metadata: authors: 0: author: Canavire Bacarreza,Gustavo Javier
1: author: Gómez Aliaga,Guillermo
2: author: Britton,Chevanne Regina Lygia
3: author: Rios Avila,Fernando
4: author: Jimenez Pozo,Wilson Leonardo
5: author: Granados Ibarra,Silvia Juliana
6: author: Li,Ran
count: Grenada
docna: 0: docna: Fiscal Incidence on the Island: Grenada’s
            Fiscal System and Its Incidence
docty: Policy Research Working Paper
abstracts: cdata!: This paper examines the distributional
            effects of fiscal policy in Grenada. Using data from the
            2017&#x2013;18 Living Conditions and Household Budgets
            Survey and following the Commitment to Equity analysis
            framework, the paper estimates the effects of fiscal policy
            interventions on inequality and poverty. It analyzes the
            distributional incidence of direct and indirect taxes,
            direct transfers provided by social transfers and school
            feeding programs, and in-kind transfers generated by public
            services in health and education. The results show that
            Grenada has a tax system that is neutral on the value-added
            tax side and progressive on the personal income tax side.
            Furthermore, direct transfers make a modest contribution to
            poverty reduction and are almost neutral in their
            distributive impact. The results contribute to the
            understanding of who bears the burden of taxation and
            benefits from transfers and of how Grenada&#x2019;s
            fiscal system can improve its redistributive effect.
display_title: Fiscal Incidence on the Island:
            Grenada’s Fiscal System and Its Incidence
listing_relative_url: /research/2024/01/34243167/fiscal-incidence-island-grenada’s-fiscal-system-incidence
topicv3: Public Finance m1326315 713,Fiscal Incidence Analysis m1326940 711,Conditional Cash Transfers(CCT) m1327202 761,Growth, Poverty and Inequality m1327633 1091,Labor Taxes m1504100 2786
publishtoextweb_dt: 2024-01-22T00:00:00Z
dois: 10.1596/1813-9450-10678
origu: Off of Sr VP Dev Econ/Chief Econ (DECVP)
no_of_pages: 32
author_keys: 0: author_key: 715971
1: author_key: NA
2: author_key: 2136902
3: author_key: 1974997
4: author_key: 1987580
5: author_key: 2128001
6: author_key: 1678637
model_extractions: Policy Research Working Paper 10678 Fiscal Incidence on the Island Grenada’s Fiscal System and Its Incidence _Gustavo Canavire-Bacarreza Guillermo Gómez Aliaga Chevanne Britton Fernando Rios-Avila Wilson Jimenez Pozo Silvia Granados Ibarra Ran Li_ Poverty and Equity Global Practice & Macroeconomics, Trade and Investment Global Practice January 2024
Policy Research Working Paper 10678

# **Abstract**

This paper examines the distributional effects of fiscal policy in Grenada. Using data from the 2017–18 Living Conditions and Household Budgets Survey and following the Commitment to Equity analysis framework, the paper estimates the effects of fiscal policy interventions on inequality and poverty. It analyzes the distributional incidence of direct and indirect taxes, direct transfers provided by social transfers and school feeding programs, and in-kind transfers generated by public services in health and education. The results show that Grenada has a tax system that is neutral on the value-added tax side and progressive on the personal income tax side. Furthermore, direct transfers make a modest contribution to poverty reduction and are almost neutral in their distributive impact. The results contribute to the understanding of who bears the burden of taxation and benefits from transfers and of how Grenada’s fiscal system can improve its redistributive effect.

This paper is a product of the Poverty and Equity Global Practice and the Macroeconomics, Trade and Investment Global Practice. It is part of a larger effort by the World Bank to provide open access to its research and make a contribution to development policy discussions around the world. Policy Research Working Papers are also posted on the Web at http://www.worldbank.org/prwp. The authors may be contacted at gcanavire@worldbank.org; ranli@worldbank.org; Chevanne.britton@gmail.com; friosa@gmail.com; wjimenezpozo@gmail.com; sgranadosibarra@worldbank.org; and ggomezaliaga@worldbank.org.

_The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the views of the International Bank for Reconstruction and Development/World Bank and its affiliated organizations, or those of the Executive Directors of the World Bank or the governments they represent._ Produced by the Research Support Team
# **Fiscal Incidence on the Island: Grenada’s Fiscal System and Its Incidence**<sup>*****</sup>

Gustavo Canavire-Bacarreza<sup>†</sup> Guillermo Gómez Aliaga<sup>‡</sup> Chevanne Britton<sup>§</sup> Fernando Rios-Avila<sup>**</sup> Wilson Jimenez Pozo<sup>††</sup> Silvia Granados Ibarra<sup>‡‡</sup> Ran Li<sup>§§</sup>

**Keywords:** Fiscal incidence, Poverty, Inequality, Taxes, Social Transfers, Public Expenditure, Public Revenue **JEL CODES:** D31 **,** H11 **,** H22, H5, I14, I24, I3, O54

> * The findings, interpretations, and conclusions expressed in this paper do not necessarily reflect the views of the World Bank, the Executive Directors of the World Bank or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. The authors would like to thank Carlos Rodríguez-Castelan, Gabriela Inchauste, Cesar Cancho and Gabriel Lara for helpful comments and suggestions.

> † The World Bank, Poverty and Equity Global Practice; gcanavire@worldbank.org.

