Cynics might say the new Framework for Fiscal Responsibility signed by the premier in November will give Cayman a reprieve of up to three and a half years to sort out its government finances before the call for direct taxation will return more forcefully than ever.

If government was unable to cut expenditure and/or revenues did not grow sufficiently - both are not unrealistic scenarios - the UK would have good arguments again to press for the introduction of direct tax revenue sources. The question is what effect a property tax would have?

Principles applied to taxation systems require that taxes are adequate, meaning that they raise sufficient revenue in a stable way. They should also be equitable or fair both horizontally and vertically.

Horizontal equity refers to the way the tax burden is shared across society equally between those in similar circumstances (eg between wage earners and investors or Caymanians and expatriates), whereas vertical equity refers to whether rich or poor people are affected more by a tax, ie the progressive, proportional or regressive structure of a tax.

Moreover, taxes should also distort the economy as little as possible (neutrality) and they should be simple, both in terms of how a tax is assessed and in the way it can be collected.

Property tax I

Cayman already has a tax on property transfers in the form of a stamp duty. This levy on property sales brought government $21.3 million in 2010 down from $47.1 million in 2006.

Any increase in this duty will undoubtedly hit the sales activity in the real estate market, but it also has a major flaw in that it is a tax borne only by the buyers and sellers of properties rather than all property owners. Tax experts would say the tax is not fair (horizontal equity), because only some members of the community pay for the benefit of all.

This is a flaw in Cayman’s tax revenue base generally. Government revenue is supposed to pay for the services that the residents of a country expect from its government in terms of education, security, healthcare, pension and infrastructure etc.

However, in 2010 about one third of the tax revenue was derived exclusively from non-residents and expatriates (through work permit fees and fees imposed on non-residential businesses). The remainder is shared by all residents, in large part in the form of import duties. Yet, not all residents benefit fully from government services. Expatriates for example have no access to the education system and are largely excluded from social grants.

As a result Cayman’s tax system is horizontally inequitable. It is also vertically inequitable as the main source of revenue, import duties, are akin to a sales tax that is regressive. Because the same tax rate applies to everybody, sales taxes hurt people with less income more.

Property tax II

Another type of property tax, which could be introduced in the form of a community service charge that is assessed on the size of a property (land and buildings) similar to a council tax in the UK, would at least partially address both these problems.

The main argument in favour of such a property tax is that it is predictable and stable. If you live in the Cayman Islands you would pay, either directly as the property owner or indirectly through increased rents, if you are renting.
This would also make it a more horizontally equitable or fairer tax because everybody is subject to the tax, in particular those who benefit most from the services funded by the tax revenue.

Property taxes tend to be progressive (the larger the property, the higher the tax, with possible exemption for small properties), while the services provided are proportional. This shifts more of the tax burden from poorer to richer tax payers.

How straightforward it would be to assess a property tax is anyone’s guess, but the Lands and Survey Department should have the necessary data with regard to property values.

The disadvantages are that such a property tax significantly distorts the real estate market by making purchases of Cayman property by investors from abroad less attractive. In addition, like any other form of direct taxation, it would be difficult to collect, although government could put a lien on the property to enforce the payment, and the cost of collection would in part erode the tax intake.