Category: Taxation

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Take from the Poor and Give to the Rich

Introduction
Perhaps not surprisingly the only feedback I received to last week’s column on tax evasion and tax avoidance was from persons who would generally be considered among the better off. And who want more from the society and the tax system because “they work hard, create jobs and have a choice.” Those comments are filled with arrogance, self-importance, self-interest and self-delusion. As though the stevedores, the public health workers, the cane-cutters and others do not work hard, or do not have a choice. They have a choice and that is why they daily flock the Passport Office in Camp Street from 5.30 AM for a passport to go to the Caribbean, North America, to anywhere, to work harder, to earn and to enjoy the fruits of their harder work.

In Guyana the tax system is heavily weighted against the poor and the commentator and columnist was only mildly exaggerating when he said that workers pay a total of 49% of their income in taxes – 33 1/3% income tax and 16% VAT. In fact that commentator forgot to mention the employees’ 5% NIS contribution which in public finance is a form of tax while the rough calculation of 49% ignores the range of zero-rated VAT items and the personal allowance of $35,000 per month. Overall however, the tax burden is very much around the 50% tax to GDP which makes Guyana one of the most heavily taxed countries in the world.

Soaking the Poor
Yet, for some reason there is no real commitment to tax reform about which we have been hearing since 1992. Tax reform is rat poison, for all practical purposes off the table, better understood by those who pay taxes than those who impose them. This is ironic, for some of the most important steps in the march to democracy involved taxation. The Boston Tea Party has to be given pride of place for its inspiration to the independence movement in the US and the iconic statement “no taxation without representation”. How can those of us who were around in the sixties, forget Peter D’Aguiar’s Axe the Tax Campaign when then Premier Dr. Cheddi Jagan sought to introduce a measure of tax reform? Ann Jardim, one of the leaders of the UF carefully ignored the introduction of new taxes but rallied the working class against a miniscule increase in the rate of the personal income tax. Today those who have followed her in the UF are part of the new scheme that takes from the poor to give to the rich, in taxes and state assets.

In the sixties, the political classes were on different sides of the political divide – a left-leaning government seeking to achieve a more equitable sharing of the benefits and responsibilities of citizenship by the trader and business class. Today while the ruling party may have vestiges of working class preferences, its Government seems beholden to the business class whose position of influence – whether at the head table at the Office of the President or at the Pegasus Poolside on Friday evenings – has come to be the defining feature of the Jagdeo Administration. We no longer hear about equity in the tax system, let alone the distinction between horizontal versus vertical equity. Indeed, any acceptance of the concept of tax reform by this Government is not out of conviction but out of a commitment made as a precondition to receive more and more gifts and grants from the donor community.

Stranglehold
Businesses’ stranglehold on the agenda is not peculiar to Guyana. The current wave of globalisation, driven first by the Reagan-Thatcher axis and adopted and sold by the international multilateral institutions across the developing world like snake oil salesmen of old, has witnessed a concentration of wealth and income and a widening of the socio-economic divide. The effect has been a corresponding increase in business’s ability to set the agenda for political discussion and its effective veto over public policy. In Guyana, under the agreements made by the Administration with the donor community any semblance of economic policy is driven by the National Competitiveness Council that is dominated by business interests rather than national interests. The NCC has been more successful at stalling in the interest of the status quo than at achieving any meaningful changes.

Recent research under President Bush revealed that elected officials tend to be unresponsive to the policy preferences of low-income citizens and that they disproportionately favour business interests and the wealthy in all areas of public policy. Like their counterparts in the US, those interests in Guyana also opt out or are favoured by a tax system set up in 1929 for the ruling plantation and trader class and only episodically reviewed subsequently for reform. Indeed, since 1929, there have been only two or three events that could qualify as tax reform and with only one being targeted at getting the rich to pay a fair share of the tax burden. The first of the reforms took place in the early sixties when Dr. Cheddi Jagan brought in Hungarian-born world-class economist and socialist thinker Professor Nicholas Kaldor, to overhaul the country’s tax system. Those reforms included the introduction of the Capital Gains Tax, the Property Tax and steeply progressive but at the highest end, counter-productive, marginal tax rates that went up to 75% from a base 5%.

Burnham and Hoyte
In 1970 the Burnham Administration enacted the Corporation Tax Act which introduced a separate regime of companies while incorporating over seventy sections of the Income Tax Act into the new Act. The next wave saw the abolition of dividend taxation and pensions, unification of the corporate tax rate, the abolition of the progressive income tax and the abolition of allowances – all pro-business and anti-worker in their effect. The PPP/C before President Jagdeo has the distinction of reversing the unification of tax rates and introducing the Minimum Corporation Tax on all, and then only on commercial, companies. Jagdeo has to his credit the immoral imposition of the 16% Value-Added Tax. Now, if tax evasion is illegal then we have to find a word for the imposition of a tax at a rate that is knowingly and admittedly excessive and wrong.

