Chapter

Chapter 6: Enhancing Fiscal Revenue

Author(s):
Alfred Schipke, Aliona Cebotari, and Nita Thacker
Published Date:
April 2013
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Author(s)
Aliona Cebotari, Melesse Tashu, Selcuk Caner, Denise Edwards-Dowe, Brian Jones, Vinette Keene, Robert Mills and Sumiko Ogawa 

Fiscal adjustment will be one of the main forces shaping policies in the countries of the Eastern Caribbean Economic and Currency Union (OECS/ECCU) in the near to medium term.1 Against the background of already high public indebtedness and weak growth, the deterioration of the fiscal deficits in the union following the 2008–09 global economic and financial crisis has further highlighted the need for fiscal consolidation to preserve debt sustainability. The fiscal adjustment required to improve debt dynamics is, in most cases, too large to rely solely on expenditure rationalization. Despite the robust revenue effort in most countries, additional revenue mobilization will be imperative for debt reduction.

Revenue mobilization will also be needed to offset the likely impact from the OECS/ECCU’s commitment to increased trade liberalization. OECS/ECCU countries have traditionally relied on trade taxes for the bulk of their revenue, given their very high openness, but revenue from these sources will decline with trade liberalization and tariff reform. External tariffs are being reduced gradually under the Caribbean Community (CARICOM) customs union, and most OECS/ECCU countries are pursuing new preferential trade arrangements, such as membership in the Free Trade Area of the Americas. As these developments continue to erode the international trade tax base, the region needs to find ways to bolster revenue that rely on domestic taxation.

This chapter discusses revenue mobilization efforts in the OECS/ECCU countries and explores ways to enhance them and to further improve the tax system through adjustments in tax policies, especially those affecting the tax base, and tax administration reforms. The next section provides an overview of the tax structure, revenue effort, and recent revenue and tax policy trends in the OECS/ECCU countries, placing them in an international context. It is followed by a section that discusses recent developments and challenges facing revenue administration.

Government Revenue in the OECS/ECCU

Government revenue in the OECS/ECCU is generally high, but its level and structure vary by country. For the region as a whole, revenue and grants averaged 26 percent of GDP during 2008–09, which is comparable to most regions in the world except other small island states, where large grants in the Pacific Islands make the ratio unusually high (Table 6.1 and Figure 6.1). Within the OECS/ECCU, however, the level of revenue and grants ranges from as low as 19½ percent of GDP in Antigua and Barbuda, reflecting both a low tax effort and low grant receipts, to as high as 36.2 percent of GDP in Dominica, reflecting both a strong tax effort and large grant receipts.

Table 6.1Structure of Government Revenue in the OECS/ECCU and Comparator Regions(Percent of GDP)
Revenue1 and grantsTax revenueCapital revenueNontax revenueGrants
Country or region2000–042005–072008–092000–042005–072008–092000–042005–072008–092000–042005–072008–092000–042005–072008–09
Antigua and Barbuda19.121.219.915.818.318.30.30.30.11.91.21.11.11.30.4
Dominica27.833.636.319.624.024.90.20.10.13.32.42.34.77.18.9
Grenada23.625.323.318.118.818.70.1001.91.11.33.55.33.3
St. Kitts and Nevis24.830.730.617.822.421.20006.36.36.90.82.02.5
Saint Lucia25.525.227.221.823.023.70.300.12.21.92.11.10.31.4
St. Vincent and the Grenadines24.524.529.120.021.423.70.10.20.13.61.82.00.81.03.3
Regional aggregates2
OECS/ECCU323.625.626.318.720.921.30.20.10.12.92.22.41.82.32.6
Rest of CARICOM425.127.126.721.423.622.30.50.102.02.12.71.21.41.6
Central America517.218.919.013.915.715.70.40.10.12.32.22.20.70.90.9
Rest of Latin America620.223.222.515.317.516.70.10.20.34.55.45.40.30.30.2
Small island states740.843.741.918.419.819.70.10.307.67.25.714.716.416.6
EU15829.730.229.027.227.526.8n.a.n.a.n.a.2.52.62.2000
Emerging Europe922.624.422.819.921.320.5n.a.n.a.n.a.2.83.02.3000
Sources: Asian Development Bank online database; Eurostat database; IMF country desk data; United Nations Economic Commission for Latin America and the Caribbean database; and IMF staff estimates.Note: CARICOM = Caribbean Community; n.a. = not available.

Figure 6.1Tax Revenues in the OECS/ECCU and Comparator Regions

Sources: Asian Development Bank online database; IMF, World Economic Outlook database, and country desk data; OECD. Stat; United Nations Economic Commission for Latin America and the Caribbean database; and IMF staff estimates.

  • Despite the region’s relatively high per capita income, the OECS/ECCU countries receive a fair amount of grants, averaging 2½ percent of GDP during 2008–09. Grants include transfers from the European Union, either as compensation for lost sugar and banana trade preferences or general budgetary support, as well as bilateral grants, often from nontraditional donors such as China and Venezuela. Reliance on grants differs by country, however. Dominica and Grenada are the largest recipients of external grants in the union (about 7 percent and 4 percent of GDP, respectively, since 2000), reflecting both their lower per capita income and, for Dominica, the international donor community’s response to the country’s significant fiscal adjustment in the mid-2000s. Conversely, Antigua and Barbuda and Saint Lucia received relatively small amounts (1 percent of GDP since 2000).

  • Nontax revenue is relatively small, about 1 to 2 percent of GDP in most countries except St. Kitts and Nevis, where it amounts to 7 percent of GDP, owing to the provision of utility services by the central government.

  • Tax revenue accounts for about 21 percent of GDP, on average, in the OECS/ECCU and is generally greater than what might be expected given the members’ level of economic development and the tax levels in the emerging countries of Latin America and Europe, and in other small island economies (Figure 6.1, top panel). In part, this was necessitated by the high fixed costs of maintaining modern government structures in very small economies and, in part, to high spending levels. Among the OECS/ECCU countries, Antigua and Barbuda and Grenada have the lowest tax burdens (18 percent and 19 percent of GDP, respectively), characterized by the existence of significant tax expenditures and generous income and consumption tax regimes.2 The tax burden in the remaining four states is much higher, at about 24 percent of GDP. Tax ratios have increased in most countries since 2000, reflecting tax reforms initiated in the early 2000s that included, most notably, the introduction of the value added tax (VAT). Gains in tax revenue ranged from 6 percentage points of GDP in Dominica, where the VAT introduction has been very successful and VAT productivity is high, even by international standards, to almost none in Grenada (Figure 6.1, bottom panel).3

Tax Revenue and Policies

The tax system, which accounts for more than four-fifths of total revenue (Figure 6.2), underwent major reforms in the early 2000s. The introduction of the VAT during 2006–12 was the cornerstone of the successful tax reform. The VAT has helped eliminate many distortionary taxes, increased the efficiency and stability of the revenue system, created the potential to accommodate trade liberalization—while replacing the revenue from customs duties—and offered substantial administrative advantages, thereby freeing the limited revenue administration capacity in many of the countries.4 Another achievement, albeit less uniformly shared by the OECS/ECCU countries, has been the drive to reduce the top marginal personal income tax rates. In addition, excise taxes were introduced or expanded to the traditionally excisable products to support the VAT implementation (Dominica, Grenada, St. Kitts and Nevis, and St. Vincent and the Grenadines), and the importance of the existing excises was increased with the introduction of the VAT by boosting VAT revenue on excisable goods.

Figure 6.2Revenue and Grants in the OECS/ECCU, 2005–09

Sources: Country authorities; and IMF country desk data.

The tax system in the union relies heavily on indirect taxes—the countries’ high degree of openness and the relative ease of collecting taxes at customs make trade taxes an attractive source of revenue. In addition to the taxation of international trade, indirect taxes are bolstered by the newly introduced VAT regimes in five out of six countries (with Saint Lucia expected to follow suit in 2012). Indirect tax revenue, at 15¾ percent of GDP, is close to the OECD average and higher than in many developing countries. However, revenue from direct taxation is below expected levels compared with countries of similar income levels, as a result of low personal income tax (PIT) rates (e.g., Antigua and Barbuda), narrow tax bases (e.g., Grenada), or a small corporate sector (e.g., Dominica) (Figure 6.3).

Figure 6.3The Structure of Taxes

(Percent of GDP)

Sources: Asian Development Bank online database; IMF, World Economic Outlook database, and country desk data; OECD. Stat; United Nations Economic Commission for Latin America and the Caribbean database; and IMF staff estimates.

Note: CARICOM = Caribbean Community. See note to Table 6.1 for composition of regional groupings.

