Government spending is the elephant in the room
Budget time is also a time to think about taxes and tax systems. The Budget speech lamented that the tax system exacerbates the gap between the rich and poor. I recall making the same speech. The Government has pledged to find a new system to help to reduce that gap.
I pointed out many times, as Minister of Finance, that Bermuda’s tax system, with its emphasis on duties and payroll taxes was and is regressive. This has been well known for decades. The last Budget I presented was the first time any government or any finance minister had ever taken any steps to ameliorate the problem. We put in a progressive payroll-tax system and simplified customs duties.
The so-called cap on taxable remuneration for payroll tax means that people whose compensation exceeds $950,000 per annum pay no tax on remuneration in excess of that number. So overall, the tax is still regressive — but not as bad as it once was.
I have also heard commentators from various sectors complain that, under the present system, the higher revenues that are required by the Government to balance the budget will add to the cost of doing business in Bermuda. As such, taxes will be passed on to customers. This also applies to the financial services tax, which I introduced. These taxes have added and will add to the cost of doing business in Bermuda, and will, on margin, reduce our competitiveness and increase the cost of living for Bermudians.
This begs the question: “What kind of taxation can the Government put in place that will not increase the cost of living and doing business?”
The only type of tax that I know of that cannot be passed on to customers is a full-blown tax on personal and corporate income, ie, income tax. Simply put, with income tax, if a company tries to up its prices to compensate for a rise in income taxes, that price increase — all other things being equal — will cause its taxable income to increase and the tax it pays will increase accordingly. So the only party that will have gained is the Government.
Bermuda’s economy is not suited to income tax. Many Bermudians see our huge, profitable international companies as a big, juicy apple that the Government should take a bite out of to solve all its financial problems. They say it will also mitigate the exterior criticism of the island as a tax haven. This view is naive in the extreme.
First, one of the components of our attractiveness to international capital is that there is no income tax. Does this confirm that we are a tax haven? Certainly not. Many countries compete on taxes, now even the United States. The term “tax haven” encompasses many evils separate and apart from absence of income tax, and Bermuda has gone the extra mile to address those issues, such as money laundering, terrorist financing, secrecy, non-cooperation, etc. We are already ahead of the curve in these areas.
Second, the insurance business has, by its very nature, very uneven profit flows. For example, many reinsurance companies suffered huge losses from hurricane-related claims during the fourth quarter of last year. If the Government was relying on that for tax revenue, it would have had to exist for a full quarter, or longer, without any tax revenue at all. You cannot run a government with that kind of uncertainty. This doesn’t happen in larger countries that have the diversification of industry to smooth that unevenness of cash flows.
Third, everyone should know by now that the bottom line, or “Net Income”, can be massaged by corporations’ armies of clever accountants and lawyers to create structures to minimise their tax exposure. To combat this, governments in all income taxpaying countries have to hire their own army of clever accountants and lawyers in a continuing tug-o-war to see through the structures invented by their corporate counterparts, and prise the tax revenue out of them regardless. Globally, the private-sector accountants and lawyers have, over the long run, soundly trounced their public-sector counterparts. Meanwhile, the Government has to pay its own accountants and lawyers, along with the rest of the public sector, in this losing game, thereby increasing the need to raise more tax revenue or debt.
Fourth, income tax has failed miserably in most developed countries to narrow the gap between the rich and the poor. According to a new paper by economist Edward N. Wolff, taken from the US Federal Government’s Survey of Consumer Finances, “the wealthiest 1 per cent of American households own 40 per cent of the country’s wealth. That share is higher than it has been at any point since at least 1962. The wealth owned by the bottom 90 per cent, meanwhile, fell over the same period to 22 per cent”.
Wolff also sites Organisation for Economic Co-operation and Development studies that say: “In high-inequality countries, people from poor households typically have less access to quality education. This leads to large amounts of wasted potential and lower social mobility, which directly harms economic growth.”
But there is a problem with this conclusion because the countries with the most glaring wealth inequalities, such as India, China and many developing countries, trounce growth rates in “income distribution” countries that can be found in the European Union and Scandinavia.
The notion that simply by introducing income tax to Bermuda will narrow the gap between the haves and the have-nots is dangerously naive. It may make for good political point-making, but there is no evidence that income taxes will make any difference to this issue.
The real danger for Bermuda, of course, is that such a move will drive the business we have elsewhere. Other offshore jurisdictions have already poached significant business from us without such an earth-shaking change.
It is clear now, in view of the big corporate tax cuts in the United States, that the increase in the employers’ portion in payroll taxes that I envisioned in the second tranche of payroll-tax reform is not now feasible. If I were the finance minister now, I would have had to abandon that feature, as David Burt, the Premier, has done.
However, so far the talk of taxes has overshadowed a critical issue when it comes to the ability to balance the budget. The elephant in the room is government spending. It took 18 months of “consultation” with international business to come up with the plan laid out in the 2017-18 budget. That plan included significant payroll-tax increases for international business companies. Because many international business companies voluntarily pay the employee portion of payroll tax, the increase in the tax burden for such companies was quite material. They were prepared not to object to that increase on the clear understanding that the increased revenue would go towards reducing the deficit and not to finance increased government spending. I’m not certain this budget continues that understanding.
Increasing taxes on the wealthy in Bermuda — the wealthy companies and their wealthy individual executives/managers — only to increase spending on increased government staff and various capital items is not going to go down well in the C-Suites in Hamilton, notwithstanding the polite applause being heard from that quarter at the moment.
This new government needs to demonstrate that it can indeed “jump and chew gum, at the same time”.
A great deal depends on it.
• Bob Richards is a former Deputy Premier and Minister of Finance in the One Bermuda Alliance government
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