A new study commissioned by Cayman Finance suggests that any form of new or increased taxation introduced into the Cayman Islands would have a hugely detrimental effect on Cayman’s economy, and concludes that slashing government expenditure is the only solution to solving the budget deficit. Business Editor Lindsey Turnbull reports.
The Cayman Islands: A Balanced Budget was commissioned by Cayman Finance to report on the effects of the introduction of direct taxation, the spectre of which was looming last year with the Cayman Islands government’s 2009 budget deficit of $80 million and subsequent discussions with the UK government as to its solution.
Compiled by international tax specialist and author Richard Teather, who is a senior lecturer in taxation in the Bournemouth University Business School in the UK, the report lays out many examples of why high taxes are detrimental to economies whereas periods of lower taxation actually serve to stimulate economic growth. The report says that Cayman in particular is vulnerable to the introduction of taxation because of the specific make up of its economy.
Anthony Travers, chairman of Cayman Finance says: “The Teather Report admirably highlights the current economic threats to the Cayman Islands and the folly of attempting to look to apply the “solutions ”adopted by G 20 countries to the Cayman financial model. With the exception of China, Saudi Arabia and possibly Australia (the economy of which is firmly underwritten by Chinese industrial production) virtually every G 20 country has made the same mistake with respect to economic modelling of public sector expenditure.
“In the UK for example the unfunded public sector pensions liability, which does not even appear on the UK balance sheet, now exceeds one trillion pounds. Greece, Ireland Portugal Italy France and even Germany have the same unfunded public sector liability issues. Regrettably it seems that Cayman is heading in the same direction with respect to the grossly inflated entitlements of its civil service to pensions and medical benefits, which are not sustainable with an indigenous population of 30,000 people. In the UK (and the US) the so called solution is to raise taxes but the real result of doing so is currently a worrying outflow of business with the results that tax revenues in the UK are dropping as rates are increased not rising.”
The report states that the introduction of taxes would be bad enough if Cayman’s industry was of a standard makeup and looks at the effects of raising taxes as if Cayman would be no worse affected than any other country. The report outlines: “Cayman’s GDP is around CI$2,350m (United Nations figure). Increasing taxes in the order of $100m, to cover the likely deficit, would therefore be a tax rise of 4¼ per cent of GDP.”
However, the report continues that: “an OECD study estimated that each extra 1 per cent of GDP taken in taxes could reduce economic growth by around 0.6 per cent. But even if we take a lower figure of just 0.3 per cent, more in line with other studies, that means raising Cayman taxes to cover the government’s deficit would, assuming we apply the OECD assumptions, reduce GDP by over 1¼ per cent annually for as long as the taxes remained in place.”
It estimates that the cost of such an introduction could be severe for Cayman: “approximately: CI$60m by the end of the second year; and CI$ 145m after five years.
If average employee costs were around $60,000 p.a. (including overheads), that reduction in GDP after five years could be equivalent to 2,500 jobs lost.”
Because Cayman’s financial services industry accounts for 55 per cent of GDP, is responsible for creating 12,500 jobs (36 per cent of all employment) and provides Government with 40 per cent of its total revenue the report notes that the industry is “of huge importance in the Cayman Islands”. The introduction of taxation would have a particularly detrimental effect on its financial services industry and thus on Cayman as a whole.
The report states: “This [the financial services industry] is a highly mobile industry and one that is highly sensitive to tax changes. The Offshore Financial Services Industry is based on competition.”
It then goes on to highlight examples of the introduction of taxation harming economies via driving away financial services business, namely the evolution of the London Eurobond market, which was created in 1964 when the US started levying tax on bond interest. Corporate borrowing, and the associated trading, was swiftly relocated to London. A further, more recent, example is the in the run-up to the introduction of the European Union’s Savings Tax Directive, which imposed a minimum tax on certain investments in EU and related territories. Hong Kong, the report notes, (which was outside the scope of the Directive) reported that its collective investment fund deposits soared by 56 per cent in just one year.
Travers comments: “If the UK financial services industry is showing itself to be mobile in the face of increasing tax rates with an exodus of business to Switzerland, Malta and Dubai then the Cayman financial service industry has shown itself to be even more mobile with an exodus of jobs to Canada, Ireland and other locations.”
Put plainly, the report states that although Cayman’s financial services industry offers its clients a good deal more than just tax neutrality, this does play a significant part in the jurisdiction’s success. It says: “…the ability for client funds to move in a tax-neutral environment is an essential condition of much of this financial services work. If that is lost, then the core of the finance industry – and the critical mass that makes it successful – could be lost also.”
Travers says: “Given then that tax competition will remain crucial, Cayman must remain competitive. The well reasoned Teather analysis holds good too for the higher fees imposed on the financial industry. At best these must be regarded, and indeed were always intended to be regarded, as a short term expedient and fees reduced once government expenditure is brought under control. If not, the competitive forces that the Teather describes will squeeze the life blood out of the Cayman financial services industry and therefore the economy overall.”
What’s the alternative?
Taking the possibility of introducing taxes out of the equation, the report examines two possible solutions to the Cayman government’s budget deficit: reducing government expenditure and continuing to borrow.
