F&E Comment on Syvret amendment re GST exclusions

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. Introduction

1. An  amendment  to  paragraph (a)(i)  of  the  Finance  and  Economics  Committee's  Fiscal  Strategy (P.44/2005) was lodged by Senator S. Syvret on 15th March 2005. 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][1]
2. In the amendment's report it is claimed 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. The problem is that the facts do not support these claims. This comment will show that a broad-based GST is not highly regressive, the exclusions listed are not simple and, if adopted, would significantly increase the cost of administration and compliance.
4. The report also recognises that "a financial cost will exist in respect of the revenue foregone if the amendments are approved". This point is addressed in section 2 and the claims in the amendment are addressed in sections 3 to 6.

2. "the revenue foregone"

1. Members will recall that the projected revenue from the broad based GST is £45 million. Crown Agents have estimated that the revenue that would be foregone if the amendments were approved would be over £5 million pounds before allowing for any extra administration costs (see section 6) and loss due to non-compliance (see section 2.2). With the extra administration costs alonethe revenue

foregone would be over £5.6 million.[2][2]

2. Crown Agents stress that based on international experience there would be an additional shortfall in revenue directly  as  a  result  of  non-compliance.  They  regard  the  opportunities  that  would  be introduced  for  non-compliance  as  the  most  damaging  aspect  of  the  proposed  exclusions.  It  is impossible to forecast the additional revenue shortfall with any accuracy but the level would be linked to excluding certain types of supply. From the amendment's list of exclusions food most certainly would have the biggest impact but all would be problematic.
3. The amendment offers no specific or detailed measures to recoup the lost revenue, other than to vaguely suggest a "variety of progressive taxes targeted at those who could afford them most".[3][3]

3. "Sales taxes are highly regressive"

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

essentially a proportional tax on consumption"[4][4].

2. Nonetheless Crown Agents describe their prototype broad based Goods and Services Tax 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][5]. The table then compares that

regressivity with the tax if it were amended as proposed.

Table 1 GST 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. Alternatively, Table 2 uses income tax return data, within limitations of the available data, to show the impact on taxpayers in each quintile as a percentage of income. This shows that even with the amendment's exclusions there is a very slight regressivity.

Table 2 GST 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. Tables 1 and 2 clearly show that the regressivity of the Crown Agents' broad based GST is so slight as to be negligible – it certainly cannot be termed highly regressive.
5. The amendment seeks to mitigate its claimed high regressivity by excluding a number of items from the tax, but again the tables illustrate that the effect of the exclusions is so small as to be virtually insignificant.
6. The amendment's report makes it clear that the purpose of the exclusions is to alleviate the impact of the tax on the less well-off. It is worth examining what that impact is on the households in the quintiles. Table 3 shows that the actual benefit that would be derived from the exclusions is extremely low, in fact the lowest income households would only benefit by £80 per year. In cash terms the households that would benefit most are those in the highest income quintile.

Table 3 Effect 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. "Sales taxes impinge upon those least able to afford them."

1. Table 3 clearly shows that the amendment's exclusions would not achieve much relief at all for the lower paid.
2. Crown Agents have commented on the use of exclusions to the tax as a means of helping the less 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][6]

3. The Committee fully endorses this view and has consistently said that the impact of any new taxes on those on lower incomes would have to be relieved by the new Income Support scheme. The Employment and Social Security Committee is due to lodge its proposals for the Income Support Scheme on 26th April.
4. The Finance and Economics Committee fully recognise and support the need to protect those in our community who are vulnerable and has taken great care to ensure that its overall tax package is fair and progressive.
   5. "the few simple exemptions"

1. The amendment proposes to exclude basic foodstuffs, children's clothing, medical services and products and books and newspapers. Its report describes these proposed exclusions as "simple exemptions" whereas the opposite is the case and they are generally viewed as the most complex to define. (On a technical point when these items are not taxed in other countries they are zero-rated' as

opposed to being made exempt').[7][7]

