THE States decided last week to adopt the fiscal and economic steering group’s new taxation strategy. That means the majority of businesses that operate in Guernsey will pay no income tax, although some banking activities will be subject to 10% income tax and the regulated utilities will pay 20%.

It will result in a large public deficit that the States intends to finance by increasing social security contributions and indirect taxation on alcohol, tobacco, fuel and property and by using the island’s contingency reserve in the short-term.

The States will then promote economic growth to fill the fiscal gap in the long run and, if this should not materialise, it will introduce a goods and services tax.

Economic growth is fundamental to the success of the new strategy.

The States has now made its decision and therefore it is imperative that everyone supports the strategy to try to ensure that the economy grows sufficiently to close the fiscal gap.

Businesses and consumers can now plan their futures with more certainty, which should at least improve confidence and stimulate more economic activity.

Economic growth is the annual increase in the gross domestic product or output of an economy, which can be measured by the income method that incorporates wages and salaries, company profits and rental and interest income.

Growth in national output should therefore result in higher fiscal revenues from the taxation of these sources of income, which is why the States is so earnest about encouraging economic growth.

Guernsey (and indeed Jersey and the Isle of Man) is in a different position from other countries, however, because the loss of corporate taxation means it will have to generate more fiscal revenue from employment and indirect taxation, rather than from company profits.

Guernsey must still attract and retain those businesses that make high profits, although it will not benefit from the taxation of those profits, because without them companies would withdraw their capital and be unable to pay the high wages and salaries that do generate taxation.

Guernsey must encourage the robust economic activity that should lead to further, stronger and rising profits (and indeed companies will benefit from significantly higher local post-tax profits in 2008), but more importantly it must hope that companies pay some of these higher profits to their employees and invest them in their development.

But they will not do that unless the productivity of local labour improves.

Guernsey will have to focus more on those industries that are growing, make high returns and depend on labour as their main factor of production.

That will inevitably mean more emphasis and dependence on the finance sector, which meets these criteria.

The island will have to remain the low tax regime it currently is, continue to embrace a light and responsive regulatory framework, ensure its labour market is flexible and promote ever more and better transport and communication links to attract and retain the finance sector.

Guernsey will also have to allow the creation of more jobs, encourage more labour market participation and stimulate the productivity of labour to generate more revenue from the taxation of employment.

It must resist the temptation to increase the marginal cost of employing labour through higher non-wage costs such as social security because this will act as a disincentive to the job creation that will be the lifeblood of the island.

The population will have to increase, as the finance sector demands more housing licences for the labour it needs to grow and on which the island depends to finance the public sector.

The Housing Department will have to be very strict about the criteria immigrants need to meet before it grants licences.

Guernsey will have to devise financial or other incentives to encourage more women and older people to return to or continue in work.

We will have to improve the productivity of labour by supporting more training and education, greater labour market flexibility and the superior management and organisation of labour.

There are other measures available to grow the economy and to improve the fiscal position.

A smaller public sector and/or the transfer of some service provision to the private sector would reduce expenditure and improve efficiency. More flexible planning laws, incentives to encourage investment, innovation and the wider use of technology – and the promotion of competition – are all considered classic supply side policies to encourage economic growth.

In some ways, the States has made the easy decision in going for economic growth to fill the black hole.

The harder task will be the formulation and implementation of a credible and coherent plan to achieve the economic growth that will restore the public finances to equilibrium without the taxation of profits and that does not lead to inflation or create social and environmental problems and even greater dependence on the finance sector.

* Comments to rich@hemans.net. Richard Hemans is a chartered accountant who works on a freelance basis.

* Richard Hemans’ Column will next appear on 20 July.