Tuesday, September 01, 2009

Cayman: dying by the sword?

The Cayman Islands government is heading for bankruptcy and the UK government, which has ultimate responsibility for the governance of the Caymans, has declined to bail it out. The Guardian newspaper reports that British government junior Foreign Office minister Chris Bryant, in a letter to William McKeeva Bush of the Cayman Island government, has demanded that the Caymans cut back on borrowing and debt levels and, whisper it gently, has even suggested that this notorious Caribbean tax haven should introduce income tax and property tax.

As the Guardian reports,

"the world's biggest hedge-fund venue and fifth-biggest bank centre is now threatened, as the government of the Cayman Islands heads for bankruptcy — unable to pay its own staff and facing the prospect of introducing taxes as income from the world's shrunken financial system collapses."

(We presaged this a little while ago with a little TJN scoop, highlighting the panic.)

Over a decade ago this blogger (John Christensen) and his colleague, Dr Mark Hampton, attended a special Foreign Office conference at its Wilton Park conference centre on the governance of Britain's Overseas Territories.

"Sustainability" was the buzzword. Time and again the issue of government revenue was raised. Cayman in particular was keen to fund an investment programme in new schools and health services, but lacked the income to fund from internal resources. Along with my colleague Mark Hampton, we suggested that the Cayman government should broaden its tax base beyond sales taxes and company registration fees, but the Cayman officials were adamant that they should do nothing to adversely affect their "competitive" tax system. Instead, they opted to finance their much needed investment programme through debt, backed by expectations of continued growth of the offshore financial services sector.

The tone of Chris Bryant’s new letter hints at UK government frustration with the Cayman authorities:

Clearly operating expenditure has risen too quickly in recent years. This has reduced your scope to self-finance the capital projects that you have underway, putting additional pressure on borrowing.

Given the huge level of UK government borrowing for capital expenditure programmes, albeit through ‘off-balance sheet’ private finance initiatives, the words ‘pot’, ‘kettle’, and ‘black’ spring to mind, but what the letter really reveals is that after decades of neglect the UK government has finally woken up to its responsibilities (the Turks & Caicos situation has been a rude awakening in this respect) and finds itself staring at yet another budgetary black hole.

Faced with a budget deficit of C$ 67.5 million (Richard Murphy has more details here) – a huge sum for islands with a total population of only 51,900, some of whom lives on low incomes, the Cayman government assumed a rapid resumption of growth of its financial sector. Bryant pours cold water on this assumption:

It would be unwise, I suspect, to rely too heavily on a rapid improvement in trust fund income or to expect that the Cayman Islands’ prosperity can presume on an offshore tax haven status.

Unwise indeed. But can the UK government simply wash its hands of the islands’ affairs? The answer is undoubtedly no. Hence Bryant’s clearly formulated suggestion, which reads more like a command, that the Cayman government now broadens its tax base:

To make public finances more resilient in the face of these uncertainties and to give me confidence that you will be able to service any new borrowing you will have to widen the tax base. I fear you will have no choice but to consider new taxes – perhaps payroll and property taxes such as those in the BVI.

It would be unrealistic to expect that sweeping changes to tax policy can happen overnight. Short term support will be required to prevent the already bad situation from spiralling out of control. Hence Bryant makes it clear that the British government has not totally ruled out budgetary support:

. . . if I can be sure that your plans to manage the situation are realistic, and clear progress is being made, then I am prepared to consider further borrowing request.

This is fair - but only if there is a full UK government enquiry into the governance of those overseas territories and Crown Dependencies that have taken the path of becoming tax havens, using tax competition as the basis for their economic development models. The sustainability of tax competition based developments was discussed at the Wilton Park conference mentioned earlier. Both of us advising the conference warned this would precipitate a race to the bottom, noting that those who live by the swords generally die by the sword.

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