Fixing Cayman’s financial problems

| 08/10/2009

An opportunity not to be missed…..Over a year ago I wrote that Government and the private sector should don their rain gear as the global financial crisis started to bite in Cayman. People said I was being a Cassandra. Nearly ten years ago, I wrote that Cayman’s revenue base was too narrow to sustain its development and the needs of a growing population, certainly not in a down economy.

I recommended a modest annual property tax specifically dedicated to building and maintaining the infrastructure. I also recommended that Cayman should develop a ten year plan for independence (a discussion for another day). People said I had truly lost it with these two suggestions. And now we are in the perfect storm, with the UK running interference and no real progress with long term solutions.

Earlier Governments wisely put in place mains water supply, sewage (but as yet only for part of the Islands), new airport and hospital and mandatory health insurance and pensions. But we then lived on borrowed time by deferring investment in roads, schools, port, runway extension and waste management. The previous Government decided to build the roads, schools and a new Government building simultaneously and without proper long term funding/financing for these projects. Also, over the past few boom years, Government operating expenditures troublingly grew as a percentage both of revenue and GDP. Paradoxically, the Ivan disaster produced a huge inflow of overseas insurance and reinsurance money and (even with the duty waivers and reductions) the Governments coffers filled with import duties on (re)building materials and replacement equipment and goods of all kinds. This inevitably tailed off. Then the global crisis hit and our two main economic drivers, tourism and financial services, stopped expanding and then slid backwards. Real estate, construction, support services and consumer spending all suffered. 2009 Government revenue suddenly sank well below projections, yet Government expenditure continued unabated.  

Voters everywhere continually demand more and better services, all too often from their Government. And politicians promise to deliver them. So either we stop demanding or we (not just others) have to pay for these services. And there are indeed vital projects still to be undertaken here. The most pressing (and maybe the most expensive) is waste management and the current landfills in particular. Even the most optimistic realtor, developer and “no new taxes” lobbyist must be aware that the south end of Seven Mile Beach, Camana Bay and the bypass stretch are exposed to a potential toxic disaster (air pollution already and soil and water pollution that may be happening unseen underground). What price tourism, real estate and the North Sound if that occurs (and the crime wave and poor underresourced policing continue)?

 

There are some things we should stop doing. First, bashing the UK. This may play well locally for a time but is unproductive. Second, saying we just have a short term cash flow problem and all will be well if we can borrow some cheap dollars to keep us going until the boom times in tourism and the financial services industries restart. Those times may be a while coming (and we must ensure the right platforms to encourage these key industries), and the traditional revenue streams from these industries will likely be insufficient for the long term. Third, saying we just cut Government expenditure, eliminate waste and abuse in Government services, downsize the civil service and improve civil service performance. Steps must be taken (the civil service and statutory authorities are in the aggregate far too large a percentage of the total work force), certainly to freeze the expansion, but it will be very hard in reality to turn the clock back (just count the votes). Fourth, saying that privatization and public/private partnerships and private finance initiatives are the solution. There are some sensible options, but these are not sufficient to handle the problems. Fifth, saying that our ratios of debt and debt servicing costs to GDP are and will be well in line with other countries. This is misleading if most of that GDP is off limits as a source of Government revenue, i.e. we are not prepared to tax it directly! I suspect Moody’s may not have taken this into account in their recent rating confirmation of Cayman. Sixth, parroting “do not raise taxes in a recession”. This comes from the same people who during good times say “do not raise taxes, you will stop the boom”. Lastly, painting this as a Caymanian-non Caymanian issue. We are all in this together.

We should not ape the fiscally irresponsible behaviour of the US and the UK. Fortunately, we cannot “print money” and flood the market with CI$ debt that we cheapen by devaluing the currency (since Government borrowings are essentially in US$, we leave the Fed to do that for us!). We need to reinstate sound Government finances. I believe this is possible but contributions are required from the entire resident community and those invested locally. The self-interested “nail the other guy, he’s not at the table so he can be lunch” is very unhelpful. Suggestions should be constructive with a willingness to compromise for the greater long term good.

