The Primrose Path of Tax-Break Economics

Jamaica is approaching the 50th anniversary of its independence from British rule, and I share in the pride all Jamaicans must feel on such an occasion. But I received an email from my friend Madge Marshall this morning that gave me cause for sober reflection. Attached to Madge’s email was an article from The Economist. Here’s an excerpt:

The world is used to trailing behind Jamaican sprinters. The small island has won a string of world records, and may claim more at the 2012 Olympics. Its economy, however, is not so speedy: on current forecasts it will finish the year with the slowest average growth rate since 2000 in the Americas—behind even earthquake-stricken Haiti.

On August 6th Jamaica will celebrate the 50th anniversary of its independence. But the festivities will be muted by frustration with its performance. 

The Jamaican economy should by rights be booming. The island is just a 90-minute flight away from the United States, the world’s biggest market, with which it shares a language. It is on the shipping route to the Panama Canal, and has a spacious natural harbour in Kingston. It is politically stable, without the ethnic tensions that have riven other Caribbean nations.

Jamaica has reasons for its plodding growth of late. Tourism, which employs one in ten islanders, has dipped with the world economy. And the market for bauxite and alumina, its main export goods, has been rockier than for other commodities.

However, the country’s economy was stagnant long before the credit crunch. In real terms Jamaicans are no richer today than they were in the early 1970s. And most of the island’s enduring problems, like its public finances, are home-made.

Jamaica has run fiscal deficits in 44 of its 50 years of independence. Few people pay taxes: the middle class is small, the informal economy big, and enforcement chilled-out. Only about 3,000 of the country’s 65,000 registered firms are thought to contribute. The government has steadily dished out waivers to favoured industries: tourism pays an effective tax rate of 5%.

Lacking sufficient revenue, Jamaica has financed public spending by borrowing. Years of accumulated deficits, a bank bail-out in 1995, and punishing interest rates have swollen the national debt to a Greek-style 140% of GDP. Servicing the burden now accounts for over half the budget.

The government has further hurt the economy by unwise intervention. Its tax breaks for imports by hotels have cut local firms out of the supply chain. That has limited job growth, forcing many of the young into lowly tourism posts, such as hawking handicrafts (and hashish) on the beach. “Money goes where money is, and the rest of us stay poor,” says Dee Brown, who punts tourists around the north coast’s Blue Lagoon on a bamboo raft.

The article goes on to blame Jamaican bureaucracy and government miscues for the island’s problems, but I came away with an entirely different message. To me, the island provides a warning to America. It shows what happens when you rely on tax breaks to produce growth.

I worked for the Jamaica Industrial Development Corporation, a government agency, back in the Sixties, and I saw first-hand how those seductive tax breaks can fool you. Back then, the Jamaican economy was based on agriculture, bauxite mining and tourism. The government wanted to develop an industrial sector. So they decided to give tax breaks to companies that set up factories on the island.

The program called for tax holidays of several years – I think the maximum number was 15. The idea was that once the factories had become established they would produce revenue for the island, and in the meantime they would provide much-needed industrial jobs.

But, as in so many cases, the policy was based on an incomplete analysis. It failed to take the competition into account. As soon as the tax holidays ended, most of the companies packed up and moved to some other country that offered the same type of deal.

It may sound like a good idea to lower taxes for corporations and the rich – as the Republicans plan to do if they win control of the American economy in November. You might think the rich would use their money to create jobs. But it just doesn’t work that way.

As the Economist quotes Jamaican Dee Brown as saying:

Money goes where money is, and the rest of us stay poor.

The painting reproduced above is by  the late Michael Lester and shows the view from his home at The Anchorage at Belmont, St. James.

Click here to read the Economist’s article.