An income or payroll tax is no silver bullet

| 08/11/2010

As the global economic crisis continues to have an increasingly negative impact on the Cayman Islands economy, the debate on why the government has been facing large deficits has led to many suggestions. Cutting expenditure, and privatization are among some of the suggested solutions, but the one that has really caught on is the idea, recently suggested by the FCO, that our crisis relates to the narrow revenue base that Cayman has had for all of its modern history.

More specifically, the idea of an income or payroll tax has not only been suggested but, according to some persons, has even got to the stage where members of the business community support some form of direct taxation (including a payroll tax).

The idea that the revenue base is very narrow is not a recent observation. This has been noted on several occasions over the years, including within the regular economic reviews of the Cayman Islands carried out by various FCO economists over the past decade, in separate analysis carried out as part of a five year economic plan back in 2003 and on other occasions.

What has, however, given importance to the idea of an income or payroll tax is the search for an answer to the question: why are we in this position in the first place?

Some commentators have not been convinced that the global economic recession and poor domestic policies have been the major forces behind the current crisis, but looked for other more fundamental reasons for the Cayman Islands economic and fiscal challenges. One theory is that the existing system of indirect taxation has “caught up” with Cayman and that without the implementation of either a payroll or income tax, the country could not have a “sustainable revenue base”.

Before scrutinising this theory, let’s consider the reasons put forward as to why direct and, in particular, an income or payroll tax may be more sustainable or better for Cayman. These reasons are very well researched in general and have a clear logic, but that does not mean that the theory applies perfectly to the Cayman Islands situation.

As the explanation goes, when an economy suffers a recession and it does not have direct income taxes, it experiences a larger reduction in revenues than it would if it had a system which includes direct income taxes. This is because while the government may lose revenues from indirect taxes and fees (such as import duties) due to less economic activity, it can at least benefit from having a tax on individuals’ incomes even in the economic downturn. In other words, you can still gain revenues from taxing a person’s income in a recession so the direct tax is considered a bit more “sustainable” than the indirect taxes. Another reason for the suggestion is that if the government introduces an income or payroll tax then it would be in a position to reduce some of the existing indirect taxes, thereby reducing the cost of living in the country. That summary somewhat simplifies the main arguments (and space here does not permit discussing the related assumptions), but it should suffice for now.

As the theory continues, we then need to look around us to see that the Cayman Islands is one of only a handful of countries in the world which does not have a direct tax as part of its revenue arsenal. This suggests that somehow as a country our choice of a purely indirect tax system is out of touch with the reality of today’s world and our own needs.

But is it?

Take another look at the vast majority of countries with a direct tax system which relies heavily on income or payroll taxes. Did they handle the global crisis any better than the Cayman Islands because they had an income or payroll tax in place? Are these countries boasting surpluses because their governments had chosen to maintain an income or payroll tax for the past 200 or more years? Have their national debts been contained or even reduced due to the ‘superior sustainability’ of their tax system? The fact is that most of these countries have experienced worse fiscal imbalances in comparison to the Cayman Islands.

To be clear, the main point here is not topretend that the Cayman Islands does not have its own host of challenges (some of them serious). But if we consider the many examples around us, it starts to become evident that whether a tax system is based solely on indirect taxes or one which also includes income taxes (like most countries) is unlikely to be the primary factor behind the challenges that we face as a country today. It is in fact more likely that regardless of the type of tax system that the Cayman Islands had three, four or even ten years ago, we would still have witnessed a severe economic downturn and large fiscal deficits (like just about every other country with these mixed tax systems).

Let’s imagine a new era where the Cayman Islands has introduced an income or payroll tax. Ask yourself these questions: would having that new system make the government any more accountable in its spending or would it be tempted to “tax and spend” like most other governments? Would having a new income or payroll tax help us to avoid large deficits in a downturn regardless of the level of government expenditure? Would a new income or payroll tax make our revenue base more sustainable if we are now dependent on the salaries earned by a workforce in which the majority of workers are mobile/transient? And if the government cannot rely on those transient workers (those on work permits) to stay put when things go bad, then will it not need to turn to those workers who are not as mobile to secure those income or payroll tax revenues? Finally is it fair or sensible to continue to compare the Cayman Islands to other offshore jurisdictions with an income or payroll tax (for example Bermuda) which do NOT have a disproportionately large percentage of mobile/transient workers in their labour force?

The debate on what we need to do to cut expenditures or raise further revenues is still the right one and all options should be left on the table until they are properly scrutinised. But in the meantime, we could start by examining how to improve our existing system of indirect taxes, by changing the policy environment to diversify or grow the economy, by looking at direct taxes which do not focus on incomes, or finally implementing some of the ideas put forward by civil servants on how to improve efficiencies in their own departments.