Barring one or two exceptions, every reform then has favoured the wealthy and the powerful at the expense of the poor. Here are some of the starkly contrasting provisions in the tax legislation.

1. Wages and salaries are fully taxed. Dividends are fully exempt.

2. Income from personal exertion is taxed at 33 1/3%. Capital gains and interest income are taxed at 20%.

3. The employer-provided vehicle, and sometimes more than one, driver(s) and security are fully exempt from tax. A travel allowance to the worker to help her defray the cost of getting from home to work is fully taxed.

4. The entertainment allowance paid to the executive is fully exempt; the meal allowance paid to the worker is taxable unless a strong case is made for it to a skeptical and uncompromising revenue officer who will claim that a meal is a private expense. As if entertainment does not include a high level of private benefit as well.

5. There is no limit to the pension that is tax-free. Most workers on retirement have to make do with under $20,000 per month. The retired top-executive receives hundreds of thousands tax free.

6. Overseas passage assistance – a throwback to the British planter class, is exempt for all but can only be enjoyed by those with spending power.

7. The working poor are taxed at source; the self-employed with all their benefits and concessions, can decide how much tax they want to pay.

8. There are ethnic and gender biases in the tax system that no one even wants to whisper, let alone acknowledge or debate.

9. The wage earner gets no deductions or allowances; business can deduct most expenses, whether it be the magazine or the business trip.

10. Duty and tax concessions favour those who have economic or political power over those who do not. Just look at the beneficiaries of the duty-free vehicles.

11. Businesses get tax holidays; their workers’ earnings are fully taxed.

12. The entrepreneur has a choice between taxable and tax-exempt business activities; the employee’s only choice is not to work.

No vision, no tax reform
The above, is a brief review of the relative position of the workers versus the executives and the “entrepreneur” under our tax laws. Those laws clearly cry out for reform. But then as the late Richard Musgrove, public finance specialist said, tax reform needs a clear and detailed vision of where we are going – a vision that is sadly lacking in President Jagdeo. That is why he could be so easily diverted to the LCDS as a tunnel-vision strategy for development and even as he heads CARICOM, could be completely sold on a Continental Destiny with neighbouring Brazil. If what he said in a recent speech he gave at a private function is to be believed, he is now looking to Brazil to help us with our rice industry even as his Government pumps $400 million in what by implication is an inefficient industry.

The cry for reform, no matter how compelling or loud, is unlikely to be heard or to win support from those of power within and influence without. A review I saw recently by a leading donor to the Guyana economy, actually praises the country’s fiscal performance, completely ignoring the tax burden that the citizens of the countries making up that donor would regard as completely unacceptable given the low level of public benefits available in Guyana. In many of those countries the entertainment allowance is now denied at the corporate level and in Australia the Keating Tax Reform Package dealt an effective blow at non-cash fringe benefits.

Conclusion
But at the domestic level there simply is no need or pressure for reform. With perhaps a single exception, the top tier of the opposition political parties has shown no interest in tax reform, confirming the view that there is no ideological or class difference among the political elites. Labour has been emasculated by personal interests and petty rivalry exploited by, again, the politically powerful while Ann Jardim’s successor is just another of that elite.

The Ministry of Finance has been depressingly slow at taking any initiatives in tax policies. It has left these to the tax administrators, a fundamentally flawed position – the two roles and functions being obviously different. We need lower rates of tax both on individuals and corporate, removing not the loopholes but the chasms that in some cases discount the nominal rate of tax by as much as 75%. We need a society in which the fiscal benefits and obligations are shared and borne fairly by all and in which relief must not be sought in tax evasion.

Similarly, the President has allowed elements in the private sector to hijack the social and economic debate including tax reform. If any progress is to be made, then the hijackers will have to be brought into line. Failing that, we are left with an inequitable and dysfunctional tax system, high tax rates and massive evasion. That is in no one’s interest.

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Question: What’s the difference between tax avoidance and tax evasion?

Answer: the thickness of a prison wall

That is how the former Labour Chancellor of the Exchequer in the UK, Denis Healey defined the two related practices but which have distinctly separate consequences. He was also tough on tax evasion and also said “It will squeeze the rich until the pips squeak.” The first quote in fact matches the general view on the contrasting level of permissibility of what others may call aggressive tax practices. Remember however that Mr. Healey made his statement decades ago. Internationally, things have changed since then and not only tax administrators but legislators and very importantly, the courts, certainly in the more advanced economies, are taking more direct action against aggressive tax practices.

It may in fact be due to Bush’s War on Terror targeting not only those who pulled the trigger or threw the bomb but those who financed those who pulled the trigger or threw the bomb. The evidence is that the coordinated and sustained efforts to contain domestic tax evaders and the tax haven jurisdictions that have for decades facilitated them are yielding significant results. As one international tax specialist wrote recently, “the seemingly endless game of cat and mouse seems to be shifting largely to the cat’s advantage.”

