Economist: VAT model underpins dollar

As Barbados struggles to rebuild a sagging economy, an American economist has backed the consumption tax model of the Value Added Tax. insisting that it is helping to shore up the value of the Barbados dollar.

Central Bank of Barbados 2019 Distinguished Visiting Fellow Dr Linda Tesar, a Michigan University economics professor, said a key part of the reform process for Barbados, given its high debt, was maintaining its fixed exchange rate of $2 to US$1.

Dr. Tesar was addressing the sixth annual Caribbean Economic Forum at the Courtney Blackman Grand Salle on Thursday night under the theme “In a World of Rising Debt, How can Caribbean Countries Stay Afloat?” The forum was also broadcast on national and regional television.

She said: “A key component when a country is having a debt crisis is what is the anchor to the economy. And I think part of the anchor here in Barbados is the fixed exchange rate and the credibility that a Barbados dollar can be exchanged for a US dollar, and that there are reserves to back that up. That is a key part of the reform.”

Suggesting that an exchange rate can provide an important signal about “relative conditions”, Dr Tesar said that a moving exchange rate could introduce uncertainties.

“So having a fixed exchange rate gives you a lot of predictability and the ability to maintain a peg is also, when successfully done, a good signal that the Government has things under control,” she added.

Acknowledging that Barbados was facing a high debt situation, Dr Tesar said: “I do believe when debt levels are very high some hard decisions have to be made.”

“So some of it is looking for inefficiencies in spending and figuring out is this the place that cuts can be made that won’t be too damaging to the people involved and to the situation so you can make those cuts.”

Governments use three major strategies to help them get out of debt – an economic growth strategy, a cut in spending, and introduction of belt-tightening measures through taxation, she said.

Although pursuing an economic growth strategy may seem the easier path to emerge from a high debt situation, it was one of the most difficult, she added.

Dr Tesar said: “So more often the way out is to be combining business-friendly strategies that promote growth, along with having to raise taxes and cut back on spending.

“Here in Barbados and across the Caribbean, because the economies are more open some of that cut back is going to land on not buying so many imports, and that is going to help with the balance of payments and build up reserves and making it easier to service the debt.

“I think that is going to work a little bit. So we are going to get more of a beneficial outcome from that austerity than in the European case.”

The other measure, she said, was to raise taxes in order to increase revenues, adding that consumption tax – such as the VAT – was the best way to go.

“I think a strategy that moves away from taxing capital and labour and shifting more to taxing things like consumption, land and wealth, that kind of tax reform, which I understand is underway, is going to be beneficial and lead to more revenue,” she said in support of VAT.

The American economist acknowledged that getting the economy out of the level of debt into safer waters would take several years, and it was important that there was constant communication and residents should exercise patience.

She said: “What I am impressed with though, with the strategy that the current government has adapted, is that doing things sort of in a short time frame and doing them simultaneously. So really addressing tax reform, addressing some austerity, addressing reforms in the business sector to try and bring out greater efficiencies,

“People are going to have to stay behind this for a while.”

She told the audience that generally it takes from five to seven years for public debt levels to come down to more manageable levels.

But the University of Michigan professor warned that Government must better manage its resources in order for economic outcomes to benefit the population. And as technology becomes more advanced and widespread, she said governments needed to come up with training strategies to keep people employed.

She declared: “As a small economy there is not a lot of room for error.

“Facing these global markets it is a bit daunting and relentless, so it is really important to get these things right, and I am impressed with how engaged the people are in grappling with all of these issues.”

Dr Tesar also pointed to the importance of raising the country’s credit ratings because “it tends to spill over in the private sector and this makes it hard for people to get credit to undertake business ventures”.

“So this is a burden that if it can adjust relatively quickly, that could ease pressure on the economy,” she said, adding that attracting more foreign investment and implementing strategies to tackle natural disasters would also play a critical role in the reform process.