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The naivety of pandering to EU on income taxes

The views expressed here are mine alone and not representative of any organisation or political party.

In a recent address to his party faithful, the Premier clearly laid out the rationale for the introduction of income tax to Bermuda, framed in the need to reduce income inequality. He buttressed his argument with references to the latest report from the Fiscal Responsibility Panel.

That report referred to income inequality as one of the issues that relate to tax matters, but it was not its major thrust. The FRP framed its thesis for income tax within the context of revenue raising.

The United States and Britain have had a system of income tax for more than 100 years, yet income inequality is still a significant issue there. In a recent study by the Organisation for Economic Co-operation and Development, which has 37 member countries, the US was fourth highest in terms of income inequality. Britain was fifth highest.

In the US, the top 1 per cent earns 38 per cent of the entire country’s income. The income gap has widened over the past 50 years. A Pew research paper showed that in 1968 the top 20 per cent earned 43 per cent of the nation’s income while in 2018 the top 20 per cent earned 52 per cent of the nation’s income. Across the Atlantic, it is said that there are more billionaires in Britain per capita than any other developed country in the world. Billionaire Warren Buffett once said that his secretary paid a higher percentage of taxes on her income than he did. So much for income taxes promoting income equality. That premise, in the real world, is patently false.

Legislating income taxes is easy, collecting income taxes is another matter. The structure of Bermuda’s private sector creates peculiar challenges in collecting income taxes. Take dividends, for example. If I own 100 shares of Butterfield Bank, the dividend would get paid to me and there would be a clear audit trail if I failed to declare it as income. But most local businesses are privately held, family-owned enterprises. In such cases it would be easy, in a myriad of ways, to extract a return on your capital without paying a dividend.

To close such gaps, we would need corporate income tax as well. That way the taxman can try to match tax deductible corporate expenses against owners’ income. This is what they do in large countries with their armies of IRS and Inland Revenue accountants. And the wealthy still legally beat the system — ask Warren Buffett.

Bob Richards was the Minister of Finance for the One Bermuda Alliance government between December 2012 and July 2017

The cost of collecting such passive income will be enormous. In a large country, that cost can be spread over millions of taxpayers, but not in Bermuda. We would have to swell the Civil Service just to attempt to collect such taxes, but wealthy people have the resources to hire tax professionals to mitigate their tax burden. Average and poor people don’t. In Bermuda, a balance must be struck between levying taxes and the cost of collecting those taxes.

This is why payroll taxes work so well for Bermuda. Collection of payroll taxes from businesses is relatively straightforward. This is why I instituted a progressive structure on payroll taxes while I was Minister of Finance. Despite the efficiency of collection, there were still uncollected payroll taxes, primarily from smaller local businesses. Even with the simple taxes we have at present, a mountain of uncollected taxes has accumulated over the years.

Why is that?

It is because no Bermuda Government — neither United Bermuda Party, Progressive Labour Party nor One Bermuda Alliance — has had the testicular fortitude to take tax cheats to court and confiscate their property or put them in jail, to collect unpaid taxes. Like they do in the US or Britain. It has something to do with these folks and their families also being voters. That paradigm will not change with income tax.

I was disappointed to read that the FRP used the European Union anti-tax haven pressure and OECD base erosion and profit shifting initiative as a justification to institute corporate income taxes in Bermuda. Quite frankly, the FRP is being quite naive in this instance. If we institute corporate income tax for local companies and not exempted companies, it will offend one of the primary tests for being a “tax haven”. This test says that, “A country that ‘ring-fences’ certain companies so that they don’t pay taxes makes the jurisdiction a tax haven”. Therefore, if Bermuda imposes income taxes on local companies, it must be prepared to impose the same tax regime on international companies in Bermuda, including those without a physical presence. Otherwise, we will fall into the tax haven trap. At present, we don’t have income tax on either local or exempted companies, so we pass the ring-fence test.

You might say, ignoring the tax haven issue for the moment, so what’s wrong with corporate income tax? Well, size matters! If you look at the financial size of some of our leading Abir-type companies, compared to even your larger local companies, it’s like comparing Goliath with David. If Bermuda levied a low corporate income tax rate, say 5 per cent, on all companies, both local and exempted, the percentage of the total revenue raised would be probably 95 per cent from international companies, just by virtue of their huge size.

You might say, so what’s wrong with that? The largest international companies are insurance companies. By their very nature, the profit stream of insurance companies is very volatile. A cluster of hurricanes or floods or earthquakes, or a 9/11-type event, could result in huge losses for insurance companies. Of course, that’s why they exist: to pay out claims in times of disaster. But when that happens, their bottom lines turn red and they will pay no income taxes, perhaps for many quarters, or longer.

If the Government’s revenues depend 95 per cent on such companies, what does it do for government revenues? The answer is the Government will have to make do with virtually no revenue for a period of time. You cannot run a government on a revenue stream that is so volatile. This doesn’t happen in large countries because they are diversified, but Bermuda is highly undiversified; therefore, government revenues from corporate taxes would become unpredictable and render budgeting impossible.

Furthermore, and this is the really naive part, a low corporate tax rate will in no way reduce the external pressure from the EU and the OECD. They are convinced that tax havens steal their tax revenues and are, by definition, illegitimate — even though this is demonstrably false.

They want to eliminate us, period!

The EU once even threatened to place sanctions on Ireland for having a 12.5 per cent corporate tax rate, and Ireland is an EU member country. We are not going to win a reprieve from the EU by introducing corporate income tax. It’s a threat we are going to have to live with for the foreseeable future.

As it relates to Bermuda having lost a valuable ally in the post-Brexit era, this notion is completely false, in my estimation. I went to battle for Bermuda in Europe, fighting blacklists from France and similar threats from Brussels. My experience was Britain promised support but never delivered. Some of Bermuda’s biggest detractors are right there in Britain. My experience with Britain proves there is only one thing worse than an enemy: that is an unreliable “friend”.

Our most effective advocates in Europe are European private-sector leaders who would be damaged by the elimination of, say, our competitively priced reinsurance sector. That’s because without us, European insurance companies would be financially harmed and European premiums would rise. That is how we got off the French blacklist — not through advocacy from London. We must increase our advocacy through corporate connections in Europe. European governments listen to them; they don’t listen to us or British diplomats.

While our government has the luxury of a large majority in the legislature, it presides over the weakest economy in our history. Bearing in mind that any kind of tax increase will harm economic growth and job creation, it would be better for our politicians to be more practical and less political at this time of great economic peril. The risks of politically popular but practically harmful initiatives have never been greater than at this very moment.

Bob Richards was a Member of Parliament from 2007 to 2019 and Finance Minister from 2012 to 2017.

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Published February 04, 2021 at 8:23 am (Updated February 04, 2021 at 12:22 pm)

The naivety of pandering to EU on income taxes

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