> ‡ The World Bank, Poverty and Equity Global Practice; <u>ggomezaliaga@worldbank.org.</u>

> § Grenada’s Ministry of Finance; <u>chevanne.britton@gmail.com.</u>

> ** Levy Institute at Bard College; <u>f.rios.a@gmail.com.</u>

> †† Fundacion Aru; wjimenezpozo@gmail.com.

> ‡‡ The World Bank, Poverty and Equity Global Practice;  sgranadosibarra@worldbank.org.

> §§ The World Bank, Macroeconomic and Trade Global Practice; ranli@worldbank.org.
# **1. Introduction**

Because of their idiosyncratic economic characteristics, small island developing states (SIDS) face greater challenges that elevate the costs associated with delivering public services, including education, health, and social programs. The direct impacts of these challenges have repercussions on public finances, pushing governments to assess and prioritize sectors in determining where to focus their investments (OECD 2018). This problem is aggravated by the vulnerability of SIDS to shocks that limit their domestic revenue generation, largely due to their dependence on tourism activities (OECD 2018). In this context, a fiscal incidence analysis becomes of prime importance, as Lustig (2020) points out.

This paper focuses on Grenada, an SIDS with a population of around 113,000, that is highly dependent on tourism. As a result, the country is vulnerable to climatic shocks and economic downturns in developed countries. Grenada is at high risk for climate-related disasters, ranking third globally in terms of GDP vulnerability and seventh in terms of fatalities per 100,000 inhabitants due to weather-related losses. Approximately one-fifth of the country’s population lives below the national poverty line (OECD 2018; World Bank 2021; Grenada, Ministry of Foreign Affairs 2022). The COVID-19 pandemic severely impacted Grenada’s economy, particularly its tourism sector, leading to a significant economic contraction and increased unemployment.<sup>1</sup> The government’s response measures contained the initial spread of the virus, but subsequent waves caused further economic challenges. Despite some recovery in 2021, Grenada’s GDP remains below pre-pandemic levels, and the government had to suspend the fiscal rule for three consecutive years to address the pandemic’s extended impacts.<sup>2</sup> The extended impacts of the pandemic have made additional fiscal stimulus necessary (see Appendix A) to support vulnerable groups and maintain economic activities.

The paper examines the redistributive impact of taxes and public spending, following the Commitment to Equity (CEQ) framework (Lustig 2018). The framework aims to provide a comprehensive picture of the redistributive effects of fiscal policies on household income and consumption. Here the CEQ framework is used to assess Grenada’s fiscal policies, focusing on pre and post fiscal incomes in order to determine the net beneficiaries and payers of these policies (Lustig 2020). For the Grenada context, a fiscal incidence analysis through the CEQ framework is relevant, because it can provide evidence concerning the extent to which the government’s fiscal policies are impacting the welfare of the country’s households and inform future policy decisions.

This paper makes multiple contributions to the existing literature. First, we assess the fiscal system of an SIDS, Grenada, which faces resource constraints, natural hazards, and a high poverty rate. These characteristics make it important to determine whether the country’s fiscal system has a redistributive impact. Furthermore, Grenada is located in a region where fiscal incidence is understudied. Previous work on Caribbean islands using the CEQ methodology has focused on bigger and more developed islands such as Jamaica (Katayama et al. 2021),

> 1 Before the COVID-19 pandemic, Grenada was making a strong commitment to economic reform and resilience building with the support of international organizations. It achieved an average annual growth of 4.5 percent between 2014 and 2019, surpassing the regional average. Fiscal reforms, including the Fiscal Responsible Act (FRA) of 2015, led to a significant reduction in public debt and the accumulation of a fiscal surplus. Nevertheless, Grenada’s economy remains less diversified and highly susceptible to climate change and natural disasters.

> 2 MFMOD Database, the World Bank’s World Development Indicators (WDI), and GEM databases, IMF. Most sources available in https://data.worldbank.org/.

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Barbados (García-Peña Bersh 2019), and the Dominican Republic (Aristy-Escuder et al. 2016). Second, we provide a comparison with similar countries in the Caribbean in order to understand the differences between a small developing island and larger counterparts. Finally, we incorporate into the analysis fiscal interventions that have not been previously analyzed, such as the personal income tax (PIT), which was readjusted in 2019; the most important direct transfer to poor and vulnerable households, the Support for Education, Empowerment and Development Programme (SEED); and school transfers.

The results indicate that Grenada’s fiscal system has the potential to decrease poverty rates and inequality in the country, but it shows neutral incidence. Grenada’s fiscal policy design is indeed oriented toward the low-income population. Focusing only on inequality and accounting for all fiscal interventions does decrease inequality, as observed in countries like Jamaica and the Dominican Republic. These results point to the redistributive potential of fiscal policies pursued by the government of Grenada. As expected, higher segments of the income distribution pay more taxes than the low-income population, and furthermore, the middleincome population pays more than they receive, as does the population making up the high part of the income distribution. However, overall indirect taxes tend to be neutral, meaning they affect household income proportionally across the income distribution; these taxes do lower inequality, but also increase poverty rates. While direct taxes (PIT) do not have an effect on poverty, they help to reduce inequality in Grenada, indicating a well-targeted structure. In sum, indirect taxes are neutral, and direct taxes are almost progressive.

In the case of direct transfers, their effect on reducing poverty is higher than their impact on inequality. However, SEED reduces headcount poverty by almost three percent, signaling that the policy is well targeted, but it has a low redistributive effect, even though low-income households receive a higher amount, indicating this program is relatively regressive. In-kind transfers show mixed results: government funding of education benefits the poor, with primary and secondary education benefiting low- and middle-income households, while government funding of tertiary education benefits the higher echelons of the income distribution. Health is clearly regressive, providing a greater benefit to poorer households. However, their impact on monetary poverty is challenging to describe due to the need to monetize these services to estimate their effect.

