Archive for July 19th, 2010

The Real Never Never Land

A local businessman, writing in this month’s Journal, struggles to explain to his 14 year old grand-daughter why her generation will be saddled with a debt run up by successive governments of his. A reader could be forgiven for concluding from this that the author is what political observers would call a "deficit hawk" (political observers themselves, deficit hawks are fiscally conservative beasts, decrying excessive government borrowing on principle).

But reading on, you may be surprised to find, as I was, that the only thing he considers worse than his grand-daughter having to pay for today’s government profligacy, is having to pay for it himself. A principled stance indeed.

You see the article’s author is ardently opposed to tax, comparing the Cayman Islands government to a hungry monster determined to eat you out of house and home. But politics is as full of paradoxes as economics and this particular conundrum is surely as old as parliamentary democracy itself: How do you stop governments over-spending? One method propounded by fiscal conservatives is to "starve the beast".

The so-called "starve the beast" argument goes something like this. Governments spend money like it grows on trees. The only way to stop them spending more money is to not give them any more, that is, by constraining revenues, or taxes as they are better known. There is one tiny problem with this strategy: it doesn’t work. Governments still have access to the same, for all intents and purposes unlimited, reserve of cash no matter how much they raise in revenue.It’s called borrowing. For as long as the British government (bless its cotton socks) is willing to continue increasing the Cayman Islands’ credit limit, trying to stop the government spending money by constraining tax revenue is like trying to stop people drinking liquor on Sundays by closing liquor stores. Hey ho, there’s always the bar.

Citing "readily available statistics", the author reports that the Cayman Islands Government spends 31% of GDP while British government spending is "below 25%". A shocking statistic indeed… if it were true. According to HM Treasury (see page 59), the British government spends 47.3% of GDP. Whilst the mistake is no doubt an innocent one, The Journal itself, purporting to be a respectable business publication, should be ashamed of itself for publishing such egregious misinformation without question.

Even the staunchly ideological Miller Shaw Report disagreed that Cayman government spending was excessive compared to other western economies such as the UK, stating on page 12:

“The Cayman Islands enjoy a modest burden of government compared to most nations. Revenues consume less than 25 percent of economic output, roughly comparable to jurisdictions such as Singapore, Hong Kong, and Liechtenstein. Most developed nations, by contrast, divert larger shares of output to government, while some Nordic nations top the charts, with governments in Denmark and Sweden taking more than 50 percent of economic output.”

Citing the advice of "overseas professionals", the Journal contributor goes on, "Imposing, and then inevitably increasing taxes to paper over the ever-widening cracks will spell the economic death-knell for these islands". A broad statement, but what taxes is he referring to? I can see why his foreign friends might be scared of further fee increases or corporation tax but why would these "overseas professionals" care if Cayman brought in direct personal taxes? If anything, their costs would come down, as our government would no longer rely on them and their clients to pay its bills.

It is a preposterous over-simplification to claim that all taxes are bad for the economy, or society for that matter. Take the Danes, cited by the Miller Shaw report above, whose tax-happy government takes a 50% plus share of GDP in revenue. Perhaps the Danish government will find some comfort in their country being named the world’s happiest by a recent Gallup poll, as well as coming ninth in The Economist magazine’s authoritative 2005 study of national quality of life (among the other high-tax Nordic nations invoked by the Miller Shaw Report, Sweden came fifth, Norway third). Enough to make the most ardent fiscal libertarian pine for the fjords.

The writer offers an anecdote of business leaving the Bahamas after the introduction of nebulous "unattractive business conditions". He doesn’t go into detail, but whatever these new unattractive conditions were, they certainly weren’t direct taxes. The Bahamas have had a payroll tax since 1972. And again, in what way would direct personal taxes constitute "unattractive business conditions"? Perpetually increasing work permit and other business fees are pretty unattractive. Direct personal taxes would have precisely the opposite effect if the government were to continue to try to cut costs and simply rebalance some of the costs currently being borne by the private sector to the general public. And few things are as unattractive to business as an insolvent government.Dubai anyone?

Just look what happened to those other down-and-out financial centres with direct personal taxes such as Bermuda with its annual property and payroll tax and its government spending a whopping 60% of GDP. No wonder Bermuda never amounted to anything after it brought in property tax in 1967 (well, not counting achieving the highest GDP per capita on the planet in 2005). But just look what happened when they brought in a payroll tax! Economic disaster! Right? Wrong. After introducing payroll tax in 1995, Bermuda’s GDP grew a record 35% in a single year (see chart below).

How about Jersey with its 20% income tax? How much louder a "death knell" could you get for a small island than a 20% income tax? A look at the Jersey Finance homepage reveals that the jurisdiction is in all kinds of trouble these days having won a measly four international business accolades in the last year including Best Offshore Centre (Global Investor Awards), International Finance Centre of the Year (STEP), Best International Financial Centre (International Fund & Product Awards) and coming top among offshore jurisdictions in the Global Financial Centres Index. Funny that some of the very same overseas professionals reportedly predicting a tax-induced Caymanian death spiral appear to be doling out awards to an offshore competitor with one of the highest personal tax rates of any so-called tax haven. How their financial sector must rue the day their (solvent) government introduced income tax!

Do taxes, as the author contends, "take money out of circulation in the economy"? This is the kind of economics-is-too-complicated-for-you-to-understand soundbite that is plausible for only as long as you don’t actually think about it. The government doesn’t take the money it raises in taxes and hide it in a giant vault at the base of Mount Trashmore. It spends it, almost entirely in the local economy. In fact, in the hands of the public, money is much more likely to be "taken out of circulation" by being saved or spent overseas. Not that such a fate is a bad thing for your hard-earned dollars, but it is incontrovertibly a bad thing for the local economy.

Is the civil service inefficient? You bet. Governments are inefficient by nature. Is that the same as you and I not getting value for money for our tax dollars? Not necessarily. The Cayman Islands spends an average of around CI$12,000 per resident. It collects from residents less than CI$4,000 on average. The balance is paid by the private sector and tourists. Sacking every single civil servant and completely eliminating capex would reduce government spending to around CI$6,500 per resident. So, under such impossible (or as some would argue, idyllic) conditions, you and I would probably still be getting CI$2 of services for every CI$1 we paid. And who would we accuse of gross inefficiency then?

It is precisely the strategy of demonising taxes in general, and indignantly insisting the government should spend less even though it won’t, that has backed the Cayman Islands government into the corner it is now in, having to borrow money hand over fist and increase private sector "fees" left and right to make ends meet.

Why have so many fund administrators set up and expanded offices in relatively high tax Canada instead of the Cayman Islands? Because the Canadian government doesn’t expect fund administrators to pay for their roads. Canada, like nearly every other developed nation in the world, has the crazy "socialist" notion that public services ought to be paid for by the public.

The ultimate irony is that the best strategy to reduce government spending isn’t constraining revenue, or becoming apoplectic at the mere mention of taxes, it is creating the democratic will to reduce costs by making the electorate pay for the services they receive. The reality is that there will never be any real political will, in the broadest sense, to reduce spending so long as what is being spent is mostly other people’s money (that of private sector shareholders, tourists and government debt-holders).

In any case, our friend need not necessarily worry about his grand-daughter’s financial fate. So long as her peers are as successful scaremongering about taxes in her day as he and his peers have been in ours, neither of them will have anything to worry about.

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