Data requirements and training of a successful TPU

17. National accounts data on the income and expenditure components of GDP are essential data sources for tax policy analysis. Hence, the TPU should establish the relationship between taxes and the macroeconomic aggregates. In addition, the TPU must obtain consistent taxpayer data from the CRA (over an extended period), which must be different than the processing data that the revenue departments have hitherto generated. At a minimum, tables and statistics on the following should be produced periodically (extracted from tax return data): Sources of income and tax by size of income for individuals; sources of income and expenditures by industry, sales and asset size for businesses; turnover by size and industry for indirect taxes. For VAT in particular, all input purchases as well as output sales by industry and size are needed for assessing the tax gap.

Recommendation

• Establish a TPU to conduct revenue analysis and tax policy development.

Standard rate

30. The proposed standard rate of 15 percent is comparable to those in the region (Table 3). A 2002 IMF/FAD mission recommended this rate, and it remains broadly appropriate. Of course, a final determination of the tax rate would depend on an analysis given the desired revenue goal, decisions on the final form of the VAT base, and the measures adopted with respect to tariffs and other domestic taxes.

Table 3.

The Bahamas: VAT in Comparator Countries and Regions

Source: Adapted from Schipke, Cebotari, and Thacker (2013); and country authorities.

¹12.5 percent for hotels and 10 percent on gaming.

²In addition, 20 percent for mobile telecoms and 7.5 percent on certain construction (temporary rate).

³For hotels and restaurants, until April 2013.

Table 3.

The Bahamas: VAT in Comparator Countries and Regions

	Date of Introduction	Standard Rate (%)	Hotels Rate (%)	Threshold (US$000s)	Revenue (% GDP)	Revenue Productivity
Country
Antigua and Barbuda	2007	15	12.5 1/	110	6.4	0.40
Barbados	1997	17.5	8.75	40	10.5	0.70
Dominica	2006	15	10	44	9.8	0.67
Grenada	2010	15	10 2/	44
St. Kitts and Nevis	2010	17	10	55
St. Lucia	2012	15	8 3/	67
St. Vincent and Grenadines	2007	15	10	44	7.8	0.50
Regional aggregates
OECS/ECCU		15.4			7.4
Rest of Caricom		13.6			7.3	0.50
Central America		12.6			4.2	0.46
Rest of Latin America		16.4			6.4	0.43
Small island states		11.3			6.5	0.56
EU15		19.9				0.38
OECD		17.9				0.39

Source: Adapted from Schipke, Cebotari, and Thacker (2013); and country authorities.

¹12.5 percent for hotels and 10 percent on gaming.

²In addition, 20 percent for mobile telecoms and 7.5 percent on certain construction (temporary rate).

³For hotels and restaurants, until April 2013.

View Table

Table 3.

The Bahamas: VAT in Comparator Countries and Regions

	Date of Introduction	Standard Rate (%)	Hotels Rate (%)	Threshold (US$000s)	Revenue (% GDP)	Revenue Productivity
Country
Antigua and Barbuda	2007	15	12.5 1/	110	6.4	0.40
Barbados	1997	17.5	8.75	40	10.5	0.70
Dominica	2006	15	10	44	9.8	0.67
Grenada	2010	15	10 2/	44
St. Kitts and Nevis	2010	17	10	55
St. Lucia	2012	15	8 3/	67
St. Vincent and Grenadines	2007	15	10	44	7.8	0.50
Regional aggregates
OECS/ECCU		15.4			7.4
Rest of Caricom		13.6			7.3	0.50
Central America		12.6			4.2	0.46
Rest of Latin America		16.4			6.4	0.43
Small island states		11.3			6.5	0.56
EU15		19.9				0.38
OECD		17.9				0.39

Source: Adapted from Schipke, Cebotari, and Thacker (2013); and country authorities.

¹12.5 percent for hotels and 10 percent on gaming.

²In addition, 20 percent for mobile telecoms and 7.5 percent on certain construction (temporary rate).

³For hotels and restaurants, until April 2013.

Lower rate for hotel accommodation

31. Hotel accommodation is usually taxed under VAT, even in countries with a partial VAT and where no distinction is made between accommodation provided to tourists or to residents. (An exemption of hotel accommodation for residents is difficult to rationalize or to monitor properly.) Definitional issues arise in distinguishing hotels from boarding houses, homes for the aged, etc. Some countries provide an end-use exemption for the latter forms of accommodation, but the best rule is probably a straightforward time period exemption stating that accommodation provided for a stretch of time in excess of, say, one month or six weeks, is exempt.

32. Food and drink is invariably taxed when supplied by hotels and restaurants, the small-business exemption being used to leave small establishments outside the net. Other tourism services provided through hotels are also generally taxed. As a general principle, a desirable characteristic of a VAT is to have a single positive rate. Single rates, applied uniformly to all goods and services, greatly facilitate compliance and administration, especially by avoiding disputes about classifications of goods and credit claims due to differential VAT rates on inputs and outputs. In addition, multiple rates can distort the market as efforts are made to package commodities and services in a way that brings more sales under the lower rate. Multiple and differentiated VAT rates have seriously impeded the functioning of a number of VATs around the world in the past.

33. On the other hand, many countries have introduced VAT with a second, lower rate for hotels and perhaps other tourism services.¹⁶ Table 3 above provides an indication of rates in use in the region. A 10 percent rate, equivalent to the current hotel guest tax rate in The Bahamas, is certainly comparable to practice in these countries, as is the gap between the standard rate and the lower rate. The mission would nevertheless recommend against a second rate—among other reasons, a uniform rate would allow a lower tax rate for any given revenue requirement—however, in the current environment, doing so is defensible.

34. If a lower rate is introduced, its negative impacts can be controlled through a number of other provisions. First, the lower rate should be applied to the full charge for accommodation—including hotel levy, gratuities, and any surcharges added to the room rate. This is the correct treatment in most cases, and prevents a number of possible adverse incentives.¹⁷ Second, the scope of the lower rate should be restricted to accommodation; restaurant food and other tourism services offered by the hotel should be taxed at the standard rate, to level the playing field between similar services offered by other businesses outside the hotel, which will be subject to VAT at the standard rate, and to protect revenue.¹⁸ Finally, multiple rates complicate the administration of the tax in the case of businesses that use all-inclusive prices; for these firms, it will be necessary to review the current allocation rules to ensure their accuracy, and fairness relative to other businesses.

Domestic zero-rating

35. Since the provision of electricity and water is undertaken by public utilities, the proposed zero-rating of limited quantities of residential sales of these items should be straightforward to administer. The mission does not have a view on whether the preferentially treated amounts are appropriate; it does note, however, that zero-rating is a second-best measure to reduce the regressivity of the VAT; since all taxpayers will benefit, the total revenue cost of the measure will be much larger than the value of the benefit that accrues to the targeted households. If total purchases of these items were taxed, it would generate more than enough revenue to compensate targeted households through the expenditure side of the budget. For this reason, zero-rated quantities should be restricted.

Exemptions

36. The tax base should be chosen as broadly as possible, preferably with no exemptions (and ideally with zero-rating limited to exports only). A broad base protects revenues and keeps compliance complexity to a minimum. Any exemptions, beyond the relatively high registration threshold (see discussion above), especially if applied to intermediate products, would result in tax cascading and increase the tax burden of downstream businesses. Exemption of intermediate inputs may also induce businesses to find substitutes of their inputs and supply to themselves.

37. However, it is common in all VATs to exempt certain types of activities. Even though preserving the VAT chain is crucial, some sales are usually exempt. This is mainly for equity reasons (e.g., basic food items, education, and health) or due to administrative difficulties (e.g., margin-based financial services). However, in modern VATs (i.e., Australia, Canada, New Zealand, Singapore, and South Africa) more items have been included in the VAT base such as hospital and medical care, university education, postal services, and radio and television broadcasts. Taxation has administrative advantages, and there may be scope to compensate for any increase in costs by an increase in subsidies. The proposed Bahamas approach is somewhat retrograde in this respect, but the approach may reflect the current strengths of the administration and the state of feasible expenditure policy at this time. In this section, a number of selected issues in exemptions are discussed.