Indirect Taxes

International trade taxes continue to be a significant source of revenue in the OECS/ECCU, despite reductions in the common external tariffs in the context of the CARICOM customs union. On average, more than a quarter of tax revenue in the region derives from international trade taxes,5 the highest next to other small island states even after controlling for the importance of international trade to the overall economy (Figure 6.4). This generally reflects high tariff rates, among the highest in the Latin America and the Caribbean region. St. Vincent and the Grenadines is an exception, with relatively low import tariff rates and consequently less reliance on international trade taxes than might be expected for its level of openness (Table 6.2 and Figure 6.4).

Figure 6.4Dependence on International Trade Taxes in the OECS/ECCU and Comparator Regions, 2000–09

Sources: Asian Development Bank online database; IMF, World Economic Outlook database, and country desk data; OECD. Stat; United Nations Economic Commission for Latin America and the Caribbean database; and IMF staff estimates.

Note: CARICOM = Caribbean Community. See note to Table 6.1 for composition of regional groupings.

Table 6.2Central Government International Trade Taxes in the OECS/ECCU
Import dutiesCustoms service chargesOther
Country or region2000–042005–092000–042005–092000–042005–09
Percent of GDP
Antigua and Barbuda2.62.62.02.41.51.5
Dominica2.52.71.21.31.31.4
Grenada2.42.41.92.00.30.6
St. Kitts and Nevis2.92.91.32.00.81.1
Saint Lucia1.72.20.61.33.63.9
St. Vincent and the Grenadines2.12.31.51.60.40.2
OECS/ECCU2.42.51.31.81.51.6
Percent of total tax revenue
Antigua and Barbuda16.514.513.013.29.48.2
Dominica12.911.16.05.16.65.8
Grenada13.012.910.110.51.53.2
St. Kitts and Nevis15.312.66.98.64.14.9
Saint Lucia8.09.42.65.716.316.7
St. Vincent and the Grenadines10.610.37.27.22.21.1
OECS/ECCU12.611.97.18.77.77.5
Sources: IMF country desk data; and IMF staff estimates.

Unlike many regions in the world, the role of international trade taxes in the union has not diminished much over time, as a result of a relatively slow reduction in tariffs and their substitution with other trade-related charges and taxes. Import tariff rates in the OECS/ECCU have declined only slightly since 2000, with the average effective tariff rate down from 13.3 percent to 9.8 percent during the first decade of the 2000s, and the most favored nation tariff rates only down to 12.5 percent from 13.3 percent during the same period (Figure 6.4 and Table 6.3). Most OECS/ECCU countries seem to have recouped their import tariff revenue losses through higher customs service charges and other taxes, such as an environmental levy and embarkation and travel taxes.6,7 Although customs service charges have been accepted by CARICOM on the grounds that they are user charges rather than a supplement to the tariff, questions may be raised in international forums about their scale and their ad valorem nature, suggesting the vulnerability of the OECS/ECCU’s international trade tax base as it pursues accession to the Free Trade Area of the Americas. In addition, some coordination of the customs service charges may be needed among the OECS/ECCU countries.

Table 6.3Weighted Average Tariff Rates and Customs Service Rates in the OECS/ECCU and Other Caribbean and Latin American Regions(Percent)
Overall applied rates1Most favored nation ratesCustoms service charge rates2
Country or region2000–042005–082000–042005–082000–042005–08
Antigua and Barbuda13.412.913.414.64.95.0
Dominica14.17.814.113.03.53.1
Grenada13.19.013.112.14.94.9
St. Kitts and Nevis13.312.313.313.93.65.5
Saint Lucia13.510.913.512.64.24.6
St. Vincent and the Grenadines12.76.112.78.84.03.9
Regional aggregates
OECS/ECCU13.39.813.312.54.14.6
Rest of CARICOM12.29.612.211.5n.a.n.a.
Central America6.75.77.36.7n.a.n.a.
Rest of Latin America9.65.810.89.1n.a.n.a.
Sources: IMF country desk data; World Bank, World Development Indicators database; and IMF staff estimates.Note: CARICOM = Caribbean Community; n.a. = not available. See note to Table 6.1 for composition of regional groups.

Taxes on goods and services are the largest source of tax revenue for the OECS/ECCU countries,8 accounting for about 10 percent of GDP, higher than most of their regional and income peers (Table 6.4). VAT and other consumption taxes account for about 65 percent of taxes on goods and services, excises for about 12 percent. The rest is accounted for by stamp duties and other small taxes such as licenses. Revenue from taxes on goods and services has increased substantially since 2000, from 8.1 percent in 2000 to more than 10 percent of GDP in 2008 (Figure 6.5). This increase was driven fully by the introduction of the VAT in Dominica (2006), St. Vincent and the Grenadines (2007), and Antigua and Barbuda (2007)—accompanied by the introduction of excises in the former two—with revenue in other countries remaining relatively flat during this period.9 Grenada and St. Kitts and Nevis subsequently introduced the VAT.

Table 6.4Tax on Domestic Goods and Services in OECS/ECCU Countries
Share of GDPShare of tax revenue
Country or region2000–042005–072008–092000–042005–072008–09
Antigua and Barbuda7.08.58.944.546.048.5
Dominica9.913.214.250.454.857.3
Grenada9.59.49.152.350.148.6
St. Kitts and Nevis7.510.18.542.344.940.0
Saint Lucia9.48.38.743.236.336.8
St. Vincent and the Grenadines9.611.213.248.152.255.7
Regional aggregates
OECS/ECCU8.79.69.946.345.946.5
Rest of CARICOM6.87.27.831.530.734.9
Central America7.08.07.750.450.849.1
Rest of Latin America8.48.98.954.651.153.6
Small island states6.57.57.732.433.935.9
EU1511.211.0n.a.41.040.6n.a.
OECD11.111.0n.a.42.241.5n.a.
Sources: Asian Development Bank online database; Eurostat database; IMF country desk data; United Nations Economic Commission for Latin America and the Caribbean database; and IMF staff estimates.Note: CARICOM = Caribbean Community; n.a. = not available; OECD = Organization for Economic Cooperation and Development. See note to Table 6.1 for composition of regional groupings.

Figure 6.5Taxes on Domestic Goods and Services

Sources: Asian Development Bank online database; Eurostat database; IMF country desk data; United Nations Economic Commission for Latin America and the Caribbean database; and IMF staff estimates.

Table 6.5The VAT and the Taxes Replaced by the VAT
Antigua and BarbudaDominicaGrenadaSt. Kitts and NevisSt. Vincent and the Grenadines
Consumption taxConsumption taxGeneralConsumption taxGeneral
Hotel (bed-night) taxSales taxconsumptionHotel and restaurantconsumption tax
Hotel guest taxEntertainmenttaxtaxStamp duties
Hotel guest levytaxAirline ticket taxCable TV taxHotel tax
Restaurant andHotel occupancyMotor vehicleVehicle rental levyTelecommunication
catering servicestaxpurchase taxInsurance premium taxsurcharge
taxExport dutyEntertainment tax
TelecommunicationsPublic entertainment
taxtax
Lotteries tax
Gaming machine tax
Traders tax
Telecommunications
levy
Parcel tax
Revenue as percentage of GDP
VAT16.49.6n.a.n.a.7.8
Taxes4.87.7n.a.n.a.6.7
replaced
by VAT2
Source: Country authorities.Note: n.a. = not available.

The introduction of the VAT reshaped the revenue structure. The VAT streamlined existing taxes on consumption and hotel accommodations, replacing 3 (Grenada) to as many as 12 taxes (St. Kitts and Nevis) (Table 6.5). Most of the countries adopted the standard rate of 15 percent, with a lower rate of 10 percent applied to tourism industries10 (Table 6.6). The rates are similar to those in other CARICOM countries but are higher than in Central America (about 12½ percent on average). During the short time since its introduction, VAT collections and productivity are faring well by international standards, reflecting the relative ease of collections at customs. Among the OECS/ECCU countries, Dominica’s VAT productivity is especially strong.

Table 6.6The VAT in the OECS/ECCU Countries and Comparator Regions
Country of regionDate of VAT

introduction
Standard

rate

(percent)
Other rate

(percent)
Threshold

(US$

thousands)1
Number of

registrants1
Average

revenue

(percent of

GDP)2
Revenue

productivity3
Antigua and BarbudaJan. 29, 200715.010.51101,2686.360.40
DominicaMar. 1, 200615.010.0447279.840.67
GrenadaFeb. 1, 201015.010.044867n.a.n.a.
St. Kitts and NevisNov. 1, 201017.010.055686n.a.n.a.
Saint Lucia4Oct. 1, 201215.08.0671,200n.a.n.a.
St. Vincent and theMay 1, 200715.010.0448967.820.50
Grenadines
Regional aggregates
OECS/ECCUn.a.15.4n.a.n.a.n.a.7.430.00
Rest of CARICOMn.a.13.6n.a.n.a.n.a.7.250.50
Central American.a.12.6n.a.n.a.n.a.4.160.46
Rest of Latin American.a.16.4n.a.n.a.n.a.6.400.43
Small island statesn.a.11.3n.a.n.a.n.a.6.500.56
EU15n.a.19.9n.a.n.a.n.a.n.a.0.38
OECDn.a.17.9n.a.n.a.n.a.n.a.0.39
Sources: Country authorities; and IMF, Fiscal Affairs Department.Note: CARICOM = Caribbean Community; n.a. = not available; OECD = Organization for Economic Cooperation and Development. See note to Table 6.1 for composition of regional groupings.

