The ‘Cayman Tax’

First Published: 2008-01-25

Copyright 2007. Reprinted with permission of Grand Cayman Magazine.

Few economies have been able to reach the level of success that the Cayman Islands have achieved in such a short period of time. In one generation, the Cayman Islands have come from being a prototypical, slow-moving, Caribbean country to being a key player on the international financial stage.

This success is even more impressive when one considers Cayman’s economic endowments. Besides it natural beauty, it has no natural resources to speak of. It has no unique technology or process that would draw international recognition. And a generation ago it had a very small and not very well educated population.

At first glance, Cayman’s success seems to be the result of carefully crafted “social institutions” – laws, a regulatory environment, social stability – that promoted economic growth.

People – talented people – are at the heart of Cayman’s success. Whether these people work at creating and maintaining the social institutions or are employed in businesses that benefit from such institutions, it is from the talented people in Cayman that its success is derived.

There is, however, a challenge in creating effective social institutions.

For instance, when one sees the growth of an effective international financial regulatory environment, it may lead one to believe that more of the same will lead to even greater success. However, when it comes to creating government bureaucracies, this is surely not the case. The nature of Cayman’s government bureaucracy in the domestic economy is emerging as a serious threat to its future.

There is no arguing that there is a role of government in creating the physical and social environment conducive to doing business. However, it is possible for government to become an impediment to economic progress.

Public Finance

Part of the mystique of Cayman is its lack of taxes – no income, sales, or property taxes so typical of the rest of the world. Of course, the government needs some revenue to play its necessary role in a modern economy. These revenues primarily come from duties on imports, license fees on businesses, work permit fees for expatriate workers, and fees paid by tourists.

In 2005 the Cayman Islands government collected revenues of CI$429 million, and spent CI$339.4 million. For that year, government expenditures represented 17.6 percent of the country’s Gross Domestic Product.

Relative to other affluent economies, the government in Cayman is not inordinately large. However, it is not just the size of government that determines its impact. The impact of government is as much related to how it plays its role as it is in the activities it undertakes.

As much as Cayman’s financial regulatory environment stimulates economic growth, its domestic bureaucracy stifles it. It is much more than the incredibly cumbersome and slow delivery of public services that stifles growth. The greatest obstacles come from Cayman’s social institutions around business development, human resources, and the role of government.

Bureaucratic Burdens

The bureaucratic inefficiencies of Caymanian government services are legendary. From long lineups and unpredictable processing of work permits to the requirement to lineup to buy a 25-cent form as part of the seemingly endless process of paying duties on imports, the bureaucracy seems to be focused on anything but the efficient provision of service. As much as government inefficiencies are concerning, the creation of bureaucratic processes that create disincentives for businesses to be more efficient is much more serious.

The economic success that Cayman has enjoyed over the past three decades has required many changes to occur. Besides the creation of a unique, stable, reliable, and innovative international financial regulatory environment, there have had to be changes in the physical environment (e.g., residential and commercial developments, transportation and telecommunications infrastructures), and changes in the social institutions – from education and immigration to health care and social services.

As much as the regulatory and physical development has been a boon to Cayman’s success, its social institutions have lagged behind those of similarly affluent countries. It is the underdeveloped social environment that hinders Cayman’s ability to sustain its economic success and is at the heart of what I call the “Cayman Tax.” The Cayman Tax comes from a cumbersome bureaucratic structure that allows government to impose costs on businesses in Cayman.

Caymanian Business

In 2005 there was a total of 74,950 licensed businesses in Cayman. For an employed labor force of 35,464, there are more than two business licenses for every worker in Cayman. About three-quarters of the licenses are classed as “exempt” businesses. These businesses mainly operate outside Cayman, are exempt from any taxes that may be imposed over a 20-year period, and must have a registered office in Cayman. Taking these businesses into account, there are about 20,000 businesses in Cayman.

The process that must be followed in getting a local business license provides some insight into the relatively unique responsibilities of businesses in Cayman. Each business must be 60 percent Caymanian owned. With about 22,000 Caymanians in the labor force, and the dominance of men over women in the business community, there is a relatively small group of people who can be drawn on to meet the 60 percent Caymanian ownership requirement.

The license application requires details about the nature of the business and a human resources strategy where plans for hiring Caymanians, and providing them with opportunities to advance in the business, are outlined. Generally, two Caymanians must be hired for each expatriate. The human resources plan is “audited” and must be adhered to.