Following this introduction, section 2 provides the context of Grenada’s economic performance and poverty and inequality situation, as well as an overview of fiscal revenues and expenditures. The fiscal incidence methodology is described in section 3, while section 4 presents the main results. Section 5 concludes the paper.

# **2. Grenada’s Context: Growth, Poverty, and Fiscal Performance**

Grenada’s economic growth is heavily affected by external factors, though structural reforms contributed to the country’s sustained positive growth between 2014 and 2019 (figure 13, Appendix A1). Thanks to growth-enhancing reforms that expanded tourism and a benign global economic environment, real output growth averaged 4.5 percent annually between 2014 and 2019. The high growth rate led to a dramatic increase in Grenada’s per capita GDP. By 2019, Grenada’s GDP per capita was only surpassed by those of St. Kitts and Nevis and Antigua and Barbuda (figure 14, Appendix A1). However, the pandemic, compounded by the war in Ukraine, ended the trend of solid growth and led to a sharp economic contraction of 13.8 percent in 2020, followed by a slow recovery in 2021–22. The economic volatility driven by external factors reflects the intrinsic vulnerabilities of Grenada as an SIDS.

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In line with the macroeconomic behavior, moderate poverty decreased from 2008 to 2018. However, in the same period extreme poverty increased slightly. As of 2018, Grenada’s poverty rate had decreased by almost 13 percentage points compared to 2008 (the previous year for which data were available). In contrast, extreme poverty in Grenada increased by 1.2 percentage points (figure 1, panel a). Regarding inequality, we observe that during this 10-year period, the Gini coefficient, which measures the inequality of the income distribution, increased from 0.37 to 0.40 (figure 1, panel b). This increase in inequality from 2008 to 2018 may imply some degree of deterioration of conditions for the lower part of the consumption distribution, which is also shown in the increase of the extreme poverty rate during this period.

**Figure 1 Poverty and Inequality Measures**

<!-- Start of picture text --> (a) Poverty and Indigence (%) (b) Gini Index<br><!-- End of picture text --> <!-- Start of picture text --> 37.7<br>32.1 0.45<br>0.40<br>24.8<br>0.37<br>12.9<br>2.4 3.6<br>1998 2008 2018 1998 2008 2018<br>Extreme poverty Total poverty Gini<br><!-- End of picture text --> _Sources_ : Government of Grenada, Central Statistical Office, Survey of Living Conditions and Household Budget Survey (SLCHBS) 1998, 2007–08, and 2018–19.

Grenada’s fiscal position has varied over the years, partly due to natural and external shocks. Following a modest performance in 2009–13, revenues and grant collection shifted to an upward trajectory in 2014, growing by an average of 11.2 percent annually until 2019. Taxes accounted for 83.2 percent of total government revenue between 2009 and 2021 (figure 2). Tax revenue comprises direct and indirect taxes levied on individuals and businesses. The direct taxes are taxes on income and profits and on property, while taxes on domestic goods and services and on international trade and transactions comprise the indirect taxes. For the purposes of this paper, we focus on the PIT under direct taxes and the value-added tax (VAT) and excise tax under indirect taxes, because these have the most significant impact on individuals and households while also being crucial income earners for the government, as shown in figure 3. PIT in 2021 accounted for 53.4 percent of Taxes on Income and Profits and 10.2 percent of tax revenue. The VAT accounted for 83.8 percent of Taxes on Domestic Goods and Services and 35.0 percent of total tax revenue in 2021. Because the VAT is charged to consumers at the point of purchase, it has implications for individual and household consumption. The excise tax is charged at a fixed rate per quantity of specific goods (imported and locally manufactured goods) referred to as “excisable goods” and accounted for 2.8 percent of tax revenue in 2021.

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**Figure 2 Revenue and Grants Collection**

_Source_ : Eastern Caribbean Central Bank Statistics.<sup>3</sup>

**Figure 3 Tax Revenue by Tax Type**

_Source_ : Eastern Caribbean Central Bank Statistics.<sup>4</sup> Turning to government expenditures, on average, from 2017 to 2021, 32 percent was allocated annually to social programs, including education, health, and public assistance transfers (figure 15, Appendix A2).<sup>5</sup> The most important direct transfer to poor and vulnerable households is done through SEED, which is administered through the Ministry of Social Development. Also important is the School Feeding Programme, which focuses on providing meals to needy students.

Expenditures in education increased over the period 2017–21 and accounted for roughly 10 percent of annual government expenditures (figure 16, Appendix A3). Government recurrent expenditure in public education generally is provided in four stages: pre-primary, primary, secondary, and tertiary (including vocational training). Several institutions also provide special education to serve students with disabilities and special needs. The government largely subsidizes education up to the secondary level (including special education). The level of subsidization decreases at the tertiary level, with higher fees required to access training leading

> 3 Available in https://www.eccb-centralbank.org/statistics.

> 4 Available in https://www.eccb-centralbank.org/statistics.

> 5 This is based on data retrieved from the Annual National Budget and excludes debt repayments (both principal and interest). In 2022, the Grenada government instituted a cap on gasoline prices, which constituted an energy subsidy. This measure will be analyzed in a future iteration of the tool.

