A poverty trap or a policy scorecard | VAT exemption versus targeted income support ‘TIS’

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Shoppers in front of a major supermarket in Suva. Picture: FILE

The VAT exemption was a principal driver for the change in dietary habits that led to the NCDs explosion.

It also helped to create a poverty trap in the rural communities. The higher NCDs rate are a drain on family resources and on the working potential of affected individuals, which contribute to their being trapped in a poverty cycle.

The Fiscal Review Committee (FRC) has signaled that the VAT exemptions should be removed as a way to consolidate and increase government revenue. While the net result is good, the policy rationale suggests that it would have remained in place if there wasn’t the need to find avenues of increasing government revenue.

There are other more equitable tax revenue options. While targeted income support (TIS) is an option that puts money into the hands of the targeted recipients to spend on basic necessities, there are many reasons why it does not find favor amongst policy leaders and public officials.

The often-cited reasons; that it is prone to abuse with the income spent on alcohol and tobacco rather than basic necessities, that it stigmatises the recipients and kills motivation, and that it is socially regressive, are all cliched reasons.

They are not compelling reasons to reject an income support program, especially when the tax on alcohol has been reduced. There is a more fundamental reason why TIS is put on the back burner, and the VAT exemption chosen as the preferred option to assist the poor.

TIS forces accountability, quantification and measurement, transparency, and real time data, all of which would make some policy makers and officials uncomfortable. In order to explain this, we need to consider “what is the amount or value of the VAT exemption that was put in place to assist the poor?”

Reality or perception – ‘It’s for the poor’ – $3000 + per household

The numbers cited by the FRC on the quantification of the revenue lost through VAT exemptions has ranged from $160m to $220m.

Doing back of the envelope calculations, we can see why. The total amount of the VAT exemption was calculated based on financial models that put it at 2.2 per cent of GDP of $10b (hence $220m).

However, the financial models also showed the impact on the poor was only 0.6 per cent of GDP.

Hence, the World Bank Review allowed for a direct transfer to offset the negative impact on lowincome households of 0.6 per cent of GDP, $60m. The cost of the VAT exemption was $220m, but the benefit the poor received was only $60m. The benefit to the “not poor” was $160m.

Assuming the total cost of $220m that was meant to support the poor was in fact given to the poor, it would have dramatically changed their lives and livelihood, as they would receive $3000 plus per household.

Given the choice, I am sure the poor would have opted for direct income support, to receive cash in hand rather than a VAT exemption on some goods, where they received only a fraction of the benefit.

This would have an element of Catch-22. If the poverty rates were low, at say 25 per cent as claimed by some, then the benefits would be significant at $3556 per household. Likewise, if the benefits were to be reduced to say $1778 per household, then the poverty rates must be really high at 50 per cent.

The reality would be eye-opening, and the perception that it creates will be a problem. And perception matters, especially for those in the political arena. The VAT exemption was a program or policy initiative designed to financially cost government $220m, sold to the public on the basis that it was being done for the poor, but structured so that the others (“not poor”) receive the bulk (73 per cent) of the benefit.

It widened the wealth gap and locked many into a poverty trap, especially in the rural communities which accounts for most of the poverty in Fiji. The real beneficiaries and big winners were shielded from public view, the losers were oblivious, and the full negative consequences and impact was not immediately felt but became apparent later, effectively reducing the opportunity for the average person to “connect the dots”.

Fiscal policy is more than just a tool of revenue generation. It can encourage or discourage consumption of high GI foods, alcohol and tobacco. Whilst their consumption is a personal choice, they do have societal costs and implications, that can become a drag on the welfare and living standards of everyone.

The VAT exemption is a nontransparent program and is an easy sell. It will continue to find favor among many policy makers and leaders, and it also serves a political agenda for some. The perception that endures is that the VAT exemption was purely for the benefit of the poor.

It was not and was never designed to be! And as Ivanka Trump has said “perception is more important than reality”.

Scorecard of poverty – a challenge for policy leaders

Which therefore begs the question – why not direct income support? Because, it will force accountability and transparency, and reveal the true state of affairs on poverty.

1. The amount of support to the poor must be quantified.  How much will it cost Government? How much will be provided in income support? This forces officials to put forward a number.

2. There has to be a benchmark cutoff income level, whether it be single line or graduated.  This forces officials to transparently declare the level of income that qualifies for income support.

3. There has to be a registration and tracking mechanism to capture all those who qualify. The total number of households needing income support will clearly establish the poverty rates.

4. If there is a periodic revalidation (every 3, 6 or 12 months), it will give a clear indication as to how all the other government policies are impacting on poverty. Is the poverty rate going up or down? What are the numbers coming in to poverty, the number still in poverty, and the number exiting poverty. It will show the incidence of poverty by ethnicity and geographic areas.

5. It will move the responsibility for poverty alleviation to the whole of government. It will be a scorecard of government’s economic philosophy and direction. We will know whether the government policies are working or not, in reducing poverty, in real time.

Test of confidence – will government’s economic policies work?

If those in leadership and in policy making roles honestly believe that their socio-economic policies will make an impact on driving down the poverty rates, they will want to have a program of TIS.

But if they are not confident their policies will drive down poverty rates, they will find every excuse to avoid implementing a program of TIS. They would prefer programs that allow them to say “look at the number of different programs we have in place to support  the poor”, and not “look at the results”.

The last 16 years of economic leadership did not lower the poverty dynamics in any significant way. It merely shifted the burden to families and friends working outside Fiji, to provide income support to those in Fiji.

The incoming overseas remittances of around $1b is the equivalent of a new export industry sector employing 50,000 workers on an average wage of $10 per hour, or $20,000 per annum, who don’t have to show up for work.