In 2008, Germany paid an informant for records taken illegally from a Liechtenstein bank, in an effort to track down German tax cheats including some of its international tennis stars. But it was the United States that has shaken the very foundation of Swiss bank secrecy – which essentially forbids access to information of or about the account of any person other than the account holder – when it demanded from the Swiss bank UBS the names of 52,000 account holders suspected of tax evasion. The Swiss initially refused but the tide had been turning against those “fiscal and moral termites who have been eating away at tax revenue bases throughout the world in an unprecedented fashion over the last thirty or so years.”

The Swiss blinked and now the Obama Administration is planning to go even further with the enactment of new legislation, the Stop Tax Haven Abuse Act – that is designed to better enable US authorities to obtain information about offshore trusts and accounts used by Americans to hide their income and assets from the Internal Revenue Service of the US. The position is that the US can access the information under the scores of Double Taxation Treaties which the US has with countries across the world or under what are called Tax Information Exchange Agreements such as the one it has with Guyana. In the alternative, the US simply threatens sanctions against those it considers uncooperative.

Tax evasion, tax avoidance and tax planning
It seems fairly simple to distinguish between tax evasion and tax avoidance. It is the difference between working outside the law and working within the law (though against its spirit). Tax evasion can and often is contrasted with tax avoidance, but also with tax planning/mitigation, and it is here that the issue becomes difficult. Tax evasion typically involves the non-payment of a tax that would properly be chargeable if the taxpayer made a full and true disclosure of income and allowable deductions. Common examples of tax evasion include a deliberate failure by a business to report the full amount of revenue received or the deliberate claiming of a deduction by a business for an expenditure it has neither incurred nor paid. There is no ambiguity about tax evasion – it is illegal and a crime under our laws. On the other hand, tax avoidance can be considered either as permissible or impermissible, although they are not that easy to distinguish.

Tax planning or tax mitigation can be traced back to a well-known and oft quoted case involving the Duke of Westminster in which the court ruled that “every man is entitled to order his affairs so that the tax attaching under the appropriate Acts is less than it otherwise would be”. One simple example of tax planning is where a business promoter makes his decision on the form of the entity on the basis of the applicable tax considerations. If the trader was to set up a company it would be taxed at 45% and be subject to Minimum Corporation Tax. On the other hand if he operates under his or a business name the profits all accrue to him and the trader would be taxed as an individual at the personal tax rate of 33 1/3%. Tax planning may also include the decision to lease or buy an asset which would have different tax consequences but both of which are entirely legal.

Pandemic
Where it becomes really difficult is in respect of “impermissible tax avoidance”, which refers to artificial or contrived arrangements, with little or no actual economic impact upon the taxpayer, and which are usually designed to manipulate or exploit perceived “loopholes” in the tax laws in order to achieve results that conflict with or defeat the intention of Parliament. In fact this is what section 74 of our Income Tax Act seems to address but uses the words “artificial” and “fictitious” and gives the Commissioner wide powers to disregard or set aside such transactions. In tax jargon our section 74 is a general anti-avoidance rule (GAAR) and is designed to protect the revenue base from erosion by “fiscal termites” that seem to have created a pandemic in our economy, much worse than any Swine Flu or AIDS. .

Since revenue collection is a primary function of any tax system, any systematic and widespread avoidance activity will clearly have an adverse impact on that function. But avoidance does more than this – it also significantly affects the efficiency and equity of tax systems by siphoning off resources from more productive ventures, redistributing the tax burden and threatening to undermine compliance. We seem not to care that the poor employees are burdened by high and unavoidable tax personal taxes and wrongly charged VAT, all for the benefit of the private sector entrepreneurs, a term that has come to include drug dealers, money launderers and tax dodgers.

Changing administrative approach
Across the major economies, national revenue authorities have been taking measures to identify and shut down perceived impermissible tax avoidance activities. Within the UK, Her Majesty’s Revenue and Customs Anti-Avoidance Group co-ordinates anti-avoidance activity including litigation strategies in relation to avoidance. To counter tax avoidance, the Group deploys its resources where it considers the risk greatest and provides direction for the effective use of resource within other areas of HMRC. The approach is now a form of cooperation between the tax authorities and larger entities that is designed to bring about effective consultation, certainty and speedy resolution of tax issues. Changing from the old command style tax administration to a more co-operative approach, the authorities enter arrangements with the taxpayer whereby the latter would submit its tax strategy on a particular issue and have this cleared by the tax authorities in return for which it is saved the time and cost of revenue audits and litigation.

Another approach is increased cooperation among the tax authorities of various countries with the Organisation for Economic Cooperation and Development (OECD) and the Joint International Tax Shelter Information Centre set up by Australia, Canada, the UK and the US being prime examples.

The tax authorities are also aware that much of the tax avoidance by the big companies is hatched and or blessed by their tax advisors.

They have therefore not been hesitant to go after the larger accounting firms that design and market packaged boutique packages sold under attractive but expensive labels including asset protection and the virtues of mainly offshore tax shelters.