5
to associate degrees and certifications from the institutions providing this level of schooling. Government expenditure in public education is considered an in-kind transfer because the service can be accessed by all school-age children regardless of socioeconomic background.

Expenditures on health also increased in the period 2017–21, accounting for 7 percent of annual government expenditure as of 2018 (figure 16, Appendix A3). In this paper, funds spent by the government in the health sector amount to in-kind transfers to the public because these services are available to all. Citizens, residents, and visitors can freely access the services in the public health system with no differentiation in fees<sup>6</sup> according to income level or socioeconomic class.

In addition to the in-kind transfers in education and health, the government implemented a social protection system within the SEED program. The program targeted school-age children, people with disabilities, the elderly, the chronically ill, pregnant women, lactating mothers, and the adult poor. Beneficiaries are selected via proxy means testing, which uses household characteristics such as age, household size, marital status, assets, disability, and housing conditions as indicators or “proxies” to determine household expenditure or consumption. Cash is transferred to households: in 2017, it was EC$300 per month or EC$3,600 per annum. In 2018, the amount given to elderly households was increased by EC$100 per month, and in 2022, the government raised the amount paid to all beneficiaries by EC$150 per month. Government annual expenditure on SEED increased from EC$14 million in 2017 to approximately EC$18 million in 2021 and is expected to have increased further in 2022. From 2017 to 2021, the government spent an average of EC$2.9 million per year on the school feeding program.

# **3. Data Sources**

The primary data source is the Survey of Living Conditions and Household Budgets (SLCHBS) conducted by the Central Statistical Office (CSO), the country’s national statistics office, between April and May of 2018–19. This survey encompassed a sample of approximately 1,689 households. The primary objective of this questionnaire was to collect information related to household socioeconomic and living conditions as well as the household budget in order to construct the consumption variable (as the survey did not collect income information), data that are crucial for measuring poverty in Grenada. It should be noted that this survey did not gather information regarding pensions received or any social security contributions, neither by individuals nor the government. The survey comprised two distinct parts, one focusing on household conditions and another for obtaining individual characteristics of each household member. The person interviewed was one adult member (older than 18 years old), though the survey collected information on every single household member.<sup>7</sup> The use of administrative data on taxable wages for the PIT complements the survey information. The source of this data set was the Inland Revenue Division (IRD), a division within Grenada's Ministry of Finance (MOF). This data set covers wages for different workers and is disaggregated into two parts: the estimation of the share of the wage allocated for pension funds, and the other being the gross income, which is the taxable part of the wage received.

> 6 Fees are waived for some services provided to children, the elderly, and the indigent. All fees and co-payments were not included in the analysis given the low amounts reported in the SLCHBS of 2017–18.

> 7 To evaluate the accuracy of the data for fiscal interventions, a macroeconomic validation is presented in Appendix B3.

6
We utilize this administrative database for two years, 2017 with 7,442 observations and for 2018 with 8,146.

Because income information is not available in the survey, we compare the administrative data, specifically the taxable portion, with the consumption estimation. This allows us to obtain a more comprehensive understanding of the income distribution. In some cases, we complement missing survey information with administrative data. Because this data set is disaggregated by gender and occupational category, both with values for the taxable income, the administrative data prove useful. Additionally, the administrative data enable us to compare the income distribution to ensure data consistency and improve the exercise's macroeconomic validation. The result is an accurate set of information that makes constructing the taxable income distribution possible.

# **4. Methodology**

This paper uses the Commitment to Equity (CEQ) methodology to assess the distributional impact of the fiscal system in Grenada. According to Lustig (2018), “The CEQ Assessment is a diagnostic tool that uses fiscal incidence analysis to determine the extent to which fiscal policy reduces inequality and poverty in a particular country” (62). Fiscal redistribution effects refer to the process by which a state collects revenue from individuals and households (through taxation) and allocates this revenue to finance direct transfers, subsidies, and in-kind benefits individuals and households enjoy (Lustig and Higgins 2018). Because this study focuses on the distributional effects on the population, state interventions that affect firms or other privatesector institutions are excluded from the methodology. The CEQ framework aims to answer four main questions: (1) How much income redistribution and poverty reduction is being accomplished through fiscal policy? (2) How equalizing and pro-poor are specific taxes and government spending? (3) How effective are taxes and government spending in reducing inequality and poverty? and (4) What is the impact of fiscal reforms that change a particular tax or benefit's size and/or progressivity? (Lustig 2018).

To calculate the distributional effects of fiscal policy, the CEQ framework constructs different income concepts in sequential stages, starting from pre-fiscal income that includes only private income sources to final income that incorporates the (almost) full set of taxes and government benefits. In summary, the CEQ (Lustig and Higgins 2018) identifies four main concepts of household income (when the household surveys include variables of different sources of income).<sup>8</sup>

> 8 _Market income_ includes factor income (all wages and salaries received by workers and capital income), plus private transfers (remittances, private pensions, etc.) plus imputed housing rent, all income before taxes and social security contributions, government transfers and old-age pensions, minus the contribution to social insurance oldage pensions (only in cases where pensions are considered deferred. The contribution to old-age pensions is not subtracted when contributory pensions are financed by the state). _Disposable income_ is market income plus direct cash and near-cash transfers, minus personal income taxes and employee social security contributions (only when contributory pensions are treated as transfers). _Consumable income_ includes indirect subsidies (energy, food, and other general targeted price subsidies) and excludes indirect taxes (VAT, excise taxes, and other indirect taxes). _Final income_ (post-fiscal) is consumable income plus the value of in-kind transfers, such as free or subsidized government services in education and health with copayments and user fees subtracted; it reflects post-fiscal income.