According to the report, the latter is not a sustainable option, as it states: “Debt finance should not be regarded as an ongoing solution.” Borrowing to fund government expenditure, while a disastrous move for big economies such as the UK and the US, could prove to be catastrophic for small economies such as Cayman.
The report says that Cayman’s reputation as a sound and prudent jurisdiction in which to do business would be severely undermined if such action continued. It states: “Serious doubts would be cast on Cayman’s financial, fiscal and even political stability if deficits were allowed to continue annually. Unlike major G20 jurisdictions, the Cayman Islands cannot print money and issue debt.”
Travers furthers: “You cannot borrow indefinitely to meet current obligations. At current rates the US interest cost will rise to 35 per cent of annual revenue in the foreseeable future. But that option does not exist for the Cayman Islands where the ability to borrow is now limited (possibly exhausted) and which cannot print money to meet current obligations.”
The Cayman Islands government should look carefully to moving swiftly to maintain Cayman’s solid and prudent reputation, as the Teather report states: “If the government does not demonstrate the political will to tackle the deficit, then the perception of fiscal risk will increase.”
Thus, the report concludes: “…the only option is to reduce spending levels.”
Cayman’s government expenditure needs to be reigned in
When analysing exactly how Cayman competes with its peers when it comes to government spending, the report finds some worrying evidence that Cayman is “wholly out of line with its peers, having far higher levels of public spending than any other comparable jurisdiction. This is the same whether we look at total spending or spending per head of population.”
Pertinent findings from the comparison (which looked at a total of 19 jurisdictions, all non-Europe countries and territories with a population between 5,000 and 125,000, around half Caribbean nations and half located elsewhere in the world) as are follows: “the Cayman Islands government is almost:
- Twice the level of the next highest (Antigua & Barbuda, which has a higher population of 88,000); and
- Two and a half times the level of the nearest jurisdiction with a similar population level (St. Kitts & Nevis, population 52,000).”
Furthermore: “Government spending per head of population in the Cayman Islands is:
- Over twice as high as the average level for comparable countries; and
- Almost 40 per cent higher than the next highest (Turks & Caicos Islands).”
Looking at the comparisons, former Chairman of the Cayman Islands Monetary Authority, Timothy Ridley says: “Cayman Finance is to be congratulated on commissioning the report. It sends a stark reinforcement of the message that the government needs to get its financial affairs on a sound footing as soon as possible. But it would carry more compelling weight if it included statistics from more of our small financial centre competitors such as Bermuda, the Bahamas, Barbados, the Crown Dependencies and Monaco. BVI and Turks and Caicos are hardly the best comparisons.”
Travers says the solution to all of this is clear and that “the simple and essential truth will be recognised by every Caymanian family faced with balancing its weekly expenditure. The costs of the Cayman Islands government must be cut drastically to a figure that represents sustainable expenditure going forward. In the context of implementation the finger pointing that characteristics the current political debate should be consigned to the schoolyard.”
However Ridley warns: “The report urges immediate cutting of government expenditure as the way forward. This is indeed a vital part of any solution. But the reality is far less simplistic and far more nuanced than that. The most critical issue for Cayman is to deal with the current dynamic locally that is impeding any meaningful progress on the creation and implementation of the many faceted programme that is necessary to restore the financial health of the Islands. No report, however well researched and written, can address that problem. And there is not much time left before the next cash crisis comes.”
Travers believes that what is needed now is a united approach by all interested Caymanians in developing a viable solution. He says: “Belt tightening must be shared by all. The initial response of the Civil Service here must therefore be described as disappointing.
“If it is based on the belief that monies to support the public sector can be found elsewhere, the Teather Report reveals the belief to be mistaken. In a shrinking economy there is nowhere for the public sector to hide. What has to be better understood is that the current public sector entitlement system cannot be maintained.”
He says that it would therefore be in everyone’s interest if the solutions were developed from within and calls for “mature and realistic leadership”.
“The conclusion of the Teather report, which appears self evident when we look at the economies of the struggling G 20 countries, is that raising taxes is a potentially fatal suggestion an particularly given the Cayman financial services industry is highly mobile and we are left therefore wondering at the true motives of those who have suggested the introduction of direct taxes as a solution to the Cayman problem.”
Travers says the solution to the Cayman problem is that “Cayman cuts its (now transparent) cloak according to its cloth.”
Don Seymour, managing director at dms Management points out this report confirms the widely held view that the current level of government spending is unsustainable.
“Although this is conventional wisdom outside government, this report quantifies this conclusion and its consequences in stark terms never considered before,” he states.
“Economic growth is a delicate balance between businesses, consumers and the government. Each party has to contribute fairly to this partnership and although businesses and consumers have taken the essential steps to survive the economic downturn by reducing spending and debt, government has not taken any meaningful steps to contribute its fair share. Even a modest 10 per cent reduction in government expenditure would be a positive first step in addressing the economic malaise in the country.”
Travers looks to the future: “We are of course now keenly awaiting the Miller Shaw Commission Report commissioned at the request of the FCO which has the broader remit of analysing the Cayman economy overall and its findings should be interesting. It may be too that other revenue sources are available to the Cayman Islands and doubtless those options must be considered, but until those new revenue options represent reliable sources of income unrealistic expenditure must be cut and cut immediately. That is the political imperative,” he concludes.