We now have deficit figures for the last fiscal year (disturbing even if predictable), an optimistic proposed budget for the current fiscal year and UK in-principle and conditional consent to a portion of the loans requested (as yet we do not know which financial institutions have made firm commitments to fund the loans). The UK still requires, not only satisfactory short term fixes, but also a long term plan for sustainable revenues/financing and expenditure cuts/containment to match (phased implementation should be possible). In our own interests, we should also set clear priorities.

The short to medium term solutions outlined so far in the proposed budget call for swingeing increases in the usual indirect fees and duties (e.g. import duties…effectively our sales tax…, financial services and company fees, work permits etc.), a 2% levy on money transfers through licensed money services companies (but not through banks) and various other miscellaneous fees, a new annual business premises fee payable by the tenant of 10% per annum of the rent (with the concession that no such fee is payable on leases in force on which stamp duty has already been paid), one off savings (e.g. deferrals and perhaps cancellations of services and projects) and windfalls, civil service/statutory authority hiring and remuneration freezes, disposition/refinancing of Government assets/liabilities etc., and improved efficiencies, performance and collections (delivery is another question). But I fear that, given there is little hard evidence of sustained cuts on the expenditure side and of specific long term funding/financing of capital projects, there needs to be detailed study followed by action that broadens in the longer term the revenue base through meaningful new levies (implemented in a sensible staged manner) that are not so dependent on perpetual boom times and buoyant consumption. And this is not simply because the UK tells us this. If we fail to do this, we are likely only kicking the can down the road for a short while.

Taxes should be fair, have the lowest adverse impact on economic activity and should be cost effective to collect and enforce. There are two new proposals in particular that do not meet the tests.

The proposed 2% levy on money transfers through money services licensees is unfair as it hits those at the bottom end of the economic scale (who have also been abandoned by the traditional banking system…perhaps the retail banks will be good community citizens and now rethink this poor attitude). It also sets a very ill advised precedent (thin edge of the wedge) as it will be seen as a tax on cross border fund transfers, an anathema to the global financial industry. Finally, it can only be short term, as in a few years, it will be uncollectible as electronic money transfers by cell phone will be possible (this is happening elsewhere already).

The proposed 10% business premises levy on rents (to be an obligation of the tenant but, it appears, to be collected by the landlord and remitted to the Government) fails to meet all the tests (the last one in particular) and is potentially open to nonpayment and fraud, in the same way as stamp duty, health insurance and pension contributions. And in the current climate, I fear that it may finally drive under many small businesses that are already struggling, if they have lease renewals coming up. Also, the new 10 % annual levy may adversely impact one of the key things Cayman needs to do to get the economy going again; that is to encourage greater economic activity here with new financial businesses establishing physical offices with people living and working here in and making real decisions. My concern is that this new in-your-face line item (combined with the ever increasing work permit fees) in the budget of a fund or investment manager considering a physical presence here might be a turn-off. To put this in perspective: currently a 5 year lease at an annual rent of US$250,000 carries upfront stamp duty of 5 %, i.e. a one off US$12,500 approximately; under the new regime, no stamp duty but an annual tax of 10%, i.e. an annual US$25,000, and thus US$125,000 over the five years.

I also question whether this new levy will result in tenants buying or building their own premises. Anecdotally, the response seems negative. The market is a lot more complex than that. First, many smaller tenants are in no financial position to buy or build. Second, in Cayman other than major retail banks (and most already have their own bricks and mortar), financial services and professional firms typically do not own their office premises as it limits their flexibility for growth (or downsizing) and ownership causes succession problems and more for partnerships. Third, major tenants are usually already tied into long term leases. Fourth, I wonder if the existing landlord/owner lobby has thought carefully enough about the implications in the unlikely event of their major tenants constructing their own buildings and vacating their current premises. A whole lot of empty buildings, so be careful what you wish for.