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For each income concept, the inequality and poverty indexes are calculated and both magnitudes are compared before and after fiscal interventions. In this regard, the CEQ framework considers variants according to the characteristics of each country, harmonizing the aggregates but not the specific items.

# **4.1 Income Aggregates Estimation**

Grenada’s information system has limitations when it comes to applying the detailed CEQ framework. Certain data characteristics are needed to model fiscal incidence within this framework, such as an adequate household income aggregate. While Grenada has conducted the SLCHBS recently,<sup>9</sup> as well as maintaining administrative records of social programs and the characteristics of the tax system, the module of incomes within the SLCHBS is limited. The survey captures income data in brackets, records few details on nonlabor incomes, and does not have information on pension affiliation or amount received by individuals, so it is not possible to construct net market income plus pensions for this exercise in the Granada context. Thus, the NSO opted for building welfare aggregates from household consumption<sup>10</sup> instead of household income. This poses a challenge for the implementation in this paper because we need household incomes to estimate the fiscal incidence and run simulations. Following (Katayama & al.,2021) for the case of Jamaica, in this paper we assume that current consumption equals disposable income.<sup>11</sup> This assumption is the most important for applying the CEQ methodology to Grenada, in that it simplifies the reconstruction of income aggregates by tracing back to market income definition as our measure of base income (before taxes or fiscal interventions). As is known in the estimation of welfare measures in developing countries, the distribution of household consumption tends to be more concentrated than income. Of course, this characteristic could introduce some bias and underestimate the extremes of the distribution; however, there is no other option in the absence of household income data.

Once household consumption is defined and thus consumable income is available, the rest of the income aggregates established in the CEQ methodology are calculated according to the tax structure, social protection, and social delivery in Grenada. Our point of departure is disposable income, which is reported by the survey and is assumed to equal household consumption. Then, to identify the distribution of gross income and, after that recreate the distribution of the market income, it is necessary to work backward, following the steps shown in Figure 4: _Net market income (NMI):_ This concept (a pretax income) is obtained by adding the amount of personal income tax ( _PIT_ ) to disposable income ( _DI_ ): N NN= DDNN+ PPNNPP

> 9 Through the NSO, Grenada implemented SLCHBSs in 2007–08 and 2017–18. The latter (used in this paper) collected information on household characteristics (housing, demographics, education, health status, social protection, and shocks and coping strategies). In addition, this survey focused on household consumption expenditures on food and nonfood items and other transactions such as financial payments, investment acquisitions, fees, and voluntary contributions.

> 10 This consumption aggregate is constructed from the following components: (1) expenses and received gifts of food and beverage items, (2) expenses of nonfood articles, (3) value of consumption of durable goods (such as vehicles), and (4) imputed rent of own housing. Household consumption was used as the basis for the official measurement of poverty and inequality in Grenada (World Bank 2021), following the guidelines for measuring welfare aggregates (Deaton and Zaidi 2002).

> 11 Other studies that use consumption as primary income are Lara Ibarra et al. (2019) (Arab Republic of Egypt), World Bank (2018), (Kenya), and Majia-Mantilla et al. (2019) (Uganda).

8
_Market income (MI)_ : This aggregate is constructed by subtracting direct transfers ( _DTr_ , for example, via SEED and the School Feeding Programme) from _MI_ : N = N Consumable and final income, on the other hand, are constructed forward from NN−DDPPDD _DI_ .

_Consumable income_ : This is equal to _DI_ minus indirect taxes, including VAT and Excise taxes plus indirect subsidies ( _IS_ ): 19F<sup>12</sup> _Final income (FI)_ : This aggregate is obtained after including in-kind transfers for inpatient CCNN = DDNN − (VAT + Excise) + NNII.

_Final income (FI)_ and outpatient care provided by the health system (hospitals and community health centers) ( _ikTrH_ ), as well as care provided by the educational system at the preschool, primary, secondary, university, and special levels ( _ikTrE_ ): . **Figure 4 CEQ Income Concepts** FFNN= CCNN+ i PPDDii+ i PPDDii <!-- Start of picture text --> PRE- FISCAL<br><!-- End of picture text --> <!-- Start of picture text --> TRANSFERS<br><!-- End of picture text --> <!-- Start of picture text --> MARKET INCOME<br> Wages, salaries, incomes from<br><!-- End of picture text --> <!-- Start of picture text --> TAXES<br><!-- End of picture text --> <!-- Start of picture text --> PLUS Direct<br><!-- End of picture text --> <!-- Start of picture text --> SEED (child, school<br>support and disability<br><!-- End of picture text --> <!-- Start of picture text --> PLUS Indirect<br>Transfers<br><!-- End of picture text --> <!-- Start of picture text --> PLUS Monetized<br>values of main in-<br><!-- End of picture text --> <!-- Start of picture text --> Outpatient and inpatient<br>care, Community health<br><!-- End of picture text --> <!-- Start of picture text --> NET MARKET INCOME<br><!-- End of picture text --> <!-- Start of picture text --> DISPOSABLE INCOME<br><!-- End of picture text --> <!-- Start of picture text --> CONSUMABLE INCOME<br><!-- End of picture text --> <!-- Start of picture text --> FINAL INCOME<br><!-- End of picture text --> <!-- Start of picture text --> MINUS Direct Taxes<br><!-- End of picture text --> <!-- Start of picture text --> Personal income<br><!-- End of picture text --> <!-- Start of picture text --> MINUS Indirect Taxes<br><!-- End of picture text --> <!-- Start of picture text --> VAT, Excise Tax<br><!-- End of picture text --> <!-- Start of picture text --> MINUS Copayments<br>and<br>user fees<br><!-- End of picture text --> _Source_ : Author’s adaptation based on CEQ Framework (Lustig 2018).

