Bermuda’s Unique Economy
The new OBA Government must now decide the best way to stimulate Bermuda’s struggling economy. This is obviously an important issue because if they can get it right, they will create new jobs while decreasing the national debt; but if they get it wrong, they may cause Bermuda to continue its downward spiral into economic depression.
The problem is not unique to Bermuda. Many economists, businessmen and political leaders around the world are trying to decide the best way to stimulate their respective economies.
Some argue that government spending is best; others believe tax cuts are the way to go.
Because there are merits to both sides of this economic debate, it is difficult for these countries to decide which road is best for them.
Fortunately, in Bermuda, the appropriate choice is much less difficult because Bermuda’s economic structure is fundamentally different than that of most other countries.
Part One Why Government stimulus spending doesn’t work well in Bermuda
Bermuda’s economic structure has three unique factors that dramatically decrease the effectiveness of stimulus spending.
First, unlike most countries, almost all goods and materials purchased in Bermuda are imported from foreign sources. That ’s a big problem for many stimulus spending programmes because every dollar of spending that goes toward the purchase of foreign materials adds zero benefit to the Bermuda economy.
For example, Government spending on physical infrastructure like the new courthouse was helpful to the extent the money was used to pay local architects, contractors, masons, electricians and general labourers, but it was unhelpful to the Bermuda economy to the extent the money was used to pay for the foreign-produced bricks, steel beams, lumber, drywall, electrical wiring, tile, new furniture and hundreds of other items that were purchased to build and furnish that building.
In other words, Bermuda’s reliance on imported goods and materials generally makes spending on physical infrastructure in Bermuda a less effective economic stimulator than similar spending in other countries where all of the labour, goods and materials are produced in that country.
Second, unlike most countries, the main driver of Bermuda’s economy—International
Business —consists of foreign companies that sell their products outside of Bermuda. That means that Bermuda Government stimulus spending in Bermuda will effectively do nothing to stimulate demand for the products sold by the companies that are the main driver of the
Bermuda economy. And since a huge number of Bermuda local companies do their hiring based on the direct and indirect demand for their services from International Business, stimulus spending will provide much narrower “trickle-down” benefits throughout the Bermuda economy.
Finally, and perhaps most important, it is structurally much more difficult in Bermuda to raise the tax revenue needed to pay for stimulus spending because International Business —the main
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driver of the Bermuda economy —consists of foreign companies that can easily arrange their affairs to minimize their exposure to Bermuda taxes by simply moving jobs to other jurisdictions
(as they have been doing for the last four years). So even if stimulus spending in Bermuda were an efficient way to create jobs in Bermuda (which, as discussed above, it isn’t) the raising of taxes to pay for that spending could trigger a large exodus of jobs at a much faster rate than in other countries, thereby negating much or all of the benefits of the stimulus spending.
Indeed, the exodus of IB jobs after the large payroll tax increase in 2010 is a perfect example of that problem.
In other words, most other countries can raise taxes without fear of a large percent of their companies simply getting up and leaving the country. But in Bermuda, that is not the case. A significant increase in taxes will result in a large exodus of the companies that form the core of
Bermuda’s economy. For that reason, increased government spending (and the debt it creates) is much harder to pay down in Bermuda and it would take a much lower debt threshold to cause a complete collapse of the economy.
So the reality is that, in Bermuda, Government stimulus spending creates much less benefit and has a much higher cost than stimulus spending in other countries —it provides proportionately less stimulation to the Bermuda economy and it results in higher tax costs that cannot be easily passed on to anyone other than Bermudians.
Most important, the debt threshold created by stimulus spending will bring Bermuda to economic collapse much sooner than it would in other countries because Bermuda can’t easily pass on that debt by increasing taxes without risking a mass exodus of International Companies and jobs.
That makes Government stimulus spending in Bermuda not just a high cost/low benefit proposition —which is always a bad investment—but it also makes it a very dangerous game that could easily lead to economic collapse. For that reason, the Bermuda Government should try to find a more effective, less expensive and less risky method of stimulating the economy.
