The New Today

Commentary

A mix of direct and indirect taxes

Traditionally, taxes have been the main source of government operational revenue in the countries of the Eastern Caribbean Currency Union [ECCU]. This high dependence on tax revenue began to change in the 1980’s as some countries increased their dependence on inflows from the Citizenship by Investment [CBI] programme.

In Grenada, the Citizenship by Investment Act came into effect in 2013 and inflows from the CBI programme contributed to Government non-tax current revenue and to capital revenue which is classified by the Government as ‘grants’. The CBI as a source of revenue is expected to be volatile. Therefore, taxes would remain an integral part of Government revenue, particularly to finance current operations.

The burden of taxation would continue to be debated as taxes are compulsory payments and are not directly linked to the receipt of a particular good or service. Government uses the tax revenue collected to provide public goods and services for the benefit of the population.

This leads to the issue of who should bear the cost of providing these public goods and services, and how this cost should be shared among the population, referred to as the fairness of the tax system. The fairness or equity of taxation is associated with the payment of taxes based on the ability to pay, that is, persons with higher income should pay a greater proportion of their income in taxes or bear a greater burden of the cost of government.

To facilitate analysis of the fairness of the tax system, taxes are classified into two types: direct and indirect taxes. The direct taxes are levied on individuals or entities, and they are generally tailored to the economic circumstances of the individual or entity. The tax is expected to be borne by the individual or entity on whom it is levied, and it cannot be shifted to another individual or entity.

In Grenada, the main direct taxes are the personal income tax, corporate tax, withholding tax and property tax. The indirect taxes are levied on transactions in the economy. While indirect taxes are paid by an individual or entity, based on the legislation, the tax is passed on and therefore paid by the consumers and clients. These are mainly the Value Added Tax [VAT], import duty, customs service charge and petrol tax.

It is necessary to maintain a balance of direct and indirect taxes. The tax system should not be so heavily dependent on direct taxes of income and profits that it impedes investment and production. At the same time, too much dependence on indirect taxes places a greater burden on the no and low-income segments of the population.

There is no scientific method of determining the balance between direct and indirect taxes in a country. It is dependent on the philosophy of the government, the nature of the economy and the existing social and economic conditions, particularly related to the distribution of income and the level of poverty.

However, countries with high income generating resources generally have a high intake of revenue from taxes on income and profits. This is the case in the petroleum base economy of Trinidad and Tobago where direct taxes accounted for 68.2 percent of tax revenue in 2019. A comparison of countries with similar characteristics provides a guide to assessing the mix of direct and indirect taxes.

In Barbados, with a per capita income of EC $46,000, direct taxes accounted for 33 per cent of tax revenue in 2019. The countries of the ECCU, although fundamentally similar, there are some slight variations, influencing the combination of direct and indirect taxes. Among the independent countries of the ECCU, there are the tourism dependent countries of Antigua and Barbuda and St Kitts and Nevis with high per capita income of EC$40,540 and of EC$44,123 respectively, comparable with Barbados. These countries have maintained a philosophy of no comprehensive taxation on personal income which has determined the mix of direct and indirect taxes.

In Antigua and Barbuda, there is an education levy which is equivalent to the taxation of personal income. Consequently, direct taxes accounted for 16 per cent of tax revenue and indirect taxes accounted for 84 percent of tax revenue in 2019. In St Kitts and Nevis, where the full-fledged personal income tax was abolished, the structure of the taxes on income and profits differs from Antigua and Barbuda.

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The personal income tax is in the form of a social services levy that is paid in equal percentage by the employers and the employees, and along with the corporate income tax there is a business levy. With this structure, direct taxes accounted for 32.7 percent of tax revenue and indirect taxes accounted for 67.3 percent of tax revenue in 2019. For the tax system in Antigua and Barbuda, the low-income groups pay a higher proportion of their income in taxes, compared with the system in Barbados and St Kitts and Nevis.

The other independent countries namely, Dominica, Grenada, Saint Lucia and St Vincent and the Grenadines have greater similarities. They are more agricultural based and are developing tourism and financial services. The per capita income is comparatively lower, estimated at EC$20,463 in Dominica, EC$26,893 in Grenada, EC$30,877 in Saint Lucia and EC$20,189 in St Vincent and the Grenadines.

They exhibit some similar social indicators such as high youth unemployment as reported in Saint Lucia [35.95%], and St Vincent and the Grenadines [39.76%] in 2019 and in Grenada [38.6%] in 2021; and high poverty rates of 20.3 per cent in Saint Lucia [2016] and 25 per cent in Grenada [2019].

Among these countries, the ratio of direct and indirect taxes to tax revenue was 20 per cent direct taxes and 80 percent indirect taxes in Dominica, 25.9 percent direct and 74.1 percent indirect in Grenada, 26.6 percent direct and 73.4 percent indirect in Saint Lucia and 32.6 percent direct and 67.4 percent indirect in St Vincent and the Grenadines.

Except for Antigua and Barbuda with the philosophy of no personal income tax, and Dominica that is dominated by agriculture production, Grenada’s tax structure is more dependent on indirect taxes compared with the neighboring countries, implying that for the tax system in Grenada the lower income earners pay a higher portion of their income in taxes. In the aftermath of the Covid-19 Pandemic, there was a notable shift in the dependence on indirect taxes in Grenada and the ratio moved to 23 percent direct taxes and 77 percent indirect taxes in 2021.

This implies that the no and low-income segment of the population were paying an increasing portion of their income in taxes. Among the other countries of the ECCU, this increased dependence on indirect taxes was also a feature of Dominica’s tax system.

The increased post Pandemic burden of taxes on the lower income group could be alleviated by improved targeting of zero-rated goods and services, particularly frequently purchased goods and services that emerged with the onset of the Covid-19 Pandemic. The application of the customs service charge should be examined.

The customs service charge was introduced as an administrative cost recovery. It was expected to be maintained at a relatively low rate, and a maximum of 5 percent was considered appropriate.

The customs service charge is integrated in the tax system and is applied on a compounded base of the CIF value of the goods and import duty. Then the VAT is further levied on the compounded base of the CIF value of the good, the import duty, and the customs service charge.

The customs service charge should be eliminated from the compounded calculation of the taxes of imported goods; and it should stand as a separate charge that is levied on the CIF value of the goods.

The mix of direct and indirect taxes is based on the philosophy of the government and the state of the economy. In countries with high unemployment and poverty, high dependence on indirect taxes places a great burden on the no and low-income segments of the population.

Knowledge is power and experience is the greatest teacher.

Laurel Bain is a Grenadian-born former economist with the St. Kitts-based Eastern Caribbean Central Bank