I must emphasise that new taxes should only be imposed if and to the extent that the various short-medium term  measures outlined in the budget fall short or are not sustainable. Applying the three tests outlined above, I suggest for mature study and consideration three possible new revenue sources. First, a modest annual community service charge on real estate dedicated to appropriate infrastructure and services (like waste management) and collected by the Land Registry (there can be exemptions for those who genuinely cannot pay and for low value properties, perhaps variable rates/bands depending on the usage and value and a credit/reduction of the upfront stamp duty already paid or payable). Second, a levy on electricity, telephone (including prepaid cell phones), TV and water bills collected by the utility companies. Thirdly, and very reluctantly if all else fails, casino licences (collected by a new Gaming Board). These could together raise a stable CI$45-CI$75 million annually for Government fairly, with low adverse economic impact, at a reasonable cost and with a high collection rate.

This article is an expanded version of the article that appears in the October issue of the Journal

 

                                                     © Timothy Ridley 2009

 

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Category: Viewpoint

Comments (10)

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  1. Joe Average says:

    Someone please correct me if I’m wrong, but it seems at least in light of an obviously bloated Civil Service, that at some point an assumption was made Cayman would be inhabited by a number of financial service industries and/or banks….and everyone else would work for the Government.  It was also assumed a few work permits would be issued for those willing to do menial labor, garden, repair vehicles, or act as housekeepers for Government employees.  When it was found not everyone could work for the Government…because there would then be no need for it… the plan suddenly became "unworkable" and other means suddenly had to be found.  That search continues.

    • Knal N. Domp says:

      Your supposition that Government would be the other leg of the economy, fails not because of any structural or operational impossibility, but that it would require a Plan to achieve it, and as such, impossible to achieve hereand unlikely to be achievable anywhere else. No, the civil service simply burgeoned because no one believed that the revenue stream would ever dry up and that additional staff was hired because it was easier to shift tasks to the newbies that get them done efficiently by oneself. When resources are miraculously paid for by unseen processes, or are assumed to be ‘free’, the farcical 120-staff Cabinet Office rapidly becomes reality. Does anyone remember the days not too long ago when the Governor’ Office staff consisted of Kate Joad, the other nice social secretary and that skinny operations guy?

  2. tim ridley says:

    There are indeed a number of indirect fees, levies and taxes that can be introduced and existing ones that can continue to be increased. Customs duties are effectively a sales tax, i.e. a consumption tax, as pretty well everything is imported. My suggestion of a levy on all utility bills is a logical extension of that, i.e. a consumption tax, that would like customs duties be cost efficient to collect. 

    The difficulty is that revenue from consumption taxes falls in a down economy (and noone has ever invented a perpetually booming economy) as consumers cut back their spending. Cuts in Government spending are far less elastic, however much we wish they were, and thus cannot match the decline in revenue from consumption revenue.

    We should not assume an exceptionalism in the way we have traditionally raised revenue in Cayman. We have to be prepared to change. Or we have to accept a significant reduction in services from our Government.

    The bottom line question in my mind that puts the issue succinctly is, "how to we pay for waste management, starting with the landfill?" I do not believe we can without a community service charge. We all (and particularly property owners) have a huge interest in solving this problem and sooner rather than later.

    • Mises’ Musings says:

      A levy on utililty bills is indeed a logical extension and one that should be considered, even though the timing, incidence and efficacy of customs duties separate duties from classical sales taxes.

      We should be careful not to fall into the trap of assuming that each year’s public sector spending must be paid for from that year’s revenue. Both revenue and spending smoothing is possible. Expenditures ideally are planned to some extent. Cyclicality and random variation in government revenues derived from consumption taxes and user fees can be addressed in a variety of ways.

      The incidence of consumption taxes in relation to individual consumables and the elasticity of demand for such consumables and any substitutes determines, in part, susceptibility to revenue fluctuations related to consumption taxes. Ideally government would accummulate a reasonable surplus in times of plentiful government revenue which could be drawn down judiciously in times of economic downturn. It is however understood that fiscal discipline and political will do not necessarily coincide. 

