The question on whether to continue or remove the VAT exemption is more nuanced than just deciding whether the loss of revenue is bearable and a helping hand to the poor is justified.
At first glance, a VAT exemption on basic food items seems like a very “good idea” and a “political no brainer”, to show compassion and care for the people. Sadly, this could not be further from the truth.
A pandora’s box of issues and problems opens up when we explore how a VAT exemption for some of the basic food items has played out.
In a nutshell, the VAT exemption aided and enriched a small number of producers, created many losers, inhibited the development and wellbeing of a large segment of the community, and helped to generate and fuel a national health crisis.
Its negative impact is most noticeable in the rural and iTaukei communities, where it has fundamentally changed dietary habits.
It provided the financial inducement and motivated many to move from traditional foods towards imported high glycemic carbohydrates and foods high in fat, salt and sugar.
People switched from a diet rich in fibre, vitamins and minerals to a diet that is associated with a higher risk of developing diabetes and heart-related diseases.
A national NCD crisis was created. Rural subsistence cum commercial farming of traditional foods was hit hard. And, additional tonnes of used consumer food packaging continue to be thrown into the environment.
How and why did this happen?
A VAT exemption conflated two very different policy objectives into one, resulting in many unintended and unfortunate consequences.
The first is a policy to help the poor and the second is a tax policy that was designed to ensure VAT was fair and equitable across the board.
Selectively exempting a few products made the tax policy inherently unfair, which created the negative consequences we are seeing today.
It is unequivocally accepted that some form of assistance and support is needed for the poor. The question was how. The assistance and support to the poor could be delivered through targeted income support. Money transfers can be sent directly into the recipient’s mobile phones.
Government has the databases and the digital technology to put in place a system of targeted income support that is economical, efficient, trackable and accountable. Income support to the poor would provide them with the funds to pay for the food items and basic necessities of their own choosing.
However, a succession of political leaders chose not to follow this policy option. Instead, they chose a range of products for VAT exemption, making those products more affordable for everyone (rich and poor) to purchase.
This was always promoted and viewed by the media as a political masterstroke. VAT was exempted for flour, rice, sugar, salt and oil among others. For some of these products, there were direct substitute products, such as traditional root crops, competing for a share of the consumers’ wallet.
The VAT exemption for these basic food items changed the market structure in the economy. It gave the producers, importers and suppliers of the VAT exempt foods an extra “margin space”. This financial subsidy and pricing buffer allowed them to increase their investment in branding.
One only needs to count the large number of advertisements and promotions taking place to see the big shift. A commodity type product was changed into a whole range of prepackaged and branded consumer packs.
All this was done to increase consumption, aided and supported by government. People’s purchase and consumption behaviour changed, “shifting away from the traditional root crop based diet to cereal based” as was recently highlighted by the current Minister for Health.
The VAT exemption discouraged the production of root crops for the domestic market, as flour and rice were now a much cheaper subsidised alternative. Economic development in the rural communities was hampered.
Subsistence/commercial production of root crops became less economically viable in the face of competition from the subsidised VAT exempt foods. Root crop production dropped and prices increased.
However, input costs for subsistence/commercial agriculture remained high and were not subsidised. Small rural subsistence cum commercial farms that needed assistance were instead penalised and forced to compete on unfair terms. A rural-based farming lifestyle quickly became untenable for many.
Not surprisingly, manufacturers, importers and supermarkets came out as the big winners. The rural subsistence/ commercial farming sectors were the big losers while the unsuspecting consumers were blissfully happy, basking in the belief that they were not paying a tax.
Whole communities began changing their diets, increasing their risk of having diabetes and heart-related diseases. The medical system was kept busy performing amputations, and we continue debating whether the VAT exemption should stay.
How could this have been prevented?
One of the key principles that is applied in tax policy formulation is the concept of fairness and neutrality. It is crucial to the discussion and the process. Any change or design of a new tax policy should not favour one industry, producer or economic activity at the expense of others.
When VAT was introduced in the ’90s, issues of neutrality and other tax policy considerations were holistically evaluated and the consequences foreseen, and as a result no favouritism was created.
When the VAT exemption was being considered the issue of neutrality would or should have been part of the discussion. The questions and analysis should have raised a number of red flags, even if it was done at the cursory level.
