INSIGHT

Higher Tax Revenues: Induce Compliance and Inspire Growth

This is the second instalment in a series of articles that we are publishing to encourage the government to do its part in ensuring that all stakeholders on the island are living up to their potential to stimulate economic growth and human development. On April 5th, 2018, we introduced the tourism sector as the driving force of our economy. Today, tax reform will be explored.

Sint Maarten’s economy is on the verge of collapse, causing our government to deplete its coffers. Last September, our seemingly endless stream of tourists’ dollars dried up overnight and consequently our country’s tax revenues decimated. For every closed resort, empty restaurant or failing business, our government can’t pave a road, provide a hospital bed, pay a teacher’s salary or fuel a police car. If government is expected to provide us with basic amenities (and more), tax revenues need to match those ambitions. Sadly, they don’t because our tax system neither induces compliance nor inspires growth.

“Under Sint Maarten’s current conditions, the only effective tax system can be taxing businesses for the turnover they generate and the labor they employ…”

While experts across the board have long agreed on our tax system being inefficient and outdated, reform was never implemented. Partly due to differing views on taxation, mainly due to the fear that our fragile budget couldn’t even absorb the slightest shock or hick up associated with transitioning into a better system. However, an expected loss of revenue of a staggering $273 million (rough estimate) in 2018 renders such fears irrelevant and calls for a tax system that generates, by design, the highest possible revenues.

Higher revenues by design are only possible if taxation reflects our current conditions instead of theoretical models or socio-political convictions. For Sint Maarten the facts are clear: turnover tax (TOT) is the only tax that works, while other taxes fail to significantly contribute to our country’s finances and/or hurt our budget and economic growth potential.

TOT is simple to understand, accept and factor in for business owners, and a sure and easily auditable revenue stream for our government. The profit and wage/income tax have become too complex to understand, comply with and enforce, remained too high to be acceptable and competitive, and are simply not the right tools for one of the smallest countries on earth (due to high operational costs). Taxes on gifts/inheritances and dividends are on the books but have never taken effect or have not been levied for decades – these taxes merely divert interested investors and potential high net worth residents to jurisdictions like Anguilla and the BVI because of the risk that Sint Maarten might start enforcing them.

Under Sint Maarten’s current conditions, the only effective tax system can be taxing businesses for the turnover they generate and the labor they employ. This means that all taxes, except for the TOT, should be abolished and that a payroll tax should be instated. As a crisis measure, the TOT should be raised to 10% and full compliance should be coerced by implementing POS-systems for all businesses. A payroll tax (see insert) will simply tax businesses’ entire payroll expenses at a flat rate of 10-15%. The result: businesses (and not individuals) will be the only taxpayers. Individuals will no longer be burdened with any kind of direct taxation whatsoever – wages will be net, inheritances will be unburdened, income from investments and loans will be tax free and most importantly no tax returns will need to be filed.

Taxing only businesses will free up the tax office’s entire capacity and all resources to start enforcing the TOT and payroll tax. In other words, all tax inspectors and auditors that struggle to finalize the review of the 2014 (!) individual income tax returns can verify current TOT and payroll-tax returns (by auditing businesses). A measure that instantly leads to a substantial increase of monthly revenues. At present, our collective tax compliance rate ranges between 40-60%. In practical terms, we are advising to redirect well-paid and skilled civil servants from reviewing individual annual income tax returns for mishaps of a few hundred dollars to compel businesses to pay tax on their entire turnover and payroll expenses. For example, us auditing a restaurant/bar declaring half of its monthly $30.000 USD turnover entails an annual increase of $18.000 (at 10% TOT and without penalties) – far better use of auditing capacity.

It’s clear that our budget and citizens will benefit from our proposed reform, however, individual businesses and more importantly business in general stand to gain as well. Inspiring a long-term upward spiral where higher tax revenues, more and better business activity and foreign direct investments go hand-in-hand.

