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Features - Jan 2006



The Bahamas Investor

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Monetary man

Monetary man

Minister of State for Finance James Smith on taxes and the opening of capital markets

The Bahamas Investor Magazine
January 1, 2006
January 1, 2006

Senator James Smith is Minister of State for Finance for The Bahamas, as well as a former governor of The Central Bank of The Bahamas and a former ambassador for investment and trade. He has also served as a director on the domestic stock exchange and on the Bahamas Financial Services Board, a private-sector-led trade association.

In conversation with The Bahamas Investor, Senator Smith tackles the sensitive subject of tax reform in a developing economy preparing to open itself to the world by seeking membership in the World Trade Organization.

Q: A big touchstone has been the question of proposed tax reform to increase national revenue and lessen reliance on customs duties, something external forces from OECD to WTO are pressing for. So how and where exactly does a country known as a “tax haven” start introducing tax reform?

A: Well, the phrase “tax haven” for The Bahamas is a misnomer because no country obviously can operate without taxation. What we do have is a series of indirect taxes, which studies have demonstrated tend to be regressive and tend to fall heavily on low-income households. We are essentially a services economy … we are at least 80 per cent or more [dependent on] services and growing. Yet our tax system, which has served us well over the years, is directed primarily at commodities, at goods.

With the growing demand for public services in terms of health, education, welfare, maintenance of parks, grounds and so on, one would necessarily have to reform the tax base so that it can capture the larger amount of activity in the economy.

In looking at the need for tax reform we could approach it from any number of ways. Externally The Bahamas has indicated an intent to join the World Trade Organization. As a member of WTO, at some point, we would have to reform the tax structure because tariffs would be regarded as barriers to trade. That in itself means we should be looking at reform. But more importantly, and despite any of the external pressures, we need to apply taxes to the largest contributor to GDP, which would be services.

The system we are looking at is the value-added tax, which is a sophisticated form of sales tax. It might be really a second-best solution for The Bahamas, but it’s one that we know would be palatable and one that would have general support of the populace.

An income tax would theoretically be even more progressive but we know-without even asking–that that won’t sail. The modern Bahamas has never really relied on direct taxation like taxation on income.

Q: On the subject of capital markets, there’s been talk about issuing government paper on the local exchange, relaxing exchange control restrictions as they pertain to both residents and non-residents. Why is it important to look at these steps economically?

A: Well, no modern economy can progress unless it deepens and widens the capital markets in the sense that the capital markets generally provide a more efficient way of allocating savings to investments, bringing together the resources of a nation and then applying them efficiently.

It provides for the public a better way of providing for their future with a broader range of products to invest in. In the market itself, you give the entrepreneur an opportunity to open or expand a business without doing it exclusively with debt instruments such as loans. And of course, with this being regulated, it simply provides more opportunities to efficiently use a nation’s savings for economic development.

It also permits, in time, a way to engage the wider world, because if your companies begin to perform and they have above global average returns, then clearly savers in other parts of the world will approach them through your stock exchange for equity. So it’s a way of attracting investment.

Q: So this eventually would become an emerging market for the non-resident investor?

A: Precisely. Of course in our context, you see, we still operate with capital controls on the exchange, so it’ll be necessary to relax those, going forward, to permit this. But at the same time keep an eye on getting the sequence right, and the pace right with which we liberalize the local capital market. The experience of others can be quite instructive here. We don’t want the disasters we have seen in the region … the Latin American markets in particular opened their markets rather rapidly and allowed, with the exception of Chile, portfolio investments. And when their markets began to go south, the investors just pulled their money out and, in doing so, made a bad situation worse. It destabilized the economy … they’re still pulling themselves out of it.

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