Both corporate as well as high-net worth individuals seems to consider the risks associated with tax evasion as more than compensated for by the rewards.

The changing attitude of the courts
The Duke of Westminster case (1936) has long dominated the thinking of the courts and more recently they have propounded what is called the Ramsay principle (1982) under which the courts would examine transactions that seem to have no commercial purpose and ignore or set them aside as envisaged by section 74 of our Income Tax Act.

The Ramsay principle was seen as a separate theory of revenue law which said that tax laws must be interpreted very strictly in favour of the taxpayer. That principle appears to have ended in 2005 in a case that came before the House of Lords.

The latest case essentially ruled that tax provisions dealing with tax evasion should be given a purposive construction which could have wide effect since all anti-avoidance measures are designed to prevent tax evasion. But life will never be as simple as this and no doubt the courts will continue to be challenged by the creativity of tax advisors and dishonest taxpayers even as the nature of transactions become ever novel and complex even for tax administrations.

The Guyana scene
There does not appear to have been any reported case out of the Guyana courts addressing section 74. That is equally true of the region with one notable exception in Jamaica, involving a leading case on asset stripping, under similar anti-avoidance provisions.

On the other hand, there are some frequently used permissible tax planning strategies, none of which again appear to have reached the courts but this is because they have not been challenged by the Revenue Authority. Some of the more common strategies include the structuring of the business (corporate or individual); the efforts to take advantage of the differential tax rates applicable to companies (non-commercial company and therefore taxed at 35% or commercial and taxed at 45%); and transactions designed to benefit from low or no tax under some of the provisions under Double Taxation Treaties of which the Caricom Treaty is a prime example.

What seems more common is the rank tax evasion where income is blatantly ducked and the money laundered abroad under the permissive exchange control regime we enjoy and very often abuse.

Another is to charge all forms of personal expenses to the business and get full deductibility while yet another is the use of fake invoices which overstate the figures in the accounts and understate those given to the Customs, both of which are accepted unknowingly by the GRA. Businesses can generally count on finding a friendly accountant willing to sign off on their make believe financial statements that seem to get past just as easily, the tax authorities as well as the lending institutions.

Guyana is the only regional country that has a net property tax capturing the assets held here and abroad. The overseas assets are almost invariably overlooked by the GRA despite arrangements that allow for the exchange of information with the tax authorities of all our major trading partners. The Cambios seem custom-designed to facilitate such evasion while the country appears only willing to pretend that we have serious intentions about preventing money laundering.

One glaring example of how tax evasion takes place under the noses of those in administrative, political and professional positions is with respect to political donations. It is known that businesses contribute significantly to the elections war chest of the major political parties, sometimes more than they pay in taxes. Yet, none of this gets its way into the books. Is it just possible that some of these donors who are feted under the full glare of publicity actually pay more to the political parties than in taxes? Or is it that they consider that this gives them tax immunity?

Conclusion
Tax reform in our case has first to deal with tax evasion and administration. This government has been paying lip service to tax reform ever since it came to power seventeen years ago. Unless it thinks that imposing VAT on top of high personal tax rates is tax reform, it has done nothing and tax evasion is now worse than it has ever been. VAT has brought in immoral windfalls, reducing the incentive for reform which the Government has delegated to the National Competitiveness Strategy. So far, that body which is chaired by the President has shown no intention, appetite or capacity to deal with it. And the GRA is either overwhelmed by the level and scale of tax evasion or is not utilising the tools and deploying the resources at its disposal to deal with the crisis.

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The boring auditor

Introduction
The stereotypical auditor as a fat, prematurely aging, bald, boring and unenterprising man probably says as much about the audit profession as it does about its practitioners. For many forced to use their services, they are just a necessary cost imposed by the law, spending several weeks at great inconvenience to the management and staff, to write a single page report for which they charge a bomb. They are not even worth a good joke, and the most famous but yet barely quotable one is how many auditors it takes to change a light bulb, with the answer being the question: How many did it take last year? It is also true that on most occasions when we consider the auditor, it is to ask the question, but where were the auditors? Where were they in the Enron saga or the spate of frauds that rocked America in the early part of this decade? Where are the auditors when a government squanders billions in corruption, nepotism and mismanagement? It is not entirely unfair to say that the profession is often perceived as concerned more with self-protection and self-preservation and limiting its liability for negligence than in adding value to its clients. This column is really not about the audit profession but only incidental to it, with a view to showing that the profession can be interesting for the practitioners (and hopefully their clients as well).

