Wednesday, March 10, 2010No New Taxes

Alan MarkoffLess Public Spending Only Option

A report commissioned by Cayman Finance and written by a renowned European tax specialist concluded that raising taxes here would devastate the economy and that the only viable way of balancing Cayman’s budget is through reduced government spending.

“...Detailed studies into the effect of different taxes find that direct taxes - income tax and corporation tax - are the most damaging type, far more harmful to the economy than sales taxes or other consumption taxes,” the report states. “Consumption taxes are often said to hurt the poor, but in fact it is taxes on business that hurt low-income workers the most, although the damage is less easy to see because it is through lowered wages and job cuts.”

The report, titled ‘The Cayman Islands: A Balanced Budget’, was written by Richard Teather, a senior lecturer in taxation at the Bournemouth University Business School in the UK.

Teather’s report stated that the effects of raising taxes could be much more severe in Cayman than in other places because a large part of the economy is built on the highly mobile financial services industry, which can react very quickly – by leaving Cayman – to tax increases.

After dismissing tax increases – particularly direct taxes such as income tax or corporation tax – as a possible way of balancing the budget, Teather’s report stated that there are only two alternative policy routes: debt finance/borrowing or reducing public expenditure.

The report says debt finance “should not be regarded as an ongoing solution.”

“As well as the economic problems of debt finance... it would be highly damaging to the Cayman Islands’ reputation as a place to do business,” the report stated. “Serious doubts would be cast on Cayman’s financial, fiscal and even political stability if deficits were allowed to continue annually.”

An ongoing deficit would also increase fears of future tax rises, something that could cause “businesses and investors to regard Cayman as a fiscally unstable jurisdiction,” the report stated.

Other offshore finance centres include an absence of debt as part of their marketing, Teather pointed out.

The report concluded the only option is to reduce public spending.

“The longer the Cayman Islands Government refuses to cut spending, the more likely it is that taxes would have to rise to maintain spending levels and service debt obligations – and businesses and investors will begin to factor this into their decision as to where to invest,” Teather stated.

“If the government does not demonstrate the political will to tackle the deficit, then the perception of fiscal risk will increase,” the report continued. “But in addition the deficit will come to be regarded as a political risk, since the population will be led to believe that the level of government spending is acceptable.

“It is therefore important for the Cayman Islands’ reputation that the deficit is dealt with quickly. And since that cannot be done by levying direct taxes or by on-going borrowing, the only option is to reduce spending levels.”

Comparative public spending

Although the report does not propose specific areas of spending to be cut, it does compare the government spending in the Cayman Islands with that of similar countries or territories.

The comparison was made with 19 non-Europe countries and territories with a population between 5,000 and 125,000. About half of those places were in the Caribbean and half elsewhere. All countries in the group are in a similar situation to the Cayman Islands, in terms of having relatively small populations and having the logistical problems of being relatively remote islands, the report stated.

“When that comparison is made, it becomes clear that the Cayman Islands government is wholly out of line with its peers, having far higher levels of public spending than any other comparable jurisdiction,” Teather wrote.

The report stated that based on UN data for the group of 19 countries and territories, “the Cayman Islands are immediately prominent as having levels of government spending massively higher than the other members, both in absolute terms and when compared to the size of the population.”

Cayman’s total government spending is twice the level of the next highest member of the group – Antigua and Barbuda - which has a higher population at 88,000. Cayman’s total spending is also more than two and a half times the nearest jurisdiction with a similar population size – St. Kitts and Nevis - which has a population of 52,000.

In terms of government spending per head of population, Cayman spends more than twice as much the average level for the comparison group and almost 40 per cent higher than the next highest in the group, which is Turks and Caicos.

“...The group overall shows that spending per head is generally lower for those [jurisdictions] with higher populations, presumably due to economies of scale in government operations,” the report stated. “However the Cayman Islands break this trend, by having significantly higher spending per head than both smaller and larger countries.”

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