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Taxing remittances is not a good idea

Sanket Mohapatra's picture

Photo: istockphoto.com
Remittances sent by migrants have become a massive financial resource flow for developing countries with over $300 billion received annually. While most governments have encouraged efforts to increase these hard-currency flows through formal channels, some are considering taxing remittances as an additional source of revenue.     

A few receiving countries already tax remittances, often through indirect means. For example, remittances sent from the US to Cuba can only be paid to recipients in Cuban Convertible pesos (CUC) or Chavitos with a tax of 20 percent for conversion of US$ to CUCs. The US government and a US senator called upon Cuba to repeal this tax when the US lifted restrictions on sending remittances to Cuba. Other countries that have a parallel market premium with an overvalued official exchange rate, e.g., Ethiopia, Pakistan, and Venezuela to name a few, also implicitly tax remittances when they require recipients to convert remittances to local currency at uncompetitive official exchange rates. Philippines used to impose a small Documentary Stamp Tax (DST) of 0.3 pesos for every 200 pesos, but this was scrapped in November (see article).

Some destination countries also tax remittances but for different reasons. Oklahoma state in the US taxes remittances sent through money transfer companies – a fixed tax of $5 for amounts sent up to $500 and 1 percent above that (see article). Legal residents and citizens can apply for refunds when filing state taxes, so this tax appears to target undocumented migrants who are perceived to be putting a burden on public services. (Remittances sent through banks or credit unions are exempted.) Kansas is reportedly considering imposing a similar tax.

There are several reasons why taxing remittances is a bad idea:

• A tax on remittances is additional to income and sales taxes already paid by migrants. Imagine New York taxing the remittances of an employee who came from Washington! Or New York taxing this worker’s Christmas gifts sent to family members in Washington!

• A remittance tax would immediately reduce the incentive to send remittances and the amounts received by the beneficiaries, and ultimately the development impact of remittances. 

• A remittance tax would also drive these money flows underground. A shift of flows to informal channels can hurt efforts to leverage remittances for increasing access of recipients to formal financial services (financial inclusion) and to raise financing for infrastructure and other development projects (e.g., the recent US BRIDGE initiative).

• Such a tax is difficult to administer as remitters can resort to using informal channels. Also such a tax is highly regressive. And they produce huge deadweight losses as remittances are highly cost-elastic.

The action of the Philippines to eliminate the DST is commendable. Even though it will lose some revenues in the short run, the gains from increased remittances could easily outweigh the losses. Other countries that require recipients to exchange the remittances at overvalued official exchange rates should consider relaxing these restrictions.

Measures to appropriate some fraction of resource flows that have recognized development and poverty reduction impacts could prove counterproductive. Instead, facilitating remittances by reducing transaction costs and increasing transparency and competition, and leveraging these flows to increase access to finance of households and the capital market access of countries, can benefit both the migrants and their countries of origin.

Comments

Submitted by Sanket on
In an interesting development, CubaStandard.com reports today that the U.S. Department of Treasury now allows U.S. residents to wire Cuban convertible pesos (CUC) to family members in Cuba, according to a Western Union official. The article says: "In 2006, the Cuban government reacted to a U.S. crackdown on foreign banks doing U.S. dollar business with Cuba by imposing an 8-percent penalty on the exchange of dollars to Cuban pesos. This made dollar-denominated remittances more expensive and led to under-the-table remittances in CUC. A few weeks later, OFAC — the sanctions enforcement branch of Treasury — issued a circular to licensed forwarders specifically limiting remittances to U.S. dollars, Canadian dollars, Swiss francs, British pounds an euros." (see http://www.cubastandard.com/2010/12/20/efe-u-s-allowing-cuban-peso-remittances/) Lifting these onerous restrictions will only benefit the ultimate beneficiaries of remittances, and more broadly, the Cuban economy and its people. We can only hope that the recent experiences of the US, Cuba and the Philippines will motivate other migrant sending and receiving countries that impose implicit or explicit taxes on remittances to follow suit!

Submitted by Sanket on
The implicit taxation of remittances to Cuba because of compulsory conversion requirements appears to have ended because of a welcome change in US policy. Andrea Rodriguez of the Associated Press reports (see http://classic.cnbc.com/id/40822284): "Cubans who rely on remittances from abroad are hailing a U.S. policy change that means they now can receive transfers in the island's convertible currency instead of dollars, sidestepping a 10 percent exchange surcharge....Previously, the Treasury Department's Office of Foreign Assets Control required dollar transfers to Cuba to be paid out there in dollars, forcing recipients to pay the 10 percent fee that the Cuban government imposes on cash dollar-to-CUC exchanges." This measure will likely increase flows through formal remittance channels such as banks, money transfer companies and credit unions. According to the AP article: "In a bid to avoid the surcharge, many have resorted to intermediaries, known here as "mules," to deliver remittances directly in CUCs." Larger amounts flowing through formal financial channels will not only benefit the recipients, but also the help in greater financial inclusion and deepening.

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