Bermuda and Cayman – 
precarious government finances

In part 2 of the series on the economic situation in Bermuda and the Cayman Islands the Journal is looking at government spending and revenues, which started to run in opposite directions in both countries long before the financial crisis started. When the global economy turned, the effect was felt with some delay but governments were unable to react and ran up debt levels that are in danger of becoming unsustainable. 


Of course the governments of Bermuda and Cayman are not alone in having difficulties in addressing their growing debt in an economy that ideally would call for more government spending to stimulate the economy and keep voters in jobs. The resulting conundrum of how to reduce the size of a civil service that is no longer supported by government revenues is difficult to resolve for politicians who find themselves both in Bermuda and Cayman close to general elections. 


Apples and oranges  

Ultimately the financial problem can only be addressed, if the severity of the situation is evaluated correctly. Both Bermuda’s and Cayman’s government like to point out that their debt to GDP ratios are much lower than those of many developed countries that are also struggling with a high debt burden. Bermuda has a debt to GDP ratio of about 21 per cent in 2012, up from 3 per cent in 2006, and Cayman’s debt level stood at 25.7 per cent of the GDP in 2011, up from 10 per cent only five years earlier. 

This compares to government debts of over 80 per cent of GDP in the UK and Germany and over 100 per cent in the US. The thrust of the argument is that Bermuda and Cayman are nowhere near the dangerous debt levels of these countries, have a higher ability to raise revenue and will not take as long to pay back their debt.  

It is however not entirely possible to directly compare small offshore financial centres and island economies with industrialised nations, because by their very nature low tax jurisdictions have difficulties raising new or increasing existing taxes without putting into question the effectiveness of their economic model, which is heavily reliant on attracting international business by being cost-effective. The fickle nature of government’s ability to raise new revenue could be seen in Bermuda when government attempted to raise the payroll tax rate by two per cent in 2010. When the damaging impact of the tax rise on business in Bermuda was greater than the tax revenue collected, government was forced to retract the measure the following year. 

In Cayman an ill-fated attempt to introduce a payroll tax for expatriate workers was heavily criticised for its social divisiveness. Although the proposal was later withdrawn and replaced with yet another round of fee increases for work permits and businesses across the board, the reputational damage of the idea to introduce direct taxation in Cayman was already done. 

The difficulties in taxing economic activity in offshore financial centres can also be seen in the government revenue to GDP ratios. In Bermuda the government is only able to raise about one sixth, 15 to 17 per cent over the years, of GDP. In Cayman the ratio is slightly higher at 22.8 per cent. Industrialised nations in contrast have much higher revenues of up to 40 per cent in Germany and the UK and 27 per cent in the US, which allow these economies to support much higher total debt levels. 

The conclusion that the undoubtedly unhealthy indebtedness in these countries means that government finances in Bermuda and Cayman are significantly better is therefore not valid. 


Revenue and expenditure  

The comparison of government revenues and expenditures in both Bermuda and Cayman shows that government finances were out of kilter long before the impact of the financial crisis could be felt. This impact together with the need to borrow to fund recurrent government spending compounded the financial situation in both countries. In Bermuda government expenditure started to exceed revenues from 2005 and in Cayman spending surpassed the collected revenue first in 2004 due to Hurricane Ivan and then again in 2007. 

This means, at least initially, the problems were homemade and not the direct result of international economic depression. Meanwhile total debt levels that in Bermuda and Cayman are exceeding the tax intake of an entire year not only make it more difficult to repay the debt in a foreseeable timeframe but also limit government expenditure with ever higher debt service costs and interest payments, which do not even contribute to lowering the debt burden.  

How out of sync the increase in government expenditure in Bermuda and Cayman really was shows a comparison of government spending with the growth of the population, who benefits from government services, the labour force, which funds the services and GDP growth, which has to be high enough to ensure sufficient government revenue growth to pay for the services it provides. 

