“There is an ongoing debate about the impact of a country’s tax structure on entrepreneurship generally, and on innovation specifically. … Suffice to say that most experts believe that relatively high marginal personal and corporate income tax rates discourage entrepreneurs from taking the risks of starting new business ventures and firms. … Since new firms are frequently the conduit for introducing new products and production processes into an economy, relatively high marginal tax rates are likely to discourage innovation.”—Stephen Golberman, 2012.
In recent weeks, the Business Perspective (BP) has been focusing on the role and importance of innovation in any economy. In the ambit of lifting potential growth, it is often repeated that Belize—like our sister countries in the region—ought to boost our levels of productivity and innovation. That is usually all well and good to say, but the real crux of the conversation is on the how.
The innovation policy mix is usually comprised of the so-called supply- and demand-side measures. It is important to note that these measures often influence and overlap with each other; therefore, the utilization of such dichotomous distinctions is simply used here to aid in the discussion.
In terms of the demand-side, most would recall that a private-sector firm would be driven to produce new products or new processes if they are sufficiently convinced of the expected levels of profitability to be gained from making such investments. Of course, if we are talking of profitability, one cannot ignore the costs and potential risks, both of which an entrepreneur would also weigh.
Said differently, as costs decrease and/or risk-adjusted profitability increase, we can expect to see an increase in innovative practices. Naturally, on the cost side, one could look at the cost of capital. However, another factor that also eats away at the expected profits is the level of taxes that businesses have to pay.
As the opening quote to this BP article suggests, higher tax rates serve to “discourage entrepreneurs from taking risks”. The body of empirical works into this area has essentially confirmed and re-confirmed the inverse relationship between corporate tax and economic growth—driven by innovative business activity. One such study, albeit not for the Belizean economy, found that “a 10 percent cut in the company tax rate produces an increase in annual per capita growth between 0.57 and 1.82 percent” (Lee and Gordon, 2005).
Now, one would recall that at the start of Fiscal Year 2017/18 the Government of Belize had implemented several tax measures geared at boosting government’s revenue. Among these measures was the increase in the Environmental Tax from 2 to 3 percent; the increases on excise duties charged on goods such as beer, aerated water, cement, fuel and paint; as well as other changes. The revenue packages’ (which is a mix of tax and non-tax sources) stated target was to raise roughly $83 million (or 2.26% of GDP).
Before one even considers the impact on innovation, as was discussed in an earlier BP article, these revenue measures had already manifested adverse impacts on some existing domestic firms. For instance, the Statistical Institute of Belize (SIB) in its Quarter Two and Three updates for 2017 explicitly attributed the decrease in beer production to the increased excise tax charged on that product. And by mid 2017, one domestic airline had already attributed the cancellation to three routes to the increase in the departure fee for non residents.
One would not have to venture too far to then surmise how such policy approaches would also dissuade those would-be innovative small firms, who already have to contend with the high cost of capital and the costs associated with research and development activities, from taking the leap forward.
This level of dissuasion carries its own ripple effects. For one, if we agree that it’s the creation of new businesses that provide new jobs, then one would have to acknowledge that any deceleration in this area, by extension, could also have an impact on employment levels as well as other social factors.
To be fair, any discussion regarding reducing taxes on businesses would trigger a concern about the revenue needs that government also has. It is unrealistic to assume that a government could forgo revenue so easily, because that also translates to the cutting back in certain social services provided. To that end, the balance between both private and public sectors’ respective needs is found revenue-neutral proposals, a matter to be explored in a future BP article.