Despite the VAT’s good performance to date, two areas weaken the VAT systems: exemption creep and the lower rate for tourism services.

  • Exemptions and zero-rating. Although the VAT systems initially had few exemptions, the list of exemptions began expanding soon after the VAT’s introduction. Currently, some services are exempt from the VAT, such as medical, educational and most financial services, as well as electricity in St. Kitts and Nevis and Antigua and Barbuda. Increasingly, some countries are giving special exemptions to companies in the form of non-payment of VAT or a refund of paid VAT. In addition to exemptions, most countries zero-rate domestic supplies such as basic foods and a defined portion of monthly household electricity consumption.

  • Treatment of tourism services. The main justifications for the lower VAT rate on hotel accommodations (or consumption taxes) and related services are often (1) the high elasticity of demand for tourist services and the need to maintain lower rates to attract tourists who can substitute between similar tourist goods and services offered by different countries; and (2) that tourism is a labor-intensive industry, so responding to highly elastic demand for tourism services with lower tax rates would result in job creation. In regions such as the Caribbean, where each country offers somewhat similar opportunities for tourists, the elasticity of demand for each country’s tourism services in isolation may be relatively high. However, the elasticity for the region as a whole may be much lower, in which case a higher VAT rate in all countries may not be harmful to the tourism industry. (Figure 6.6 demonstrates the supply response of hotel accommodations to a higher VAT rate.) Thus, a joint action to charge the standard VAT rate for hotel accommodations would be unlikely to discourage tourists and could be revenue-enhancing, although competition with countries outside the OECS/ECCU region would, of course, continue to exist.

Figure 6.6The Effect of Increasing VAT on Hotel Accommodations

Source: Authors’ illustration.

Note: Q = quantity; P = price; S = supply; D = demand; and Δt = change in tax.

Table 6.7Excise Taxes: Coverage and Revenue, 2009
Taxed goodAntigua and

Barbuda
DominicaGrenadaSt. Kitts

and Nevis
Saint LuciaSt. Vincent and the

Grenadines
Alcoholic beveragesxxxx
Tobacco productsxxx
Petroleum productsxxxx
Motor vehiclesxxxx
Excise tax, total (% of GDP)03.11.40.11.81.7
Excise tax, petroleum (% of GDP)n.a.1.91.4n.a.0.7n.a.
Source: Country authorities.Note: n.a. = not available.

Moreover, multiple VAT rates complicate administration and compliance, and create opportunities for abuse. The tourism sector is no exception. For example, when accommodation services are subject to a lower VAT rate, hotels have an incentive to package other goods and services as part of the hotel service to access the lower rate—while also creating a situation in which foreign tourists pay lower tax rates than citizens for the same services. Finally, it is often argued that lower VAT rates for the hotels and accommodation industry would create jobs. However, VAT is not the best instrument for job creation when more direct instruments, such as lower payroll taxes and training programs, can be used to target increases in employment.

Excise tax collections vary widely among the OECS/ECCU countries, largely because of differences in coverage, and there is significant scope to strengthen them (Table 6.7). Excise taxes contribute about 3 percentages points of GDP in Dominica, but excise revenue in Antigua and Barbuda and in St. Kitts and Nevis is negligible. Indeed, Dominica and St. Vincent and the Grenadines have the widest coverage that includes alcohol, tobacco, petroleum, and motor vehicles. However, the coverage is more limited in Antigua and Barbuda, which levies excises only on luxury vehicles, and until recently in Grenada and St. Kitts and Nevis, with the former taxing only petroleum products and the latter only alcohol and tobacco products until 2010.11 Thus, there is significant scope to broaden coverage in some countries to all traditionally excisable goods (such as tobacco, alcohol, and petroleum, i.e., products with externalities), as well as to increase some ad valorem rates and update the specific rates on all nonpetroleum excisable products to keep up with inflation.

Direct Taxes

Income taxation in the OECS/ECCU has undergone two rounds of reforms since 2000. In the early to mid-2000s, reforms focused on the consolidation of direct taxation: the PIT was introduced in Antigua and Barbuda, and a 3 percent levy on salaries was introduced in Grenada to aid the reconstruction effort after Hurricanes Ivan and Emily, propping up income tax collections until it was repealed in 2009. Corporate income tax (CIT) revenue also increased during this period, particularly in St. Kitts and Nevis primarily as a result of a new tax audit program and increased profitability of the indigenous bank. Toward the end of the decade, the second round of reforms focused on reducing income tax rates, along with some widening of the base and a reduction in the number of PIT brackets. For the most part, these changes have not affected revenue (Tables 6.8 and 6.9). In Dominica, for example, a PIT reform during 2008–10 gradually reduced the lower (upper) rates from 20 (40) percent to 15 (35) percent, and increased the taxable threshold to about 1.1 times per capita income. In St. Vincent and the Grenadines the top personal income tax rate was reduced to 32.5 percent in 2010, but further reductions to 30 percent were put on hold to safeguard revenue in the face of the global economic crisis.

Table 6.8Central Government Income Taxes in the OECS/ECCU and Comparator Regions(Percent of GDP)
Country or regionCorporate income taxPersonal income taxOther1
2000–042005–072008–092000–042005–072008–092000–042005–072008–09
Antigua and Barbuda2.11.71.801.21.20.200
Dominica1.01.31.92.93.22.51.00.50.2
Grenada2.52.02.50.61.01.50.20.10.2
St. Kitts and Nevis3.34.35.31.81.91.90.50.60.5
Saint Lucia2.62.73.52.32.42.51.01.41.7
St. Vincent and the3.02.72.52.82.93.10.40.30.3
Grenadines
Regional aggregates
OECS/ECCU2.42.42.91.31.92.00.70.40.4
Rest of CARICOM2.93.13.13.13.53.12.33.43.0
Central America1.61.51.70.50.70.71.32.12.5
Rest of Latin America2.33.73.80.70.71.10.50.50.5
Pacific Islands3.33.54.23.13.12.8000
EU15n.a.2.92.3n.a.9.79.9n.a.0.10
Emerging Europe2.12.5n.a.4.74.6n.a.00.1n.a.
Sources: Asian Development Bank online database; Eurostat database; IMF country desk data; United Nations Economic Commission for Latin America and the Caribbean database; and IMF staff estimates.Note: CARICOM = Caribbean Community; n.a. = not available; OECD = Organization for Economic Cooperation and Development. Regional aggregates are simple averages, with the exception of the OECS/ECCU and the EU15. See note to Table 6.1 for composition of regional groupings.
Table 6.9OECS/ECCU Income Tax Rates(Percent)
Country20032010
Personal income tax, top rate
Antigua and Barbuda15.025.0
Dominica40.035.0
Grenada30.030.0
St. Kitts and Nevis211.011.0
Saint Lucia30.030.0
St. Vincent and the Grenadines40.032.5
Corporate income tax rate
Antigua and Barbuda40.025.0
Dominica40.030.0
Grenada30.030.0
St. Kitts and Nevis35.035.0
Saint Lucia33.330.0
St. Vincent and the Grenadines40.032.5
Sources: Country websites; Eastern Caribbean Central Bank, 2005; IMF, Fiscal Affairs Department, 2003; and www.taxrates.cc/html.

Income taxes yield relatively little revenue despite the high marginal rates. The OECS/ECCU countries collect, on average, about 2 percent of GDP in PIT and slightly less than 3 percent of GDP in CIT, somewhat behind their peers at similar levels of income (Figure 6.7, panels a and b). Even after the latest reforms, rates remain relatively high (Table 6.9 and Figure 6.7), and together with social security contributions, these taxes create a high tax wedge on labor in most countries, reaching as high as 39 percent in Dominica (Table 6.10).

Figure 6.7Personal and Corporate Income Taxes in the OECS/ECCU and Comparator Countries

Sources: Asian Development Bank online database; government websites; IMF country desk data, Fiscal Affairs Department, World Economic Outlook database; OECD. Stat; United Nations Economic Commission for Latin America and the Caribbean database; World Bank, World Development Indicators database; and www.taxrates.cc/html.