> 12 This component was considered equal to 0, because the data did not have information to estimate indirect subsidies.

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# **4.2 Assumptions and Implementation of the Fiscal Incidence Analysis**

# **_PIT paid by households_**

We assume that PIT is only paid on the labor income of the employed population in the formal sector. Because we do not have a direct measure of labor income, we use an approximation based on our definition of market income. The following steps were taken to calculate the PIT payment for formal workers using the SLCHBS from 2018: (1) we identify the disposable income; (2) we obtain the net market income, subtracting direct transfers; (3) we divide the resulting value by the number of employed adults; (4) we calculate the taxes paid based on the PIT rates corresponding to the brackets; and (5) we aggregate again at the household level.

# **_VAT paid by households_**

The VAT is levied on all forms of consumer spending—goods and services. The tax is computed on the value of imports and the value added (or markup) that one business charges another or the final consumer when a good or service is provided. The VAT rate is 15 percent on the selling price; however, hotels and dive operations are charged a rate of 10 percent. Some goods and services, for example flour, rice, sugar, and powdered and evaporated milk are not taxed, nor are postage stamps and supply of textbooks as prescribed by the regulations.

Expenses associated with cell phone services have a tax rate of 20 percent and water and electricity services are partially subsidized, based on consumption bounds. In the case of electricity, the quantities are obtained from the costs paid by the households and the exogenous estimates of the prices per kwH are obtained from the Grenada authorities. Households who consume less than 99 kwH per month are exempt from paying the VAT, while households who exceed this consumption pay the VAT on the excess over the limit. Similarly, the water consumption limit is 2,900 gallons per month, with households paying the VAT on the excess consumption over the stated limit.

Because the VAT is already incorporated in the price, a pretax rate is first calculated for each E <u>E</u> good using the equation P = and then the rate is applied to the pretax value. v jj 1+rr vv Although the VAT regulations require companies to have a special registration document showing that they offer taxable products for EC$12,000 per year or operate for at least 12 months, this information is not available in the data source consulted. Therefore, it is difficult to know whether households buy in stores exempt from the VAT registration requirement or sell informally. Likewise, the application of the incidence of indirect taxes does not consider cascading effects, given the difficulty of imputing household deductions to reduce the net payment of these taxes. Consequently, there is an overestimation of the effect of the VAT and excise taxes.

# **_Transfers received by households_**

Direct transfers in the model are mainly associated with the SEED program and the School Feeding Programme. The SEED transfer is identified in the SLCHBS through a direct question to the households. Based on administrative records, we identify the amounts of program transfers to children, youth, and elderly individuals. Finally, we aggregate the amounts at the household level. The SEED amounts are reduced for households to ensure that base/market 10
income is never negative so that if the income is less than the transfer, the latter is adjusted to avoid the definition of income being negative.

# **_Estimated value of health care and education services received by households_**

Using data from the SLCHBS we identify individuals who used public education and health services and imputed values for the use of these services. Based on the utilization of health services by the individuals who responded to the survey, a distinction is made between those who received inpatient care and those who received outpatient care in hospitals and community health centers. We then found data on average unit costs by type of care and imputed it to the individuals who used the service to proxy for the state’s current expenditure on health services. As for education, we assume that the public education system serves the entire preschool, primary, secondary, and postsecondary school population. The current expenditure on education was derived from the costs per level of education specified by the Grenada government. Once the annual cost of each level of education was obtained, it was imputed to each student in a household according to the level at which they were enrolled.

Due to the information limitations on household income structure and national accounts in Grenada, we could only perform a basic application with direct effects, omitting considerations on agents’ behavior. As more information and parameters on fiscal interventions become available, they could be added to the estimates of fiscal incidence.

# **5. Main Results**

A set of poverty, income distribution, and indicators of progressivity measures were constructed to answer the questions posed above. Next, we present the main results of the simulations.

# **5.1. How Does the Fiscal System Affect Poverty?**

The fiscal system has a high potential for poverty reduction in Grenada (table 1), with the highest impact being associated with in-kind transfers. After adjusting the disposable income, the poverty rate in Grenada for 2018 reached 22.77 percent under the definition of consumption per equivalent adult (equivalent to the definition of disposable income in this document), using the national poverty lines as defined by the CSO (EC$6,782 per year per person, 2017–18). Departing from this measure, the model builds all the other income aggregates as described in the previous section. In the absence of fiscal interventions, such as PIT and cash transfers, 25 percent of the population would live in poverty, with an estimated poverty gap of 8.24 percent. Moreover, after accounting for all taxes and direct transfers, the poverty headcount would be 26.35 percent. In sum, four relevant aspects can be noted. First, the direct transfers (SEED and School Feeding Programme) reduce the incidence of poverty by 2.2 percentage points; these are also reflected in other indicators sensitive to changes in income distribution among the poor, such as poverty severity and the Sen and Watts indexes. Second, the PIT does not change the poverty measures, because it is paid by the population with incomes above the national poverty lines. In fact, based on our estimates, only around 10 percent of the employed population has earnings high enough to be subject to the PIT. Third, indirect taxes such as the VAT (and excise taxes) increase poverty by about 3.6 percent; this is explained by their being structured to be neutral taxes.