The harsh reality is that these alternative approaches involve some very tough decisions for both the government as well as the wider community. The real question is whether we are ready to embrace these decisions today, before it is too late.

But the idea that simply switching to a system of income or payroll taxes would solve our problems because “other countries have it, and we should therefore try it” needs far more scrutiny. We must do this before stepping on the accelerator towards a situation where the Government takes revenues from you depending on how much you earn.


Paul Byles is MD of Focus Consulting. He has an MSc from the London School of Economics (LSE).

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  1. Anonymous says:

    Cayman has a very small tax base with no direct taxation. Why ruin that that this business model which has brought us to where we are today.

    This succeeded because the Government was small an restricted itself to core responsibilities.

    However over the years , governments added on or took over services which today this cuntry can ill afford to sustain

    As th saying goes, the smaller the government, the country does better including performance



  2. Dagny says:

    Thank you Paul for presenting your enlightened arguments.  My only disappointment is in the people who have made comments to your article in support of direct taxation.  I cannot for the life of me understand why someone would be begging Government to take a portion of his or her hard earned money and use it at their (frivolous) discretion.  I would much rather share my peanut butter sandwich with my neighbour than give it to the CIG to determine where it should go, because they obviously cannot spend it wisely.

    Those who have taken the time to read the Miller-Shaw report (and do not respond to this post unless you have read it – all) will know that there is significant evidence that shows the CI civil service are amongst the very highest paid in the world (taking into account high salaries and unprecedented benefits packages).  I am hoping some level-headed person will be able to explain to me why the rest of the country should be forced to pay a direct tax in order to support a grossly obese civil service that is over 6,000 strong and is the highest paid in the world.  The Miller Shaw report proves that by natural attrition and a few necessary redundancies (it does NOT say that there should be massive lay-offs) and a reduction in pay and a reversion to contributory pension and health benefits, the budget would be brought back in line within a five year period. 

    The Miller-Shaw team also ran some numbers in a theoretical exercise that showed that had their recommendations been enacted July 1 2008, by June 30 2009, the CIG would have enjoyed a $50 million surplus instead of the $56 million deficit it marked up.  I hope it is not necessary for me to point out that this period (2008/09) was the highlight of the financial crisis and both the financial services and tourism industries faced serious downturns.   There is obviously not a problem with revenue flow.  This is an expenditure issue.

    The increase in fees (such as work permit and incorporation fees) can be reversed once the Government expenditure is checked, which will bring relief to the businesses here and just might inspire more companies and investors to come here.  But, then, that is all on the assumption that the home-grown’s actually want that business (and the people that would need to be imported to run them).  That is a discussion for another day.  In the meantime, if the paycheques of the civil service are not addressed and a direct taxation system is implemented, the entire Caymanian population had better be civil servants – they will be the only ones left who will be paying direct tax to support their own salaries, because the rest of the population will be long gone.

    • Anonymous says:

      The Miller-Shaw report proved what it set out to prove.


    • Slowpoke says:

      Miller-Shaw channeled Ayn Rand while writing this report so, it automatically has a fan base. 

      • Non-sense says:

         Miller Shaw report was most revealing, not for its lack of thoroughness nor for it’s blatant failure to do what it was supposed to (rumour has it that the UK doesn’t consider it a complete report), but for the flock of sheep who have been bleating it’s merits as if it is the gospel of economic recovery!

        Talk about a bunch of groupies…

        people of these islands should ask for a refund from Miller-Shaw.

  3. Anonymous says:

    Is this the same Paul Byles listed as Financial Advisor to the Government of the Cayman Islands? 

  4. Anonymous says:

    Aside from stating the glaringly obvious i’m not quite sure what this viewpoint achieves.

    If the author is genuinely concerned about the finances of our nation he’d use his remarkably easy access to the halls of power to persuade the government to minimise the hiring of costly consultants and quickly introduce cost cutting measures.

  5. back to reality says:

    I agree, why are we jumping up and down to bring in a new form of tax when we cannot even get the current ones to work?

  6. Anonymous says:

    The UK was the first to try to put pressure on us in saying that the reason we were in such a crisis is dueto the lack of payroll tax,. I recall seeing this in the media a lot and also the letter which was posted somewhere by chris underpants guy.. former fco minister. lets stopping drinking that UK coolaid please. lets face our issues and stop running away from them. whatever direct taxes we bring in, will get wiped out anyway with lack of accountablility…

  7. Businessman says:

    The article and the comments is a bit long for my taste and becomes confusing.

