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The pre-Budget on first principles

Nathan Kowalski, Financial Ramblings from the Rock

What follows are my thoughts on the 2018/19 pre-Budget report policy options recently released by the Government, considering a set of first principles. Let's assume our goals or principles in building a Budget revolve around the following:

1. We must keep the cost of doing business in Bermuda down.

2. We want to increase the working population in Bermuda.

3. We want to alleviate or reduce inequality.

4. We do not want to escalate the fiscal deficit and risk further credit downgrades.

Readers, of course, can immediately reject these or have their own opinions on each individually but these are, in my opinion, key principles we, at least, need to consider if we want to be serious about Bermuda's future success and fulfil the new government's mandate.

Payroll tax

Not moving ahead with further tax increases for payroll at this stage seems to be the right idea. In order to adhere to 1 and 2 above it seems critical to not further escalate the cost of labour in Bermuda. If you want more of something you do not make it more expensive. Given the overall uncertainty with the lower US corporate tax rate, the last thing international business and even local companies need to deal with at this stage is a shifting set of rules. To address 3, we will, at some stage, need to revisit the progressive nature of payroll and other forms of taxation.

Incentives to repatriate jobs to Bermuda

This jives with principle 2 above but I am a bit suspect on how effective this will be. Unfortunately, globalisation has caused international business to move many jobs to lower cost jurisdictions over the past decade. Furthermore, some jobs lost have not been simply moved, they are gone due to technological obsolescence. There needs to be more details on this proposal: what are the terms, what is the actual relief, to whom does it apply? What exactly are the incentives?

Cracking down on notional salary ambiguity

The notional salary concept has always struck me as peculiar. I still do not understand the rationale in most cases for this very obvious loophole. If we want to adhere to 3 and 4 above then it would seem to me to be only fair to treat various forms of income with more equality. The mere reclassification of payments and its rather ambiguous nature strikes me as a bit confusing. Simply changing the criteria on notional salaries doesn't really solve this. The recent Fiscal Responsibility Panel report does suggest “the taxation of dividend income where dividends are being taken as a form of salary payment”. The Cartac Report also notes: “The concept of notional remuneration of deemed employees and self-employed persons may be an important loophole as it is practically impossible for the Office of the Tax Commissioner to make a judgment on the fairness of the taxpayer's valuation and taxpayers are well aware of such weakness …. One possible solution is a procedure similar to those used by Nordic countries to separate capital and labour income for purpose of their dual income taxes.” I think this is worth clarifying and analysing in more depth.

General services tax (or professional services tax)

Adding a tax to certain services is akin to picking winners and losers to some degree. I also am somewhat sympathetic to the plight imposed on physical goods vendors versus services and the current imbalance there. A broader and more equitable system is needed. Basically I would suggest that the whole tax system needs to be adjusted and not on a piecemeal basis. Duty and service taxes need to be considered together. Additional taxes placed on professional services just lowers our competitive position (especially if this is simply passed on).

Furthermore, it is essentially an indirect tax on labour for those service organisations that charge on hours worked. I also worry that work will be outsourced from Bermuda to sister companies in other jurisdictions and the final product will just “magically arrive” in Bermuda. Intellectual property is fluid and impossible to truly domicile in many cases. Ironically, what we need in Bermuda is more lawyers and accountants. The increased competition would drive down costs and bring in bodies, satisfying both principles 1 and 2. To me a PST should be removed from consideration until a comprehensive wholesale analysis on goods and services taxation is conducted.

Sugar taxes (customs duty)

Let me air my inherent bias on this publicly. Given my family's ardent desire to live a healthy lifestyle and our concern for Bermuda's current problem with obesity, I am for almost anything at this stage that “nudges” or incents individuals to choose healthy foods.

By penalising those that continue to make poor food choices, my hope would be that they will be almost forced to adopt a healthier lifestyle. I would encourage two aspects that I think are critical if a sugar tax is implemented: taxation revenues raised are ring-fenced and are used only for health-related initiatives and do not become part of the Consolidated Fund general revenues. Possible consideration is for proceeds to be used to subsidise healthier foods and/or pay for escalating government healthcare programmes — both directly or indirectly help principle 1 if we can somehow push back on escalating healthcare premiums and costs.

Commercial rents

The proposed taxation on commercial rents seems to be a better place to focus on. The market is highly competitive so not as likely to be able to pass on the full increase to renters so unlikely to violate principle 1. Even if it was or could be passed on, given the reduced rental prices, this would not, in my opinion, push us into any uncompetitive position versus other jurisdictions based on cost for other financial centres.

Of course, owners and realtors would suggest it is lunacy to tax a struggling sector but this would be an unfair comment because payroll tax increases and duty changes would have surely punished struggling companies as well.

It is also true that this stream of income is effectively taxed to some degree already with commercial land taxes and Corporation of Hamilton taxes. These, of course, need to be considered if any additional taxes are levied. For example, it would be worth considering how the combined rates compares to the high combined rate of payroll tax. Not everyone will be happy when it comes to new taxes, especially if it affects them. This, however, targets a whole new stream of passive income that possibly benefits the wealthy disproportionately so it adheres to principle 3. It also does not directly, at least, escalate the cost of workers or labour so it does not frustrate the hopes of principle 2. This widens the tax base and addresses inequality with little to no effect on the cost of labour. There are, of course, other negative potential side effects but no tax system is perfect. If the tax is levied, however, it should be a small amount or phased in over time. The additional revenue obviously raised helps principle 4.

Tax collection and accounts receivable

This, of course, is a necessary aspect that is crucial if we are going to begin assessing various new or changed taxes. Collecting nearly $300 million in unpaid taxes would dramatically assist in principle 4. If we can't collect the taxes due now what are the chances that new and maybe more complex taxation schemes will be collectable? The only other comment I will add is that collecting taxes, although necessary, may, in the short run frustrate principle 2. I suspect that there are a number of companies that are behind in paying taxes because they are struggling. Forcible collection will likely force some of these marginal establishments to close. This is all part of creative destruction and would lead to a more stable and effective business environment longer term but could come at the expense of job losses in the near term. Fear of job losses, however, should not be cover for non-compliance.

One quick word on the committees being formed. In essence there should be only one committee. You cannot have one group advocate for a certain tax policy that counters the aims of another group trying to create an economic vision for Bermuda.

You can't have one group building an immigration policy that does not co-ordinate or fit into a plan to diversify our economy or maybe even levy taxes in certain ways. You can't have someone setting “living wage” standards without noting tax changes and or job classification desires.

Basically all groups need to talk to each other and be on the same page otherwise we are likely to develop a scrambled set of desires and principles. We may have too many chefs in the kitchen and I fear the end results will be a conflicting mess of prescriptions unless all committees and groups are aligned.

One of the largest challenges for Bermuda and many jurisdictions is creating jobs for the local population and a great deal of this depends on attracting capital and job makers from outside Bermuda to help evolve in a rapidly changing world.

Nathan Kowalski CPA, CA, CFA, CIM is the chief financial officer of Anchor Investment Management Ltd and the views expressed are his own. The author can be contacted at nkowalski@anchor.bm

Disclaimer: This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources deemed by the author to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. Past performance is no guarantee of future results. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader. Investment involves risks. Readers should consult their financial advisers prior to any investment decision. Index performance is shown for illustrative purposes only. You cannot invest directly in an index

Sneak preview: the Ministry of Finance released the Pre-Budget Report on January 18

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Published January 29, 2018 at 8:00 am (Updated January 29, 2018 at 12:08 am)

The pre-Budget on first principles

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