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**Table 1 Poverty Measures According to CEQ-Income Definitions** **<u>(In percentage)</u>**

|**Poverty measures**|**Market**<br>**income**|**Net market**<br>**income**|**Disposable**<br>**income**|**Consumable**<br>**income**|
|---|---|---|---|---|
|Headcount poverty|25.00|22.77|22.77|26.35|
|Poverty gap * 100|8.24|6.73|6.73|7.80|
|Poverty severity * 100|4.10|2.97|2.97|3.45|
|Watts Index * 100|11.94|9.23|9.23|10.71|
|Sen Index * 100|11.56|9.06|9.06|10.54|

_Source_ : Authors’ estimation based on SLCHBS 2018.

Although the net balance of transfers and taxes (direct and indirect) translates into a higher incidence of poverty, the same is not true for the poverty gap (it decreases the poverty gap by about one percentage point) and other poverty measures. All of these show a reduction after the fiscal interventions.

# **5.2. How Does the Fiscal System Affect Inequality?**

The fiscal system in Grenada has heterogeneous redistributive characteristics with a significant potential to reduce inequality. The effects of fiscal interventions on income distribution are heterogeneous, as seen in Table 2. First, the direct transfers (SEED and School Feeding Programme) have low redistributive potential; between the market income and net market income, the Gini index change is below one percentage point. The potential of these transfers is better understood when examining the lower section of the income distribution through the ratio P90/P10, which decreases from 7.4 to 6.8. Second, because the PIT is concentrated in the middle- and upper-income distribution, the effect is noticeable only in the P90/P10 ratio (from 6.8 to 6.6) and on the Gini coefficient, which declines from 0.406 to 0.397. Third, though the VAT and excise taxes seem to be very neutral, they, in fact, cause all inequality measures to decline, although not significantly.

**Table 2 Inequality Measurements According to CEQ-Income Definitions**

|**Inequality**<br>**measures**|**Market**<br>**income**|**Net market**<br>**income**|**Disposable**<br>**income**|**Consumable**<br>**income**|
|---|---|---|---|---|
|P90/P10 ratio|7.461|6.856|6.639|6.775|
|P90/P50 ratio|2.822|2.781|2.701|2.733|
|P10/P50 ratio|0.378|0.406|0.407|0.403|
|Gini index|0.416|0.406|0.397|0.395|
|GE(-1) index|0.300|0.362|0.346|0.340|
|GE(0) index|0.304|0.279|0.267|0.264|
|GE(1) index|0.302|0.288|0.272|0.270|
|GE(2)index|0.411|0.393|0.364|0.360|
|Atkinson (0.5) index|0.140|0.132|0.126|0.125|
|Atkinson (1) index|0.262|0.244|0.234|0.232|
|Atkinson(2)index|1.000|0.420|0.409|0.405|

_Source_ : Own calculation based on SLCHBS 2018.

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<!-- Start of picture text --> 900 30.00<br>800<br>;00 25.00<br>500¥8 600 22 20.00<br><48.g&& 400300 a§ég 10.0015.00 |<br>5.00<br>0 | | | | | 0.00 a a = |lf FSF<br>1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10<br>Decil Decil<br>m Pre-school attendance Primary school attendance _mTM Secondary school attendance m Pre-school attendance Primary school attendance _TM Secondary school attendance<br>w Tertiary attendance m Special education attendance w Tectiary attendance m Special education attendance<br><!-- End of picture text -->

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<!-- Start of picture text --> Concentration Index - All Interventions<br>Special Education = -0.7)<br>Tertiary Education Ms (0.24<br>Secondary School -0.16<br>Primary School -0.23<br>Pre-School -0.24<br>Education in-kind Transfers -0.15<br>Community Center -0.07<br>Inpatient Care Mmm 0.12<br>Outpatient Care Mm 0.10<br>Health in-kind Transfers mm 0.07<br>In-Kind Transfer -0.04 &<br>VAT 0.42<br>Indirect Taxes 0.42<br>Personal Income Tax (PIT) es (0.87<br>Direct Taxes es 0.87<br>All Taxes 0.52<br>School Feeding Program -0.31<br>SEED -040<br>Transfers -0.39 DE<br>-1.00 -080 -060 -040 -0.20 0.00 020 040 060 0.80 1.00<br>m Concentration Index Baseline<br><!-- End of picture text -->
# **5.5. How Progressive or Regressive Are Interventions and Overall Fiscal Policy?**

Grenada has managed to establish a tax system with progressive direct taxes, neutral indirect taxes, and globally progressive transfers that is redistributive but that has substantial space to increase efficiency in the reduction of inequalities. Calculation of the concentration indexes of fiscal interventions in Grenada and obtaining the revenue concepts yielded the following results, which are presented in table 3. All taxes have a concentration index of 0.522, higher than the Gini index of market income, and a Kakwani index that is positive but close to 0, which defines this intervention as globally progressive. This result is stronger in the PIT case, while the VAT behaves more like a proportional tax. Similarly, when the transfers are analyzed, they show a negative concentration index and a positive Kakwani measure, so that they can be considered globally progressive in absolute terms. Both transfers have this characteristic in such a way that the benefits (per equivalent adult) decrease when (prefiscal) market income increases.