    The point is not how we raise the money, the point is simpler, the Government is spending 20% of GDP (Gross domestic product) in a service economy with no manufacturing. That is simply unsustainable.

    Almost 10% of the population and around 20% of the workforce work for the Government, this is simply unsustainable.

    We are at a cross roads, either the Government is shrinked through privatization and freeze in hiring (I’m not asking for redundancies in the middle of the recesion) or the population needs to grow and with that the revenue will grow while the cost must be kept under control.


  8. Leona Hemsley says:

    It doesn’t matter if they are direct or indirect. Only the little people have to pay them.

    • Anonymous says:

      That is why they should be progressive and not regressive.

    • Anonymous says:

      Consumption taxes are paid by all so any classist rant needs to at least be factual to carry any weight.

      My disagreement with gambling or lottery is that those who can least afford to play the lottery and lose will be the bulk of the customers.


  9. Karyll Iton says:

     Very good article. 

    Some strong arguments there and I totally agree that the priority should probably be on accountability for public spending.



  10. Anonymous says:

    Mr. Byles’ article is an eloquent riposte… to a number of arguments that have never been made.

    First, nobody, but nobody, is suggesting an income tax.  It is precisely this conflation of a modest, fair, simple and workable tax with one that is patently unsuitable on many levels that causes so many in the community to become apoplectic at the mention of any “tax”.

    Second, every commentator outside of the civil service agrees that government should reduce spending.  That is without question.  Many opponents of direct tax attempt to portray those proposing moderate alternatives as wild-eyed liberals intent on creating a profligate welfare state.  The notion that direct taxes are more inclined to “creep” than indirect taxes, or that government is more inclined to “tax and spend” with direct tax, is self-evidently untrue when one looks at the work permit and other business fees which have doubled, trebled and worse in recent years, not to mention recent import duty hikes.  

    Third, nobody has said that Cayman would have avoided the crisis if it had only had direct taxes.  The comparison with other offshore jurisdictions which have thrived in spite of direct tax (the list is long and distinguished) is merely to demonstrate that the implementation of such a system here in Cayman would not be the economic apocalypse many predict.

    Fourth, nobody has claimed that a direct tax system is inherently superior to a system of indirect tax.  Most countries have indirect taxes and there is a place for them in any tax system.  In fact, it is Paul that seems to make the opposite of the argument he is projecting on others, contending that Cayman’s tax system has been and continues to be inherentlysuperior without evidence and in spite of the evidence that the system is foundering.

    In addition, the article fails to draw the crucial distinction between the mobility of workers and the mobility of the companies that employ them.  It also neglects to acknowledge that it is precisely the level of taxes paid in the form of fees that is currently driving away the mobile businesses, to the cost of those service providers and job-seekers that remain here.  Many argue that it would be better to shift some of that cost to the public to encourage existing businesses to grow and new ones to establish themselves here.  No one has yet explained the basis for, or provided any evidence for, the conventional wisdom that a modest amount of payroll tax would cause workers to flee to other countries with tax rates an order of magnitude higher and jobs few and far between besides.  In any case it is better to lose a worker than a job. 

    The real debate is over how much of our tax should be paid by the people who receive the benefit of the services as compared to that paid by others who receive no benefit whatsoever.  The more we attempt to extract from those who do business here over and above the value of the service they receive from government, the less competitive we become and the more demand for the service falls.  That is basic economics and it has played out exactly as the text books would have predicted in recent years.

    Furthermore, the disconnect between the spending of government and the direct cost to the electorate (in the form of tax) is squarely in the frame as the primary driver of historic government profligacy.  As one panelist pointed out during the recent roundtable discussion, would the government be proposing a CI$9m hurricane shelter on the Brac if Brackers were being taxed to pay for it?  To quote Mr. Byles’ article, “would having that new system make the government any more accountable in its spending or would it be tempted to ‘tax and spend’ like most other governments?”.   Good question, you be the judge.

    Ironically one of the main arguments in favour of a modest payroll tax is one that appeals to almost every opponent of it: that it would reduce the cost to the country of 6,000 civil servants overnight.  A 5% payroll tax on employees would shave CI$15m from the core government payroll alone.  In other words, it would eliminate the deficit, even if it did not raise one penny more from the beleaguered private sector.

    In any case, the article overlooks the fact that there is already a direct tax and, in fact, a payroll tax in Cayman for all intents and purposes.  Making it arbitrary and regressive and calling it a “work permit fee” makes it no less of a tax.  Employers (particularly SME’s) in Cayman should look at the alternative system in Bermuda and ask themselves whether they, and the Cayman Islands, would truly be worse off under such a system.