38. Food: In common with many other countries, it is proposed to preferentially treat basic food items. While understandable, the argument against this approach is analogous to that for zero-rated domestic consumption above: the reduction in regressivity of the VAT comes at a very high price in terms of lost revenue, since higher-income households spend more absolutely on food.¹⁹

39. Financial Services: A practical approach to taxing financial services has so far been elusive. Consequently, the proposed approach of exempting financial services is defensible, with one important proviso: all banking services for which a fee is charged should be subject to VAT, in particular for those services provided to VAT registered taxpayers. This has been the trend as additional countries have introduced the VAT. In addition, hire-purchase agreements and financial leases should be taxed in full. This is so that an incentive is not introduced to avoid tax by leasing rather than an outright purchase of an item.

40. Insurance: Consider bringing insurance into the VAT. The authorities are contemplating maintaining the current BLF levied on 3 percent of the gross premium from local policies, and otherwise exempting insurance from VAT. This proposal, in general, outlines the current structure of taxes on insurance in the EU countries. This treatment is administratively complex and economically distortionary. More modern VATs have taken a different approach: insurance taken out is fully taxed, while registered businesses receive a credit for the VAT paid on insurance premiums. For the insurance company, value added is calculated as the difference between premium revenue and the sum of indemnity payouts and taxable purchases. This value-added can be included in the tax base by taxing insurance premiums and allowing a presumptive tax credit for the VAT imputable to payouts (plus a credit for the VAT paid on purchases). The presumptive tax credit should be treated as an output VAT collection at the level of registered businesses, while final consumers would receive the VAT along with indemnity payments without any further tax liability.²⁰

41. The VATs in Australia, New Zealand, Singapore, and South Africa have adopted variants of this approach in their VATs, and this should be considered for The Bahamas VAT, at least for property and casualty insurance. Accompanying this, the separate BLF on insurance should be abolished. Full taxation under VAT has been shown to be feasible, simpler, and more efficient than exemption.²¹

42. Gaming: In principle, spending on gambling activities should be subject to VAT in the same manner as other forms of consumption expenditures. In The Bahamas, the argument is tempered somewhat by the fact that only nonresidents are customers; nevertheless, other types of consumption by nonresidents intend to be taxed under the VAT, and gambling should not be treated differently in this respect. Currently, gaming is taxed under the Casino Taxation Act. The CT has two components, the first is a fixed annual fee, based on the size of the casino, divided into three categories, plus an ad valorem charge that is applied to the difference between the total amount wagered and the winnings paid out, called the gross winnings. The tax rate varies by gross winnings, 10–15 percent for smaller casinos and for larger casinos, a declining variable rate between 25 percent and 5 percent (the latter rate applying to winnings in excess of US$20 million). Casinos are exempt from the BLF.

43. There are several possibilities with the introduction of VAT. First, casinos can be exempt, and the CT maintained. Alternatively, casinos can be brought into the VAT. The appropriate way to do this is similar to the treatment of insurance as described in the previous section—gaming as a business has several strong structural resemblances to insurance, and the approach to taxation can exploit this. The tax base would remain gross winnings, and output tax would be determined by applying the appropriate tax rate to this base. The casino would in addition take a credit for VAT paid on other purchases involved with operating the business. The net amount would represent the VAT liability. Accompanying this, the CT would be eliminated or significantly reduced. Since under the CT, the tax rate ranges up to 25 percent, taxing gambling at the standard VAT rate would yield a comparable level of revenue to the CT (the analysis should be done to verify this).

44. The mission recommends that consideration be given to bringing the casinos into the VAT net at the standard rate, as described above, and reducing or eliminating the CT. This is the approach adopted by a number of modern VATs, including in Australia and South Africa.²²

45. Real Estate: The VAT treatment of real estate being considered by the authorities has many standard elements, but the interaction with the stamp duty on property transfers has not been adequately addressed. The stamp duty, at rates up to 10 percent, has effects similar to a cascading turnover tax, and can introduce serious distortions into the market. Consideration should be given to an alternative approach that reduces the magnitude of these distortions in the case of property transfers between VAT nontaxpayers, while preserving a portion of the revenue collected under the stamp duty, but in a manner that is consistent with taxing value-added.²³

46. The proposed approach would tax the change in value of the property at the time of the transfer rather than tax the transfer value. Under the VAT, the taxation of new properties is correctly thought of as a prepayment of VAT on the flow of housing services that the property provides. However, this prepayment approach fails to tax any subsequent changes in the value-added from the property. This can be remedied by taxing the increase (or decrease) in the value realized at the time of the transfer. This change in value should be taxed at the standard VAT rate. With this tax in place, the highly distortionary stamp duty can be eliminated (the lock-in effect of the stamp duty is reduced, since the new tax is levied on the change in value, rather the entire transaction value).

47. The proposed tax should continue to be enforced by the registrar’s office. Sellers and buyers are not registered VAT taxpayers, and it would be burdensome to require them to register for a unique property transaction. Consequently, the easiest implementation would be to retain the stamp duty legislation (suitably modified), and continue to have the tax enforced by the property registrar’s office.²⁴

Registration threshold

48. The role of the registration threshold is to limit the size of the taxpayer population at a minimal sacrifice of revenue. This approach optimizes inter alia on administrative and compliance costs. Operating a broad based consumption tax can imply a large taxpayer population, many of them being small businesses with relatively small turnover and value-added. Administering many small, often noncompliant, businesses is costly and ineffective; in addition, compliance costs can represent a larger share of the total return for smaller businesses. It is very important to set the registration threshold at an appropriate, fairly high level to balance these and other considerations.

49. The authorities are currently collecting data to analyze the likely VAT taxpayer population. However, it is relatively clear at this point that the optimal threshold is likely to be somewhat in excess of the previously proposed level of US$50,000. The mission concurs with the authorities’ current estimation that the threshold should be upwards of US$100,000, likely in the range of US$150,000. A threshold at this level will almost certainly capture businesses that account for an overwhelming percent of total turnover in The Bahamas.

50. Especially at introduction, when administrative capacity is being built up, a high threshold that limits the number of potential registrants is desirable. In addition, it is necessary to introduce provisions for voluntary registration, in particular for smaller businesses that export, or which sell mainly to registered businesses. By registering, these firms can take a credit for VAT paid on purchases, and their business customers can also take a credit for VAT paid on purchases from them. It may be appropriate to have tighter provisions in this regard when the tax is introduced and relax them, allowing more firms to voluntarily register, as the VAT administration matures.

Treatment of businesses below the threshold

51. Businesses with turnover below the threshold should not be required to register. Non-registered businesses in the VAT system are simply exempt entities. It means that they are treated like final consumers—they must still pay VAT on their taxable purchases, but are not required (nor allowed) to collect VAT on their supplies. As a result, they cannot claim credits for VAT paid on purchases and hence have to absorb the tax they pay on their purchases. Nevertheless, being exempt is advantageous to businesses that sell mainly to final consumers.

52. It is common to levy a simplified tax on businesses below the VAT registration threshold. The authorities have proposed to levy a flat annual fee (for example, US$100, the amount of the BLF on businesses with a turnover level below US$50,000) on all businesses below the VAT threshold. The mission recommends an alternative approach, which would raise more revenue. Specifically, it is recommended that all businesses below the threshold who are not registered should continue to pay the BLF; micro-businesses (those with turnover below say US$50,000) would continue to pay a flat annual fee, while those above this level and below the VAT registration threshold would pay an annual tax based on turnover.

53. The tax rate on turnover for these businesses should be unified. There are sector-specific tax rates in the current BLF, and it would be appropriate to unify these, in the interest of simplicity.

Recommendations

• Introduce VAT with a single rate.

• Tax fee-based financial services under the VAT.

• For exempt financial services, maintain the BLF. Consider adjusting the definition of the base to wages plus salaries plus profit.

• Tax property and casualty insurance under VAT. Consider taxing life insurance. Eliminate the BLF on policies taxable under VAT.

• Tax gaming under VAT. Eliminate at least the portion of the Casinos tax that is levied as a percent of winnings.

• Tax telecommunications services under the VAT, (except possibly for the cost of basic telephone service). Maintain the BLF on mobile telecommunications.

• All surcharges, gratuities, and hotel levies should be included in the base for VAT on hotel accommodation. If hotel accommodation is taxed at a lower rate, other taxable supplies by hotels should be taxed at the standard rate.

• Consider replacing the real property transfer tax on transfers between VAT non-taxpayers with a tax on the increased value-added of the property.

• Subject to further data collection and analysis, consider adopting a turnover threshold of about US$150,000. Make adequate provision for voluntary registration of businesses below the threshold.

• Preserve the BLF on businesses below the VAT threshold as a simplified tax. For these businesses, unify the rate structure.