In the case of the Cayman Islands it becomes clear that the problems started after 2006. From 2001 to 2006, growth of government expenditure (36.8 per cent) was supported by population growth (28.5 per cent), a growing labour force (25.1 per cent), increased GDP (37.3 per cent) and significantly higher government revenues (75.3 per cent). However, from 2006 to 2011 this picture changed dramatically. Government expenditures continued to grow even more (by 44.6 per cent) even though the growth of the population (4.4 per cent), labour force (4.6 per cent), GDP (17.4 per cent) and ultimately government revenues (9.1 per cent) did not support it. To fund the shortfall Cayman’s government raised new debt and grew total government debt by nearly 200 per cent. 

Bermuda followed a similar pattern but unsustainable government spending started even earlier. An increase in government expenditure from 2001 to 2006 by 43.6 per cent was matched by economic growth (44.5 per cent) but not by high enough revenues which grew only by 29.3 per cent. The extent of government spending was also not in response to a significant increase of Bermuda’s population which grew only 3.2 per cent. From 2006 to 2011 the picture worsened noticeably. Like in Cayman, government spending in Bermuda grew even faster than during the previous five years (48.7 per cent) but economic growth was comparatively anaemic (6.9 per cent) as both the population and the labour force declined. Government revenues were not able to match the increased expenditure growing only by 23.7 per cent so that massive borrowing was needed to fund government service. The result is a whopping 471.9 per cent increase in the level of total government debt. 

One difference between Bermuda and the Cayman Islands government finances is that the government budget in Cayman has to be approved by the UK Foreign and Commonwealth office. It is safe to assume that debt levels in Cayman would be even higher without the UK’s intervention, given the critical dialogue between the Cayman government and the FCO each year during the budget negotiations. 

With regard to the budget interference by the UK in Cayman former Premier of Bermuda Sir John Swan says at some stage Bermuda may be facing something similar. “If it is not done by the British government, it will be done by the rating agencies and the bankers saying we are not going to put any more money in unless you tell us what your plan is.”  

Swan says, “The bottom line is if you look at government revenue and you look at expenditure, it is an unsustainable set of conditions. It is all public knowledge.” 

Craig Simmons, economics lecturer at Bermuda College, says: “The government’s behaviour suggests that it is committed to mild stimulus. I think this is the correct approach. But there are costs in the form of rising debt to unsustainable levels.” 


Government spending and the size of government   

In Bermuda the number of people working in public administration, what in Cayman would be termed core government, increased by 12.7 per cent since 1998. Since 2005 international businesses employed more people than the public administration but in 2011 roles reversed and the number of civil servants exceeded the number of employees in international business. This was partly due to a decrease of international business activity and partly the result of increased numbers in the civil service from 2007 to 2009. Since 2009 the number of civil servants stayed flat at around 4,300. 

Like in Cayman there are however many more workers on the government payroll. Quasi-autonomous non-governmental organisations or short Quangos are a misnomer in that their not inconsiderable number of employees is paid by government. Quangos include anything from the Monetary Authority to public transport, public hospitals, development organisations or Bermuda College.  

Detailed figures for staff increases are not immediately available but the largest increase in Bermuda’s workforce since 1998 has been in health and social work with 44.8 per cent, which includes only a minority of private organisations. Since 2007 it is estimated that the number of government and Quango employees increased by 11 per cent, against the backdrop of declining employment in the private sector of 10 per cent.  

Simmons says, “There is no doubt that the civil service is bloated and that overspending has occurred, but now is not the time for British-style civil service cuts.”  

But reversing the growth of government, when not supported by sufficient revenue, is difficult to achieve through attrition alone.  

Swan says rather than “going through a blind austerity programme, you must have a measured austerity programme”. He argues the civil service was allowed to bloat up during boom times but then the economy deflated too fast for natural attrition to resolve the problem. He says he understands that redundancies will be difficult but believes sacrifices must be made.  

Swan suggests a four day week instead of a five day week or pay cuts. “We have got to manage our ways through these difficult times and my understanding is we could be back to a substantial recession.”  

He points to the private sector which has gone through the process already, reducing staff and freezing salaries. “The government just looks at it from the point of view either you tax or you borrow money,” he says.