The most basic question would have been “does the VAT exemption have any negative consequences and what are they? The following simple questions would also have unravelled the negative impacts of exempting VAT.
Will the VAT exemption for flour, rice, oil, and sugar favour those producers over others, including their direct and indirect competitors? Will it give the producers an unfair competitive advantage? Are there competing or substitute products?
Will it change purchase and consumption behaviour? Will it change market behaviour? Will it affect economic production decisions? Will it affect the development of a sector or community? Will it have consequences on other sectors beyond a tax revenue loss?
Will it change lifestyles? Analytical rigor in the policy process would have captured most if not all of the negative consequences. However, no policy advice would have made a difference if the VAT exemption was made for political, ideological or favouritism reasons.
High GI foods or cash
Almost every Minister for Health has delivered a speech lamenting that an unhealthy diet high in salt, sugar, fat and processed foods is a major risk factor contributing to the rising crisis of NCDs which is now also the leading cause of death in Fiji.
International donor agencies have also spent millions of dollars to promote the cultural and nutritional value of traditional diets. At the same time the Fiji government’s fiscal policy was actively encouraging a shift away from the traditional diet towards a more “modern diet”; rich in fats, salt, sugar and high glycemic carbohydrates.
It was one step forward and two steps backward. It is tragic that it has gone on for so long. Now, the Coalition parties have a clear choice ahead of them.
They can either put extra money into the hands of the poor, targeting only the poor, to buy the foods of their own choosing, or they can continue to encourage the poor to change their diet, by subsidising the price of high glycemic foods.
Increasing the consumption of high GI foods will of course help generate economic growth opportunities in the hospital and funeral business. But that will not lift the standard of living for Fijians.
Will they continue to listen to the power brokers and the “expert” lobbyists who helped shape the polices over the last two decades, or will they take stock of reality, question what’s happened, and be guided by their moral compass.
It will be a real test of what they believe in, what they care about, and who they care for. Will they just talk the talk or will they start to actually walk the talk.
World Bank and tax policy
Given the negative impact that the VAT exemption has had on the economy, rural development, and NCD rates, it should not come as a surprise that the World Bank has consistently advised Fiji government officials to discontinue the illconceived policy of VAT exemption.
They recommended a switch to a system of targeted income support for the poor. It was not an issue of revenue. It was a structural and equity issue that was tearing the social fabric apart and damaging the economy.
Whatever negative impressions people may have of the World Bank policies and advice, leaders and policy makers owed a duty of intellectual honesty to look deeper into, and to fully analyse and understand the full implication of the World Bank recommendations, instead of simply ignoring it.
As we look forward to reading the Fiscal Review Committee’s report, we need to be mindful of what are the possible tax revenue pathways available to government.
Fundamentally, the ability or pathways to collect taxes from a taxpayer (individual or corporate/organisation) falls into three broad categories: income, consumption and a broad definition of wealth.
In Fiji, only two of the three categories currently provide sources of tax revenue – income and consumption. Income tax is generally considered and can be structured to be progressive (the more you earn the higher you pay) whereas a consumption tax is regressive (impacting low-income earners more than the wealthy).
However, over the past two decades, a significant portion of income from the highest income generating groups in society was not taxed or had a reduced tax rate. As a result, there has been a huge accumulation of wealth among a few.
This begs the question as to whether a threshold wealth or property tax should be seriously considered as the third major source of tax revenue, given the need to bring government finances back to order.
Or will it be dismissed, because “the time is not right”, and it never will be. Food for thought. Finally, should the VAT exemption be removed, and can the NCD trend and crisis be slowed or reversed? Yes! The VAT exemption was a mistake, not removing it will be a bigger mistake.
Simultaneously, a system of targeted income support for the poor must also be put in place. Reversing the NCD trend is a bigger challenge.
It will require a committed and strong fiscal response that is not VAT related, combined with new regulations on advertising and labelling, the innovative use of social marketing frameworks and techniques to effect behavioural change at the national level, a more nuanced, honest and rigorous approach in policy formulation, and the immediate removal of the VAT exemption.
It needs all the stakeholders to have a holistic and agreed understanding of the underlying issues and the key drivers before an integrated set of policy solutions can be put in place.
The danger is that politicians and the public officials could succumb and embrace the use of populist clichéd solutions to simply show that something is being done, and may possibly create another pandora’s box.
• 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 robertleefiji@gmail.com