• Consider as a temporary measure preserving the Business License Tax on all businesses subject to VAT (except for insurance policies that are taxed under VAT).

The revenue identity

69. When considering property tax reforms in any country, there are five factors in the “property tax revenue identity” that inform the tax reform discussion: (1) the tax base; (2) its valuation; (3) the tax rate; (4) coverage ratio; and (5) collection ratio. These five factors can be expressed as a useful equation³¹ that always reflects the operation of a land and property tax. They can be used to quantify the revenue loss if valuation, coverage, and collection ratios are influenced by other considerations (i.e., granting exemptions):

Revenue = Legally Defined Tax Base x Tax Rate x Valuation Ratio x Coverage Ratio x Collection Ratio

70. In this expression, the defined tax base refers to the properties identified in the law as being subject to a property or land tax and the methods to be used to determine their taxable value. The valuation ratio is the proportion of the fully defined value that is actually assessed for tax purposes. The tax rate is simply the rate applied against the tax base expressed as a value or area (sq ft/m²). The coverage ratio refers to the proportion of properties that should be included in the base which have actually been identified and are included in the cadastre. The collection ratio refers to the proportion of assessed taxes that are actually collected. Ideally, the coverage, valuation, and collection ratios will all be one, or 100 percent. In practice, this is almost never the case. The following example indicates how sensitive revenues respond to changes in the valuation, coverage, and collection ratios (the latter three ratios being identifiers of administrative effectiveness). Consider a case in which the legally defined base is the market value of all land and capital improvements (buildings) and the rate is set at 1 percent of that value annually. For a variety of reasons, only 80 percent of the taxable land parcels have been identified and are included on the tax rolls. Moreover, the valuations are several years old, resulting in properties being valued only at 90 percent of their current market value. The tax administration is rather effective in collections and enforcement, but only collects 85 percent of the tax liabilities due. According to the revenue identity, only 61.2 percent of the theoretical revenue will be collected (see below):

Example: Revenue = Legally Defined Tax Base x Tax Rate (=0.01) x Coverage Ratio (=0.8) x Valuation Ratio (=0.9) x Collection Ratio (=0.85) or Revenue = Base *0.01*0.8*0.9*0.85 or just 61 percent of the theoretical revenue.

Setting the statutory tax rate

71. The property tax liability is calculated by multiplying the assessed value with the rate. Given the size of the tax base, the second most important element, the tax rate, determines the revenue potential of a property tax. Countries use different approaches for rate-setting. There are three key considerations as to the tax rate: (1) who should determine rates; (2) should there be a single rate or differentiation; and (3) how high should rates be? Table 6 summarizes international practices for rate-setting.

Table 6.

International Practices with Property Tax Rates

Source: USAID, 2009: 14.

Table 6.

International Practices with Property Tax Rates

Practice	Rationale
Flat ad valorem rate	Simplest way to tax property values.
Flat specific rate	Simplest way to tax an area base.
Progressive ad valorem rate	Establish more fairness for the system by taxing higher valued properties at higher nominal rates.
Differential rates applied to different types of property, with non-residential property usually attracting higher rates, agricultural and residential properties benefiting from lower rates.	Usually to protect agricultural property from higher taxes, and to capture the greater tax-paying capacity of commercial and industrial land.
Different rates applied to land/site and capital improvements/structures; surcharge rate applied as penalty for sterilizing valuable/potentially productive land or a penalty for underutilization (e.g., Brazil, Senegal and Venezuela).	To encourage the development of vacant and underutilized land.
A progressive tax rate is applied to the total value of an individual’s land holding (e.g., Peru).	To put higher burden on concentration in property holdings or wealth concentration.
Annual increase in tax rates to compensate for the failure to revalue properties or adjust through indexing.	To protect revenues when revaluations are delayed.

Source: USAID, 2009: 14.

View Table

Table 6.

International Practices with Property Tax Rates

Practice	Rationale
Flat ad valorem rate	Simplest way to tax property values.
Flat specific rate	Simplest way to tax an area base.
Progressive ad valorem rate	Establish more fairness for the system by taxing higher valued properties at higher nominal rates.
Differential rates applied to different types of property, with non-residential property usually attracting higher rates, agricultural and residential properties benefiting from lower rates.	Usually to protect agricultural property from higher taxes, and to capture the greater tax-paying capacity of commercial and industrial land.
Different rates applied to land/site and capital improvements/structures; surcharge rate applied as penalty for sterilizing valuable/potentially productive land or a penalty for underutilization (e.g., Brazil, Senegal and Venezuela).	To encourage the development of vacant and underutilized land.
A progressive tax rate is applied to the total value of an individual’s land holding (e.g., Peru).	To put higher burden on concentration in property holdings or wealth concentration.
Annual increase in tax rates to compensate for the failure to revalue properties or adjust through indexing.	To protect revenues when revaluations are delayed.

Source: USAID, 2009: 14.

72. Property tax rates for real property are either set by central government (as is the case in The Bahamas) or locally, with often some rate range restrictions from the center. Setting the property tax rate locally is crucial for accountability on local taxation decisions (while central government determines the property tax base) but fiscal decentralization considerations are not yet an issue in The Bahamas. Ultimately, this may become an issue for the Family Islands. It is common practice for central government to restrict rates to a statutory range to minimize inter-jurisdictional distortions.

Differentiation between flat and graduated rates

73. Globally, governments often impose rates that are differentiated according to property class—as is the case in The Bahamas. This could result in different rates per property class and even result in complete tax relief for some property classes. Theoretically and ignoring for a moment the overriding simplicity imperative, differentiated tax rates may be justified on a number of grounds: (1) For fairness reasons in respect of benefits received (i.e., property tax being a benefit tax, the amount of local public services may vary across property categories). For example, businesses may receive fewer public services than residential properties (i.e., schools, clinics, parks, etc.) and, hence, should attract a lower tax rate. This is rarely the case; indeed, as in most countries the opposite holds; (2) In line with efficiency considerations, properties that are least elastic in supply could carry a higher tax burden. Normally, business investments tend to be more mobile than residential properties and, again, should be taxed more lightly than residential property. Yet, international evidence indicates the opposite, with much lower property rates for residential properties; and (3) Variable rates can be introduced to induce desired land use objectives. Alternatively, some countries in Africa—e.g., Botswana, Namibia, and South Africa—allow municipalities to apply higher rates on vacant buildable land within cities to encourage property development.

74. Many jurisdictions specifically provide for lower property tax rates in the case of residential properties. This is the case in countries such as Australia, Canada, India, Pakistan, and South Africa. Granting a tax-free threshold is ineffective since it benefits low and high value properties. Then again, some countries apply higher rates for commercial properties; or lower rates for selected industries and service providers such as manufacturing and tourism. Alternatively, the values of properties occupied by preferred business sectors could be under-assessed; or central government could grant other kinds of tax relief by explicitly legislating zero or low rates or tax deferrals. As indicated above, the differential or favorable tax treatment of residences is not consistent with the concept of a benefit tax and therefore does not recognize the differential use of public services.

75. There is therefore no strong economic case for higher tax rates on commercial or industrial properties as the tax is ultimately borne by households—in an inefficient manner. Differentially higher taxation favoring residential over commercial properties distorts land use and may lead to overinvestment in residential properties. It may also lead to the illegal use of residential properties for commercial or industrial enterprises—especially in jurisdictions where zoning laws or regulations are poorly enforced or absent. Rate differentiation complicates the design, the transparency, and the administration of a property tax. Best practice suggests that only one rate for both residential and commercial properties should apply as it would induce investment choices that are based on the best use of property. The rate differentiation and the capping of an absolute tax liability at US$50,000 has an adverse distributional impact on low- and middle-income property owners in The Bahamas, clearly illustrating that these current threshold, rate, and tax liability caps primarily benefit the high-net worth individuals (Table 7). The mission would, therefore, propose complete standardization and elimination of the caps to improve vertical equity by raising tax burdens on property valued above US$5 million.

Table 7.

The Bahamas: Capped Tax Liability Impairing Distributional Fairness

Source: IMF staff calculations.

Table 7.

