Cayman’s business community largely dismisses the idea of a payroll tax as the best way forward for Cayman. The tax does not address the actual problem of overspending, it will be difficult to collect and it is going to create a burden on the economy.
This burden was highlighted by a study commissioned by government in 2009, which forecasted a 6.2 per cent reduction in GDP over the six years following the introduction of a payroll tax. Moreover, the discriminatory and unfair nature of a payroll tax applied only to expatriates is economically unjustifiable.
The government of the Cayman Islands has experienced budget woes for quite some time. Ever since in 2007 government spending started to exceed revenues government has been unable to balance the books. This was later exacerbated by the financial and economic crisis.
The latest round of budget negotiations has for the first time produced a government proposal for direct taxation. This has long been demanded by the UK Foreign and Commonwealth Office, concerned it may have to foot the bill if Cayman defaulted on its government loans. Yet it was widely rejected by the business community in the Cayman Islands and the Cayman government – until now.
The Premier of the Cayman Islands McKeeva Bush has dubbed the 10 per cent direct tax on salaries of expatriates in the private sector euphemistically a “community enhancement fee”, a term that would deserve its own chapter in the public relations book “Toxic sludge is good for you”.
A payroll tax imposed solely on expatriates in Cayman’s workforce would fall well short of the most basic principles of fairness.
Don Seymour, managing director of DMS, says “government needs a rational and sustainable approach to balancing its budget comprising both revenue measures and cost reductions. It cannot expect to finance its deficits on any one segment of our community.”
Under the proposal, foreign workers will be significantly impacted financially by the payroll tax and the loss of employer pension contributions. If employers choose not to contribute anything toward the employee’s payroll tax, the effective tax rate would be 14.28 per cent of gross salary, up to $60,000 per annum. This rate would be the highest among Cayman’s main offshore financial centre competitors.
If an employer continues to contribute five per cent to the pension plan or contribute that five per cent toward the payroll tax, the effective tax rate would be 9.52 per cent.
In addition, foreign residents, and those foreigners contemplating moving to the Cayman Islands, will have to ask themselves whether they would want to live in a country where they are openly discriminated against on such a scale. Non-Caymanian residents already have no access to government services, such as schooling for their children, and they are subject to higher property taxes in the form of stamp duty rates. Now this discrimination would be extended to income taxation and pension benefits.
Concerns over the contravention of human rights by a payroll tax that solely applies to foreign residents have also been raised.
The Bill of Rights, Freedoms and Responsibilities of the Cayman Islands constitution exempts in article 16 (4) subsection 1 the appropriation of revenues and the imposition of taxation from its general non-discrimination rules. But legal commentators such as Sara Collins, a member of the Human Rights Commission, called the potential legal implications of the tax “a grey area”.
What is certain is that the idea of applying income or payroll taxation only to foreigners is unique. An analysis of the potential to introduce a payroll tax for expatriates in the Cayman Islands, carried out by the Economics and Statistics Office in 2009, noted that payroll taxes in other countries are non-discriminatory with regard to the nationality of employees “based on the principle of equal compensation for the same level of productivity regardless of nationality”.
Moreover, there is no economic reason for excluding Caymanians in the workforce from the proposed payroll tax. The 2010 Census shows1 that Caymanians earn significantly more than non-Caymanians. Although there are more non-Caymanians than Caymanians in the workforce (18,761 compared to 15,453), there are significantly more Caymanians in jobs that command salaries above $28,800 per annum (10,265 Caymanians compared to 8,012 non-Caymanians). Even in the highest wage brackets Caymanians outnumber expats.
Government disregards recommendations
Even if applied universally, the payroll tax proposal appears to go against previous reports and recommendations commissioned by government. The Miller Shaw report, drafted in response to UK demands for a proper assessment of government spending and potential new revenue sources, concluded a payroll tax is certainly capable of generating substantial revenue, but even a well-designed levy “would have adverse effects on the Cayman economy”.
The Miller-Shaw report was also critical of the interplay between a payroll tax and work permit fees. “A payroll tax in addition to work permit fees would add to employment costs and make Cayman less competitive in the market for skilled professionals,” it said.
“Implementing a payroll tax would remove a significant competitive advantage in attracting talent to the Cayman Islands,” he says. “It would also increase the cost of doing business simply because the employer pays the employee. The proposed payroll tax together with the increased work permit fees would make it considerably more expensive to hire in the Cayman Islands than in any competing jurisdiction”.
Steve McIntosh, CEO of offshore recruitment firm CML, says the introduction of payroll tax would be a severe blow to a beleaguered private sector. “Work permit fees have always been a de facto payroll tax on foreign workers for all intents and purposes. If the payroll tax and work permit costs combined come to 20-30 per cent of salary, we’re in the territory of a regular onshore tax regime,” he says.