2. On the face of it basic foodstuffs seems a reasonable exclusion from the tax, however it is universally accepted that they are the most complex type of goods to define. In the U.K. there are more rules, procedures, rulings and staff dedicated to the application of VAT on foodstuffs than any other goods or service. The reasons are obvious when thought, as these examples in paragraphs 5.3 and 5.4 show.
3. If it is decided that confectionery is not a "basic foodstuff" where should the line be drawn. If sweets are not a basic foodstuff, what about chocolate biscuits? If chocolate biscuits are excluded from the tax, what about cakes? If cakes are also excluded what about 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. Catering (including restaurant food) is normally taxed but should takeaways be included? Some food consumed off-premises is eligible for zero rating but then "premises" also needs to be defined. More problems emerge– what to do with food served for immediate consumption from mobile kiosks/vans or at food fairs' – are these to be taxed or not?
5. There are similar difficulties in defining children's clothing (e.g. will size be the only criterion?– in the U.K. the method of display is also important – to be eligible for zero rating the items 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 medicines be excluded?); and books and newspapers (e.g. does this include journals, periodicals, leaflets and will top shelf' magazines be in or out?).
6. These are just some of the challenges that will arise. Far from being "simple exemptions" more intricate and convoluted examples could not have been chosen. This is not hypothetical, it is based on well-documented live operational activities and experiences of GST/VAT administrations elsewhere in the world.
7. The added complexity would ensure many more rulings having to be made, requests for extra-statutory concessions, and appeals before independent Commissioners of Appeal – which would 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. The Crown Agents have designed a simple system and the Committee accept their reasons for avoiding complexity. It is true that some countries have a number of exclusions or reduced rates in their GST or VAT, but it is generally accepted that the most successful application of these taxes is in countries that have a simple broad based tax with a single rate and a high threshold– similar to that proposed by Crown 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 in most of the E.U. member states.[8][8]

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

1. Extra staff and more money would definitely be required if the amendment were to succeed.
2. The complexity of a GST/VAT style tax is a direct consequence of the amount of positive rates applied and the number of exempted and/or zero rated items. The more there are the more complex it becomes for government and business to administer and the more opportunity for avoidance. This leads directly to increased costs of collection/payment, compliance and regulation.
3. Administration costs for the Crown Agents prototype GST have been estimated at £500,000 per annum. Crown Agents estimate that a move to a GST with Senator Syvret's exclusions would cost £1 million per annum. In other words they would double.
4. Crown Agents estimated that 10 extra staff would be needed by the Income Tax and Customs Departments for the broad based GST. The amendment's proposed changes would move this requirement to approximately 20 additional staff between the 2 Departments.

7. Conclusion

1. The Committee has made it very clear that its proposals for the Fiscal Strategy should be taken as a package. The individual elements of taxation, economic growth and, crucially, Income Support have been designed to complement each other. Overall they produce a progressive effect.
2. It is common and perhaps understandable that the inexperienced eye will view GST/VAT types of taxes as inherently and highly regressive. However as this comment demonstrates at worst they could be slightly regressive and there is even an informed opinion that says they can be regarded as proportionate.
3. This comment shows that the effect of the amendment's exclusions would be to help the lowest income households by the modest sum of £80 per year. But at what 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 10 to 20. The experience of the U.K. shows that business would also suffer from the increased complexity. In short the benefit simply does not justify the cost.
4. The Crown Agents have provided a prototype GST that they have designed specifically with Jersey in mind. At the 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. The Committee is convinced that this is the best solution for the community as a whole and that any adverse impacts on the less well-off are better dealt with by targeted intervention through Income Support.
5. The current thinking in relation to the GST/VAT family of taxes can be succinctly summed up by this quote from the recent International Tax Dialogue Conference on the VAT –

"Exclusions 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][9].

6. Members are urged to reject the amendment.

[1][1]

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

[2][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][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 of revenue from non compliance, and (c) cover the additional admin. costs, a 5% rate would probably be needed.

[4][4]

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

[5][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][6]

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

[7][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][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][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.)