The Bahamas: Capped Tax Liability Impairing Distributional Fairness

Property Value	Statutory Tax Rate (In percent)	Property Tax Liability Without Exempt Amount	Effective Rate	Taxable Base After Tax Threshold	Statutory Tax Rate (In percent)	Property Tax Liability After Exempt Amount	Effective Tax Rate on Market Value
2 50,000	-	-	0.00	0	-		0.00
500,000	0.75	3,750	0.75	250,000	0.75	1,875.00	0.38
1,000,000	1.00	10,000	1.00	750,000	1.00	7,500.00	0.75
5,000,000	1.00	50,000	1.00	4,750,000	1.00	47,500.00	0.95
6,000,000	1.00	50,000	0.83	5,750,000	1.00	50,000.00	0.83
10,000,000	1.00	50,000	0.50	9,750,000	1.00	50,000.00	0.50

Source: IMF staff calculations.

View Table

Table 7.

The Bahamas: Capped Tax Liability Impairing Distributional Fairness

Property Value	Statutory Tax Rate (In percent)	Property Tax Liability Without Exempt Amount	Effective Rate	Taxable Base After Tax Threshold	Statutory Tax Rate (In percent)	Property Tax Liability After Exempt Amount	Effective Tax Rate on Market Value
2 50,000	-	-	0.00	0	-		0.00
500,000	0.75	3,750	0.75	250,000	0.75	1,875.00	0.38
1,000,000	1.00	10,000	1.00	750,000	1.00	7,500.00	0.75
5,000,000	1.00	50,000	1.00	4,750,000	1.00	47,500.00	0.95
6,000,000	1.00	50,000	0.83	5,750,000	1.00	50,000.00	0.83
10,000,000	1.00	50,000	0.50	9,750,000	1.00	50,000.00	0.50

Source: IMF staff calculations.

76. Best practice suggests that one should pursue simplicity when it comes to rate-setting in order to minimize complexity in administration and to encourage compliance. If there is rate differentiation regarding quality, use of properties, and multiple property ownership, taxpayers will seek to artificially reclassify use or values simply to benefit from the lower rate. Hence, a single rate may be the correct approach as market valuations to a large extent already reflect differences in ability-to-pay—making discriminatory rates superfluous. In a simplified value-based or area-based system, however, differentiation may be more appropriate.

Level of rate

77. Internationally, and especially in developing countries, property tax rates are mostly very low, explaining partially property taxes’ low revenue importance expressed as percentage of GDP. If The Bahamas would need to raise more revenues from the real property tax, after the administrative reforms have run their course, the target might be at the higher end of the current global revenue range of 0.6–2 percent. This goal would necessitate an increase in nominal rates. Globally, tax rates for market value-based system typically range from 0.5–2 percent.

Property tax relief for social policy or economic development objectives

78. Political, socio-economic, and practical considerations influence many facets of a tax instrument. These are often reflected in differentiated rates (see above), deductions, exemptions, thresholds, or tax holidays in order to accommodate economic hardship cases or to pursue some development or industrialization policy (see the mission’s adverse views on the real property tax holidays for the hotel industry). In assessing whether to exempt certain properties from property tax the following key analytical questions need to be posed: (1) What cost does the exempt property impose on local (or central) government with regard to service delivery (e.g., water or sewage connections); (2) Should the property be billed by user-charging for the costs it imposes; (3) Does the property owner create public good benefits that exceed the value of tax forgiveness; and (4) Would the tax exemption provide the owner with an unfair economic advantage? Numerous and wide-ranging exemptions often lead to significant revenue loss and erosion of the property tax base. Tax base erosion then triggers rate increases if revenue neutrality is maintained. As a result, many countries then make up for suffered revenue losses by taxing businesses more heavily than residential properties. It seems that in The Bahamas, the near non-taxation of the hotel industry imposes ultimately a higher tax burden on residential and other commercial property owners.

Low-income households and pensioners and the current tax threshold

79. There are good reasons to shield low-income owners from potential adverse impacts of the property tax. Measures may entail forgiving property tax for those living in properties below a stated value or area threshold. The poor often live in areas with limited infrastructure and as a consequence low assessment values for their properties. An exemption would accord some rough justice to areas where tax collection costs likely exceed the revenue take anyway. An area threshold is regressive because it gives more relief to luxury homeowners in good locations than to those in modest homes and mediocre locations. Another approach, determining the tax threshold based on the number of people residing in one property, is administratively complicated and results in unfairness because a large family size does not necessarily signal an unaffordable property tax burden. For this reason, some countries have adopted a value threshold for a market-value based property tax. The appropriate value threshold must be determined carefully so as not to be too generous or too restrictive. It is evident from Table 5 that the threshold for The Bahamas is clearly excessive as it exempts more than 83.34 percent of all registered property owners on the fiscal cadastre from the real property tax. Alternatively, one could keep the system clean without any exemption, and for taxpayers unable to discharge their obligations, one could introduce tax deferment provisions (or ‘mortgaging’ of property tax liability)—when the property changes ownership on death or any other disposition—outstanding amounts can be collected.

Recommendations

• Maintain a single-rate property tax without differentiation for property use or value gradients.

• Remove the cap of US$50,000 as it benefits the high-net worth individuals without any indication that the exemption encourages activity in the construction industry.

• Reduce or eliminate the property tax threshold of US$250,000 and scrap the property tax exemption for Bahamians on the Family Islands as they are being provided with public services for which some payment is due.

• If and when low-income residential properties deserve relief, this could be achieved by granting a tax-free amount only for properties located in suburbs commonly inhabited by low-income households.

• Limit all other exemptions to an absolute minimum.

• Property tax relief for the elderly and the poor should be granted on application, must be reviewed annually, and be means-tested.

• Alternatively, introduce ‘mortgaging’ of outstanding property tax liabilities.

Current law

80. Next to the real property tax levied on the market value of immovable property, the Stamp Duty Act provides for a graduated stamp duty (transfer duty) on the transfer or sale of immovable property. The sale of land connected to the construction of a new dwelling house or building, whether commercial or residential, constitutes a single taxable transaction for the purpose of this act. The graduated-rate stamp duty in the absence of an income tax is taxing progressively rising values of property conveyances:

Value of Realty Transaction	Ad Valorem Stamp Duty Rate (In Percent)
Transactions under $20,000	4
Between $20,000 to $50,000	6
Between $50,001 to $100,000	8
Over $100,000 to $250,000	10
Over $250,000	10

View Table

Value of Realty Transaction	Ad Valorem Stamp Duty Rate (In Percent)
Transactions under $20,000	4
Between $20,000 to $50,000	6
Between $50,001 to $100,000	8
Over $100,000 to $250,000	10
Over $250,000	10

81. The buyer and seller typically share the stamp tax (unless otherwise agreed). They are also responsible for their individual attorney’s fees (determined by The Bahamas Bar Association), which amount to an additional 2.5 percent of the gross sale price of the property. There is also a small recording fee when the title deeds are recorded at the Public Registry. Hence, transaction costs are considerable for property conveyances. Total stamp duty revenue in 2007/08 from real estate transactions reached a high of US$183.9 million or 2.41 percent of GDP vs. US$39.1 million in 2002/03 or 0.67 percent of GDP—signaling a rising revenue importance. In 2010/11, real estate transfer duties declined to US$108.3 million or 1.35 percent of GDP—and for the period FY2003–11, transfer duties revenues were on average 1.56 percent of GDP. Since FY2008, stamp duties on realty conveyances generate the lion’s share of all stamp duties—on average, more than 61 percent.

Issues—transaction taxes impede efficient property markets

82. Seen from an economic impact perspective, too-high transfer duty rates impede the proper functioning of property markets—even though many developed and developing countries are raising significant revenues from transfer duties. Transfer taxes are assessed when the statutory title to immovable property is transferred to another party. Generally, the transfer tax is applied to the total market value of an immovable property transaction and must be paid in order to complete the title transfer. Stamp duties on the acquisition (and/or alienation) of immovable property are quite common and are often imposed even if the transfer is not the result of a sale (e.g., changing beneficial ownership of shares in a company). Table 8 provides for a sample of countries stamp/transfer duty rates in 2010. It is evident that there is a wide variation in transfer duty rates.

Table 8.

Global Transfer Duty Tax Rates: 2010

Source: UN Habitat, 2011. Land and Property Tax—A Policy Guide.

Table 8.

