Tax policy incoherence - More incentives for foreigners?!

Rosalea Hamilton, Guest Columnist

Tax incentives to attract foreign investments have persisted for more than 50 years in Jamaica, without an adequate assessment of their benefits to the economy. In the absence of such analysis, the Government continues to hope for benefits with a new bill that will exempt non-residents of Jamaica who perform prescribed operations here from the payment of income tax.

The memorandum of objects and reasons of the Bill to Amend the Income Tax Act clearly states: "It is hoped that, by facilitating the establishment of group head office companies in Jamaica, other companies will realise the economic benefits, including increased foreign investments, access of alternative capital providers, new markets and the creation of new jobs."

This bill contradicts the promised tax-reform package to be implemented over a three-year period intended to achieve several objectives, including 'Reducing distortions through drastic reductions in tax incentives and waivers', according to the minister of finance in his 2012 Budget presentation.

Critiques of the use of tax incentives have long argued that it creates market distortions, mainly of two kinds: (1) distortion in business decisions; and (2) distortion in the competition between firms. But in our weak economy, starving for investment to drive growth, it is precisely the 'distorted' business decision to set up head offices in Jamaica that the Government hopes to achieve with this bill. The distortion argument, therefore, sounds superfluous.

WHERE'S THE OMNIBUS INCENTIVE LEGISLATION?

Of course, the same argument can be made for the use of incentives to attract local investments. In the absence of equivalent incentives for Jamaican business owners and their employees, the Bill to Amend the Income Tax Act appears to discriminate against hard-working Jamaican employers and employees.

This perception is fostered by the absence of the Omnibus Incentive legislation proposed in the 2011 Green Paper on Tax Reform and supported by the Private Sector Working Group on Tax Reform that provides a comprehensive and coherent approach to incentives in Jamaica. This new incentive for foreigners should be considered in the context of this Omnibus Incentive legislation after a careful analysis of the cost and benefits of such incentives.

After months of exhaustive dialogue and consultations on the 2011 Green Paper on Tax Reform, there was widespread agreement that the Omnibus Incentive legislation was the best approach to dealing with the thorny and contentious issues involved in retaining past incentives and creating new, performance-based incentives.

In these tax-reform discussions, the micro, small and medium-size enterprise (MSME) sector was asked to temper the demand for small-business tax incentives, as MSME and entrepreneurship incentives would be addressed in the Omnibus Incentive legislation and/or the promised MSME and Entrepreneurship Policy.

To date, neither incentive exists for the MSME, a sector considered to be the engine of growth in Jamaica. Instead, the engine is being weakened by the new taxes proposed in the 2012-13 Budget, creating new financial burdens that many of the MSMEs are unable to bear.

HARD QUESTIONS

Several worrying questions
arise:

1 The argument presented by Finance Minister
Peter Phillips is that the bill was tabled in Parliament because of
commitments that were given by the previous JLP administration against
which some companies acted to establish group headquarters in
Jamaica.

This argument speaks volumes about the
commitment and legislative priorities of our Government. What about the
commitment made to the Jamaican people to table in Parliament the White
Paper on Tax Reform in May 2012, at the same time as the 2012-13
Estimates of Expenditure? In addition, what level of attention, if any,
was given to the cries of local businesses, especially MSMEs in the
creative/cultural industries, who have been calling for tax incentives
for years?

2 Has the possible unintended, negative
impact of this tax exemption been weighed against the possible benefits?
For example:

a. Are local entrepreneurs likely to be
deterred from investing in domestic capital and increasing exports
necessary for growth and development?

b. There is no
provision in the bill to prevent a company selling goods and services
that compete with domestic businesses from being designated a 'group
head office company'. Will this create a competitive disadvantage for
local competitors or worsen existing disadvantages?

c.
Will this incentive contribute to the escalation of our already grave
crime problem? It has been reported that in 2000, there was a dramatic
increase in smuggling in Zambia after a grant of generous tax breaks to
foreigners as local traders tried to offset the competitive disadvantage
that they faced.

d. Will this encourage
'round-tripping', which occurs when local firms leave the country to
return disguised as foreign investors to take advantage of tax
incentives? Analysts suggest that round-tripping accounts for up to 25
per cent of foreign investment in China.

e. Will
unscrupulous companies exploit the provision in the bill (s.36F(2)(c))
that enables the grant of a certificate if the minister is satisfied
that the company "proposes to employ ... 30 per cent or more of its
employees to perform group head office activities from among citizens of
Jamaica" by not employing them after reaping the
benefits?

f. Will the Jamaican counterpart of those
employees getting the tax exemptions and, doing the same or equivalent
work, be demotivated and become less
productive?

CONCLUSION

In the
context of Jamaica's feeble economy, there is some merit in seeking to
attract group head office investment, which is expected to generate not
only jobs, but also introduce important technical and research and
development (R&D) activities which can create knowledge
spillovers and other benefits for Jamaica.

Many
analysts, however, question whether such tax exemptions are the best
strategies to achieve this objective. This ought to be determined by a
careful assessment of the past and existing tax incentives we give
foreigners, as well as the experience of other countries. The
conclusions of the 2012 European Commission Study on
'Internationalisation of business investments in R&D and
analysis of their economic impact' are instructive:

1
First, policymakers should try to create a research-friendly
environment. Rather than trying to attract R&D intensive
foreign-owned firms, results from the econometric analysis indicate that
policy should look to maintain stable economic 'fundamentals', increase
the skills of the workforce, strengthen university research, and
increase the innovative capabilities of firms.

2
Second, in order to maximise spillovers from foreign-owned firms, policy
should raise the capabilities of domestic organisations to absorb
knowledge and help foreign-owned firms to integrate into domestic
innovation networks.

3 Third, policymakers should not
be too worried about R&D activities of European Union firms
outside the Union. There is no evidence that these activities substitute
domestic research; in contrast, they are a means to open up new markets
and may contribute to growth at home.

The proposed
tax incentives should be performance-based and should be part of a
comprehensive, coherent and holistic legislative framework for all
incentives, with supporting policies, to enable us to achieve our
development objectives.

Only in such a framework will
incentives for foreigners, as well as Jamaicans, be meaningful and
transparent. The promised White Paper on Tax Reform and/or the Omnibus
Incentive legislation should, therefore, be
tabled.

Last Friday, senators - as members in the
Lower House had already done - will rubber-stamped this bill, failing
to show strong and inspired leadership by breaking with tradition in
this, our 50th year of Independence, and listen to the voice of local
business people.

We are watching, and we will
act!

Professor Rosalea Hamilton is Scotiabank chair,
Entrepreneurship & Development, UTech. Email feedback to
columns@gleanerjm.com and
rosaleahamilton@gmail.com.