A week is a long time
After more than thirty-five years, I still find the profession interesting, so much so that I look forward to a visit I make annually to Berbice on audit business to meet not only with the clients of Ram & McRae, but with the business community and ordinary, everyday folks as well. To say that this year was the most interesting would be unfair to those staff of Ram & McRae, who were holed up in a small room while the heavily armed bandits created havoc at the Republic Bank Rose Hall branch a couple of years ago. But this year too had its own interest, even without guns or bandits. I learnt for example that in Guyana we still have cocoa tea and coffee tea and Milo tea. I was greeted by a businessman who made an unsolicited offer for my old-model car with the assurance that payment will be all in cash! I also had to fetch my suitcase up three flights of stairs in what described itself as a business hotel, even though there was no writing desk or telephone in the room in which I stayed. When I complained to the proprietor he lamented that the guard did not come to work that afternoon and that “no one wants to work these days.” Like his Georgetown counterparts he could not recognise that people want to work in a job that offers a remunerative salary, self-respect and dignity. That an economy built on plantation-type businesses is a backward concept, even though it is now being embraced by no less than our Russian-trained President.

As I carried my suitcase up those stairs I reflected whether our under-worked and over-exposed Ministry of Tourism has ever thought that these facilities should be rated so that potential guests can inform themselves in advance of the type of premises and services they can expect for the price they are called upon to pay. Many of these facilities that describe themselves as hotels are no more than guest houses, fit for nothing more than a few hours, and hardly the type of place for the businessperson or to take the family.

Guyana Times and Chronicle
At 10.30 am one working day, I could only find the Guyana Times and the Guyana Chronicle and wondered whether the Kaieteur News and Stabroek News, unblessed with state resources could not have vendors on the Corentyne. I learnt instead that the latter two were already sold out, while the Times and Chronicle were slow sellers, even in the strongholds. The vendor even offered to sell me these two at a discount! Seems that even the ordinary person on the street understands the principles of business better than those who manage and control the state-owned or state-friendly papers, which ignore any ideas of journalistic independence, impartiality and balance.

I experienced first hand as well the difference in the cost of living between what we in Georgetown pay and those in the countryside. I had a full, fairly balanced meal and a beverage for half the price of what one would expect to pay in Georgetown. I was so struck by what appeared to have been a mistake by the person who served me that I challenged the price charged. No, it was not a mistake.

In all of this I was an interested observer, noting some of the differences between rural and urban life. The one incident in which I was just more than an observer was when I went into a shop to buy an item and was given a small piece of square cardboard with the price written on it and told to go pay the amount stated to the cashier. I approached the cashier with money in hand and asked for a bill/receipt. It was just as if an alien or a bandit had entered the store! Some other person who I assume was the proprietor was summoned, and I found myself explaining that I needed the bill so I could claim back my expense from the office, which was not quite true.

One of those generic receipt books was then pulled out from somewhere and I left the store convinced that I had just become complicit in a tax-evasion scam.

The Republic
Berbice of course is not unique for its tax-evasion but it certainly has a reputation. Many years ago one senior politician well known for his creative language, described Berbice as a Republic with its own laws, customs and practices. Seems that nothing has changed. A Georgetown-based client of the firm recently told us customers and potential customers in Berbice were refusing to do business with him if he issued any invoices to them since they did not want to be part of the official records. I confirmed this with a Corriverton businessman who lamented the unfairness of a system in which the honest businesses are driven out by the tax-dodging ones.

The Berbice business person of course feels protected and special. With the knowledge that they are the home of the ruling party, they demand and receive anything they want, whether it is a bridge, a university, the removal of a police officer or a disproportionate share of the national budget. The businessman who hoards millions in his home to evade taxes expects the police to protect him and to respond at a minute’s notice to his call in an emergency. There are some homes in Berbice which would make you forget that you are in Guyana, because of their extravagance and opulence which borders on vulgarity. One wonders how the owners of these properties would account, if in fact they do, for such wealth in their Property and Income Tax Returns.

Berbice is very much part of Guyana and deserves to have services like everyone else. And should the rest of the nation begrudge that part of the country because it seems to be favoured by the ruling party and the government? But is it not right for the rest to expect that the Berbice businessman should be willing or if not, be forced to contribute to the coffers of the state? Some years ago I was told that one of the tax offices in this country did not bring in enough revenue to pay salaries for its own staff, and am aware that some senior owner-managers earned no more than the tax-free threshold. That would no doubt have changed by now, but by how much is anyone’s guess.

TRIP them up
That does not mean that I do not understand that a tax office may not collect all the taxes that arise from the businesses in a particular area or region, with GuySuCo being an obvious case in point. But I still do not understand the failure to make the annual reports of the Guyana Revenue Authority more informative and meaningful. We hear of the marvellous flexibility and capability of the multi-million dollar new computer programme TRIPS now used by the GRA. Could it not produce information by tax offices, regions, sectors, types of taxes, etc?

Part of the problem as well is that the GRA is too Georgetown-centric so that the best of its resources are devoted and dedicated to the better-equipped offices in Georgetown with staff in the regions being far less qualified and capable, comparatively, than their Georgetown counterparts. Corriverton is generally regarded as the smuggling capital of Guyana, but only the Georgetown Customs Officers have been the objects of presidentially-directed investigations.