Global Transfer Duty Tax Rates: 2010

Region / Country	Transfer Tax
	Rates in Percent
	Minimum	Maximum
South and Central America:
Argentina	2.50
Brazil	2.00
Chile	0.00
Costa Rica	2.30
Peru	3.00	9.50
Venezuela	0.00
Unweighted average	1.63
North America
Canada	2.00
Mexico	2.00	5.00
United States	0.00	2.00
Unweighted average	1.33	3.50
Asia and Australia
Australia	5.50
Cambodia	4.00
China	8.00	10.00
Indonesia	5.00
Japan	2.50	5.00
Republic of Korea	4.60	9.40
Malaysia	1.00	3.00
Philippines	0.50
Unweighted average	3.89	7.10
Europe
Belgium	10.00	12.50
Cyprus	3.00	8.00
Denmark	0.60	1.50
Finland	4.00
France	0.70	5.10
Germany	4.50
Greece	9.00	19.00
Ireland	0.00	9.00
Italy	10.00
Luxembourg	10.00
Malta	5.00
Netherlands	6.00
Norway	2.50
Portugal	0.80	7.30
Spain	0.00	7.00
Sweden	3.00
Switzerland	0.00	3.30
United Kingdom	0.00	4.00
Unweighted average	3.84	7.67
Russia and Former Soviet Union
Czech Republic	3.00
Poland	0.00
Romania	0.00
Russia	18.00
Ukraine	22.40
Unweighted average	8.68
Africa
Burkina Faso	8.00
Dem. Republic of Congo	3.00
Mauritius	5.00	15.00
Mozambique	2.40
Namibia	1.00	8.00
Niger	1.50
South Africa	0.00	8.00
Unweighted average	2.99	10.33

Source: UN Habitat, 2011. Land and Property Tax—A Policy Guide.

View Table

Table 8.

Global Transfer Duty Tax Rates: 2010

Region / Country	Transfer Tax
	Rates in Percent
	Minimum	Maximum
South and Central America:
Argentina	2.50
Brazil	2.00
Chile	0.00
Costa Rica	2.30
Peru	3.00	9.50
Venezuela	0.00
Unweighted average	1.63
North America
Canada	2.00
Mexico	2.00	5.00
United States	0.00	2.00
Unweighted average	1.33	3.50
Asia and Australia
Australia	5.50
Cambodia	4.00
China	8.00	10.00
Indonesia	5.00
Japan	2.50	5.00
Republic of Korea	4.60	9.40
Malaysia	1.00	3.00
Philippines	0.50
Unweighted average	3.89	7.10
Europe
Belgium	10.00	12.50
Cyprus	3.00	8.00
Denmark	0.60	1.50
Finland	4.00
France	0.70	5.10
Germany	4.50
Greece	9.00	19.00
Ireland	0.00	9.00
Italy	10.00
Luxembourg	10.00
Malta	5.00
Netherlands	6.00
Norway	2.50
Portugal	0.80	7.30
Spain	0.00	7.00
Sweden	3.00
Switzerland	0.00	3.30
United Kingdom	0.00	4.00
Unweighted average	3.84	7.67
Russia and Former Soviet Union
Czech Republic	3.00
Poland	0.00
Romania	0.00
Russia	18.00
Ukraine	22.40
Unweighted average	8.68
Africa
Burkina Faso	8.00
Dem. Republic of Congo	3.00
Mauritius	5.00	15.00
Mozambique	2.40
Namibia	1.00	8.00
Niger	1.50
South Africa	0.00	8.00
Unweighted average	2.99	10.33

Source: UN Habitat, 2011. Land and Property Tax—A Policy Guide.

83. In traditionally Common Law countries (i.e., those with a largely British heritage), such as Australia, Canada, New Zealand, the United Kingdom, and the United States, these taxes tend to be levied as a stamp duty on the deed of sale—usually at rates around 2 percent. In Civil Law countries (i.e., countries with a European continental heritage), such as Belgium, France, the Netherlands, Portugal, and also South Africa, stamp duties on realty transfers are usually levied at rates, often exceeding 6 percent. The stamp duty rates in The Bahamas are high and the reasons for differentiating between 4 percent and 10 percent are not that clear. In deciding on an appropriate duty rate on realty transfers, their distortive economic impact should be considered. As VAT and the real property tax reforms gain traction and raise more revenues, a gradual duty rate reduction on property conveyances should be considered as high transfer tax rates may discourage business investment or may lock in investors into immovable property, resulting in suboptimal returns. Furthermore, high transfer duty rates encourage misrepresentation of sales prices by buyers and sellers, which generally undermines tax morale. Perhaps most detrimentally, if taxpayers perceive the transfer tax to be too high, they are less likely to register the property transfer at all with an adverse impact on the coverage ratio. High rates, therefore, require effective anti-avoidance legislation.

First-time homeowners exemption

84. On application, stamp (transfer) duty exemption for ‘first-time’ homeowners is granted up to a value of US$500,000 per dwelling or land for construction of a dwelling. This tax expenditure can be exploited as there is no anti-avoidance provision against, for example, a husband and wife both applying separately for this benefit and registering the home in their names, potentially benefiting from a total relief of up to US$1 million. This relief expires at the end of June 2013. Instead of its possible renewal, raising the general tax threshold to say US$35,000—indexed periodically—and which everyone is automatically entitled to would be easier to administer and fairer.

Recommendations

• Reduce stamp duty rates as collections from a reformed recurrent real property tax compensate for resulting revenue losses—and only when fiscal consolidation has been achieved.

• Replace the first-time homeowner’s exemption with a generally applicable tax threshold for all property conveyances.

Current law and practice

85. Currently, recurrent license fees are imposed on motor vehicle ownership. For the period FY2009–11, the annual motor vehicle license fee (or circulation tax) contributed on average 72.4 percent of total revenues on motor vehicle ownership. Other fees and charges include the annual fee for driver licenses, motor vehicle inspection fees, license plate fee, other licenses, and franchise fees for taxis and buses. The license fee structure is graduated against the weight of a vehicle which is very common internationally—(1) The Class A vehicles (0–5,000 lbs) attract US$150/annum; (2) Class B vehicles (5,001–15,000 lbs) are taxed at US$550/annum; and (3) Class C vehicles (15,001 lbs and over) attract a license fee US$700. The vehicle license fee is sporadically adjusted, leading to modest collections. The authorities are concerned about incomplete registration records of the active vehicle population which undermines compliance and collections. Table 9 indicates the modest revenue importance for licenses, averaging for the last decade 0.29 percent of GDP.

Table 9.

The Bahamas: Vehicle License Collections, Fiscal Years 2002–11

Source: The Bahamian authorities; and IMF staff calculations.

Table 9.

The Bahamas: Vehicle License Collections, Fiscal Years 2002–11

Collections in Millions $	2002	2003	2004	2005	2006	2007	2008	2009	2010	2011
Motor Vehicle Licenses (MVL)	15.70	14.03	17.29	19.31	19.56	22.49	21.92	20.02	26.63	28.36
Total revenue	716.63	851.45	978.94	928.72	1,052.83	1,209.03	1,189.09	1,293.78	1,327.58	1,080.86
MVL collections as percent of total taxes	2.19	1.65	1.77	2.08	1.86	1.86	1.84	1.55	2.01	2.62
MVL collections as percent of GDP	0.27	0.24	0.28	0.29	0.28	0.29	0.27	0.25	0.34	0.35
Fiscal GDP in $ millions	5,812.00	5,900.00	6,166.20	6,564.70	6,896.40	7,644.50	8,033.60	7,854.30	7,880.30	8,010.80

Source: The Bahamian authorities; and IMF staff calculations.

View Table

Table 9.

The Bahamas: Vehicle License Collections, Fiscal Years 2002–11

Collections in Millions $	2002	2003	2004	2005	2006	2007	2008	2009	2010	2011
Motor Vehicle Licenses (MVL)	15.70	14.03	17.29	19.31	19.56	22.49	21.92	20.02	26.63	28.36
Total revenue	716.63	851.45	978.94	928.72	1,052.83	1,209.03	1,189.09	1,293.78	1,327.58	1,080.86
MVL collections as percent of total taxes	2.19	1.65	1.77	2.08	1.86	1.86	1.84	1.55	2.01	2.62
MVL collections as percent of GDP	0.27	0.24	0.28	0.29	0.28	0.29	0.27	0.25	0.34	0.35
Fiscal GDP in $ millions	5,812.00	5,900.00	6,166.20	6,564.70	6,896.40	7,644.50	8,033.60	7,854.30	7,880.30	8,010.80

Source: The Bahamian authorities; and IMF staff calculations.