      Perhaps your bottom line question could be rephrased to include the concept that duties/consumption taxes may be used to both shape what goes into the landfill and to pay for most solid waste management. We should consider that the vast majority of the volume going into the landfill represents detritus derived from what we previously imported. 

      At present we fail to recognise the true "life cycle" cost of what we import in our calculation of duties. If the cost of handling of the detritus of imports were to be dealt with at the time of importation, then the financial side of the problem is largely solved. There are existing models for the costing of future recycling and the disposal of future solid waste. In our situation disposal could involve sending much of our solid waste to suitable "onshore" recycling facilities.

      To paraphrase an old adage, "Imports In – Garbage Out".    

    • Anonymous says:

      sell Dart the dump and the land it sits on…PROBLEM SOLVED!

  3. anonymous or else says:

    What is unfortunate is that No one in power will listen to good advice.  They don’t seem to be interested in the future at all and only interested in themselves in the present.  If only Cayman was interested its future and not just in its domination of the island.  I’m sure there is notjust one way to save The currrent system that will work.  But not listening to someone like Mr Ridley who has the experiance and credentials in this field only highlights the many efforts by the current leaders of Cayman that have failed and led us up to this point.  With no change in operation all we can do is sit back and watch the inevitable happen.  It started out as a comical satire to watch but now it will turn tragic as the honest, hard workers will fall first and of course the ones resposible last.  The only way this can get better is if the system fails completely (runs out of money and collateral completely). Does anyone not completely under the leaders spell not see this happening?  Please try to see this as just one mans OPINION 1. a belief that rests on grounds insffticient to produce certainty.  I would be interested in hearing Tim Ridleys advice on what will happen here after the fall.

  4. Anonymous says:

    It is unfortunate that Mr. Ridley chose not to reiterate the idea that potentially there is another significant amount of money available to government. This money, as Mr. Ridley and others before him have pointed out, is to be found within the spread which the banks charge on CI-US and US-CI conversions. These conversions are in effect guaranteed by government at no cost to the banks. Government should cease this subsidy and charge the banks between 0.5 and 1.0% on all such conversions. That would still leave the banks with a healthy profit but would also require banks to pay an appropriate fee for government’s guarantee in relation to such conversions.

    This revenue source would clearly meet the criteria which Mr. Ridley identifies as desirable in relation to revenue measures and could be used to avoid the odium associated with the proposed 2% tax on the communities least well off.  

  5. Mises’ Musings says:

    Mr. Ridley makes a number of observations worthy of comment, his version of “I told you so” notwithstanding. He is to be commended for repeatedly stepping forward with ideas, despite being confronted from time to time by the irrefutable logic of his critics.

    In this article Mr. Ridley both repeats previous suggestions and offers new ones. He opines on the characteristics which taxes ought to reflect and makes recommendations accordingly. His normative formulation for the propriety of taxation is however flawed to the extent that he calls for each of his three criteria for acceptable taxation to be assessed individually and in isolation, rather than collectively and in a weighted fashion. Further, his concept of what is fair is flawed to the extent that it imports any notion other than socially acceptable utility within a relatively narrow social context. Nonetheless, Mr. Ridley’s conclusions in relation to the new tax on money transfers, and the current formulation for a tax on commercial rent payments are not disputed.
     
    Shaping the reality in which Cayman’s fiscal regime must be structured is the fact that small jurisdictions which supply services founded on client trust must take care to ensure that taxation regimes reflect a strong foundation in principal, in addition to exhibiting efficacy. Principal in this context connotes, among other things, predictability sufficient for the requisite degree of commercial certainty. It also connotes a commitment to an economy which is robust and flexible. On that basis, and with respect, I must disagree with certain unarticulated assumptions apparently underlying a number of Mr. Ridley’s propositions, as well as certain of his articulated propositions.
     
    I will attempt to deal with several of the propositions which I dispute in the sequence in which they appear in his article.
     