Or the equivalent of 125,000 workers on minimum wage. Consumption increased but income, skill levels, productivity and work opportunities did not improve. Not surprisingly, the change in the poverty measuring index from income to consumption painted a rosy picture for the leadership.

It fueled a boom in the retail sector and a spike in GDP, and diverted attention away from improving the competitiveness and overall structure of the economy, which remains weak. The continuation of the same economic philosophy of the past 16 years will not address the poverty issue in any significant way.

It did not work then, and why would it work now. TIS will be a scorecard and a test of the effectiveness of government’s economic philosophy and policy focus. Are the benefits filtering down to the poor?

Are people better off? Are incomes rising? TIS will also put pressure on the policy makers to take into account the full consequences of their policies and takes away the incentive to put in populist policies that cause more damage than good.

It will bring a higher level of intellectual honesty and analysis into designing policies that work. Failure to do so will show up in the numbers, how many are applying for income support. TIS is needed, but it will attract a lot of opposition and a firewall of resistance from the policy elites.

Key performance indicators (KPIs) based on how many boxes are checked, will become irrelevant if the results are not there. It will shift from “show me what you have done” to “show me the results”. It is the results that matter.

KPI’s that show how many meetings were held, or number of boxes checked merely shows that the person showed up for work, and that the process was followed, not how effective they were. No one measures the success of a rugby team or coach by the number of coaching sessions or team meetings held, the number of meters the players ran, or the number of tackles made. It is the final score and the number of winning games that counts.

TIS is a scorecard of results. There will be those who would want a TIS mechanism while others will strongly object to it. At least we will have a better idea as to why.

Fallacy of comparison

There are many supporters of the VAT exemption for basic foods. Some say “even affluent countries like Australia, the UK and most states in the US do not tax food”. While the statement is factually correct, the circumstances in those countries are very different.

They do not have a large percentage of the population whose dietary habits are based on traditional foods, and whose livelihoods and economic activities are based on subsistence cum small scale commercial farming of root crops and other traditional food items.

They are not faced with an issue where the removal of a tax on imported and processed food items would:

• create a significant financial inducement for a large percentage of the community to move from traditional foods towards imported high glycemic carbohydrates and foods high in fat, salt and sugar,

• help create a NCDs crisis and tear away at the social fabric in rural communities, with amputations running at over 1 per 1000 population, and

• make it harder for rural subsistence cum small scale commercial farming of traditional foods to compete against subsidized high GI foods that are not taxed, and cause a structural shift in the market.

However, Australia, the UK and the US did have similar issues in the not-too distant past, and the results were tragic. The use of alcohol and other drugs was not a traditional part of Aboriginal or Torres Strait Islander culture.

Similarly, the native American communities had little or no experience consuming strong alcohol. In both those communities, they were encouraged to consume more in exchange for labour, and/or in exchange for the furs and skins.

And the rest is history. Likewise, the sale of opium by the British traders in ports of Hong Kong and Canton.

The comparison to Australia, UK and US as justification for a VAT exemption on high GI foods is without merit. Or perhaps it is, depending on where one’s moral compass points.

Policy or moral choice, investment opportunity or poverty

Knowing the negative consequences of the VAT exemption, the decision to exempt VAT on high GI foods is more than just a policy choice. If it is being done for the purpose of assisting the poor, TIS is a better and more effective option.

If it is being done for other ideological or other policy reasons, then it is an ethical and a moral choice. It reveals what the policy and decision makers value, what they care about, and who they care for.

It is understandable why some in the political sphere would want a VAT exemption on high GI foods. It would make a lot of sense if their political support and powerbase can be found amongst those whose dietary habits are traditionally based on flour, rice and oil.

They would of course benefit and not suffer the negative consequences as those in other communities did. It fundamentally changed dietary habits and lifestyles, and uprooted the socio-economic viability of rural agriculture.

Likewise, the explosion of NCDs has also been seen as an attractive investment opportunity into the healthcare sector. The Private Sector Diagnostic study for Fiji prepared by a joint World Bank-IFC team estimated that by 2040, the rising number of premature deaths caused by NCDs will cost Fiji’s economy roughly 10.9 per cent of GDP (in today’s term, over a $1b).

They saw this as creating a high potential opportunity to attract private sector investment in healthcare.

Today, the cost to the economy is estimated at around $500 million and climbing.

The decision to retain the VAT exemption or replace it with TIS is both a policy and a moral/ ethical choice. The continuing rise in NCDs can be seen as an investment opportunity to be exploited, and/or a health crisis that needs to be arrested and hopefully reversed.

Financially inducing and keeping a community trapped in poverty should not be a choice.

The VAT exemption should be replaced with TIS. Today, 75 per cent of those in poverty are iTaukei and that percentage will continue to increase if we continue to follow the same underlying economic philosophy of the past 16 years, the core of which was endorsed at the recent National Economic Summit. The VAT exemption is a poverty trap. Tragically, it is not the only one.

A number of policies designed by policy officials in the last eight years, that are currently in place, have created a perfect storm that has put and continue to keep communities in poverty. We need a major change in both our economic and fiscal policy priorities!

“We can’t solve our problems with the same thinking we used to create them.” – Albert Einstein.

ROBERT LEE played a key role on the committee that designed and implemented VAT and was also a member of the post implementation review panel. He has worked and consulted extensively in the strategy and policy area. He holds postgraduate degrees from Northwestern and Harvard University where he was a Fulbright Scholar. He is a sometime resident in Fiji and can be reached at robertleefi ji@gmail.com

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