Circulation taxes and taxing informality

86. The authorities expressed a concern that taxing the informal sector is difficult and that high income earners are inclined to understate transaction values or turnover for BLF. Equally, tax compliance with real property tax is low and arrears are mounting. If there is widespread hiding of income—and if ineffective tax administration would continue in certain areas—tax instruments should be employed that impose charges on all forms of visible wealth. Since some of the property tax bases are immobile, they constitute efficient forms of taxation. Simultaneously, property taxes are progressive and become a useful distributional tool in pursuit of horizontal or vertical equity. If properly designed, taxes on all visible forms of wealth can generate stable revenues for governments. Vehicles, albeit mobile, remain in most of the world a popular bearer of ostentatious wealth. People hide income or wealth from the tax authorities but wealth or high income is seldom concealed when consumed. Consequently, an annual circulation tax is an effective instrument to tax incomes in economies plagued by informality or a tax system that ignores income as base.

The design of annual circulation taxes

87. Many jurisdictions impose an annual license fee—also classified as a property tax—on the ownership of motor vehicles. This is in addition to environmental excises and road user charges that can be reflected in the retail price of gasoline and diesel as the consumption of fuel is a good approximation for road use, environmental degradation, and congestion (a highly relevant matter in New Providence Island). It would be part of a comprehensive set of road use charges and environmental measures. It can be justified both from an environmental perspective but also as a wealth and income indicator or a taxpayer’s ability-to-pay. In the European Union (EU), annual motor vehicle taxes are characterized as environmental charges. According to the tax literature, the minimum EU excise on gasoline is about the right amount for the pure road charge and green tax element in the EU.³²

88. The forms of motor vehicle taxation vary widely.³³ Countries impose charges such as a circulation tax on vehicle weight (i.e., the Bahamian practice), a registration tax, a road tax hypothecated to road maintenance, motor vehicle weight taxes, passenger and fuel consumption taxes, road user charges in lieu of a toll fee, heavy good vehicle tax, tax on vehicle axles, and a weight tax on diesel vehicles.³⁴ Passenger vehicles are usually taxed differently than commercial vehicles. Annual ownership taxes are more common than taxes on the acquisition of motor vehicles. The annual tax on ownership may vary by the size of the motor (in cc), weight, fuel consumption, horse power, and CO2 emissions. Acquisition taxes are mostly ad valorem levies on the purchase price. An annual ownership tax over an acquisition tax is to be preferred, because the revenue from annual taxes would be more predictable and stable. The circulation tax in The Bahamas is simple and transparent and there is an attempt to ensure some equity, as the tax is varied by weight which is a rough approximation for value—more expensive vehicles (e.g., SUVs) tend to weigh more. This suggests that the tax might vary by the weight and age of the vehicle. In Europe and the OECD member states, vehicle circulation and fuel taxes are solid revenue earners—VAT is imposed on the final duty paid retail price and on fuels—being the excise-inclusive price. Nearly an equal number of OECD member states differentiate their vehicle registration or circulation tax according to vehicles’ cylinder capacity (easy to identify) but with a minimum charge, irrespective of capacity.

89. Imposing more ambitious annual circulation tax on passenger vehicles would increase collections from visible wealth. Overall, it would improve the tax system’s fairness and progressivity. Only limited disaggregated data for The Bahamas’ vehicle stock in terms of weight is available—that is, rough estimates from the Department of Road Traffic indicate that 85 percent of the total estimated vehicle population of 125,000 are Class A vehicles; 10 percent are Class B; and the rest are Class C. The projected revenue of US$27.2 million is close to vehicle license collections of US$28.4 million in 2011. By increasing the circulation tax rates by 20 percent, collections could easily reach 0.41 percent of GDP and with improved registration and enforcement, the revenue importance of circulation tax could attain, over the short term, 0.5 percent of GDP. To put the proposed 20 percent increase of the circulation tax in perspective: in Nassau, it costs approximately US$90 to fill up a 60-liter fuel tank of a passenger car. Hence, the increase of the recurrent vehicle license from US$150 to US$180 (20 percent increase) would be equivalent to the gas pump price of one-third of a tank filling. This is not an unaffordable amount and policymakers should, therefore, express the circulation tax as a multiple of the gas pump price of a fuel tank filling. Motorists evidence a fairly price inelastic demand for gasoline, even in a rising fuel price environment. Finally, increasing gasoline taxes together with higher circulation taxes may just provide the necessary push for motorists to switch to the proposed Unified Bus System in Nassau with the view to reducing costly congestion and rising fuel import bills.

Recommendations

• Increase the vehicle licenses by 20 percent but for distributional reasons, differentiate more carefully by introducing higher rates for heavy vehicles such as SUVs.

• Index the charge to keep it constant in real terms.

Proliferation of tax expenditure legislation

93. The Bahamas has promulgated at least eight stand-alone acts that provide wide-ranging tax concessions. In addition, the BIA through the Office of the Prime Minister can grant additional discretionary concessions in so-called “Heads of Agreement” between the government and the investor. There appears to be room for rationalization of the individual tax concession laws by consolidating these into an overarching concession law with individual sector chapters or schedules. This act would have the status of a money bill and it should only be introduced, amended, and withdrawn by the minister of finance. It should contain, in lieu of discretionary powers, published objective criteria which would indicate whether an investor would qualify for a set of incentives. The soon-to-be established CRA should be solely responsible for the administration of incentives and should be empowered to withdraw tax concessions from taxpayers that transgress any of the relevant provisions or fail to meet the investment yardsticks. However, relevant line departments must assist the CRA in verifying compliance with investment criteria as the CRA is specialized to be an effective revenue agency and cannot become the guardian of an industrial or labor market policy initiative.

94. By consolidating the individual incentive legislation, the authorities would have an opportunity to review the present system of tax expenditures. The relevance for some of the incentives with a term of more than 50 years could be reviewed. It would enable a comparison of foregone revenues against the uncertain benefits of additional investments stemming from these long-term concessions. There is a very good chance that some of the hotel incentives are no longer needed as the sunk investments into immobile hotel assets have locked investors into The Bahamas and they should begin to make a bigger contribution to revenue collections. Generally, the long duration of tax concessions in The Bahamas are a concern as these incentives should only be available for an initial trigger period to induce investors to come in and place the investment in the hope that initial time-limited revenue losses for government will be followed by years of more buoyant revenue take on the back of an expanded tax base. Also, it is important that any initial incentive period will not be renewed after the initial start-up years as this will translate into perpetual rent seeking through lobbying for incentives in lieu of focusing on cost-effective operations.

95. Empirical evidence suggests that a country’s tax burden is not the main factor in business investment decisions. According to a survey of firms investing internationally by the World Bank, national taxes rank number 11 among the top 20 important factors in determining their location decisions. Accessing markets, political stability, labor markets, and other operational costs are more important than taxes on location decisions of the firms (Table 10). Tax measures are poor substitutes for these key determinants of investment. In such cases, the first-best solution would be to address these underlying problems directly. For business investment decisions, the most important tax considerations are not necessarily the relative tax burdens of competing economies. It may be more relevant whether the tax system is stable, predictable, and transparent. Stable tax policy is an essential feature of a competitive tax system as frequent changes create uncertainty, dissuading potential investors from investing. Also, existing investors may refrain from expanding their businesses. For example, the high energy costs in The Bahamas should be addressed directly and not through the granting of tax exemptions to compensate for an uncompetitive power pricing structure.

Table 10.

Objectives and Determinants of FDI Location

Source: MIGA; Foreign Direct Investment Survey; World Bank/MIGA, January 2002.

^1/Ranked by order of importance.

Table 10.

Objectives and Determinants of FDI Location

	Objectives of Firms Investing Overseas 1/		Most Important Determinants of Location
1	Improved market access	1	Access to customers
2	Reduced operating costs	2	Stable social and political environment
3	Other factors	3	Ease of doing business
4	Source of raw materials	4	Reliability and quality of infrastructure and utilities
5	Consolidated operations	5	Ability to hire technical professionals
6	Develop new product lines	6	Ability to hire management staff
7	Improved productivity	7	Level of corruption (???)
8	Develop new technologies	8	Cost of labor
9	Improved labor force access	9	Crime and safety
10	Reduce risk	10	Ability to hire skilled laborers
		11	National taxes
		12	Cost of utilities
		13	Roads
		14	Access to raw materials
		15	Availability and quality of university and technical training
		16	Available land with all services in place
		17	Local taxes
		18	Access to suppliers
		19	Labor relations and unionization
		20	Air service

Source: MIGA; Foreign Direct Investment Survey; World Bank/MIGA, January 2002.

^1/Ranked by order of importance.