Former chairman of the Cayman Islands Monetary Authority Tom Ridley summarises the wider criticism of the proposed payroll tax, saying “the current flawed proposal beggars belief – it is unfair, likely uncollectible and sends a terrible message both locally and internationally.”
It is also unclear why the revenue measure would make more sense now than in the past when government vigorously rejected it.
“There are a number of ways of developing sustainable revenues sources that link the payment for public services to those who benefit from the services – and that are fair, cost effective and non-disruptive to the local economy. The payroll tax is not one of them,” says Ridley.
The government commissioned 2009 ESO report “A proposed payroll tax for the Cayman Islands” which assessed the economic impact of such a charge on Cayman’s economy supports this conclusion.
The ESO study expected revenue of $40 million in the first year and $48 million in the following years based on 2008 employment data. This amount however is much lower when the negative impact of the tax on employees and employers is taken into consideration.
The report noted expats account for 41 per cent of the total consumption of goods and services in Cayman. It argued that consumption of housing, food, etc. would decline together with government revenues from consumption as a result of the payroll tax. Employers in turn, if they were to take over the cost of the tax, would experience lower profits and reduced funds for expansion and investment. When these effects are taken into account, the ESO study says the revenue from a payroll tax is reduced by approximately 54 per cent to $17 million in the first year and $22 million in the subsequent years.
The report points out that when people are taxed their propensity to consume is reduced and the multiplier effect on GDP of the spending by non-Caymanians in the local economy diminishes.
The study projected a GDP decline of 6.2 per cent for a six-year period after the introduction of a payroll tax of 10 per cent.
It should be noted; however, that the impact on the local economy would be even larger, because Cayman’s GDP includes significant offshore activity that has no measurable local effect.
The report further acknowledged that “employers of non-Caymanian employees in the offshore financial services industry will be hard put to pay their share of the payroll tax given the deep cuts in their income since the latter half of 2008, plus the remaining uncertainty on the future of the global financial market.” Three years of recession later, the conditions have rather worsened than improved.
The report added: “The sector’s competitiveness could be negatively impacted by the proposed measure. It may be noted that financial services account for 83 per cent of Cayman’s GDP.”
McIntosh says the effect on employers depends on the employers’ ability and willingness to absorb the additional cost, and their willingness and ability to move work overseas. “If employers feel they have to absorb some or all of the extra burden and they are in an ‘untethered’ industry, such as fund administration, this could well be the straw that breaks the camel’s back, accelerating the decline of the sector in Cayman to the benefit of competitors like Canada and Ireland.”
These concerns are echoed by Cayman Finance, the representative body of the financial services sector. In a statement, the organisation notes that the Cayman Islands is already a relatively expensive place to do business, in particular in regards to work permit fees and trade and business licenses.
“The proposed tax will undoubtedly lead to a further increase in the burden faced by all businesses in the Cayman Islands, despite the suggested optional pension contributions for expatriates.”
The negative impact of the payroll tax on competitiveness was not even included in the ESO analysis due to a lack of data and time for preparation. The report does, however, expect a sharp upturn in inflation and the cost of living, to the extent that cost increases can be passed on to consumers.
Even in terms of the labour effect, the ESO analysis is pessimistic. While the tax could have a positive impact on the employment of Caymanians in those occupations and level of skills where the local supply is available to replace non-Caymanians, the ESO said, “it is known that Caymanian labour supply is severely limited”. Overall total employment would fall by 1,600 under an 8 per cent payroll tax and by 2,300 under a 12 per cent scenario during a six year period following its implementation.
McIntosh says it is difficult to predict how this will affect the employment market. “Right now there is a lot of anger and indignation which is inevitable whenever taxes are raised. But the real question is not how people feel about it but what they will do about it,” he says. “It’s hard to imagine an exodus of financial professionals fleeing to countries with far higher tax rates and weak employment markets besides.”
Because there are fewer jobs available, the supply of finance professionals is strong right now, says McIntosh. “Therefore the new tax shouldn’t create shortages in the foreseeable future.”
He believes, doing away with the pension contribution would, perversely, mean that employers can advertise higher salaries without incurring any additional cost, because salaries are always advertised gross of tax but not gross of pension contributions.
The payroll tax would also be difficult to collect, according to the Miller-Shaw report, which said “any form of income or payroll taxation would require the imposition of an entirely new tax system, with both high set-up costs and potentially significant and permanent compliance costs”.
Given the sketchy record of some Cayman companies in making pension contributions, enforcement will be a major issue, particularly when the taxable amounts are getting larger. A review by the Complaints Commissioner in 2010 found 670 companies in Cayman delinquent on their pension payments.
“Collecting and enforcing the payment of a payroll tax would likely require a new bureaucracy whose costs would offset any potential gains or require further dramatic tax increases,” says Seymour.