And I continue to wonder why the GRA continues to issue so-called tax accountants and consultants with tax practice certificates to go out there and aid and abet businesses to evade taxes. In fact these certificates amount to licences to cheat and to rob the revenues of the country at the expense of the working poor and the unemployed, who have to pay PAYE and VAT at a rate that the government knows was wrongly calculated. In fact on the question of VAT I have heard of discussions among businessmen that they are better off with VAT, since only they know how much they collect and can therefore decide how much they share with the government. In practice, it makes them look better to the GRA because they use some of the VAT money they improperly withhold to pay their other tax liability. Let me not hesitate to state that such collusion is not restricted to the “tax consultants” but to the qualified accountants as well, who enjoy statutory exclusivity but many of whom seem not to understand that there should be corresponding professional and ethical integrity.

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On the line: Guyana Bank for Trade and Industry Annual Report 2008

Guest business column by Robert V McRae, CPA

Come Tuesday afternoon the Guyana Bank for Trade and Industry (GBTI) will be holding its 21st Annual General Meeting at the Pegasus Hotel, a stone’s throw from where it is constructing a new multi-storey head office. The results of the bank for the year continue a trend of excellent performance by the banking sector during 2008 with GBTI’s profit before tax topping the billion dollar mark, increasing by 14% to $1.1B and profit after tax by 18% to $941M. The satisfaction in the results is reflected in the glowing reports by the Chairman Mr Robin Stoby SC, and Mr RK Sharma, CEO, as well as in the self-congratulatory Statement on Corporate Governance about the technical competence, time, communications skill and integrity of the directors.

The Annual Report is once again well laid out with lots of pictures, charts and tables, although unfortunately some of the charts are unlabelled or the descriptions are incomplete; in one case the text has been partially over-written by a photograph while an important paragraph was cut midway in the Chairman’s report.

In his report for the year Chairman Stoby wrote about the second half of 2008 in the future tense while Chief Executive Officer Mr Sharma offers banking statistics that are several months out of date. Up-to-date information would have been so much more relevant and meaningful.

Highlights
Highlights

As Chairman Stoby points out the dividend of $6 per share proposed by the directors is the highest in the bank’s history. Yet this represents a mere 25.51% of the year’s distributable profits compared with 25.13% in 2007. Earnings per share grew by 18.25% over 2007 and a whopping 256.9% over 2004. With the company’s shares trading at $130, the P/E ratio, a popular investment measure, is an attractive 5.5. With increased profits, other measures such as Return on Average Assets and Average Equity have also improved over the year and the past four years.

Measured in terms of share price at the beginning of the year, shareholders receive a return of 41.7% in dividends and capital appreciation, while depositors of interest bearing accounts earned 3.5% (same as 2007) and the average interest earned by all depositors remained constant at 2.6%. With official inflation for 2008 running at 6.4%, the purchasing power of depositors’ funds was actually less than at the beginning of the year.

The interest earned on average loans held declined from 12.4% and 11.7% (15.1% to 13.4% if calculated on balance sheet values) and because the rate of interest paid remained constant, net interest cover declined slightly from 1.75 to 1.65. Once again a major source of income is Foreign Exchange Trading Gains which amounted to $663M or 25% of interest income, up slightly over the previous year. With an increasing share of its assets invested abroad interest earned on foreign bank deposits was $412M, up from $336M in 2007.

Distribution of assets
Of the total of $49.3B of assets, cash and cash resources accounted for 52%; loans and advances 26%; investments 12%; and the remaining 10% held in the form of fixed and other assets. The major borrowing sectors were trade and distribution (41%); agriculture (21%); household (15%); manufacturing (17%); and mining and quarrying (6%). The bias in the lending portfolio reflects the bank’s lending strategy based, as it states, on Quality Lifestyle and Commercial Loans. In fact the lending to the agriculture sector would have been less than half had it not been for a $1.8B facility from the European Union to improve the rice sector. In 2007, agriculture accounted for a mere 7.6% of the bank’s loan portfolio, down from the 9% in 2006.

Cash resources ($12B) are made up principally of deposits with other banks and investments ($11.5B). For what appears to be tax reasons, the cash resources are invested almost entirely outside of Guyana while the investments are mainly in Government of Guyana Treasury Bills.

The logic that dictates that insurance companies invest the bulk of their funds in Guyana while commercial banks are free to do otherwise should interest the country’s policymakers having regard to the new Caricom Single Market and Economy rules.

Effective tax rate
Two years ago the bank’s effective corporation tax rate was 33.1% but this fell to 16.6% in 2007. It has now fallen further to 13.6% in 2008. The reader would be forgiven for being surprised by the disparity between the nominal corporation tax rate of 45% and the 13% rate paid by the bank. The explanation lies in the opportunities offered by the tax laws, including the Caricom Double Taxation Treaty, to exclude from or significantly reduce the rate of tax on certain income. That treaty provides that the interest earned in any of the Caricom states by a resident of Guyana is exempt from tax in Guyana. The interest income which can be earned in the region ranges from zero per cent to no more than 20% so that the treaty made in 1994 and reinforced by the Revised Treaty of Chaguaramas actually rewards banks for taking Guyanese depositors’ funds and investing them overseas.

