Government spending – a measure of what we can afford

 I have been trying to work out how best to explain to my 14-year-old granddaughter, Chelsea, why she and her generation are going to have to pay for the mountain of debt incurred by our generation and how this could possibly be fair. In turn, the question led to me thinking about whether or not we could find a benchmark for the level of government spending the Cayman Islands has historically been able to afford and could sustain into the future.  Then we could identify any excesses against that benchmark and measure the extent of corrective action needed to get back to the norm, writes Peter Gibbs, a director of Pensum Ltd.
Having looked at various possibilities, the most illuminating measure was the ratio of government expenditure as a percentage of gross domestic product. If we examine readily available statistics we can see that, over past decades, government expenditure has been held steady at about 20 per cent of GDP. As the GDP grew, so also did government expenditure, but no faster than GDP growth. 
There are other countries whose government spending is higher than 20 per cent of GDP but these countries also maintain standing armies, navies, air forces, coast guards, diplomatic networks, embassies, consulates, overseas bases, state welfare and pension systems, foreign aid programmes, space exploration, research and development programmes, together with the financing of foreign wars and myriad other elements that do not pertain to these Islands. Consider that the UK does all these things and yet its government spending is still kept below 25 per cent of GDP. 
In 1994, Cayman’s government expenditure stood at 19.4 per cent of GDP.  In 2006 it was a little higher at 21.3 per cent. However, over the last four years it has exploded to the point where today it stands at some 31 per cent of GDP and is likely to be worse, once proper accounts are known, prudent capital repayment is factored in, and due allowance is made for unfunded civil service pensions. 
Even using the raw figures, this means that government expenditure is now 52 per cent above its historic average of 20.35 per cent of GDP. To bring expenditure down to this historic norm we need to see a cut of 34.4 per cent from 2009 levels. Even if we allow for a highly charitable 4 per cent GDP growth, this still leaves the need for a 33 per cent cut in government expenditure to reach the benchmark. 
As can readily be seen, this exercise quickly and succinctly reveals the extent of the current problem and raises the burning question, “What is being done to bring government expenditure back in line with its historic, sustainable norm?”

We are all aware that the civil service is recommending the imposition of tax on the public so as to sustain itself into the future. What we should remember is that its recommendations cannot be independent. Self-preservation axiomatically imputes bias and we heed that bias at our long-term peril. 
Imposing, and then inevitably increasing taxes to paper over the ever-widening cracks will spell the economic death-knell for these islands including, ultimately, civil service jobs. Talking to professionals overseas who feed our international business, their message is very simple.
“In the past we sent business to the Bahamas but, when they failed to listen and imposed unattractive conditions, we took the business away and sent it elsewhere, largely to Cayman’s benefit. If, now, the Cayman Islands choose not to listen and impose unattractive conditions, then we shall simply send the business elsewhere yet again.  We can bring it and we can take it away.” 
Bear in mind that such moves tend to be a one-way street.  The Bahamas, for example, never recovered the captive insurance business it lost, mainly to the Cayman Islands and Bermuda. Thus, by recommending taxes, the civil service is ultimately hoisting itself by its own petard because the revenue base that supports it will ultimately decline.
Then there is the domestic economic impact.  Taxes take money out of circulation in the economy. In effect, they slow down the economy by slowing down the velocity of money. Taxes also require yet another army of civil servants to administer them, with all the attendant cost of collection. Certainly, raising taxes to feed the monster is a very dangerous and precipitous path to take.
We started out by identifying what was sustainable. That which is not sustainable is, by definition, unsustainable. Why then are we considering levying taxes in an attempt to sustain what we know to be unsustainable?
Another element of paramount importance is the international dimension to tax. Remember the assault we faced in 2002 from the World Bank and OECD under the banner, “Harmful Tax Competition”? The OECD has long argued that international financial centres do not operate a level playing field because they have one tax for the domestic economy and another [usually tax-free] for registered entities operating internationally.  Cayman’s defence has always been that it has never imposed direct local taxes so its playing field is entirely level across the board of domestic and international operations. In the same vein, the BVI repealed domestic taxes in order to operate similarly and use similar arguments in the defence of its economy.
I have personally dealt with attacks on harmful tax competition, particularly with respect to shipping. For example, the OECD paper, Ownership and Control of Ships, reads like a velvet glove but, in reality, it was an iron fist poised to deal a hammer blow. All the arguments were beautifully written and appeared entirely reasonable and incontestable on first reading. However, on closer analysis, they proved to be entirely specious. Although it took considerable intellectual effort to elicit and unmask the errors of logic, it was worth it to prevent those errors from being promulgated as “immutable facts” so as to justify actions deleterious to our financial and reputational health.
The reality is that we are engaged in a form of intellectual warfare between those who seek global economic control and those who seek to preserve fundamental economic freedoms. Having personally felt the chill wind and seen the anthracitic coal-face up close, my feedback from that particular front is to be extremely careful and do nothing to encourage those who would like nothing better than to force us down the path of taxation. If we impose tax we shall open ourselves up to further rounds of attack on the harmful tax competition front, presenting very serious, adverse long-term consequences for these Islands. It could spell the demise of our financial services industry [a major source of government revenue] and is of such importance that it really should not be entertained without the full knowledge and support of the Public at large by referendum.
Recognising that with any debate, misperception is nine-tenths of the flaw, attached to every tax proposal should be the public’s health warning to government, “Danger, consuming this product could seriously damage your wealth!”