Part Two Why tax reductions work better in Bermuda than in most other countries
In most countries, the businesses that are the main drivers of the economy usually don’t have the economic mobility to simply get up and leave the country if the government raises taxes.
For instance, if the US Government were to raise taxes, it may cause a slowdown of the economy, but it is not going to cause the majority of American companies to simply get up and leave the country. Conversely, a decrease in American taxes may cause an increase in economic activity, but it’s not going to cause the number of businesses operating in America to double in the next year or two.
That’s because most businesses in America need to be in America to conduct their business.
(Yes, outsourcing can reduce that need, but for many businesses, outsourcing to other countries is not possible, e.g., shale oil production, grocery stores, railway transportation etc.)
So an increase or decrease in taxes may affect the amount of business they do, but it usually
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will not affect their decision to remain in the country. For the most part, they just have to suck it up and accept the reality of higher taxes.
In Bermuda the opposite is true. An increase or decrease in taxes has a direct effect on whether the main contributors to its economy —International Companies—stay or go. That’s because these companies sell their products and services to customers who are located outside of Bermuda, and therefore there is no intrinsic need for them to be in Bermuda to conduct their business —they can just as easily service their clients from Ireland, Switzerland, Cayman or any other low tax jurisdiction.
That makes tax rates in Bermuda a double-edged sword that can be swung powerfully in either direction.
In the same way that these types of companies have the operational freedom to move jobs from
Bermuda to more tax-advantageous countries, they also have the freedom to move jobs from other countries to Bermuda if Bermuda were to offer more competitive tax rates, particularly lower payroll tax rates.
So if Bermuda wants to stimulate its economy, one of the most effective ways to do that is to reduce payroll tax rates for IB companies to the much lower levels that prevailed before the PLP dramatically raised them.
But the Government must be careful about how it structures its tax relief because, while it would be nice to give all businesses in Bermuda a tax break, the present high national debt ($1.5 billion) makes that difficult if not impossible to do without causing the debt to further skyrocket.
Realistically, the Government can only afford to give tax relief in targeted areas, and so it should target the industry that gives the biggest bang for its tax stimulus buck. That means targeting tax relief for International Companies because, unlike most local companies, they can generate jobs not just in their own industry, but also in many other sectors of the economy.
For example, offering lower tax rates only to local companies will generate only a minimal increase in long-term growth and jobs, while offering lower tax rates only to International
Companies should significantly increase long-term growth and jobs.
That’s because a large majority of Bermuda local companies derive their revenue either directly or indirectly from International Business. If International Business is not expanding, then these local companies will not significantly expand their businesses, and no amount of tax relief is going to change that.
Conversely, if tax rates were significantly lowered only for IB companies, it would not only stem the flow of exiting IB companies, but it would also make Bermuda much more attractive to new
IB companies. The resulting increase in IB operations would not only increase the number of
Bermudian jobs at the IB companies, it would also increase the number of Bermudian jobs at the local companies that directly and indirectly provide services to IB.
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In other words, lower tax rates for IB companies would increase the number of Bermudian jobs at International Companies (e.g., insurance companies, captive management companies, mutual funds and fund administrators) which would increase the jobs at the local companies that directly service the IB companies (e.g., law firms, accounting firms, computer companies, office supply companies) and the jobs at local companies that indirectly service the IB companies
(e.g., retailers, restaurants) as well as increase the incomes of the individuals who provide services to the IB workers ( e.g., landlords, taxi drivers) and the charities that receive donations from IB (basically all charities in Bermuda).
This additional economic activity at numerous levels of the Bermuda economy would also increase future Government tax revenues giving Bermuda a five-layered positive effect from the lowering of IB tax rates. No other sector of the Bermuda economy can respond to tax reductions anywhere near as powerfully as the IB sector.
The dire state of the Bermuda economy, with high unemployment and high national debt, requires prudent governance to guide it forward. By carefully wielding the sharpest, most powerful weapon in its arsenal —lower tax rates for International Companies—the new OBA
Government can generate new jobs and higher incomes in multiple sectors of the economy.
Kevin Comeau
December 2012
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