Table 6.10Tax Wedge on Labor Income(Percent)
CountryTop marginal

tax rate
Employer’s

social security

contribution
Employee’s

social security

contribution
Social

service levy
Labor

income wedge
Antigua and Barbuda25.03.03.028.0
Dominica35.07.04.039.0
Grenada30.03.03.033.0
St. Kitts and Nevis5.05.011.016.0
Saint Lucia30.05.05.035.0
St. Vincent and the Grenadines32.54.53.536.0
Average30.54.53.931.2
Sources: International Bureau of Fiscal Documentation; and the Caribbean Regional Technical Assistance Center.

The low yield of income taxes is a result of numerous exemptions and tax incentives that narrow the base, as well as low PIT rates.

  • Low PIT rates are the main culprit behind low collections in Antigua and Barbuda and in St. Kitts and Nevis. In Antigua and Barbuda, the PIT ranges between 10 and 25 percent, with the maximum rates among the lowest in Latin America and the Caribbean. St. Kitts and Nevis applies no PIT in the strict sense, although a social service levy is applied to wages. The rates for this levy are particularly low (6–11 percent) and are only partially offset by its broad base—those with income levels of at least half per capita income are subject to the levy.

  • In Dominica and Grenada, narrow bases account for the relatively low PIT collections. Despite a high flat rate of 30 percent, the PIT in Grenada has a threshold three times per capita income (Figure 6.8), the highest in Latin America and the Caribbean, thereby significantly narrowing its tax base and keeping PIT collections at 1½ percent of GDP, among the lowest in the OECS/ECCU (see Table 6.8). Dominica’s top PIT rate of 35 percent is also very high by regional standards, but it applies at income levels above EC$70,000 (five times per capita income) thus significantly limiting the contributor base. Countries with moderate PIT rates and broader tax bases, such as Saint Lucia and St. Vincent and the Grenadines, registered higher and more stable PIT revenue. Both countries have thresholds slightly above their respective per capita incomes, and maximum rates of 30 percent (Saint Lucia) and 32.5 percent (St. Vincent and the Grenadines).

  • In addition to high PIT thresholds, several components of non-labor income are not taxed, substantially reducing the income tax base. For instance, only Saint Lucia and St. Vincent and the Grenadines tax capital gains. At the same time, low voluntary compliance on the part of professionals and entrepreneurs shifts the burden of taxation to government employees, who account for a substantial portion of taxable labor income. That said, deductions from PIT (mortgage interest expense, pension contributions, and life and health insurance premiums) have been capped in all countries except Saint Lucia, broadening the tax base starting in 2009.

  • On the corporate income tax side, the narrow base reflects (1) the exemption of several activities, such as agriculture, fishing, and offshore companies from taxation; (2) widespread tax exemptions and incentives given to hotels and manufacturing (discussed in section on tax incentives); and (3) for some countries, a small corporate sector (Dominica).

Figure 6.8Ratio of Personal Income Tax Threshold to GDP per Capita

Sources: IMF, Fiscal Affairs Department; www.taxrates.cc/html; government websites; and IMF staff estimates.

Increasing the contribution of direct taxes to revenue can be achieved by taxing non-labor sources of income that are currently excluded from the tax base. In addition to making the system more equitable, PIT and CIT rates could be further reduced, thereby improving the countries’ external competitiveness. If exempt income proves difficult to tax, the assets used in generating the income can be taxed (e.g., by taxing capital gains through existing taxes on real property transfers). To minimize tax arbitrage, the tax rate on labor income applicable to the first income bracket could be set at about the same level as the proportional capital income tax rate.

Property taxes remain an underutilized source of additional tax revenue. Real property in the OECS/ECCU is taxed at a low recurrent rate, ranging between 0.01 percent and 0.5 percent of the market value of the property,12 significantly less than the wider international practice of 1 to 1½ percent of market value. Although the revenue collected is similar to that in CARICOM countries (about 0.4 percent of GDP), high property transfer taxes account for much of the revenue, but at the same time limit the number of transactions and hinder more frequent updates to the market value of properties—and the higher revenue that could be gained from the recurrent property taxes (Table 6.11). Replacing property transfer taxes with recurrent property taxes based on periodically updated market value of property would increase tax revenues and reduce the distortions that result from property transfer taxes.

Table 6.11Property Tax Revenue in the OECS/ECCU Countries and Comparator Regions(Percent)
Share of GDPShare of tax revenue
Country or region2000–042005–072008–092000–042005–072008–09
Antigua and Barbuda0.40.30.42.21.92.3
Dominica0.40.80.81.83.23.1
Grenada0.91.11.05.26.05.5
St. Kitts and Nevis0.40.40.42.11.91.9
Saint Lucia0.20.20.10.90.80.5
St. Vincent and the Grenadines0.20.20.11.00.70.6
Regional aggregates
OECS/ECCU0.40.50.42.12.22.1
Rest of CARICOM0.60.50.52.82.22.2
Central America0.20.40.41.52.32.3
Rest of Latin America0.90.90.85.65.14.5
Small island states0.40.50.81.92.43.6
EU151.81.8n.a.6.56.7n.a.
OECD1.71.7n.a.6.46.4n.a.
Sources: Asian Development Bank online database; Eurostat database; IMF country desk data; United Nations Economic Commission for Latin America and the Caribbean database; and IMF staff estimates.Note: CARICOM = Caribbean Community; n.a. = not available; OECD = Organization for Economic Cooperation and Development. See note to Table 6.1 for composition of regional groupings.

Property taxes can be a valuable direct taxation instrument in jurisdictions where the taxation of income is challenging. Taxation of fixed assets can be used to capture revenue lost to taxpayer noncompliance. It may not be easy to tax business income and other capital income where transaction records may not be available. However, because some of the income is used to purchase fixed assets, property taxes can recover the revenue that should have been collected through income taxation. In the OECS/ECCU countries, this potential can be explored and revenue from property taxes substantially improved by increasing the property tax rate while reducing property transfer taxes. To avoid the erosion of the property tax base, the market value of the properties subject to property tax should be updated periodically. Updating cadastre values every two to three years would be needed to maintain the property tax revenue consistent with the trend in economic growth. For example, in 2006 Antigua and Barbuda increased revenues from property taxes after moving to a market-value-based assessment system and away from a system based on the value of construction.

Tax Incentives

Tax incentives, which may have been necessary initially, have become increasingly pervasive, spreading across multiple taxes and in some cases overlapping. Tax incentives have been an integral part of the OECS/ECCU tax systems since the 1970s. The main incentive schemes were enacted to attract foreign investment in tourism, manufacturing, and agro-industries, especially in attempts to diversify the economy away from agriculture, which was heavily affected by the end of the preferential treatment of banana exports to European Union markets in the 1990s. The incentives primarily take the form of tax holidays spanning 10 to 15 years, exemptions from import tariffs and the VAT, and investment allowances and tax rebates—all of which are renewable at the discretion of the government. Additional incentives include higher depreciation rates and free economic zones (Saint Lucia), and reductions in the CIT statutory rate and in other tax rates ranging from import tariffs to property taxes to small business taxes (St. Vincent and the Grenadines). Most of the incentives are provided through the investment and fiscal legislation in each country, but some incentives are provided outside this legislation, at the discretion of the ministers or cabinets.

Figure 6.9Corporate Tax Revenue Forgone

Sources: Country authorities; and IMF staff estimates.

Tax incentives benefit the largest and most dynamic segments of the economy, significantly eroding the tax base and the buoyancy of the tax system, without clear net benefits.13 The sectors that benefit from the tax incentives now account for a large portion of GDP, so tax incentives have become serious tax expenditures that OECS/ECCU countries can ill afford. For example, tax exemptions claimed at customs averaged about 4 percent of GDP in Saint Lucia during 2009–11. Data on exemptions from income taxes are not readily available because many countries do not require exempt companies to submit income statements, but CIT forgone could have averaged about 4 percent of GDP per year in the OECS/ECCU countries, ranging from about 2½ percent in St. Kitts and Nevis to 6⅔ percent in Antigua and Barbuda since 2000 (Figure 6.9).14 In addition, prolonged incentives in selected industries have required higher tax burdens elsewhere in the economy, further challenging the tax administration to ensure taxpayer compliance.

Given the urgent need for fiscal consolidation, significant scaling back of tax incentives should be high on the agenda of the OECS/ECCU countries, but its success will depend on how well these efforts are coordinated. Fewer tax incentives would help broaden the tax base, thereby spreading the burden of taxation more evenly among the sectors and allowing tax rates to be lowered to create a more competitive environment and improve taxpayer compliance. However, no single country can act in isolation because tax competition in the region and the ease with which capital can move within the region would disadvantage the country initiating the reform. Therefore, coordinated action is the only way to prevent the race to the bottom, reduce tax competition and arbitrage, and safeguard the revenue base.