If Guyana would pay any interest to tax policy it would see how dysfunctional our tax system is. Not only does it reward such practices but adds to them by allowing additional types of interest earned by banks to be exempt from taxation − low income housing and rescheduled debts being the more common examples. Yet the law allows, without limitation, all the expenses incurred in earning tax-free interest to be deductible against the remaining taxable income.

In addition, dividends are tax-free because of a popular assumption that the income out of which dividends are paid has already been taxed. Not only does such a misconception ignore the fundamental concept of source to taxation, but GBTI is one example of the extent to which practice can vitiate logic. Even if we assume that the company is a proxy for the shareholder then the shareholders of the bank would be enjoying an effective tax rate of 13% in 2008 while employees are taxed at 33.33% and a further 5.2% (subject to a ceiling) for NIS, and depositors pay a final withholding tax of 20% on interest earned. Unfortunately this and similar information are entirely missing from the sporadic debate on tax reform which is often shallow and easily dismissed by the government.

Governance
During 2007 the company appointed two new directors, Messrs Michael Cummings and Carlton James, about whom nothing is stated in the Annual Report, bringing the total to ten. The full-page Statement on Corporate Governance speaks of the bank’s sound exercise of corporate governance and identifies only a single committee considered necessary for this. This is the Audit Committee about whose operation during the year little is said. Of a board of ten there are only two executive directors, but only five of the directors are independent. In the case of the Chairman, his law firm is retained to do a range of legal work for the bank and its customers. It is time for this approach to legal work to be discontinued and borrowers be allowed to retain counsel of their choice using standard forms agreed by lenders and the legal profession.

The blog and the BoG
In late February a post on a blog alleged that the bank had applied for a billion-dollar bail-out. The Bank of Guyana reacted swiftly and “categorically denied” that it had been approached by the GBTI for liquidity support. In fact, the Annual Report states at page 55 that GBTI had overnight borrowing of $1.5B from the Bank of Guyana. Surely this could not have been done without an approach and makes the categorical denial by the BoG at best misleading.

In addition, the report shows that GBTI failed to meet its reserve requirement with the Bank of Guyana at consecutive year ends. A shortfall (described as a negative excess in the accounts) of $2.431B at 31.12.07 increased to over $4.078B at 31.12.08. This is a clear breach of the law, represents an unauthorised advance to GBTI by the BoG, is probably interest free and of course constitutes unfair competition. The reserve requirement is a form of insurance for depositors and its “negative excess” constitutes an arbitrary and unauthorised reduction by the bank which the BoG should not tolerate. It should have long instructed the bank to come into line, enforcing such penalties and interest as appropriate.

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Stimulus package – to do or not to do?

I had promised to write this week about the role in and implications of the Clico fiasco on the NBS and the NIS. Unfortunately I am still trying to confirm some information which means that I could not present a full picture. Hopefully I can do so shortly. I apologise to readers for this.

Introduction
During the discussion on the 2009 budget which has all been forgotten in the wake of the Clico meltdown, some members of the private sector had even called for a stimulus package. The call came in the wake of the announcement by the Minister of Finance that Guyana’s real GDP grew in 2008 by 3.1% and projected growth in 2009 was 4.7%, compared with average growth in the rest of the world of 0.5%. To realise its goal of a 6% growth in 2009 China is now planning a second stimulus package on top of the first package of US$600B. That Guyana can achieve its target without any such package must therefore mean that a miracle is taking place before our eyes. It makes the call by the private sector unnecessary and perhaps that is why we heard nothing further from the sector. So let us look at some other countries.

The new buzz
Stimulus package has become the new term in current economic lingo since President George Bush presented the initial package which was followed by President Obama’s US$800+ billion package after his assumption of the presidency. Using what has already become his legendary skills of persuasion, Obama has been urging world leaders to adopt aggressive, American-sized spending programmes. And indeed if we look at the number of countries that have introduced stimulus packages you would think there is general consensus about the virtues of such packages. In fact two of the greatest recoveries in modern economic history – FDR’s New Deal and the Marshall Plan − are held up as proof of their great virtue.

Those to have adopted such packages recently include Canada, a country which has run a federal surplus for the past twelve years but has announced a sweeping stimulus package of tax cuts and new spending that will push the federal budget into a US$28B deficit; Australia whose package is worth US $27B, while Malaysia’s package of US$16.2B was described as unprecedented in the nation’s history. But both in absolute dollars and expressed in terms of GDP the US, China and Germany in that order are the countries that are investing the most in stimulus packages, some more than once. Interestingly India where politics trumps economics is the big country with the smallest package expressed relative to GDP.