View Table

Table 10.

Objectives and Determinants of FDI Location

	Objectives of Firms Investing Overseas 1/		Most Important Determinants of Location
1	Improved market access	1	Access to customers
2	Reduced operating costs	2	Stable social and political environment
3	Other factors	3	Ease of doing business
4	Source of raw materials	4	Reliability and quality of infrastructure and utilities
5	Consolidated operations	5	Ability to hire technical professionals
6	Develop new product lines	6	Ability to hire management staff
7	Improved productivity	7	Level of corruption (???)
8	Develop new technologies	8	Cost of labor
9	Improved labor force access	9	Crime and safety
10	Reduce risk	10	Ability to hire skilled laborers
		11	National taxes
		12	Cost of utilities
		13	Roads
		14	Access to raw materials
		15	Availability and quality of university and technical training
		16	Available land with all services in place
		17	Local taxes
		18	Access to suppliers
		19	Labor relations and unionization
		20	Air service

Source: MIGA; Foreign Direct Investment Survey; World Bank/MIGA, January 2002.

^1/Ranked by order of importance.

96. Tax preferences distort investment decisions and more often than not constitute a deadweight loss. Instead, local favorable conditions in the business environment, natural resource abundance, or pristine beaches may have led to investments anyway. Consequently, foregone revenues stemming from tax expenditures could have been put to better use elsewhere such as improvement to the physical infrastructure. Tax incentives are bad in practice because frequently they are poorly implemented, cost-ineffective, and inefficient in their design, often inviting rampant abuse and corruption. Globally, there is little evidence that tax policy in respect of incentives has any significant effect on investment—the tax structure is more important.

Benefits and costs of tax incentives

97. International experience, therefore, indicates that tax incentives create inefficiency and inequities through socially corrosive rent seeking behavior by prospective applicants. Sparing use of tax preferences is advisable given the risk of primary revenue loss and leakage through avoidance (key drawbacks are summarized in Box 1). Granting tax preferences to new investors may undermine the competitiveness of already established companies which have been taxpayers in good standing. Tax incentives are often the quick-fix of public finance: almost everyone agrees they are not desirable, but finds them irresistible nonetheless as they seemingly indicate that the authorities are willing to absorb for the investor some of the sovereign risks or costs of an inadequate infrastructure. Ordinarily, countries offer tax incentives to attract new additional foreign direct investment by creating a competitive edge through reduced tax burdens. However, often investment incentives do not generate enough incremental investment to compensate for the loss of revenues—they only may affect location decisions.

Do concessions attract Foreign Direct Investments (FDI)?

98. Empirical evidence suggests that tax incentives rarely have any significant effect on investments. In the case of The Bahamas, incentives have been in place for decades and the strong FDI performance over the last decade may not necessarily be due only to the concession regime. In fact, the CARICOM region overall evidences a rising linear trend in attracting investments—and most of its member states achieve these results with an income tax system in place. For The Bahamas, over the last 11 years, FDI as a share of GDP have been an average of 15.23 percent and reveal a rising long-term trend (Figure 2). This deviates from the international evidence. For example, Klemm and Van Parys (2009) examine a panel of more than 40 countries over the period 1985–2004 and find no effect of tax incentives on economic growth and aggregate investment.⁴¹ It is possible that the pristine marine ecology is the attraction that does not require continuous encouragement through the tax system.

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The Bahamas: Annual Inward FDI Flows, 2000–11

(In millions of US$)

Citation: IMF Staff Country Reports 2014, 017; 10.5089/9781484377710.002.A001

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Recommendation

• Consolidate the various individual concession acts into a single fiscal omnibus act that can only be introduced, amended, or withdrawn by the minister of finance.

An income tax does not tax loss-making firms

99. Some tax incentives are more cost-effective than others which should inform future concession design in The Bahamas. Appropriately designed capital allowances as part of an income tax system—such as accelerated tax depreciation provisions—are critical for fostering a favorable investment climate, especially since these provide a cost-effective way to grant early cash flow benefits for major investments. Generally, depreciation can be more easily afforded as it merely defers government’s receipts. As an aside, an income tax regime provides start-up and loss-making firms with a tax deferral benefit through provisions that allow for the carry forward of tax losses. It is preserving cash flow for repayment of investments and government cannot tax upfront generated cash flow in situations where tax losses are suffered. In contrast, the current business licensing system together with the accompanying multiple fees and duties of the Bahamian revenue machinery ignore these fundamental cash flow dynamics of the business sector. As a consequence, taxpayers argue for even more concessions. Even though the authorities have expressed their resistance against an income tax system, even at low rates, the reality is that the current turnover based business license regime could be a deterrent to firm establishment.

Tax holidays

100. Tax holidays are commonly not well targeted as they constitute only temporary exemptions of new investments from certain specified taxes.⁴² International experience suggests that such tax expenditure tends to attract footloose industries—such as global textile manufacturers. However, these holiday schemes have minimum backward linkages to the economy. Tax holidays for hotels with a duration of decades are unprecedented and unnecessary given that once the investment is sunk, the investor will not easily relocate. It is of least value for long-term investments (with a long gestation period). Note that for long-term investors the loss carry forward provision of depreciation allowances as an essential element of a CIT already provides a de facto tax holiday (see above). Tax holidays for start-up firms are therefore ineffective. They are particularly prone to abuse such as the manipulation of transfer pricing so as to channel profits to the untaxed affiliate—which is currently of no concern in The Bahamas. However, tax holidays granted to large investors create serious distortions between new and existing firms (probably small and local), which cannot be abolished easily. Given the unfair competitive cash flow advantage handed to large foreign investors for long periods tends to erode small firms’ prospects for survival.

Free trade zone (FTZ)

101. The local FTZ legislation is comprehensive in intent providing a complete tax holiday dispensation from all import and stamp duties, business licenses, and real property taxes for an indefinite period. The concession is not entirely transparent as so-called designating orders can provide for additional concessions. Ideally, these zones should merely focus on the reduction of red tape with regard to customs procedures and should not grant direct tax incentives due to domestic transfer pricing concerns and tax leakage. The key objective of free zones or special economic zones is to increase exports. For that reason, most of the zones around the globe operate as ring-fenced enclaves. Zones are exempt from national import/export duties and VAT as these areas operate outside a jurisdiction’s customs area. Increasingly, however, direct tax incentives are added to these zones. These translate into costly administrative challenges with revenue erosion (property taxes in the case of The Bahamas). In addition, they tend to distort the direction of investments or create complacency in extending economy-wide reforms that would benefit all investors. These incentives are deemed to be simple to administer, but the fact that no reporting on associated business activities is required allows these structures to function as powerful tax avoidance vehicles for unintended beneficiaries.

102. Experience with export processing zones (EPZ) or FTZ from various countries indicate that zones cannot and should not be viewed as a substitute for a country’s larger trade and investment reform efforts. They are one tool in a portfolio of mechanisms commonly employed to create jobs, generate exports, and attract foreign investment, through the provision of incentives, streamlined procedures, and custom-built infrastructure. A critical determinant in configuring a zone development program is the type of zones to be promoted. Some commonly cited problems with zones are: (1) poor site locations, entailing heavy capital expenditures; (2) uncompetitive policies—reliance on tax holidays, rigid performance requirements, poor labor policies and practices, and poor zone development practices such as inappropriately designed facilities, inadequate maintenance, and promotion practices; (3) subsidized rent and other services; (4) cumbersome procedures and controls; (5) inadequate or duplication in zone administration; and (6) lack of coordination between private developers and governments in infrastructure provisions.

103. International experience suggests for a SEZ/FTZ regime the incorporation of the following principles: (1) Allow FTZ enterprises to locate within the same area. The development of separately fenced-off areas solely for FTZ enterprises is a less preferable, but acceptable approach; (2) Ensure that the FTZ regime is flexible, allowing a range of commercial as well as manufacturing activities. A separate commercial free zone regime is not required; (3) Promote private rather than public development of zones; and (4) Develop an appropriate legal, regulatory, and institutional framework to ensure less red tape. This will necessitate improved administrative capacities by host governments. Yet, the mission would like to stress that instead of establishing FTZs to attract FDI, a country’s entire tax system should be made more attractive to all investors.