As international experience suggests, a coordinated approach should involve a regional agreement on best practices for business taxation and tax incentives (Box 6.1). Similar agreements in the European Union, Central America, and East Africa have included provisions to award tax incentives transparently to all investors and only through legislation (thereby prohibiting discretionary awarding of incentives), as well as to eliminate existing tax incentives while grandfathering companies that have already been awarded incentives. In preparation for such an agreement, the OECS/ECCU countries should undertake a detailed inventory of existing tax incentives to show in a transparent fashion their cost to the rest of the economy. To coordinate these reform efforts and subsequent policy decisions, the OECS/ECCU member countries may wish to consider setting up a tax policy unit in a regional institution (e.g., the OECS/ECCU Secretariat).

Box 6.1International Experience in Coordinating Tax Incentives

At least three attempts have been made at regional coordination of business taxation policies, including tax incentives: in the European Union, Central America, and the East African Community (EAC).a

  • European Union member countries adopted a Code of Conduct for business taxation in 1998 to inhibit “harmful” competition between national tax systems (defined as practices that provide a significantly lower effective level of taxation than generally applicable, whether as a result of the tax rate, tax base, or other factors).b

  • In Central America, efforts to coordinate tax incentives have been long in the making. A Convention on Tax Incentives—mandating uniform tax incentives and prohibiting new ones—was in force for more than 20 years (1962–84) in four countries (Costa Rica, El Salvador, Guatemala, and Nicaragua). Coordination efforts were revived with the January 2012 approval of a Declaration of Good Practices for Investment Tax Incentives by the regional Council of Finance Ministers of Central America, Panama, and the Dominican Republic (COSEFIN).c Although adherence to the declaration is not compulsory, efforts are ongoing to have the council approve a mandatory code of good practices, so far adopted only at the level of the Central American Working Group on Tax Coordination in August 2006.

  • Finally, the approval of a code of conduct for business taxation by the EAC Council is expected in 2012.

Most of these codes of conduct share the following features:

  • They are not legally binding, but place a moral obligation on the participants (the only exception being the 1962 convention in Central America).d Therefore, no sanctions apply if a country approves tax incentives that do not qualify as good practice, but there are institutions that monitor compliance and accept complaints against noncompliant countries.

  • They call for tax systems to be transparent, with all tax incentives specified in the legislation, made available to all investors on the same terms, and not subject to administrative discretion.

  • They call for commitment not to compete through (a) new tax incentives; (b) extending the scope of or increasing existing incentives; (c) reducing tax rates below an agreed on threshold; or (d) other measures that induce harmful competition.

  • They also call for the elimination of existing tax incentives that are inconsistent with the code, although companies that have already been provided the incentives are grandfathered until the promised incentive expires.

a The EAC is the regional intergovernmental organization of Burundi, Kenya, Rwanda, Tanzania, and Uganda.b More information can be obtained at http://ec.europa.eu/taxation_customs/taxation/company_tax/harmful_tax_practices/index_en.htm.c The Central American countries covered include Costa Rica, El Salvador, Guatemala, Honduras, and Nicaragua. The declaration was preceded by a wide-ranging exercise to quantify the cost of existing tax incentives, with a view to making a stronger case for their removal.d Although the European Union (EU) Code of Conduct was not in itself directly binding on the member states, the EU Commission successfully used its powers under the EU Treaty with respect to illegal state aid to pressure, and in some instances, force—ultimately through the EU Court of Justice—member states to scale back tax incentive regimes that the EU Commission considered to be both “harmful” under the code and “illegal state aid” under the EU Treaty. This may be relevant to the region because the CARICOM Treaty prohibits members from providing “prohibited subsidies,” and allows members to take action against others who grant prohibited subsidies. Indeed, the CARICOM Treaty specifies that government revenue that is otherwise due and is forgone or not collected (e.g., fiscal incentives, such as tax credits) is considered a subsidy for the purposes of the Treaty (Articles 96 et seq. Revised Treaty of Chaguaramas establishing the Caribbean Community including the CARICOM Single Market and Economy).

Finally, as an alternative to tax incentives, countries can encourage investment by restructuring investment allowances that currently consist of depreciation and tax credits. In particular, many countries (with the exception of Dominica and St. Vincent and the Grenadines) limit losses carried forward to 50 percent of income, which is unnecessarily restrictive; these limits should be relaxed to allow all losses to be carried forward.

Tax Policy Coordination

Against the background of increasing regional economic integration, tax policy coordination and harmonization is becoming ever more important. Economic integration and the currency union make it easier not only for the mobile capital but even for professionals to relocate to jurisdictions with lower taxes. Tax harmonization is needed to retain the mobile resources in the country and avoid a welfare-reducing race to the bottom, in which a tax reduction in one country triggers a response from other countries in the region, resulting in a narrow tax base and low tax revenue. There is significant scope among OECS/ECCU members to bring their tax systems closer, especially with regard to tax incentives offered to the tourism industry, but also in other aspects of income taxation, such as the treatment of capital income, withholding rates, depreciation deductions, and treatment of losses. As noted in Box 6.1, other regions have moved toward greater tax coordination or harmonization by establishing codes of conduct and treaties, or by simply notifying other members of current and new incentives. Harmonization would also reduce compliance costs for businesses operating in multiple countries, thereby promoting investment and growth and—if extended to indirect taxes—reducing incentives to smuggle high value added goods.

Building on progress to date, the next stage of tax reform has to focus on achieving a more equitable tax burden throughout the economy by significantly widening the tax base. A broader tax base will bring into the tax net some of the major and more dynamic sectors of the economy while affording lower tax rates conducive to enhanced competitiveness. An OECD (2010) study provides evidence that a broad-based system with low tax rates is conducive to long-term growth through its effects on factors of production. Thus, the challenge ahead is for OECS/ECCU authorities to tackle the difficult issue of eliminating, or at least significantly scaling back, the pervasive tax incentives that have considerably eroded the tax base.

With a broadened tax base, the tax system would align itself with best practices. This implies a system with few low tax rates and minimum exemptions in order to minimize distortionary effects on production and consumption choices. The PIT under such a system would have few rates and a low maximum rate on labor income and a lower rate on capital income. The CIT would have a single rate no higher than the top marginal PIT rate and would have no or limited tax incentives. The income tax system would be supplemented with a broad-based, single-rate VAT system, with zero-rated exports and a limited number of exemptions for difficult-to-tax activities and essential consumption goods.15 A presumptive tax regime would be needed for small businesses that cannot comply with the requirements of the VAT system. Excise taxes, with either ad valorem rates or periodically adjusted specific rates on selected products such as tobacco and alcoholic beverages, and specific rates on petroleum products, would be another significant component of such a system. Finally, recurring property taxes based on market value with few exemptions and low rates would contribute to the stability of tax revenue. A tax system with these features would substantially reduce the need for international trade taxes in an open economy.

Optimal Revenue Administration for the OECS/ECCU

Sound tax policy and clear tax legislation may create the potential for increasing tax revenue, but the level of efficiency and effectiveness of the revenue administration determines the extent of actual collections. The OECS/ECCU revenue administrations possess the basic elements to build a strong administration—reasonable organizational structures, some trained staff, adequate office space and equipment, and a good foundation for their information technology (IT) systems. At the same time, they suffer from critical weaknesses, many of which emanate from the small scale of their operations and cannot be fully addressed at the national level.

Recent Reform Efforts

Significant improvements have been achieved during the past decade in OECS/ECCU tax administrations, mainly related to the introduction of the VAT. The implementation of the VAT turned out to be the catalyst for comprehensive reform of the countries’ Inland Revenue Departments (IRDs) because the VAT was supported by improvements in all core functions—taxpayer services, collections enforcement, and assessments and appeals.

  • Following the 2004 OECS/ECCU Tax Commission recommendations, the VAT has been successfully implemented in five of the six independent OECS/ECCU countries. Temporary units in charge of VAT implementation were set up within the IRDs, with separate audit and collections functions, stronger tax administration capacity, and greater reliance on enhanced tax administration laws and procedures. These units were subsequently integrated into the mainstream IRD structures in Antigua and Barbuda and St. Vincent and the Grenadines, but revenue and compliance rates have improved in most countries as a result of the VAT introduction efforts.

  • The introduction of the VAT has also helped improve taxpayer services, with the establishment at all IRDs of taxpayer services sections that provide dedicated client services in addition to publicity, public education, and sensitization. Various publications have been developed to support the services provided by the tax administrations, and timely dissemination has been made easier through the establishment of websites with comprehensive tax information (in Dominica, St. Kitts and Nevis, and Saint Lucia). Annual outreach programs also highlight taxpayer obligations and create awareness of the work of the tax administrations. These efforts have resulted in a public that is more educated on tax issues, improved business practices (in particular, record keeping), and improved relationships between taxpayers and tax administrators.

  • The tax administrations have also developed corporate strategic business plans to encourage a more strategic approach to management.