This human resources plan is, in effect, a quota system that ensures that Caymanians get jobs – that they share in their country’s economic success. Fair enough. However, this system creates a disincentive to productivity improvements.

With employment practically guaranteed, what is the incentive to become better at one’s job? If an unproductive employee were fired, the business may not meet its quota and potentially lose their license, and the unproductive worker is practically ensured another job in another business that needs to meet its quota.

Although employers have obligations to provide time and bear the costs of training and education for their Caymanian employees, there is no regulatory requirement for the employees to succeed in their development. This is one of the factors contributing to the relatively insignificant role that education plays in Caymanian culture. Quotas ensure employment regardless of the level of education and skill.

In an unusual twist of logic, the demand for Caymanian labor grows as the productivity of Caymanian labor falls. Less output per worker makes more workers required to achieve a particular level of output in a rapidly growing economy. Rather than have falling productivity forcing wages down, an increase in the demand for labor, given the limited supply, drives wages up.

In effect, the business licensing policy ensures that local employment is put ahead of providing incentives for businesses to be efficient in an increasingly competitive global economy. Under such a bureaucratically imposed system, management can be forced to develop inefficient procedures (i.e., not using the latest productivity-improving technologies because it reduces the size of their workforce) for the sake of meeting their employment quotas. This removes opportunities for business to lower their costs and become more competitive.

Holding businesses to employment quotas, and associated requirements, imposes inefficiencies, and undue costs, on business. Businesses bear the costs typically born by government for the least productive segment of the labor force through unemployment insurance, welfare support, and training to upgrade skills. This imposition of costs through government policy and bureaucratic constraints on competitiveness is the “Cayman Tax.”

Tangled Public Policy

There is ample evidence to suggest that the kinds of activities being undertaken by government are accumulating in a way that will obstruct Cayman’s economic future further. Government is not assuming its responsibilities for promoting the productivity of workers and the competitiveness of its businesses. With international finance being more widespread globally and the pressures to find and develop high-end knowledge workers growing, Cayman’s conscious reluctance to recognize the challenges presented by a growingly competitive world is a serious economic threat to its future.

Perhaps there is already a trend emerging. The number of Bank and Trust Licenses declined 21 percent from 2001 to 2005. This is not a post-Hurricane Ivan phenomenon.

Over the past two years the debate over the limiting the time an expatriate can work in Cayman to seven years has seemingly come to an unfortunate end. In the interests of creating jobs for Caymanians and limiting those who can achieve “Caymanian status,” this policy will both discourage the best minds in finance from moving to Cayman and will send successful and experienced people off the island to work for competitors.

While it is clear that government is becoming even more diligent concerning businesses meeting the Caymanian employment standards, the same degree of accountability for their own employees does not seem to be an issue for government. The government’s accountability for the pension funds of its own employees seems to be of little concern. The 2000 annual report of the $138 million Public Service Pensions Board – the pensions for civil servants, legislators, and the judiciary – was submitted to the Legislative Assembly in May of 2006 – five years late.

In 2006, when it was suggested that the pay for public servants was going to be linked to their performance on the job – i.e., their productivity improvements – there was a public outcry against it. Generally, the popular culture of Cayman cannot see the centrality of improving the quality of people’s work in the public and private sectors to its future economic prosperity.

The continued, historical conflict between religion and education in Cayman – and the enduring cultural bias against moving Cayman’s students to a much higher international standard – is yet another indication of the social lag that discourages productivity improvements.

A Competitive World

Cayman is not tax free. The type of tax burden that has been proven to stifle business in other first-world economies comes from very different sources in Cayman. It is not from the imposition of direct financial payments by citizens and businesses. In Cayman it is a tangled web of public policy that discourages improvement in the productivity of labor, stifles innovation, and emboldens a cultural attitude against becoming more competitive in international markets.

Cayman is at a crucial time in its development. After a period of incredibly successful economic growth – its “adolescent” phase – it is about to enter its “adulthood.” As much as it is nice to hold onto the trappings of youth, the harsh realities of a big, competitive world presents serious challenges that must be faced – like it or not.

Public policy now needs to be looking outward – not inward. The public sector must assume its difficult role of facilitating economic growth for the sake of the next generation of Caymanians.

Dr. Phillips, an internationally renowned economist, has served on the faculty of the University College of the Cayman Islands. He is currently practicing his craft in Canada.

The views expressed are those of the author, and not necessarily those of the Nassau Institute (which has no corporate view), or its Advisers or Directors.

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