Failure to provide an accounting of expenditure
The law requires every government department and government-owned entity to maintain proper books of account and to report on those accounts in a timely fashion.  According to the outgoing auditor general, very few departments of government or bodies under its control have done this over the last four years. 
The benchmark used in this exercise clearly reveals that this is the very same four-year period when government spending shot to 52 per cent above historic norms.  Is there a linkage between lax reporting and over-spending or is it just a coincidence? Certainly, public confidence in the government needs to be restored and financial reporting in the future needs to be timely so as to enable course adjustments well before the economy is placed at risk of floundering on the rocks.  

Economic reality
A rising tide may lift all ships but navigating a falling tide is what takes special skill. Under current conditions, we have to plan for an economic tide that is likely to ebb for many years to come. Major dislocations, such as we have recently witnessed, happen rarely and usually at the burst of a bubble. Only when economic excesses inherent in the bubble have been worked out of the system, will economies start to move forward on a sound, long-term footing.  The current belt-tightening process is far from over.
Major economies first paid for the bailout and must now pay the price of the bailout. That price is partly seen in the huge debts that are already beginning to destabilise economies and currencies. Witness the Euro and Sterling, linked to the economies of Greece, Spain, Portugal, Southern Ireland and UK. Many other economies await their turn in the wings. 
History tells us that there is no short-term fix for systemic problems borne from decades of excess. Every bubble is fed by credit, compounded by leverage. When that bubble is decades in the making, then the time ultimately to unwind those excesses may also be measured in decades. Look, for example, at Japan’s economic bubble that burst over 25 years ago and yet its main market index today is still only 28 per cent of peak. In many ways, the current global position is systemically far worse than Japan’s was when its bubble burst.    

The bottom line is that we have no credible alternative but to recognise the probability that times may be hard for years, face that reality and plan accordingly. If things go better, then that should present an opportunity to build a buffer of much-needed reserves rather than entering another round of spending beyond our means. 
With or without proper accounting, the public can already see that government expenditure at current levels is unsustainable and needs to be reduced by an astonishing 33 per cent to bring it in line with historic norms. 
We only need ask one underlying question, “If, over the last four years, government spending had been held at its historic 20 per cent of GDP, would we have this problem today? The answer is a resounding “No!” The corollary is that, if we bring government spending back down to 20 per cent of GDP and keep it there, then we shall have returned to a historically proven, stable, sustainable financial footing, without the need to impose tax and thereby jeopardise the future for ourselves and for generations to come. 
Speaking of future generations brings me back to my granddaughter. I am reminded how quickly they grow up, noting that in only seven years she could be a graduate entrant to our economy, along with many more like her. What should their future look like in seven years’ time and what do we need to do today to make it so? Seven years is a short time in strategic planning.
Having served in government in the past, I can vouch for the fact that there are a lot of good people in its employ, many of whom recognise that long-term sustainability of government is very much in the best interests of those who serve it. In other words, it is in the civil service’s own best interests to work towards achieving sustainability.
We are now in a national crisis borne from excessive expenditure that has placed us in an unsustainable position. The global financial crisis may have exacerbated the position but it did not cause it.  With or without the crisis, this monster would eventually have raised its head. 
When you are confronted with a monster eating you out of house and home, you must either contain the monster or lose your home. Which is it to be Cayman?


Peter Gibbs