Customs administrations in the OECS/ECCU have also engaged in ambitious reforms. These efforts have focused on aligning customs management in the region with the governing principles of the Revised Kyoto Convention,16 which requires customs administrations to standardize and harmonize legislation and procedures to facilitate legitimate trade, assure the international trade community that reasonable service standards are maintained, and ensure that the investment in the management of international trade is efficiently delivering the intended results. Thus, customs reforms within the OECS/ECCU, although at different stages of completion, have generally encompassed trade facilitation and strengthening of anti-smuggling programs, including trade and supply chain security; adoption of the World Trade Organization valuation agreement and rules of origin in preferential trade agreements; implementation of intelligence and analysis-driven risk management and selective inspection approaches; and transition toward post-clearance controls. These reforms have broadly involved changes in organizational structures, strengthening management systems, reengineering business processes, and large investments in information and communication technology to support enhanced enforcement.

Further Reforms to Build Efficient Revenue Administrations

Despite improvements related to introduction of the VAT, progress in many areas of tax administration has lagged. Tax administrations across the OECS/ECCU are still struggling with widespread noncompliance; weak tax audit that is unable to detect and deter serious evasion and tax avoidance; organization and processes that are poorly aligned with the profile of relevant taxpayer segments or the needs of modern tax administration; weak overall management; fragmented legislation; weak appeals processes; and inadequate IT.

  • Audit capacity within all the IRDs remains weak, and attempts to build capacity within the tax audit function have been undermined by the inability to recruit and retain qualified, experienced staff, forcing some countries to contract for the services of international forensic auditors to review the returns of their larger taxpayers. Some countries (Dominica, Grenada, and St. Vincent and the Grenadines) have achieved notable success in the modernization of their national audit plans and implementation of enhanced risk-analysis techniques to identify and select the most productive audit cases; these three countries are now better able to plan their audit program and monitor its performance.

  • Limited progress has been achieved in modernizing tax administrations’ organizational structures. The organization of a modern tax administration is underpinned by three major principles: (1) a functions-based structure, with departments that execute programs related to all administered tax types; (2) integration of all national taxes in one organization to the extent feasible; and (3) management of service delivery and compliance programs around important segments of taxpayers, that is large, medium, and small (Figure 6.10).

Figure 6.10Typical Tax Administration Organizational Structure in Small Economies

Source: IMF staff.

  • 1. The OECS/ECCU countries have yet to reorganize their structures into two clear tiers: a headquarters level focused on policy, planning, and monitoring, and that provides strategic direction for the operational areas; and an operational level tasked with the day-to-day activities. Slow progress in this area is often the result of difficulties in staffing and resourcing separate headquarters units. However, St. Kitts and Nevis recently established a separate unit responsible for driving the strategic planning process and monitoring performance, in line with best international practice. Similarly, St. Vincent and the Grenadines made a start by forming a small unit that is responsible for monitoring performance against work plans, implementation of reforms, and other such work as directed by senior management, although the planning function still remains with the operational units.

  • 2. Through the Monetary Council of the Eastern Caribbean Central Bank (ECCB), the OECS/ECCU governments decided to establish revenue authorities that integrate both tax and customs administration in each country, but efforts to implement such authorities were delayed by the VAT reforms. Most countries in the Caribbean indeed maintain tax and customs under separate entities. Jamaica, which had integrated them under a single executive in 2000, reverted to separate institutions in 2010. In many other countries throughout the world, however, an integrated revenue authority has emerged as an alternative institutional governance structure to resolve many of the challenges encountered in securing resources and political support for difficult reforms or enforcement actions against special interests.17 However, establishment of an integrated revenue authority without supporting reforms is unlikely to achieve operational improvements (Crandall and Kidd, 2006).

  • 3. Efforts to segment the taxpayer population based on taxpayer size have also progressed slowly. On average across the OECS/ECCU, 100 taxpayers account for 70 percent of governments’ tax revenue; therefore, focusing efforts on those taxpayers would significantly enhance compliance results. Antigua and Barbuda and St. Vincent and the Grenadines implemented taxpayer segmentation programs in 2010 and 2011, respectively, and Dominica is considering the development of a large and medium taxpayer unit on a phased basis. Countries should leverage the operational and capacity gains in their VAT units to closely monitor compliance by this taxpayer group across all taxes, where feasible, through the creation of hybrid large and medium taxpayer units.

  • Strengthening management has been underemphasized in most countries, but it is critical to achieving sustainable performance improvements. International experience has shown that unless significant management development is undertaken, reform outcomes will be limited. The objective is to strengthen the capacity of managers to use strategic planning processes, formulate operational policies, and effectively and efficiently manage resources to meet organizational objectives.

  • The legal provisions relating to tax administration in each country need to be consolidated into a single, coherent tax administration act. Except in St. Kitts and Nevis, these provisions are dispersed among separate pieces of legislation, mainly based on tax type. A tax administration act should group together all aspects of tax administration that are common to a country’s substantive tax laws (income tax, VAT, excise duties, and so forth), defining the rights and obligations of both the tax authorities and the taxpayer with respect to tax administration and compliance. Such a consolidation facilitates tax administration because tax officials can concentrate more easily on particular functions (e.g., audit, investigation, collection recovery) for which the tax administration law defines common rules across taxes, increasing transparency and predictability for taxpayers, and facilitating tax compliance. This does not eliminate the need for individual tax statutes to remain to preserve all provisions unique to each tax type, such as the provision stipulating the credit mechanism under the VAT that relates only to VAT.

  • The establishment of an effective independent appeals process is important for minimizing disputes, building trust between the taxpayer and the administration, and fostering voluntary compliance. Some countries have made significant progress in the area of appeals, especially with the appointment of appeals commissioners who meet regularly to review appeals cases (e.g., Dominica and Saint Lucia). No country, however, has a structured system to maintain, analyze, and disseminate information related to the causes and results of objections and appeals, which would help guide future decisions of the audit and objection staff and ultimately reduce the number of disputed assessments. Although senior management is generally aware of the results of objection and appeal cases, very little information cascades down to the audit and objection staff.

  • The IT systems used for the administration of domestic taxes (the Standard Integrated Government Tax Administration System, or SIGTAS), as operated in the region, lacks sufficient functionality to meet modern tax administration needs. Deficiencies in system maintenance, along with the vendor’s inability to address identified shortcomings, have resulted in a system that does not operate in a way that reflects current international best practices (e.g., it cannot manage the unique taxpayer identifier that is the basis of modern taxpayer control). Furthermore, local modifications in several countries have transformed what started as a de facto regional standard system into several imperfect local versions, making support and future centralized upgrades for these mutant versions both difficult and expensive.

  • A number of operational reforms are also needed to strengthen revenue administration. These include (1) introduction of unique taxpayer identification numbers to facilitate management of taxpayer databases and to link taxpayers to all their taxable economic transactions; (2) targeted verification of the information on tax returns (e.g., through risk-based desk and field audits, and computerized matching of income reports), in acknowledgment that comprehensive scrutiny of every taxpayer is not feasible, thereby directing the tax administration’s limited resources toward the most significant threats to the tax system; (3) increased reliance on electronic filing and payment to facilitate more accurate taxpayer account maintenance; and (4) strengthened enforcement programs to leverage the deterrent effect to improve compliance.

Reform Challenges in Micro States

The OECS/ECCU countries are facing serious challenges in addressing these reform needs. In addition to the lack of autonomy on the part of the revenue administration agencies to manage own resources, various constraints emanate from the small scale of operation of the tax administrations.

  • Reform efforts are held back by lack of autonomy in managing human resources and rigid civil service rules that prevent many OECS/ECCU revenue administrations from recruiting, training, deploying, and managing personnel of the caliber required to deliver business results.

  • A low population base in individual member states leads to difficulties in staffing the revenue administration agencies with all of the requisite competencies, especially because even the smallest administrations with very small taxpayer populations are expected to maintain the full range of services and administrative functions. Moreover, many citizens with college degrees are looking abroad for opportunities to work or continue their studies, further limiting the pool of suitably qualified persons.

  • The size of revenue administration agencies in small or micro economies like those of the OECS/ECCU also makes it difficult to achieve the efficiencies of modern approaches to the structure of tax administration described previously. In these economies, the number of staff employed in the revenue administrations does not easily accommodate the establishment of all the required functions. Moreover, the segmentation of taxpayers according to size and their control by discrete, functionally based units may be impractical if the taxpaying base is small and the staffing level is very low. Taxpayer populations with only a small number of large taxpayers (even by local standards) make it difficult to justify the creation of a separate, fully functions-based large taxpayer unit. Other than in the audit area, large taxpayers do not generate sufficient work to occupy even minimal staffing. Similarly, when the number of staff in the administration is very low, spare capacity is not available to allow the hiving off of staff to populate dedicated teams for each taxpayer segment, if any degree of efficiency in the use of staff is to be maintained.

