People should brace themselves to pay more
The independent working group commissioned by Treasury and Resources to look at the economic impact of the proposed changes to Guernsey's corporate tax regime in 2008 released its conclusions at the end of last month.
The independent working group commissioned by Treasury and Resources to look at the economic impact of the proposed changes to Guernsey's corporate tax regime in 2008 released its conclusions at the end of last month. In its first report, the group had already endorsed Guernsey's adoption of the zero-10 model because of the need to comply with international regulations and to remain competitive with other finance centres.
The second report examines the fiscal deficit caused by the introduction of zero-10 and considers whether the solutions will succeed in closing the gap in the public finances and how they will affect the local economy.
The fiscal and economic policy steering group is recommending a whole package of measures to redress the fiscal deficit in 2008.
These include increases in indirect taxation on alcohol, fuel and property and rises in employers' social security contributions and the upper earnings limit.
The Treasury will run a deliberate budget deficit until 2011-12 that it will finance by using half of the contingency reserve.
It plans to promote economic growth and to control government spending to close the fiscal gap before 2011-12 and thereby avoid the need to introduce a goods and services tax and other measures on that date.
The IWG notes that under the recommendations, economic growth is fundamental to the closure of the public finance shortfall.
Indeed, the local economy would need to grow at 4% per annum in real terms to fill the gap, when it has grown by only 2.9% on average over the last 10 years and the IWG believes 2.5% is a prudent, reasonable growth level to expect in the future.
It is therefore unrealistic to rely on economic growth alone to resolve the black hole, particularly as there are so many risks to the ability of our economy to grow.
These include the dependence on the vicissitudes of the global economy and the financial services sector, growing competition from other finance centres and the natural ceiling placed on potential growth by our limited factors of production, namely land and labour.
Furthermore, even if GDP does grow at more than 4% per annum, there is no guarantee that this will translate into higher tax revenues. Income tax receipts from companies will virtually disappear, leaving the public finances dependent on that from individuals, payroll taxes and indirect taxation. Guernsey must therefore look mainly for growth in tax revenues from employment under the current proposals, which would necessitate a number of major policy changes.
The size of the public sector must fall as the private sector rises, the working population must increase by encouraging the immigration of highly-skilled employees and risk-taking entrepreneurs and the productivity of the working population must increase.
These supply-side policies will facilitate growth in tax revenues, but they will not be enough to cover the fiscal deficit, nor is it certain they can succeed. There is some doubt that the States can reduce the public sector because it already represents a lower proportion of GDP than many other Western countries and the island's new population strategy is still vague and politically sensitive.
This means that there remains some uncertainty about how the island will balance the public finances in future and recognition that the current proposals may not go far enough.
It seems likely that further action will be necessary to restore equilibrium, which implies either cuts in government spending or rises in taxation.
The IWG believes it will be difficult to reduce significantly public expenditure further than the levels already proposed without causing real social and economic damage to the island through poorer services and a weaker infrastructure.
Efficiency gains will also be difficult given the lack of economies of scale and the current low proportion of GDP spent on public services. There probably are more reductions available given greater cooperation with Jersey and better planning, organisation and control, but not enough to cover the potential deficit.
Therefore taxation will have to rise to cover the likely fiscal shortfall. According to the size of the gap, the States might consider increasing the current rates of taxation or introducing new taxes.
The IWG outlines numerous options the States could pursue but does not commit itself on the best solution. Instead, it rightly notes that the most important consideration is the island's competitiveness, which increases in taxation might undermine. Payroll taxes such as higher social security should be avoided because they will damage profitability and discourage the use of labour, while a goods and services tax would entail high costs of implementation and administration and affect the poor disproportionately.
The jury is still out on the ability of the steering group's proposals to fill the black hole, but it seems increasingly likely that people will have to pay more tax in the shape of a goods and services tax or higher income tax. Disposable income will fall or the price of goods and services will rise, so we should prepare for a drop in consumption in the island.
n Comments to rich@hemans. net. Richard Hemans is a chartered accountant who works on a freelance basis.