Cynics
With this kind of evidence you would think that everyone would jump on board the stimulus bandwagon. If you do you would be ignoring the politicians and the many-handed economists. It may be unfair to the Republicans to say that they voted almost unanimously against Obama’s stimulus purely on the grounds of partisan politics. Part of it may have to do with ideological differences they share with economists who start with the proposition that there is a range of packages – from the various forms of getting money into the hands of the consumer to direct spending by the government and to monetary policy.

Those who argue the case for fiscal stimulus say that with more money in consumers’ hands, more goods and services would be bought and there would be less need for companies to lay off workers, leading in turn to less demand.

George Bush’s package was based on such a theory. US Republican vice presidential candidate Sarah Palin who temporarily dazzled voters with her charm offered what appeared to be the simplest form of stimulus package: dropping money from the sky into the hands of voters/consumers. That has generally been dismissed because the evidence – or at least this is the conventional wisdom – is that such sums are saved rather than spent, defeating the whole purpose of such a package.

There is now emerging a consensus however that compared with monetary policy, fiscal policy is an ineffective tool in combating recessions. Monetary policy emphasises the ability of the central bank to make more money available − thereby increasing demand − by lowering interest rates. But this too is no guarantee since even with a more liberal monetary policy the banks may still be unwilling to lend and entrepreneurs may prefer to wait out the crisis before retooling or going into new plant and machinery. It would have been good to hear the Bank of Guyana’s views on the matter of interest rate and its role on the level of such rates.

Clash of the Titans
Then there is government spending with the potential to take the budget into (bigger) deficit. As we are seeing with the US, this can pose enormous problems. Obama may be able to convince Americans that his package is necessary, inevitable and the best. But America is the world’s largest debtor nation and no less than the Prime Minister of its major creditor country, China, has just expressed its most direct fears about its trillion dollars investment in US Government bonds and more indirectly about the US’s stimulus package. For the giants it is a clash of culture with the US believing in spending and borrowing while the Chinese are known for thrift and savings.

But it is not only China that has expressed reservations about the US’s approach to the problem. Europe’s position is more contentious with their finance ministers rejecting, ahead of the G20 meeting in London next month, Obama’s call for a two-pronged G20 effort to fix the global economy: stimulus measures and regulatory reforms. In a statement issued through their Chairman, Luxembourg Prime Minister Jean-Claude Juncker, they said the call for more pump-priming by other G20 economies did not suit them.

Juncker noted, “The European recovery programme represents a spending level of 3.4 to 4.0 percent of GDP,” and their “public finances are beginning to suffer.” He could have added that there is no unanimity in the EU either as the differing attitudes to such packages in Spain, England, Italy and Estonia show.

There is a real dilemma since no matter how much is spent domestically if there is no consensus and no uptake in world demand, domestic spending could hardly make up for the slump in exports as world demand evaporates and foreign direct investment (FDI) declines.

Poorer countries
If the big countries cannot come up with the solution then smaller ones are in for a rough ride. No small country can, even if it had the financial resources, spend itself out of this recession. Take Guyana as an example. It has already placed too many of its cards on sugar and rice and does not have many more to play.

Parliament seems to be heading to take on a multi-billion dollar obligation with Clico and our budget deficit as a percentage of revenue is a huge 23%. If we exclude grants the percentage is a staggering 42%. Our public debt is climbing inexorably while internal and external factors threaten our main exports. We face falling FDI and reduced remittances. We are burdened by high taxation and cannot be taxed any more. We will either have to draw down on our international reserves or borrow more. These are not easy options.

It is true that our 2009 budget is unlawfully inaccurate. It has no income from the politically controlled Privatisation Unit/NICIL or the Jagdeo-controlled Lotto Funds. It also excludes the PetroCaribe funds. But it seems that we have to live with such imperious illegalities.

If we look at all the recent budgets we have had essentially the effect of stimulus packages – each year spending well more than we can afford in the hope that we will achieve our goal and see a surplus in the national budget; each year boasting about the biggest budget ever, a trend that now has its own momentum.

Yet, our idea of spending is huge sums on the capital budget much of which goes directly to a handful of contractors and big ticket projects. Physical infrastructure takes priority over education, and even in health unnecessarily large amounts are spent on unlawful drug-purchase contracting.

The Caribbean is suffering badly from the crisis with retailers in the tourist economies reporting a decline in revenue of 15-20%. The energy-based Trinidad is experiencing year-on-year reductions within the same range, affecting the ubiquitous roadside vendors and even the pampers manufacturer. Trinidad which bases its budget on the price of oil has announced two budget cuts affecting in the first instance its capital programme.

No one knows what, if anything the IMF may be saying to the Government of Guyana about stimulus. But the private sector has to be careful what it calls for. To ask a spendthrift to spend more of your money is to invite trouble.

I am sure that is not what we need or they intended. What we need is a tax cut for the poor who in any case are being cheated on VAT, and better financial management.