A VATful of poison

The deep sigh of relief that greeted the Labour Party's decision to retain the Value Added Tax system reflected the uncertainty that has prevailed in this regard over the past four years. It was bottled exasperation let loose. The uncomfortable pressure on the political bladder was totally unnecessary. It was a labour of disregard on the part of the Opposition. It was an unjustified belaboured pent-up feeling on the part of the business community.

Despite impressions attributed, possibly unfairly, to the shadow finance minister, there was never a shadow of doubt that Labour would ultimately state that it would retain VAT. That was a foregone conclusion from the moment Labour lost the 1998 election. It was a measure of the present Labour leader's ability to spin out a plot that kept the business community on edge, and created fresh uncertainty regarding what would happen the next time round if there were to be another change of government that reinstated Alfred Sant as prime minister.

It was also an indication of the inability of the business community to understand how a political mind works. Despite scary tales to the contrary, that of the current Opposition Leader, like that of his exalted predecessor Dom Mintoff, is as easy to predict as the taste of pre-heated old pie, whatever the premeditated change in the socio-political pressure cooker's temperature.

Whatever. The VAT system is here to stay. That means - as Dr Sant promised when he was prime minister and had to deal with two determined EU economists, a man and a woman - the output of domestic manufacturing companies sold in Malta will remain burdened with the taxes imposed through the VAT system, as on imported products, ultimately to be paid by the consumer. The EU economists - mere bureaucrats they, not pressure-gun toting politicians - with little ado exacted a commitment from the Labour premier to do away with any preferential treatment to Maltese products proferred by the CET variation of taxing value added.

That commitment, it has now been made clear, even if it was not clearly stated, would be duly fulfilled by the new government should Labour regain office. Domestic manufacturing output will have to continue to compete with imports on an even keel. The tinkering with the VAT system suggested by the Labour leader cautiously touches on tourism, currently taxed at 5%, but, so far anyway, not on manufacturing output, presently subject to VAT at 15%.

Such caution in the pre-electoral promises regarding small changes to a retained VAT system is understandable, however it is dressed up in rhetoric. Revenue cannot be cut and cut again, without piling pressure on the structural budgetary deficit. Understandable, but it would be more appropriate to state in honest terms.

These comprise the indicated financial consideration of reduced government revenue; the desirability to encourage sustainable domestic economic activity; the constraints in this regard from the reality conditions within which a country must operate, whether because it is an associate (broadly Labour) or a member (broadly Nationalist) of the EU, or because of obligations under the Barcelona Declaration (the EU's free-trade co-operation programme with non-EU Mediterranean countries), or under the World Trade Organisation, to which Malta has subscribed.

The realities of VAT are simple and clear enough to perceive. It is an indirect tax, borne by the final consumer. So was the 1997-98 CET system which replaced it. VAT, according to my comparative appraisal, is a more coherent and efficient system. That was also the conclusion of all the domestic and foreign economists I came in contact with when I was trying to work out how to replace VAT, as finance minister from October 1996 to March 1997.

One Nordic Socialist visitor asked how on earth could it be done. With a cold fraternal smile, he wished me luck. His wish was not heard. I left the Cabinet. CET replaced VAT. Labour lost the premature election of 1998. The House of Representatives, at the behest of the reinstated finance minister, re-enacted VAT, with some modifications. Four years on, the Labour leader, who in 1994 had single-handedly committed the party to remove VAT, states that if Labour regains government it would retain VAT, with some alterations.

The road to Damascus stretches 2,209 miles from the Upper Barracca Gardens. No one would be more pleased than I if the light has been seen after honest soul-searching and application of cold rational analysis. Systems devised by man, after all, can be revised and changed by man.

Economists propound that taxes should be neutral - that is, they should be levied at the same rate, from zero to whatever, on all goods and services. Thereby, demand would not be distorted - that is, influenced by different tax rates. As one theoretically sound economist advised me as finance minister, better have a low(ish) rate on consumption of all goods and services, health, education, food, clothing, condoms, medicine and whatever else, than a relatively high(ish) rate on certain products and services, while exempting others.

A political economist or a socio-political minister not subject to constraints under any EU membership or free trade can reject such economic purism, differentiate among goods and services according to how essential he (his party) considers them to be in basic consumption, and not give much thought to any resulting distortion in demand.

The extent to which a government of a Malta that stays out of the EU but seeks a free trade arrangement with it could do that, would have to be seen. Provided that imports (from the EU) and domestically consumed Maltese output are taxed uniformly, ensuring a level competing field, such differentiating should be possible. Economic purists can always be ignored.

The revised Labour position, therefore, does have a solid political leg to stand on.

Except for one tiny thing...

The Labour leader, ragged by the hostile part of the media after he had confirmed the easy prediction that the VAT system was here to stay, was quickly needled into declaring that he continued to believe the VAT system was responsible for (Malta's) economic stagnation.

Put like that, the issue is blown wide open once more. If one honestly believes that the VAT system stagnates the economy, how can one switch from total opposition to it to undertaking to retain it? If a drink is poisonous, how can one seriously accept to pour it down anybody's throat?

The commitment to modify the VAT 'poison' relates mainly to (a) jettisoning the present government's commitment to extend VAT to food, education and health products in several years' time, and (b) reviewing the rate applicable to tourist accommodation and restaurants.

The first element - tax on basic essentials - is not in place yet. No VAT on them has been imposed to date. It cannot, therefore, be part of the Opposition Leader's diagnosis of the cause of stagnation. The prevailing tax on tourism accommodation, at 5%, is equivalent to what it was under the CET system introduced by Dr Sant as prime minister. He surely did not intend tourism to stagnate.

In fact it did not. Hoteliers could live with CET at 5%, and are not whining and wailing about VAT at 5% now. Tourism practitioners know that the rate of the consumer tax, whatever it is christened, is not the cause of actual or perceived tourism ills. Obviously, if it was whittled further or, what the heck, reduced to zero, they'd say that would be nicer, thank you. But would that be serious public finance? And would it solve the problems faced by tourism, which include the parlous state of the face of Malta, which direly needs effective public expenditure to embellish it, which expenditure has to come out of public revenue, including VAT receipts?

Does it make serious social or economic sense even to hint that the tax on consumption in restaurants would be cut? In that case, why have VAT - or CET, or excise duty, or any indirect tax - on anything at all?

Another element in the proposed revision, as indicated by the Labour leader, relates to raising the threshold for small enterprises. Thereby they would be able to opt out from imposing tax on their sales and getting refunds of funds on their VATtable purchases. That might cut some paperwork, but presumably, and unless one intends to confound the audit trail and add fuel to tax evasion, small operators would still have to keep proper books of account. So, where's the beef in this respect?

If VAT is perceived to be a fiscal poison causing economic malady, diluting it with a tot of fizzy water will do nothing to stop the patient - the Maltese economy - from going on to its death.

In that scenario, removing VAT would be an obligation, not an expediency. The debate on the tax system has been debased enough without resort to such spin.

Fact is that the tax structure must combine direct and indirect tax systems. Fact is there is wide technical agreement that VAT, even if it is not imposed uniformly as economic purists advise, is the best indirect system conceived so far, though that does not mean it is perfect. No system is or can be fool proof. VAT is less imperfect than other systems.

It is wise of the Labour Party to decide to keep it, should it be returned to office. Proposed modifications can be evaluated when they are formally and precisely submitted. Meanwhile, the less spin applied to the issue, the less dishonourable and better it will make this overdue development.