**Table** **<u>3 Concentration Index and Progressivity of Fiscal Intervention</u>**

||Size<br>(wrt Market<br>income)|Gini index|Concentration<br>index|Kakwani<br>index|Inequality<br>reduction<br>effect|
|---|---|---|---|---|---|
|**MARKET INCOME**|**1**|**0.416**||||
|**DISPOSABLE INCOME**|**0.998**|**0.397**||||
|- SEED|0.016||-0.396|0.812|0.013|
|- School Feeding Programme|0.001||-0.312|0.729|0.001|
|**All direct transfers**|0.017||-0.387|0.803|0.014|
|- PIT|0.019||0.865|0.449|0.009|
|**CONSUMABLE INCOME**|**0.927**|**0.395**||||
|- VAT|0.070||0.422|0.006|0.000|
|- Excise Tax|||||0.000|
|**All indirect Taxes**|0.070||0.422|0.006|0.000|
|**All taxes**|0.089||0.522|0.106|0.010|
|**FINAL INCOME**|**1.007**|**0.367**||||
|- Benef. Inpatient attendance|0.024||0.121|-0.295|-0.007|
|- Benef. Outpatient attendance|0.007||0.104|-0.312|-0.002|
|- Benef. Community health|0.010||-0.066|-0.482|-0.005|
|**All health attendance**|0.040||0.072|-0.344|-0.014|
|- Preschool attendance|0.006||-0.241|-0.657|-0.004|
|- Primary school attendance|0.013||-0.230|-0.647|-0.009|
|- Secondary school attendance|0.015||-0.157|-0.573|-0.009|
|- Tertiary attendance|0.005||0.240|-0.177|-0.001|
|- Special education attendance|0.000||-0.788|-1.204|0.000|
|**All education attendance**|0.039||-0.147|-0.563|-0.023|
|**All in-kind transfers**|0.079||-0.039|-0.455|-0.039|

_Source_ : Own calculation based on SLCHBS 2018.

# **5.6. What Is the Marginal Contribution to the Redistributive Effect of Fiscal Interventions?**

Other than in the area of tertiary education, Grenada’s fiscal policies contribute to the reduction of inequality. In this part of the paper, we use the definitions of the marginal contribution to the redistributive effect of fiscal interventions, mainly those contributions with respect to the relative size of specific items as well as vertical equity, included in the concepts presented in the CEQ framework. Both help with showing which interventions (or groupings of them) are effective in reducing inequality through fiscal policy. This exercise shows that, with the exception of tertiary education, the rest contribute to the reduction of inequalities. When 17
<!-- Start of picture text --> All net in-kind transfers All net in-kind transfers<br>Net education transfers Net education transfers<br>Educational Tranfer Educational Tranfer<br>Edu. Transfer Tertiary [i Edu. Transfer Tertiary as<br>Edu. Transfer Secundary Es Edu. Transfer Secundary |<br>Edu. Transfer Primary Edu. Transfer Primary i]<br>Edu. Transfer Pre-School Edu. Transfer Pre-School a<br>Net health transfers Net health transfers a<br>Health Tranfer Health Tranfer a<br>DiecttTaxss DE Direct Taxes |<br>School Feeding Progra School Feeding Progrma |<br>SEED SEED |<br>0.00 020 040 060 080 100 120 140 160 180 -0.60 -040 -0.20 0.00 020 040 060 080 1.00<br>m Derivative of Marginal Contribution to Redistributive Effect with respect to the relative m Derivative of Marginal Contribution to Vertical Equity with respect to the<br>size of a specific item relative size of a specific item<br><!-- End of picture text -->
Analyzing the Gini index, this changes by 4.9 percentage points between net market income and postfiscal income, which includes all the interventions analyzed. However, the changes attributed to direct transfers and direct and indirect taxes account for about 2 percentage points, while the remainder is attributed to in-kind transfers associated with education and health services. This demonstrates that the fiscal policy elaborated by the government does have a redistributive effect that decreases inequality.

To deepen our analysis, we calculated the concentration indexes of transfers and taxes in order to determine the progressivity of the interventions. The results are summarized as follows: (1) both the SEED program and the School Feeding Programme mainly target low-income people, which is observed through the negative sign of the concentration coefficient, indicating a negative relationship between income and transfer; (2) the PIT concentration index is very high and positive, which shows that this tax impacts high incomes; (3) as noted above, indirect taxes are associated with a positive concentration index, although significantly lower than in the previous case; and (4) health transfers are almost neutral, even though the middle- and highincome population uses the services. However, health services in community centers show a negative concentration index, indicating that these are preferentially used by the population (on both an inpatient and outpatient basis) in the lower part of the income distribution, as opposed to hospital care.

Regarding education services, it should be noted that, except for tertiary education, all levels serve mainly the low- and middle-income population. Tertiary education is available mainly to the high-income population, though education as a whole is progressive.

Regarding changes in inequality attributed to fiscal interventions, Grenada presents results in line with what is expected in comparable countries (mainly Central American countries and Jamaica; see table 8 in Appendix E). In Grenada, the Gini index is more sensitive than in Jamaica but less sensitive than in Costa Rica. These results point to the redistributive potential of the fiscal policies pursued by the Government of Grenada.

This analysis has aimed to obtain as complete a picture as possible of the redistributive effect of taxes and expenditures in Grenada. With the support of the World Bank Group, the International Monetary Fund, and other international organizations, Grenada is developing economic reforms to promote growth and support economic activities, especially in the wake of the COVID-19 pandemic, which impacted the economy and the health situation of the population quite negatively.

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