  • The small number of taxpayers makes it difficult to produce statistics to allow meaningful risk assessment of various trade sectors. Modern taxpayer control techniques are based largely on computer-supported risk assessment. Information relating to taxpayer performance is measured against that of others in the same sort of business, and of comparable size and turnover. This allows informed decisions to be made relating to an annual audit plan, frequency and type of audit, and other control measures to be directed at individual taxpayers or subsectors of the taxpayer population. If the number of taxpayers is very small, with few taxpayers in important business sectors, then meaningful comparisons become difficult, and the organization must use manual techniques based primarily on local, perhaps imperfect, knowledge and assumptions.

  • The IT systems, without which a modern revenue administration cannot function, are also relatively more expensive if they cannot be used to their full capacity. This high cost is not limited to the initial procurement of software and hardware, but also affects recurring maintenance, upgrading of systems, and renewal of hardware. Many revenue administrations in the OECS/ECCU struggle to meet these needs; failure to carry out these tasks leads to a cumulative weakening of the system, as has occurred with SIGTAS across the region.

  • Most countries in the region struggle to meet the requirement for dedicated legal support, which any administration needs to advise it on legal interpretations and disputes, and possibly represent the revenue administration in legal proceedings. Tax administrations in the union have to rely on the ad hoc support of their national attorney general’s chambers, which are normally fully occupied with other government business, and may be inexperienced in tax matters.

  • The small size of OECS/ECCU countries has also created impediments to strong enforcement measures. Some administrators are reluctant to exercise the more stringent enforcement provisions, such as garnishment, seizure of property, and criminal prosecution, because of personal relationships, concerns about staff security, and political interference in these small communities. In these countries, tax officials are well known and fear reprisal or ostracism; aggrieved taxpayers have easy access to the political leadership and can actively seek to challenge or subvert the exercise of bureaucratic authority.

Promoting Regional Coordination and Harmonization

A regional approach could solve many of the problems inherent in tax administration in small and micro economies. There are obvious economies of scale and a critical mass when a single regional revenue administration deals with all OECS/ECCU taxpayers, and shared support services and pooled professional resources can provide enormous advantages. More generally, the benefits of a regional approach include the following:

  • A regional administration, funded by apportionment between all members, should be able to recruit and retain more highly qualified staff who, because of the larger taxpayer population, will be kept more fully occupied, especially in the areas of tax administration in which the consequences of small and micro economies are most keenly felt: IT, audit, and legal support. In these areas, a regional center could be set up where the workload would justify the employment of suitably qualified personnel, and the joint funding, free of national civil service restraints, would enable a competitive remuneration package to be offered.

  • A regional approach would enable businesses that trade in more than one country to be treated consistently across the region, minimizing the opportunity for business planning decisions to be based on differing standards of treatment in individual countries.

  • A regional approach would further enhance the administrations’ abilities to avoid political interference and would minimize the potential negative effects of personal relationships between tax officers and taxpayers.

The OECS already provides a strong framework for regional cooperation and harmonization, and its members are moving toward the establishment of a single financial and economic space (see Chapter 3). One of the major areas of cooperation will be the coordination of fiscal policy, which could lead to harmonization and regionalization of certain aspects of tax systems and revenue administration. The OECS has established several regional suborganizations and regulatory bodies. The Eastern Caribbean Supreme Court, which provides the High Courts and the Court of Appeal to OECS/ECCU members, is a useful example of regional cooperation and supranational powers with potential relevance to revenue administration.18 There are also established avenues for exchange of information and policy coordination in revenue administration through the biannual meetings of the committees of Financial Secretaries, Comptrollers of Customs, and Comptrollers of Inland Revenue, as well as through the Caribbean Customs Law Enforcement Council and the Caribbean Organization of Tax Administrators.

The Tax Reform and Administration Commission of the ECCB supported the creation of a regional revenue authority in its 2005 report. It stated that “the case for a Regional Revenue Authority … rests on the need for tax harmonization within a common market, tax policy coordination to facilitate equitable resource allocation, and fiscal diversity within the region as well as strengthening tax administration through sharing vital common services” (OECS, 2003, p. 100). The report identified three options for a regional body: (1) a fully integrated and centrally managed administration, seen as more appropriate within a federal structure; (2) central management of selected functions; and (3) regional coordination within a flexible cooperative relationship. The report ultimately proposed a regional revenue authority responsible to the Monetary Council of the ECCB, which would coordinate the harmonization of tax policy, coordinate regional training and IT development, and promote best practice among the regional tax administrations. The authority would not be directly involved in operational matters, but would provide “high level support for common services delivery—technical advisors in direct and indirect taxes, legal attorney … and Information Technology Expert” (OECS, 2003, p. 101).

A more limited subregional revenue authority, with regional headquarters and a representative office in each country, could be a first step in the near term. The subregional authority would act as a technical consultant and resource to the separate national revenue administrations, and would include groups of experts to work across the region, who would deal with matters such as the audit of large and complex taxpayers. Although legislation and tax receipts would remain with the individual nations, the subregional authority would take advantage of economies of scale where appropriate and provide services across the spectrum of revenue administration, which could range from coordination and promotion of common standards to the fully delegated responsibility for an aspect of taxpayer control such as large taxpayer audit. The authority’s representative office in each country would be headed by a nonnational of that country, to avoid personal conflicts of interest and to make the work more objective. However, work must be transferred to a regional body only if there are compelling reasons and advantages in doing so, and not simply to impose another layer of bureaucracy.

Concerted efforts would be needed to overcome resistance to the establishment of a regional authority:

  • First, the political will is needed to acknowledge that the eradication of many of the existing weaknesses and shortcomings is beyond the capacity of the countries’ domestic tax departments and cannot be fully solved with training and more technical assistance.

  • Second, the unease about giving up elements of national sovereignty will have to be assuaged with an appropriate public relations campaign. As in the European Union, any steps toward harmonization that are seen to be a diminution of national sovereignty should be closely scrutinized by the media and debated by the general public before being translated into national legislation. For example, although the idea of having highly skilled, multinational teams of tax auditors from a regional authority visiting all the countries to carry out expert audits of the largest taxpayers seems entirely reasonable and beneficial, without a doubt, vigorous debates and criticism would ensue about nationals of one country coming to another to audit businesses. However, because the OECS/ECCU is striving to become a single economic and financial space, with free movement of labor, this will be unavoidable.

  • Third, the principal technical difficulty to be overcome is in designing an organization that is recognized as having legal authority and whose officials have the same powers, in each state, as revenue officials working in the individual administrations in the member countries. And finally, very crucial to the acceptance of a regional authority is the presence of a meaningful dispute settlement and enforcement mechanism to ensure that all members abide by their respective obligations and commitments. Countries are generally only willing to give up aspects of their sovereignty if they are reasonably confident that a mechanism is in place to ensure that everyone—big and small, rich and poor—plays by the same rules and will be held to the same standards. The Eastern Caribbean Court of Appeal and the Caribbean Court of Justice should play an important role in this respect.

Even without setting up a regional authority there are opportunities for greater regional cooperation in several areas of activity:19

  • Information exchange. Subject to required amendments to national legislation to deal with confidentiality issues, the formal exchange of information could be facilitated, with a view to better monitoring businesses that operate in more than one country, and establishing norms for trade sectors across the region.

  • Training. Training packages could be shared and groups of regional trainers could be formed to deliver training. Great savings would be obtained by unified training design and preparation of material. Professional attachments and mentoring arrangements would also be easier to organize and would be more productive for the countries. Tax officers could go to other countries to observe different ways to better administer their systems.

  • Taxpayer services. The OECS/ECCU countries could easily share taxpayer assistance programs. The costs of producing taxpayer education material would be considerably reduced. Also, a shared website could be set up, greatly reducing costs for the individual countries.

The cause of regional cooperation and integration will be strengthened by the initiation of the Supporting Economic Management in the Caribbean (SEMCAR) project. SEMCAR is a program funded by the Canadian International Development Agency (CIDA), the first phase of which commenced in 2011 and will run until 2014. The program is designed to support improved macroeconomic and public financial management, including revenue administration, in 12 countries in the Caribbean region. All of the OECS/ECCU sovereign countries will be clients of SEMCAR. Although the initial emphasis is to promote the use of common systems and standards throughout the client countries, the program’s approach will be to develop synergies through regional cooperation, based on the premise that such cooperation, with the sharing of experiences and the development of similar initiatives, will give the region a much better chance to modernize processes and institutions, and develop flexible and sustainable IT systems. The first phase of the project includes the harmonization and upgrading of SIGTAS and the implementation of a regional training and IT support center to oversee maintenance contracts for the regional IT systems—SIGTAS, the Automated System for Customs Data, and Smartstream—by way of providing effective cost sharing on a regional basis. The second phase, which will start in 2014, will oversee the replacement of SIGTAS.

