IMF Recommends VAT For Aruba

by Phillip Morton, Investors Offshore.com

16 September 2010

The International Monetary Fund (IMF) has recommended that Aruba implement a value-added tax regime as part of structural reforms designed to lower the budget deficit from 4% of the economy to 1% by 2013.

In its Article IV consultation with the territory, the Fund warned that achieving such an adjustment merely through expenditure reviews seems ‘exceedingly difficult’, urging instead a longer-term review of the island’s tax regime, to establish fiscal policy on a sustainable footing.

The Fund noted that Aruba’s tax revenues, at around 18% of GDP are somewhat lower than the Caribbean average of 25% of GDP. Moreover, only about half of Aruba’s tax revenues result from indirect taxes, compared to a regional average of almost two-thirds.

The IMF has therefore advocated that Aruba reviews its fiscal regime with a view to reducing income tax, removing nuisance taxes, and protecting real income levels of the poor. Against this background, the Fund has welcomed the installation of a tripartite commission to study reform options as ‘a positive step’.

The IMF report’s major recommendation is the implementation of a value-added tax system, which it said should be designed to fit Aruba’s specific needs. “A VAT would avoid the distortionary cascading effects of the business turnover tax," the IMF said. "To limit administrative costs for both the government and the private sector, the VAT could exempt small businesses. International experience suggests that a VAT introduction would require careful preparation of at least 1½-2 years. IMF staff encourages the authorities to seek technical expertise oriented on international best practices, for example by joining the Caribbean Technical Assistance Center (CARTAC)."

The IMF noted that banking had remained resilient, and profitable in Aruba. Non-performing loans, however, have increased significantly in the wake of the recession, in particular in commercial real estate and unsecured corporate lending, but are almost fully provisioned. Elsewhere in the financial system, the coverage ratios of some private defined-benefit pension funds have fallen below 100% as a result of losses on the funds’ investment portfolio, but good progress in restoring financial soundness has been made in the context of recovery plans, the IMF said.

In its analysis, the IMF did however warn that the central bank’s new monetary policy framework will likely increase the challenges to prudential regulation and supervision. In addition, it said the absence of a credit ceiling may well result in more aggressive lending, which, in turn, could trigger a deterioration in banks’ lending standards. The Fund highlighted the need for supervisors to monitor market developments closely as well as the strategies and actions of individual institutions. Enhancing the forward-looking character of the central bank’s stress tests could help in this endeavor, the Fund advised.

Lastly, the IMF said Aruba’s offshore financial sector remains small but carries a potential for reputational risk. The IMF has recommended that the offshore banking sector should be permitted only to the extent that the central bank can monitor their activities and enforce prudential rules. In this regard, requesting a material physical presence of licensed offshore banks in Aruba is crucial, the IMF concluded.

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