The ESO analysis, in contrast was more conservative in its estimate and assumed, based on public finance literature, a cost of 8 per cent of the collected tax revenue is needed for the administration and collection of the payroll tax in the first and running costs of 3 per cent of tax revenue in subsequent years. However, this would require a 95 per cent compliance rate with the tax.
Cutting spending or raising revenue?
Much of the criticism of the payroll tax is focused on the government not reining in enough on spending. Ridley says it is important that before any new revenue measures are even proposed, the government must regain the public’s trust through meaningful reductions in government waste and expenditures. “Sadly, neither the UDP nor the PPM seems able or likely to do so.”
Kim Lund, owner/broker at RE/MAX also believes “focusing on reducing costs and expenses would have been far more positive” than turning mainly to revenue measures.
“Introducing payroll taxes at this time seems a desperate attempt to balance the government’s excessive budget rather than tackle the tough decisions of reducing its own costs,” says Pilar Bush, CEO of AtWater Consulting Ltd.
“The private sector understands the challenges facing this government – we know these problems are not all of their own making; we know there are no magic bullets and we know that the necessary decisions are painful,” she says. “But together, public and private sector, we can work through this without introducing payroll taxes. I hope they will reconsider and withdraw the decision.”
Cayman Finance also hopes that further consultation will be possible and says it also stands willing and keen to assist government in these efforts to create a sustainable budget. The organisation encourages policymakers to take a more balanced approach to resolving the current fiscal challenges which includes significant efforts in the area of expenditure reduction.
“While we welcome the proposed expenditure reductions as a positive step, we support the general opinion held by many within the wider business community that the government should place the further reduction of recurrent expenditure as a priority in its current efforts to balance the budget. Such cost cutting measures should take precedence over any additional revenue measures,” Cayman Finance says.
“We encourage the government to carefully consider the wider implications for the economy, and to engage in a comparative analysis of the cost of doing business across the various competing jurisdictions before taking any decisions on this proposed tax.”
Roy McTaggart, managing partner, KPMG says “the proposed payroll tax will obviously have ramifications to our business and our people; therefore we would certainly welcome discussions with government before the implementation of any new measures.”
The Chamber of Commerce meanwhile supports the recommended reductions to government expenses and the fundamental policy shift that will now require the public sector to contribute to their pension and health care costs, which has been required by the private sector for many years.
“This is a positive step forward and an approach that the Chamber has advocated and supported for several years.”
The introduction of the payroll tax however would require more analysis and review, the Chamber said in a statement. “These types of fees have long term consequences that must be evaluated carefully. We have already received expressions of concern from various industry sectors and we plan to share our views with government shortly.”
The leadership of the Cayman Islands Tourism Association comments that it understands the need for sustainability and fiscal prudence, and that to be credibly sustainable the government’s budget will require a mix of expenditure savings and means of increasing government revenues.
The introduction of a direct tax will also change the perception of the Cayman Islands. It is unlikely that a payroll tax once introduced would ever be removed, as suggested by the premier, especially if the necessary cuts to government spending cannot be achieved even in a time of crisis.
“Adopting any form of income or payroll tax would remove much of the allure that has boosted the economy,” concluded the Miller Shaw report.
RE/MAX’s Lund says he understands how difficult this severe recession has been on government. “It has been equally difficult on business, the real estate industry, and overall economy. The global perception of this direct tax is that potential residents and investors for real estate will fear that we have now accepted direct taxation and annual property taxes could be next,” says Lund. “It is this perception versus the true situation that could drive business to other financial centers and tourist/investment destinations and ultimately away from Cayman.”
Lund says RE/MAX Cayman lost five potential deals in the first two days after the payroll tax announcement.
The Bermuda Gazette has meanwhile celebrated the fact that attracting international business will be much easier now that Cayman is introducing direct taxation for expats.
Pension fund industry
Finally, the proposed exemption of expatriates from the Cayman Islands National Pensions Law would have a significant immediate impact on the Islands’ pension plans. The decline in monthly contributions from expatriate plan members will mean that most if not all plans will regress or shrink for years to come, while monthly redemptions will maintain their current level.
“All of this would translate into much higher per unit costs for the plans – that is, lowered returns for the members,” says Charles Farrington, deputy chairman of the Board of Trustees of Silver Thatch Pensions. “At some point the plans would presumably return to growth again but it could be many years before that happens.”
Farrington does not, however, necessarily expect consolidation in the industry given that the two largest pension plans in Cayman, the Chamber of Commerce Pension Plan and Silver Thatch are not-for-profit plans.
Pension plan providers had not been consulted by government prior to the budget proposal, Farrington therefore did not know any more specifics as to what the rules and timeframes for redeeming funds from pension plans would look like if and when expatriates are exempted from the Pension Law.