Conclusion

The overall tax effort in the OECS/ECCU is in line with—and sometimes higher than—that in countries at similar levels of development, although there is significant heterogeneity within the OECS/ECCU. At the same time, the fiscal adjustments facing OECS/ECCU countries are particularly large and urgent and make additional revenue-boosting reforms unavoidable. The introduction of the VAT in virtually all OECS/ECCU countries was a significant advance in modernizing the tax system, simplifying indirect taxation, and facilitating tax administration. This commendable step needs to be built upon.

The key challenge now facing policymakers is to enhance revenue while avoiding raising the tax burden on those economic activities that are already in the tax net. Thus, the appropriate approach is to broaden the tax base significantly, thereby achieving a more equitable distribution of the tax burden while affording lower tax rates, which will enhance competitiveness and strengthen revenue performance. Significant room to expand the tax base remains in all OECS/ECCU countries, and this expansion can be accomplished through scaling back tax incentives; limiting exemptions from VAT, income, and property taxes; and expanding the scope of excise taxes to all traditionally excisable goods.

The growing regional economic integration makes tax policy coordination and harmonization increasingly important, and the success of many revenue mobilization efforts, especially a meaningful widening of the tax base across OECS/ECCU countries, will hinge on such coordination. Tax coordination is needed to retain mobile resources in the country and to avoid a welfare-reducing race to the bottom. This applies in particular to tax incentives, but other aspects of taxation can be more closely aligned as well, including the treatment of capital income, losses, and depreciation for income tax purposes.

Following the success of customs administration reforms, which focused on upgrading the supporting IT systems and streamlining procedures to facilitate trade, efforts should focus on reinvigorating tax administration reforms. These reforms include, among others, upgrading IT systems, strengthening audit capacity, and moving toward an organizational model based on function and taxpayer size (rather than tax type) to improve the focus and efficiency of tax collections. However, many of the deep-seated weaknesses in revenue administration are rooted in the small size of the countries, which inhibits economies of scale and leaves skilled personnel in short supply. These weaknesses need to be addressed at a regional level. Therefore, a move toward integration of at least some revenue administration services—such as large taxpayer audit, IT management and maintenance, and legal services—could provide significant benefits.

References

    Beyer, J.,2002, “‘Please Invest in Our Country’: How Successful Were the Tax Incentives for Foreign Investment in Transition Countries?Communist and Post-Communist Studies, Vol. 35, No. 2, pp. 191211.

    Blomstrom, Magnus, and AriKokko,2003, “The Economics of Foreign Direct Investment Incentives,” NBER Working Paper No. 9489(Cambridge, Massachusetts: National Bureau of Economic Research).

    Chai, Jingquing, and RishiGoyal,2008, “Tax Concessions and Foreign Direct Investment in the Eastern Caribbean Currency Union,” IMF Working Paper 08/257(Washington: International Monetary Fund).

    Crandall, William, and MaureenKidd,2006, “Revenue Authorities: Issues and Problems in Evaluating Their Success,” IMF Working Paper 06/240 (Washington: International Monetary Fund).

    Eastern Caribbean Central Bank, 2005, “The Tax Structure of the ECCB Territories” (Basseterre, St. Kitts: Eastern Caribbean Central Bank).

    Klemm, Alexander, and StefanVan Parys,2009, “Empirical Evidence on the Effects of Tax Incentives,” IMF Working Paper 09/136 (Washington: International Monetary Fund).

    Morisset, Jacques, and Pirnia, Neda,1999, “How Tax Policy and Incentives Affect Foreign Direct Investment: A Review,” World Bank Policy Research Paper No. 2509 (Washington: World Bank).

    Organization of Eastern Caribbean States (OECS), 2003, “New Approaches to Taxation and Tax Administration in the Eastern Caribbean Currency Union: Volume 1, A Framework for Tax Reform,” Tax Reform and Administration Commission (Castries, Saint Lucia).

    Organization for Economic Cooperation and Development (OECD), 2010, “Tax Policy Reform and Economic Growth,” OECD Tax Policy Studies No. 20 (Paris).

The authors would like to thank Rosamund Edwards and Rasona Davies for useful comments on an earlier draft and Ricardo Fenochietto for his input on international experiences in coordinating tax incentives.

The analysis in this chapter covers mainly the OECS/ECCU countries (Antigua and Barbuda, Dominica, Grenada, St. Kitts and Nevis, Saint Lucia, and St. Vincent and the Grenadines), and excludes Anguilla and Montserrat.

For example, though Antigua and Barbuda has a progressive personal income tax rate structure, the top tax rate of 25 percent applies only at very high income levels. Furthermore, in Antigua and Barbuda a large number of goods and services subject to VAT are zero-rated, thus reducing the size of the most significant tax base. In 2010, the government reduced the number of zero-rated items from 70 to 38, a measure that improves revenue performance. Grenada introduced VAT in 2010 to increase tax revenue on consumption of goods and services, but its revenue yield has been impacted by a reduced tax base and the application of lower VAT rates on some goods and services.

VAT productivity is measured as the ratio of actual VAT revenue collected as a share of GDP or consumption to the statutory VAT rate.

OECS/ECCU countries are pursuing membership in the Free Trade Area of the Americas. Joining trade blocs will erode the international trade tax base and the OECS/ECCU countries have to strengthen or find domestic sources to tax.

International trade taxes do not include VAT, consumption taxes, and excise taxes on imported goods, which are classified under taxes on goods and services.

The implicit customs service charge—calculated as the percentage share of revenue from customs service charges to the value of imports—rose from 4.1 percent during 2000–04 to 4.7 percent during 2005–09.

Embarkation and travel taxes consist of taxes collected per passenger from ships docked at the port, along with air ticket and airport departure taxes.

Mainly VAT, consumption, and excise taxes.

The 2008–09 decline in this revenue in St. Kitts and Nevis was explained in part by the prolonged closure of the Four Seasons hotel in Nevis, which had a marked impact on hotel accommodations taxes.

St. Kitts and Nevis has a higher standard rate of 17 percent. Antigua and Barbuda’s rate for the hotel industry was 10.5 percent until end-2011, at which time it was raised to 12.5 percent.

Grenada expanded the coverage of excise taxes to alcohol, motor vehicles, and tobacco in February 2010. St. Kitts and Nevis expanded the coverage of excise taxes to aerated beverages and fuel in November 2010.

The OECS/ECCU countries now primarily use market valuations for property tax purposes—for example, Dominica and St. Kitts and Nevis began doing so before 2009, Grenada and Saint Lucia did so in 2011, and St. Vincent and the Grenadines in 2012.

There is no clear empirical evidence that tax incentives are effective in attracting foreign direct investment (FDI) and boosting economic growth. Empirical studies based on investors’ surveys and econometric analyses show that investors are mostly influenced in their decisions by market and political factors and that tax policy appears to have no or little effect on the location of FDI (Morisset and Neda, 1999; and Beyer, 2002). Even if tax incentives were effective in attracting FDI at the margin, there is no clear evidence that the economic benefits of FDI offset the direct cost of forgone revenue or the indirect distortionary effect of subsidies (Morisset and Neda, 1999; Blomstrom and Kokko, 2003; and Klemm and Van Parys, 2009).

These costs are calculated as the difference between the effective CIT yield and the yield that should obtain under the statutory CIT rate, assuming, in the absence of national account data from the income side that the CIT base is equivalent to one-quarter of GDP, following Chai and Goyal (2008).

Because VAT is a tax on consumption, it applies to goods and services where they are consumed, thus causing no distortion to consumption decisions. Thus, all exports would be subject to a zero VAT because they would be taxed at the destination of consumption. Applying a zero VAT rate to exports allows exporters to claim a tax credit or a refund on the VAT they paid on their purchases of goods and services for exporting.

See the World Customs Organization website for further detail: www.wcoomd.org.

Approximately 40 countries have established revenue authorities, with many variations in structure and level of autonomy. The Russian Federation and Azerbaijan have a full-fledged ministry responsible for tax administration. The revenue administrations in Bulgaria, Hungary, Jamaica, and Latvia are agencies reporting to the Ministry of Finance and have considerably less autonomy. In between those extremes, Guatemala and Guyana have created independent revenue agencies with considerable autonomy, but still less than that of a ministry.

Other regional bodies include the Eastern Caribbean Aviation Authority and the Eastern Caribbean Telecommunications Regulatory Authority.

Closer cooperation between national tax authorities, or with a newly established regional tax authority, probably requires—in addition to any necessary changes to domestic law—the conclusion of multilateral tax information exchange and administrative assistance agreements. The existing interregional double-taxation agreement between the CARICOM countries is unlikely to provide a sufficient legal basis for efficient cooperation in this regard.

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