    • Anonymous says:

      Well said!

    • Anonymous says:

      You are right that WP fees are like a direct tax.  And I see that as a key part of the Cayman’s tax gap problem.

      A NQ accountant may earn $70,000 and pay $15,000 for work permit.

      A senior lawyer may earn $300,000 and pay $15,000 for a work permit.  

      That’s regressive.  The better paid within society are not paying their fair share.  If payroll tax was set at 15%, with the first $30,000 tax free pay, and work permits were all $1,000, the government would raise significantly more revenue, employers cost would drop (which they could use to raise pay to compensate when the system was introduced) and the net result isa more progressive system.


      • G.Akerlof says:

        You are absolutely correct. A work permit fee is an inefficient and inequitable way of charging a payroll tax on expats.  Paul misses the main problem with our system of taxation and that is a disproportionate amount is paid by persons or companies who can easily move, eg expats, hedgefunds, class B banks, captive insurance companies, cruise ship passengers, air arrivals etc. So when things go south and "what or who" is easily moved leaves, then government revenue dries up. This is the fundamental reason for calling for a wider revenue base, which can come in the form of payroll tax or property tax or land tax or VAT etc to be paid by ALL residents. This would result in more sustainable revenue and would enable RESPONSIBLE Governments to provide better public services/goods.  Also it would have the unintended consequence of the electorate demanding greater accountabilty of Ministers and civil servants, as they would be contributing more to Government coffers. In other words there would be greater sense of ownership by the electorate.

        Alternatively, Government can continue the status quo and hope that the expats and foreign companies continue to come to our lovely islands at the same rate as in the past to provide much needed revenue. Of course cutting expenditure is not a bad option but you can only cut so much, at some point Government will not be able to provide services that citizens expect.

        • Dennis Smith says:

          "RESPONSIBLE Governments" is the operative phase. It that was true we wouldn’t be having this conversation in the first place. Our tax system isn’t broken our SPENDING SYSTEM is.


          There are huge economic disincentives in a tax system that duties imports, but before we replace it with something else we need to do a lot of careful, analytical homework and we need to get our public spending and financial management under control.

          This is not the kind of decision that we should make lightly or under duress. There are just too many “unintended consequences” (Read: Incompetence) that will materialize.

          A lot of permanent improvement needs to be made in our public and political structures before we begin serious discussion about alternative forms of taxation.

          • anonymous says:

            And the plan to achieve such conditions is….?

            And those responsible for coming up with that plan are…?

            And those responsible for the analysis are…?

            And the time to fix the broken system will be…?

    • Blousenskirt says:

      Anon 9;19: As a reader of CNS and one in despair at the neanderthal quality of some of the posts -not necessarily on this subject – thank you for a literate reasoned argument, whether or not one agrees with it. Pity you have to be anon.

    • anonymous says:

      Hear, hear.  This is a view shared by many, lamentably timid, people in financial services. 

      CNS, please post this comment as a viewpoint in its own right. 

  11. Anonymous says:

    To implement a direct tax on income, would not _likely_ result in continually rising taxes due to governments overspending… its an _absolute certainty_.

    Raising taxes would then be used as a political football, every election to see who’s taxes would go up (and they ALWAYS go UP) to redistribute in forms of crumbs to the _poor_ people, we would introduce class warfare into politics, income segregation etc etc etc…


    Here’s possibly a new idea for politicians and government…. STOP SPENDING WHAT YOU _DON’T_ FREAKING HAVE!!!!!!   DAMN SELF ABSORBED GLUTTONS!!





  12. Anonymous says:

    I am all for it! the poor and the middle class are the people that are most affected with this regressive indirect tax system that we currently have.

    • Anonymous says:

      What you overlook is that payroll/income tax would not be a substitute for the indirect taxes – the poor, middle class and wealthy will be paying payroll/income tax in addition to the already high cost of living.  That also ignores the fact that shortly after the tax(es) is/are introduced prices will go up (as will the tax).

      Be exceptionally careful what you wish for.


      • Lachlan MacTavish says:

         Personally I believe that Cayman has out grown the "hidden" indirect taxation system it has now of fees, duties and taxes. Cayman will eventually recover from the world wide recession and the nay sayers of direct sustainable tax income for the country will say , see our old system works, that is until we have another economic down turn and we will be right back to where we are today. Taxes are taxes in any form and we can debate direct indirect until the conches cross the North Sound. IMHO until we have year to year sustainable taxation income like a land tax through the survey department the fees and duties will just keep increasing without thought or planning. I say land tax because the CIG cannot balance or keep up the accounts so a payroll or VAT tax is way to much for the CIG to handle. Until we have smaller CIG, accountability, new leadership and new income streams all that will happen is debate. Of course the bottom line is that with our unaccountable bottomless check writing leadership no system will feed that appetite.