Existing businesses will incur far lower compliance costs due to the simplicity of it all. Annual budgeting to meet tax obligations will no longer be required (each 15thof the month the TOT and payroll tax is fully paid and settled). Furthermore, it will inspire businesses to run a profit, either by eliminating the need for complex structures designed to incur costs offshore and/or being able to substantially reinvest profits in their business. The result is that our economy will no longer be drained from much needed cash and that national spending will increase.

To summarize: A tax system focused on businesses as its subjects and collecting only on turnover and labor will result in higher revenues due to increasedcompliance (voluntarily and coerced). In addition, it will promote more and better business. This reform will instantly put Sint Maarten on the radar of high net worth individuals looking for a sunny island to retire on and investors interested in doing business in the Caribbean. Stable, efficient, competitive taxation is what investors and high net worth individuals are looking for (and what they are being offered in the BVI and Anguilla) – this is a “market” to which Sint Maarten needs to cater to jumpstart its economy and safeguard our economic wellbeing.

As a final remark, we acknowledge that it might be counterintuitive to not tax profits, or disbursements of profits, at all. However, the profit tax only represented about 5% of the budget before Irma and stands to become another dead letter in our tax books due to our dire economic situation and (most importantly!) the ability to carry forward losses (which have been heavily incurred during Irma’s aftermath). So, why not scrap it altogether as a recovery measure and transform into Wall Street’s new Caribbean Sweetheart.

The Wall Street Journal and the New York Times have spent many words on Sint Maarten since September – which is logical as most of our hotel guests, timeshare-owners (>60%) and investors come from the Tri-State area. Both publishers and their readers would not only welcome but celebrate our proposed tax reform. It’s always possible to introduce a competitive profit tax (maybe 10%) in 5 to 10 years, after our little island has not only recovered, but become the focal point of growth in the Caribbean.

High Rates, Low Revenues:

Tax revenues are too low as a share of GDP. The current system costs more to implement than it yields in revenues. This boils down to high rates and a complex system which discourages both individual and business compliance. Sint Maarten’s tax rates are among the highest (profit tax is 34.5%) in the world and appear to be extraterrestrial compared to our neighbors (e.g. neither Anguilla nor the BES-islands have a profit tax). This makes Sint Maarten unattractive to foreign investors. Taxes on income, inheritance, property, and dividends even have a negative or no impact on our national budget. Furthermore, tax-audits are infrequent and unsuccessful and only 40-60% of taxpayers are compliant.

Kafka Vs. Ockham’s Razor (uncertainty vs. simplicity)

Sint Maarten’s tax system is highly complex and unpredictable. The lack of transparent and consistent policy and regulations creates a mine field for would-be investors to navigate. Sint Maarten has countless antiquated tax laws and policies that come in conflict with each other when referenced or put into practice. To make matters worse, the current system is counterintuitive – we grant favors and breaks on a case-by-case basis at the discretion of officials that have undisclosed standards. Even if this is done with the intention to stimulate business activity on the island, the tax system leads to a profit loss for all (with or without government favors). Our current system is rather “Kafkaesque” while it should be as simple as possible, in line with the principle of Ockham’s razor.

Stable, Efficient & Competitive

A well-oiled tax system is stable, efficient and competitive – both for the tax payer and tax collector. Taxpayers should be able to easily understand tax obligations and to plan ahead (clear laws, consistent enforcement and a long-term approach is required). In other words, the tax system and its practicalities should not deter taxpayers who are in principle willing to comply voluntarily. However, the tax collector should be on top of those tax payers who fail to comply. As the tax collector should ensure that it is not spending more money on collecting, auditing and enforcing taxes than those taxes can realistically generate, it should redirect all its resources to businesses (not individuals).

Berman | Keuning wants to perpetuate the discussion on tax reform in post-recovery Sint Maarten. If you want to join the conversation or learn more about possible reforms that can immediately be implemented, contact us at: ekeuning.com@bermankeuning.com or lberman@bermankeuning.com

Berman | Keuning is located at 68 welfare Road, Puerta Del Col Plaza, Office #211, Simpson Bay, Sint Maarten.

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