A tax on innovation
On the heels of its historic mandate, the Government laid out an ambitious programme in its Throne Speech delivered last Friday in the Town of St George.
Four hundred years after Bermuda’s legislature met in St Peter’s Church for the first time, the Government rightly celebrated how far the country had come, and explained how it plans to take the island farther.
As promised in the General Election campaign, the main goal of the Speech was to show how the Government would reduce historic inequities, primarily between the races. The Government made the argument that these inequities were laid bare by the Covid-19, and there is some truth in this, although the Covid-19 lockdown also demonstrated that the island’s economy is divided between those in the international business and financial services sector who were relatively unaffected by the crisis, and those in the domestic economy, including tourism, whose lives were turned upside down.
That demonstrates that while race may be the major factor in determining wealth and success in Bermuda, is it is not the only one; the picture is more complex than that, and the solutions to easing inequity do not therefore lend themselves to simple solutions.
In that context, the Government’s plans need to be looked at carefully.
The proposal that has drawn the most attention in the Throne Speech, perhaps because it was not in the Progressive Labour Party’s platform, is the signalling of a capital-gains tax, or some other form of wealth tax.
Bermuda now taxes people on their salaries, through payroll tax, and on their consumption, through things such as customs duty. Capital or wealth is not taxed, except through land and inheritance taxes. In the absence of income tax — a political no-go at this point — the wealthiest bear a disproportionately small tax burden, or so the argument goes.
In this sense, the Government is suggesting it sees taxation not simply as a means of raising the revenues necessary to run public services in the most efficient way possible, but as a means of redistributing wealth.
This has not always been a very effective way of achieving this goal, but it also runs the risk of disincentivising job-makers and entrepreneurs — the very people who are most likely to help the economy to grow.
In Bermuda’s case, this is particularly salient because much of its success in the past 60 or so years has been owing to its status as a low-tax jurisdiction. While there have always been other reasons for international companies and wealthy individuals to come to Bermuda, its low-tax regime has always been important. Indeed, the first PLP government recognised this soon after taking power in 1998, when it extended the exemption from corporate income tax to international companies.
Twenty-two years later, times have changed to some degree. The recession after 2008 and the Covid-19 crisis have shown the necessity of public intervention in markets. Unregulated free enterprise bears its own risks. And there is no doubt that a tax system that falls disproportionately on those less able to pay fails the fairness test.
But the experience of Western nations in the 1970s also showed the dangers of using tax as a weapon against the rich, and particularly the entrepreneurial. The very rich have the resources to find ways around taxation. It is the middle classes who end up bearing the brunt, and resenting it.
There are also many questions about how a tax on wealth would work. When the Government introduced a tax on dividends, it exempted companies trading on the Bermuda Stock Exchange and international exchanges.
Presumably, the same restrictions would apply to a capital-gains tax, if one was implemented. Exempted companies in general would no doubt expect to be left out. If this was the case, the tax would then fall on a relatively small group of people whose local businesses are not big enough to list on an exchange. A sizeable proportion of that group would be entrepreneurs trying to start new businesses. Having already risked their own savings, raised capital or borrowed money to realise their dreams, they now face the prospect of paying taxes if they are successful.
At a time when Bermuda should be doing all it can to encourage investment, and when it should be encouraging small businesses to take a chance on the island, a capital-gains tax would be another reason not to do so. There are some indications already that having floated the possibility of a capital-gains tax as obliquely as possible in the Throne Speech, the Government is now backing away from it.
There is still the possibility it could try again to implement a tax on rents, but this, too, is fraught with difficulty. Many Bermudians from all walks of life have invested in real estate with the idea that a second property, or “the downstairs apartment”, would provide a couple or individual with their primary retirement income. Often they took considerable risks in borrowing to pay for it, while also investing sweat equity in building it. To treat these people as the idle rich would seem to be unfair.
The difficulty with any tax on wealth, as opposed to on income, is that while meant well, it runs the risk of discouraging investment and risk-taking at a time when such efforts should be encouraged.
It stands, too, in contrast to the proposal to push banks to reduce the cost of borrowing by aligning the US prime interest rate with the Bermuda base rate. Such a move, while not free of problems, would enable people to borrow at better rates and to undertake risks they might otherwise avoid.
To encourage this — and the Government has also proposed some other ideas in this area — and to then hold out the possibility that any success that results will be clawed back by the Government seems to make little sense.