        • Dred says:

          In all fairness Lachlan no one faired well in this last recession, that is with or without taxes so where or how you would measure the effectiveness of either position is beyond me.

          When we recover it will be because the world recovered and our system still works to whatever degree.

          But to throw out "what happens when the next one comes" is silly at best because once again we all will be feeding from the bottom of the bowl both tax countries and non tax countries.

          I still say I find it hard to place more money into the hands of people who have proven time and again that they simply can not handle it. It’s like trying to kill a fire by trying to drown it in gasoline.

          I do not believe in more taxes because I believe it’s one step forward and two steps back. For every action there is always an equal but opposite reaction. Tax land then land sales drop and behind it possibly construction. Tax income then people buy less and become more a load on the system. Also maybe foreigners who come here says they may as well stay home so work permit fees drop.

          If you are talking a switch out of indirect to direct maybe I’ll sit and listen but if you are talking about levying another tax ON TOP of all the indirect taxes then I say no. Not until our government can fix the issues it already has.

          • Lachlan MacTavish says:

            I agree the system is broken. I believe that was the point in my last 2 sentences. My personal stand is as follows.  Cayman needs to drop district representation. We have grown out of that system and professional politicos control power and the government now, not the people. We have grown out of the indirect duty fee tax system. It was fine when it cost 3m a year to run the CIG. I believe we need to drop duties on all items necessary for day to day living. Food, clothing, gas, anything that effects the cost of utilities etc. Keep certain fees and taxes. Create some new income fees and have a land tax. Privitize and reduce the GIG. Wow , I must be still asleep and dreaming. Good luck Dred.


            • Anonymous says:

               I agree with everything but the land tax.  Most people oppose it because there are elderly people who own land that are receiving a very small pension so they would be unable to pay taxes.

    • Dred says:

      WOW. Okay. So now indirect taxes on the poor and direct taxes also. You are so kind to the poor.



      Simple solutions people…..

      – Control spending

      – Re-evaluate CIG products and efficiencies

      – Impliment more technology such as online payment and submittal systems

      – Find new revenue measures that don’t involve taking from the over burdened Cayman Islands people who already ENJOY one of the highest cost of living in ANY HEMISPHERE.

      Here’s a note the writer did not enter into….

      If you employ direct taxes by way of income taxes you face some serious issues with falling work permits because many foreigners come here to avoid taxes back home.

      If at the end of the day I am taking home 5% to 10% less will I not want a raise because let’s be real. I STILL DON’T HAVE THAT 5% to 10% to SPEND.

      And finally because I take home less it means I have less to spend hence the economy will take a pinch also.

      Fact is we have to get back to doing what we do well. As a tourist destination we have to become more viable as a destination of choice. This means raining in on prices and we can start by lowering fairs at Cayman Airways to the Cayman Islands. We can also ask our partners in the tourism industry to join us.

      BY lowering prices we should increase volume. More volume generally leads to a more healthy and stable economy.

      A next step is to lower business fees such aswork permits. This is doubling the burden upon local businesses. First they have to deal with recession and now you make them face additional fees also. This is sheer stupidity by our government. YES it’s a nice way to fatten the coffers in the short fall but for 1 year of good revenue we will suffer 5 to 10 years of fallout due to businesses leaving and closing. In my eye not worth it.

      What we should have done and what Big Mac fails to do is to develop with the UDP and PPM government a united plan for 3 to 5 years to put Cayman back in a stable financial position.

      INSTEAD what he is trying to do is to rush this process to ramp up revenues TRYING to show impressive numbers in a hope that they will sustain until the next elections so he can say LOOK WHAT WE DID. But what you will not see is the rip tide that is coming not far behind because of what he did.

      So in summary:

      – NO direct taxes

      – Continue to focus on how CIG spends money and cut where possible

      – Seek out new revenue measures to diversify base that does not mean taking from the people of the Cayman Islands

      – Do not be fooled by short term impressive numbers coming from UDP because of the long term damage we are about to face will far outweight the gains made.

    • anonymous says:

      If direct taxation was the answer – why is the USA, UK, Ireland, Greece, Italy  …. all on the verge of economic collapse.

      Dont be fooled. it is just an excuse for bigger and bigger govt spending.