    Cayman’s revenue base [is] too narrow to sustain its development and the needs of a growing population…I recommended a modest annual property tax
     
    The rationale for rejecting property taxation remains as validtoday as it was 10 years ago. The imposition of a new property taxation regime at this time is simply not prudent, let alone a panacea. There may be some basis for suggesting that property taxation is less of a drag on society than other forms of direct taxation, but that is an entirely different matter. There is simply no evidence that property taxation provides a more sound footing for prudent development than indirect taxation does, and it is less efficient. The only virtual certainty is that had a “modest property tax” been introduced 10 years ago, it would have ceased to be modest long ago.   
     
    There are some things we should stop doing…..Third, saying we just cut Government expenditure, eliminate waste and abuse in Government services, downsize the civil service and improve civil service performance. Steps must be taken (the civil service and statutory authorities are in the aggregate far too large a percentage of the total work force), certainly to freeze the expansion, but it will be very hard in reality to turn the clock back (just count the votes).
     
    The population must continue to remind our politicians in the strongest terms that the public sector must become much less expensive and much more cost effective. The fact that it will be hard to cut Government expenditure, reduce Government waste, and improve civil service performance does not mean that it is not essential. Civil service personnel do represent a large number of votes, but those voters understand that the past decade’s rate of expansion of the civil service is not sustainable. They understand that a strict near-freeze on hiring for the foreseeable future is key to returning government expenditures to a healthy position. They also understand that there will likely be some privatisation.
     
    There are some things we should stop doing…..Fifth, saying that our ratios of debt and debt servicing costs to GDP are and will be well in line with other countries. This is misleading if most of that GDP is off limits as a source of Government revenue, i.e. we are not prepared to tax it directly!
     
    What is actually misleading is any assertion or suggestion that the level of prosperity which we enjoy would remain if direct tax were introduced. GDP-based metrics are questionable as a basis for assessing our economy and we should not allow ourselves to be trapped by such estimates despite their current legislated standing. The quasi-measurable does not necessarily comprise the meaningful. The quasi-measurable avoids the meaningful entirely when metaphorical “apples and oranges” are compared. Apart from the obvious point that inter-jurisdictional comparative analysis utilising GDP-based metrics tends to be flawed even without our limited ability to measure GDP meaningfully in Cayman, Cayman’s economy is structured in a manner that is so different from that of most large economies that our targeting of GDP-based ratios should not become an end in itself.
     
    Cayman has been more successful than most countries in recent decades, and in particular it has been more successful than most geographically isolated countries without natural resources – the relevant comparator set. Those other geographically isolated countries without natural resources which have been most successful are those which have modelled their tax bases to emulate that of Cayman. Those few countries which have a better fiscal standing at present have done a better job of controlling government expenditure. Once government expenditure is brought under control and if the external threats facing Cayman are handled appropriately, Cayman’s ability to repay its debt will exceed that of most first world countries with their inefficient and initiative destroying direct tax systems.
     
    Finally, Mr. Ridley’s suggestions for “new revenue” do not focus on the social utility “value added” which consumption taxes offer. By way of example, it is questionable whether the current model for “duty-free” imports has utility from a community perspective. If the purveyors of these items wish to have their imports “duty free” then perhaps they ought to bear an alternate and equivalent charge calculated from the value of the goods they import.  
     
    Also by way of example, there are many imports which arguably ought to bear higher duties at the point of import commensurate with their social costs. Soft drinks and other so-called “junk foods” do not contribute to a healthy society any more than alcohol or tobacco do. Why should they not bear duties accordingly in order to both offset the long term direct and indirect costs of these items to our society, and alter behaviour towards greater health. These simple and highly efficient alterations to our indirect taxation regime could raise more revenue for government than Mr. Ridley’s community charge and with greater social utility. 
    • Anonymous says:

       Mises’Musings…constructive criticism is generally accompanied by alternate proposals.  What specific measures are you suggesting and what are the estimated quantitative outcomes?