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Today's Date: 01 September 2014
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Richard W. Rahn is a senior fellow of the Cato Institute and Chairman of the Institute for Global Economic Growth.  He writes a weekly economic column for he Washington Times. Previously, Dr Rahn served as a member of the Board of the Cayman Island Monetary Authority and as Vice President and Chief Economist of the Chamber of Commerce of the United States. He was the founder of the Novecon companies,including Sterling Semiconductor, now owned by Dow Corning.  He has written hundreds of articles for leading newspapers, has contributed to numerous books and professional journals, and is the former Editor-in-Chief of the Journal of Economic Growth. He was an economic advisor to former President George H.W. Bush in the 1988 campaign.  He holds Ph.D. from Columbia University, and was awarded an honorary Doctor of Laws by Pepperdine University.
 


T. +1 (703) 553 3700
E. RWRahn@aol.com 

 

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Is Cayman committing economic suicide?
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The proposed tax, since dropped, would have been a 10 per cent payroll tax on expatriates making more than $36,000 per year. Cayman had never had a direct income tax, and officials have always previously insisted that Cayman would never have one.

The lack of income taxes, along with an honest, efficient judiciary, strong protection of property rights, free movement of capital and limited and cost-effective regulation have made Cayman one of the world’s most successful offshore financial centres.

Cayman rose from a poor Caribbean backwater to an entity having a per capita income roughly on par with the US over the last four decades. There is little real poverty, relatively good infrastructure, low crime, and a well developed tourist industry, making Cayman a very attractive place to live and work.

Cayman’s Achilles heel is that it is a functioning democracy where the civil servants have a disproportionate influence – like in Greece, and in many towns and cities in the US. Because of the large number of expats living in Cayman, only about half of the resident adult population has the right to vote.

The current population is about 55,000, yet only 12,360 people voted in the last election. There are about 3,600 civil servants, up 50 per cent from 2005 when there were about 2,400, a large proportion of which are local Caymanians with the right to vote. Expatriates are employed primarily in private business.

Most of those who vote have a family member or least a good friend who is a civil servant, and Caymanians, like others, tend to defend and support their family members and friends. Politicians, being politicians (in both of the two major parties), thus pander to the civil servants to get their votes and the votes of their family members and friends.

The consequence is a bloated civil service with salaries and benefits growing far faster than the economy. Obviously this is not sustainable and has probably already passed the tipping point.

During the last five years, the Caymanian economy has been stagnant – no real increase in GDP – because of both the world-wide financial crisis, which has had a heavy impact on the large Cayman financial and tourist industries, and the negative effects on the economy of too much growth in government. As can be seen in the following chart, government spending in Cayman is growing very rapidly as is the debt burden.

There is no “tax increase” solution to this problem. Again, if government spending is growing faster than GDP, no amount of tax increase can stop the inevitable meltdown of the economy. The problem was recognised three years ago, at which time, the government engaged a group of internationally known economists and fiscal experts to assess the problem and make recommendations – which came to be known as the Miller Commission, after the chairman of the Commission.

The Miller Commission concluded that up until 2006 the Cayman government’s fiscal performance was “acceptable”, but was now on a “path that is no longer fiscally sustainable”. Its conclusions included: “The Cayman government has huge unfunded liabilities – specifically civil servants’ defined-benefit and healthcare plans.” And it also concluded: “It should be possible for the Cayman government to restore and maintain fiscal sustainability by undertaking major cuts in spending by privatising enterprises and by selling other assets.” The Commission made twelve major recommendations.

The first recommendation was: “Do not impose direct taxation.”

Yet this was exactly what the government proposed in July 2012. The fact that the government even made the proposal did great damage to Cayman. Many who moved to and invested in Cayman now realise they are in fiscal danger, and, being rational, they are looking at other places to live and work. Upper-income expats are a highly mobile group, and their capital is almost instantaneously mobile.

All countries are in tax and regulatory competition with each other. This is particularly true of jurisdictions that market themselves as having low or no taxes on capital and labour. Jurisdictions that directly compete with Cayman, or wish to do so, will be sure to try to take advantage of Cayman’s misstep.

Decades ago, Cayman was able to take advantage of the missteps of both the governments of Jamaica and the Bahamas, who undertook policies hostile to saving and productive investment.

Many Caymanians seem to have forgotten that their success was not only the result of their sound economic policies, but also partially due to the flight of human and financial capital from their poorly governed neighbours.

If Cayman is going to continue to prosper, it has no choice but to go back to pro-growth economic policies. The single most important policy is to cut back government spending to the level of current tax revenue without more tax increases. Tax revenues have been growing faster than the economy, so cutting back to the level of revenue is neither unrealistic nor draconian.

There is a rule that applies to most governments and is certainly true in Cayman, and that is that 20 per cent of the people do 80 per cent of the work. I have worked with and seen the Cayman civil service up close, and it is obvious that it could be substantially cut with no loss in service.

Again, only seven years ago the civil service was one third smaller than it is today, while in those seven years the population has only grown by 7 per cent. There is no reason why the number of civil servants should be growing at a faster rate than the population, unless there is negative productivity growth within government – which speaks to a severe management problem.

The Miller Commission cited a number of academic studies that indicate that the Cayman government has grown far beyond its growth-maximising level, which is particularly true given that the UK handles most of Cayman’s defence and foreign affairs costs with no charge to Cayman.

One study cited by the Commission was by the Joint Economic Committee of the US Congress, which found: “The optimal level of federal government spending is about 17.6 per cent of GDP. Beyond this point the resources consumed by government impose more costs on the economy than benefits.” It is clear – from both the theoretical and empirical evidence – that the Cayman government is now well over the optimum size.

Without cutting spending, the debt will continue to grow to an unsustainable level. Also because Cayman has a currency board monetary system, it will not be able to inflate its way out of a debt problem – and the cost of interest is almost certain to soar. Its only other option would be to default or sell assets.

Those who advocate increasing taxes in Cayman fail to appreciate that any significant tax increase, particularly on labour and capital, will further slow economic growth and make the jurisdiction less competitive, and perhaps drive Cayman back into a recession.

Cayman could also get rid of much of its deficit problem by eliminating most of its subsidies, which have doubled in the last five years. For instance, underwriting the losses at Cayman Airways cannot be justified as there are a number of commercial airlines who do and are quite happy to service Cayman.

The voting citizens of Cayman need to face reality. Their bloated government is about ready to kill the golden goose – and year-by-year all Caymanians will be poorer unless they take action now. The successful parasite does not kill its host, which is a lesson that many civil service representatives around the globe have failed to learn.

The book “The Rise and Fall of Cayman” has not been written – but it will be if the citizens of Cayman fail to realise that they are masters of their destiny.
 

 

 Cayman by the numbers  
    2011 Per Cent
Change
Population 52,000 55,000 5.8%
Total Gov’t Revenue (in millions) $500.4 $545.8 9.1%
Total Gov’t Spending (in millions) $433.1 $626.1 44.6%
Interest on Debt (in millions) $8.9 $32.9 269.7%
       


 

 

 

 
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