Import duty concessions

104. Duty concessions for imports of capital or intermediary inputs, targeting new capital investments, are a standard incentive feature in The Bahamas. They operate as a duty suspensive and not a duty-drawback system and are granted to registered beneficiaries of the various incentive acts (see above). They are not automatic. However, to the extent that they apply to goods that are subsequently exported, these taxes should be rebated. Note that leakage problems are higher for duty suspensive regimes than for duty-drawback schemes. Incentives for intermediate inputs into manufacturing or service businesses are not naturally targeted in this way. Generally, they tend to lead to unfair competition, relative to similar businesses not enjoying the incentive, and they are especially open to abuse through leakage into the domestic economy. Such duty concessions are most helpful for domestic producers at a current competitive disadvantage relative to international producers. Nevertheless, it would be better to address the high cost environment by reducing or withdrawing completely all tariffs on industrial or single purpose capital goods and intermediary inputs used in manufacturing processes in lieu of special concessions that are unwieldy to administer. The introduction of VAT is being recognized by the Bahamian authority as an opportunity to afford this course and is to be welcomed. The chapter on tariff reforms will expand further on the need for low or nil tariffs for certain capital and intermediary goods.

Fiscal incentives for the tourism industry

105. The Hotels Encouragement Act focuses its attention on large international firms and this may ignore the fact that a lot of activity is generated by local smaller hotels and tour operators. By introducing discretionary incentives for foreign firms the bias towards foreign investors is perpetuated, and tax administration is unduly complicated with the risk of corruption.⁴³ Many tourist destinations like The Bahamas market themselves on the basis of pristine sandy beaches and coral seas or summer weather and their tourism is based on highly valued natural resources that generate economic rents. It may therefore be entirely unnecessary for governments to subsidize this industry development—the investors would have come anyway and the incentive regime then would constitute a deadweight loss. At the very least, to renew or extend tax concessions beyond the initial jumpstart period to foreign hotel operators appears to be unnecessary. For example, Mauritius is often referenced as an example how to successfully attract tourism investment by offering initially incentives in the 1980s and abolished them once the sector had gained momentum. Today, low tax rates are evenly applied across all sectors—with a standard 15 percent tax rate applied to VAT and corporate income tax.

Mitigating erosive effects of tax competition between island states

106. In most countries, policymakers are under pressure to compete with tax incentives that can be accessed by investors in a regional grouping—the CARICOM not being an exception. Tax competition results in a race to the bottom whereby tax rates are driven down and costly tax expenditures are granted. This erodes, especially in the case of The Bahamas, tax effort and leads to a less than efficient levels of output of public services. In order to attract business investment, officials keep taxes low and hold spending below those levels for which marginal benefits equal marginal costs. It reduces governments’ ability to collect tax revenue from certain activities and thus reduces their ability to fund social programs or infrastructure. Hence, the mission cautions against participating in this relentless race to the bottom, as the granting of more tax incentives may have adverse distributional impacts. It would be, therefore, in the interest of all CARICOM member states to reduce the level of costly incentives regionally and agree, for example, on a common standard for taxing the tourism industry without exposing any individual country to unfair competition.

Recommendations

• Use tax incentives sparingly and then only in situations where they address market failures or generate multiplier effects such as infrastructure development.

• Withdraw the power to issue discretionary incentives.

• Impose a sunset clause of no more than five years for all tax incentive legislation in order to analyze whether incentives are achieving the intended purpose.

• Decline requests for extending concessions granted under the Hotels Encouragement Act.

• Influence other CARICOM member states to reduce the level of tax expenditures for especially the tourism industry so that countries could reap a bigger share of the rents.

The concept and measurement of tax expenditures

107. The introduction of an annual tax expenditure budget ought to be considered as the authorities continue with granting tax incentives. Government just as well may want to claim credit for its support to investors in the various industries. Tax expenditures,⁴⁴ being government spending through the tax system, lower tax revenues for certain categories of taxpayers (sectors, firms, or individuals) thereby deviating from the benchmark tax system. Tax expenditures may take a number of forms: exclusions, exemptions, allowances, deductions, credits, preferential tax rates, or tax deferrals. Tax holidays and free zones, for example, are tax expenditures subject to specific time periods or geographical areas. To determine whether a tax measure generates tax expenditures, it is necessary to establish the benchmark tax structure from which concessions represent a departure. Thus, to determine whether a particular tax measure generates a tax expenditure it is necessary to establish the normal tax structure from which this measure represents a departure—and that is the most difficult part of the exercise. In essence, it constitutes preferential treatment to stimulate economic activities or attain certain social objectives. These indirect income support programs should, therefore, be tabled at the same time as the annual budget and its expenditure outlays is presented to parliament—hence, its label of a tax expenditure budget.

Main steps in the preparation of tax expenditure estimates

108. Identifying and reporting tax expenditures is an intricate process that requires four steps:

(1) Establishing a benchmark tax system—There is no consensus about the definition of the benchmark tax system, and countries often use different approaches. One simple method is to use as a benchmark the main legal provisions of the tax system existing at a given date, including certain deductions and exemptions that are deemed essential features of the system (e.g., VAT thresholds or property tax without tax holiday). The benchmark tax structure should represent a consistent tax treatment, and neither favor nor disadvantage similarly placed activities or taxpayers.

(2) Identifying and estimating tax expenditures—An inventory of tax expenditures can be defined as deviations from the established benchmark. It is good practice that such an inventory would also indicate the purpose of all tax expenditures. Inclusion of the original purpose would enable comparisons with an equivalent spending program. Thus, a simple listing of tax expenditure with their intended purposes would be a good first step of a tax expenditure budget. The best initial source for the database is tax returns filed by taxpayers.

(3) Integrating tax expenditure reporting in budget documents—According to best international practice of fiscal transparency and management, information about tax expenditures should be provided with the annual budget.⁴⁵ Such integration would help improving fiscal accountability.

(4) Entrench fiscal transparency in managing tax expenditures through adherance to four rules: (a) clarify roles and responsibilities so that coordination and management of tax expenditures can be centrally monitored from the ministry of finance; (b) make the cost of tax expenditures publicly available by publishing the tax expenditure as one of the key budget documents as it would improve governance, fiscal analysis, and accountability; (c) as part of the budget execution and reporting function, the tax expenditure should contain a statement of fiscal policy objectives and an assessment of their fiscal sustainability; and (d) tax expenditures should be audited for their performance.

109. There are three principal approaches to estimate the costs of tax expenditures. All three methods are used within the OECD member states:

(1) Initial revenue loss (gain) is the most commonly used method. It is defined as the amount by which tax revenue is reduced (increased) as a consequence of the introduction (abolition) of a tax expenditure. It does not account for the change from removal of one provision resulting in increased use of other provisions, or lowering tax revenue elsewhere. In addition, this method does not take into account that the removal of a tax expenditure may result in some taxpayers moving into a higher marginal tax bracket under a progressive income tax system or higher rate under the stamp duty act.

(2) The Final revenue loss (gain) is defined as the amount by which tax revenue is reduced (increased) as a consequence of the introduction (abolition) of a tax expenditure, taking into account the change in behavior and the effects on revenues from other taxes as a consequence of the introduction (abolition) of a tax expenditure.

(3) The Outlay equivalence approach estimates the equivalent amount of direct expenditures that would be required, in pre-tax dollars, to achieve the same after-tax dollar benefit if a tax expenditure were replaced by the corresponding direct expenditure program, to which the tax expenditure is associated.

Proposed steps toward tax expenditure budgeting in The Bahamas

110. The MoF is advised to prepare an annual report on tax expenditures that is published as an attachment to the Budget and which adopts the initial revenue loss approach. The various tax expenditures should be classified by tax instrument—that is, excises, stamp duties, import duties, real property tax, business license fee, and VAT (when introduced). Ideally, this tax expenditure report should be tabled together with the annual budget documentation. A recent estimate of revenue foregone from duty concession alone is equal to 21.96 percent of total collections in 2011/12 (or 3.6 percent of GDP), up from 13.2 percent of collections in 2009/10.

Recommendations

• Structure the tax expenditure inventory per Tax Concession Act—and begin to include the revenue losses from real property tax and stamp duty exemptions for first-time home purchases together with duty concessions.

• The costs of tax concessions should be calculated by the MoF and published in a periodic tax expenditure budget.

• Integrate tax expenditures into the budget process, by grouping them in functional categories to facilitate comparison with the corresponding direct budget expenditures, thereby identifying total fiscal resources allocated to each functional area.

Recommendations

• Withdraw all discretionary powers that grant additional concessions beyond those specifically provided for in legislation.

• Maintain already granted investment incentives under an investment contract.