought, astheseexamples in paragraphs 5.3and5.4show.
3. If it is decided that confectionery is not a "basic foodstuff" where should the line bedrawn.Ifsweets are not a basic foodstuff, whatabout chocolate biscuits? If chocolatebiscuits are excluded from the tax, what about cakes? If cakes are alsoexcludedwhatabout Jaffa Cakes', are they a biscuit or a cake?This is no mere idle speculation, the problem of defining Jaffa Cakes' was long and protracted in the U.K.and is very likely to be revisited.
4. C a tering (including restaurant food)isnormallytaxedbutshouldtakeawaysbeincluded?Some food consumed off-premises is eligible for zero rating but then "premises" also needstobedefined.More problems emerge – what to do with food servedforimmediateconsumption from mobile kiosks/vans or at foodfairs' – are these to betaxedor not?
5. T h ere are similar difficulties in defining children'sclothing (e.g. will size bethe only criterion? – in the U.K. the methodof display is alsoimportant – to be eligible for zero rating theitems must also be "put up for sale" as children's clothing – this often necessitates a dedicated area of a shop); medical services/supplies (e.g. will all alternative medicinesbeexcluded?);and books and newspapers (e.g. does this include journals, periodicals, leaflets and will top shelf' magazinesbe in orout?).
6. T h eseare just someof the challenges that will arise. Far from being "simple exemptions" more intricate and convoluted examples could not have been chosen. This isnot hypothetical, it is basedonwell- documented live operational activities and experiences of GST/VAT administrations elsewherein the world.
7. T h e addedcomplexitywould ensure many more rulings having to be made, requests for extra-statutory concessions, and appeals before independentCommissionersofAppeal – whichwould all take research,

time and care to prepare. There would have to be more control visits by Income Tax auditors to traders' premises

to ensure the increasingly complex GST regime is being accounted for correctly. Any discovery of under declaration would lead to an assessment notice, and possibly penalties, which again would have to be subject to appeal. This would all lead to a spiral of control visits/compliance/ rulings/appeals which would be time consuming and contentious.

8. T h e CrownAgents have designed a simple system andtheCommitteeaccepttheir reasons for avoiding complexity. It is true that some countries have a numberofexclusionsor reduced rates in their GSTor VAT,but it is generally accepted that themost successful application of thesetaxes is in countries that have a simplebroad based tax with a single rateand a high threshold – similar to that proposedbyCrown Agents. In fact the countries generally held up as a good model for a GST are New Zealand and Singapore, where exclusions have been kept to a minimum.
9. It is also interesting to note that the exclusions listed in the amendment are generally subject to positive rates inmostof the E.U.memberstates.[8]

6 " [the exemptions] ought not to create any additional expenses or manpower requirement."

1. E x tra staff and moremoney would definitely be required if the amendmentweretosucceed.
2. T h e complexityof a GST/VAT style tax is a direct consequenceof the amountofpositive rates applied and the numberof exempted and/orzerorateditems.Themorethere are the morecomplex it becomes for government and business to administer and the more opportunity for avoidance. This leads directly to increased costs ofcollection/payment,compliance and regulation.
3. A d ministration costs fortheCrownAgentsprototypeGST have been estimated at£500,000 per annum. Crown Agentsestimate that a move to a GST with SenatorSyvret's exclusions would cost £1 million per annum. In other words they woulddouble.
4. C rown Agents estimated that 10 extra staff would be needed by the Income Tax and Customs Departments for the broadbasedGST. The amendment's proposed changes would move this requirement to approximately 20 additional staffbetweenthe 2 Departments.

7 C o n clusion

1. T h e Committee has made it veryclear that its proposalsfor the Fiscal Strategyshould be takenas a package.The individual elements of taxation, economicgrowth and, crucially, IncomeSupport have been designedtocomplementeachother. Overall they produce a progressive effect.
2. It iscommonandperhaps understandable that the inexperienced eye will view GST/VATtypesoftaxes as inherently and highly regressive. However as this comment demonstrates at worst they could be slightly regressive andthereis even an informed opinion that says they can be regarded as proportionate.
3. T h iscommentshows that the effect of the amendment'sexclusions would beto help the lowestincome households by the modestsumof £80 per year. Butatwhat cost? The increased complexity that arises in administration would double the government's costs from £0.5  million to£1 million and would double extra staff requirements from 10to 20. The experience of the U.K. shows that businesswouldalso suffer from the increased complexity. In shortthe benefit simplydoesnot justify the cost.
4. T h e CrownAgents have provided a prototypeGST that they havedesigned specifically with Jersey in mind. Atthe very core of their design is the broad-based taxation of all consumption. This follows the current  thinking  for best practice in such  taxes by keeping  the rate of tax as low as possible and minimising the administrative burden to government and business.TheCommittee is convinced that this is the best solution for the communityas a whole and that any adverse impacts on the lesswell-offare

better dealt with by targeted intervention through Income Support.

5. T h e current thinking in relation to the GST/VAT family of taxes can be succinctly summedupby this quote from therecent International Tax Dialogue Conferenceon the VAT –

" E x c lusions by exemption/zero rating (other than exports) are inconsistent with the basic logic of VAT - amongst other things they reduce revenue, are not simple to administer and tend to creep"[9].

6. M e mbers are urged to reject the amendment.

[1]

Crown Agents, Proposal for the Design of a Prototype Goods and Services Tax, January 2005.

[2]

Crown Agents emphasize that these figures and those included in the 3  tables in this comment are subject to the same caveats expressed in section  4.8 of their Proposal for the Design of a Prototype Goods and Services Tax.

[3]

Although not being proposed in the amendment members may find it interesting to note that if GST was to be used to recoup the lost revenue Crown Agents believe that to (a) produce the same target revenue yield, (b)  recoup the loss o revenue from non compliance, and (c)  cover the additional admin. costs, a 5% rate would probably be needed.

[4]

Ebrill et al, The Modern VAT, 2001, p. 106.

[5]

Each quintile has an equal number of households. Those in the first quintile have the lowest income per household while those in the fifth quintile have the highest income per household.

[6]

Crown Agents, General Guide to GST in the form of Frequently Asked Questions, February 2005, Q.37

[7]

Zero rating should not be confused with exemption. Exempt supplies are those that are not subject to tax (typically financial services, insurance and postal services). Businesses who make exempt supplies may not register for GST/VAT and therefore cannot recover GST on their business expenses. Any GST they incur sticks with them. Zero rated supplies are those transactions that are deemed to be taxable but at a zero rate. For social/political reasons this gives relief to the consumer on certain items while enabling the registered trader to recover VAT on business expenses. It provides the maximum possible benefit to businesses and traders alike but obviously has an impact on tax yield. Zero rating applies also to exports, thereby enabling exporters to be competitive in a world market.

[8]

A  table  showing  the  lowest  rates  applied  to  foodstuffs,  children's  clothing, medical  services/products  and books/newspapers in the E.U. member states (and Singapore and New Zealand) is annexed to this comment.

[9]

Professor Richard Bird, University of Toronto and consultant to the World Bank. (The International Tax Dialogue was the first global conference on VAT and was held in Rome on 15-16th March 2005. It was jointly organised by the OECD, the IMF and the World Bank and attended by approximately 100 countries.)