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My advice to the SAGE Commission

The SAGE Commission in Bermuda has been formed “to identify activities that are central to the core mission of Government; to evaluate and analyse the operations of Government and its corporate bodies and agencies in line with international best practice; and to make recommendations regarding the streamlining of such processes to improve service delivery (effectiveness), cost savings (efficiency), greater transparency and sustainability”.

They are looking for ideas to help in their mandate to essentially “right size” and make the Bermuda Government more effective. This column does not permit me to go into extensive detail but I will briefly summarise some of my thoughts on this matter.

It is first of all important to determine what number we are shooting for. What does Bermuda need to save, cut or raise to right size Government and stabilise the debt situation. To summarise, the Government has a roughly $250 million hole that it needs to fill. This is calculated by the change in the primary Budget that is needed to stabilise the debt situation. In other words, this is the dollar change from the current projected primary deficit to about a 1% primary surplus that will stop the debt to GDP ratio from escalating further. (The details of this can be found in a prior article: http://www.royalgazette.com/article/20120402/COLUMN05/704029978). In order to get there Bermuda needs to cut expenses AND raise revenues in some fashion. I will go through both aspects with some brief suggestions on how to begin shrinking expenses by $100 million and raising revenues by $150 million.

One thing to note before I proceed. In discussions I have had with various people I often hear the phrase “but” or “when things stabilise”. I think these are probably the most harmful phrases I have come across in terms of stemming any progress. Of course some changes will be difficult and may have problems implementing, but I fear that sitting on our hands is far worse and is an assured recipe for continued stagnation. Brave choices need to be made and action needs to be taken. “Waiting for the turn” will not avail any benefit.

Expenditures and Efficiencies

Government expenditures and Government’s share of the Bermuda economy has escalated over the past ten years. In 2003 the Public Sector contributed about 13.6% of the economy. It is now estimated to account for roughly 15%. In fact, even though the economy is essentially at the levels seen in 2003, the public sector has actually expanded by some $100 million from its 13.6% of GDP in 2003. If the Bermuda public sector is to get more in line with the size of island’s economy and in line with its historical average, I would suggest the goal should be to shrink Government expenses by some $100 million. Here are three suggestions for meeting that goal:

1. Privatisation. Part of the mandate of the SAGE commission is to consider privatisation of some government functions. I would suggest starting to look at the public transportation system and waste sectors. Based on its estimated revenues of $10.5 million and its expenses of $20.9 million the public transportation department appears to bleed $10 million a year. Government’s policy to provide free and subsidised transportation for seniors and students will always keep this department in a deficit but privatisation may bring more efficiency into the system. The Tynes Bay incinerator could be sold to a private consortium interested in expanding the waste-to-energy output. This may help our energy issues as well as generating cash and potentially revenues for the Government. This has been proposed in the past but I think the idea needs to be revisited. A regulated system to allow independent energy producers such as Tynes Bay and “green energy producers” to the provide power grid is important. The Government should also consider privatising quangos, such as Wedco. The latter may want to maintain some land ownership in Dockyard but the Government has valuable property that could be sold and developed by private entrepreneurs.

2. Defined Contribution Pension Plan. The Government has an escalating unfunded pension obligation that amounts to an estimated $1 billion future obligation at this stage. It is essentially costing the Government about $150 million annually. One way to prevent this from escalating further is to move public employees to a defined contribution plan from a defined benefit plan. The current defined benefit plan guarantees employees’ future pension obligations at prescribed levels and places the unfunded amount with the Government. Most private companies in Bermuda have defined contribution plans which eliminates the funding risk as it borne by the employee.

3. Hiring Freeze and Attrition. We estimate that the labour force in Bermuda, based on demographic trends, is likely to decline 1.5% as older workers leave the labour force. I would suggest targetting similar contraction through attrition and retirement in the public sector over the next five years to slowly shrink the Government workforce to a more appropriate level in relation to the economy. In 2003, for example there were roughly 9,000 public sector employees. There are currently more than 10,000 public sector employees. Reducing headcount by 1,000 jobs over five years equates to a roughly 2% reduction per year.

Revenues and Taxes

In my opinion, Bermuda will not be able to find its way to prosperity and a balanced budget through expense cuts alone. Unfortunately, the revenue side needs to be considered, and the $250 million hole will only be filled by increasing revenues. If we can arrange $100 million in budget savings then we need to raise some $150 million in revenues. Here are a few suggestions:

1. Sales and Leaseback on Government Buildings. The recent Standard & Poors report on Bermuda pointed that the Government has significant assets. As discussed above, real estate sales and privatisation is a simple way of reducing Government debt. While the commercial real estate market is under pressure due to over development, Government should first identify properties that can be sold over the next five years. The Government also owns a number of buildings throughout the Island that occupied by public employees. If they entered into what are called sales-leaseback arrangements with private investors they could immediately raise funds from the sale that could be used to add to the sinking fund and/or retire some debt immediately. The properties sold would then be leased by the Government from the new private owner under a longer-term contract. Depending on how many structures are sold and the prices achieved a great deal of money could be raised to help stem escalating debt. The first step would be to identify the public sectors long-term requirements with the idea of adding efficiencies and lowering the public footprint. The public/private partnership to develop the hospital is a good example of funding a project without raising public debt but the privatisation of the hospital may make its operation more efficient and lower the Government healthcare burden.

2. Gaming. This, in my opinion, could be an immediate boost to economy. It’s likely to create construction jobs (which are sorely needed) in addition to licensee and gaming revenues. It’s very difficult to estimate the size of this revenue stream but initial licenses could generate tens of millions of dollars and it would provide an ongoing additional revenue stream. The Government should also negotiate more attractive contracts with the cruise lines to allow them to have gaming while in Bermuda.

3. Hire More Government Employees. Wait a second you say. You just said stop hiring?? In this case I think I have an area where the public sector needs to hire. The aircraft and shipping registration divisions in Government mint money. Aircraft registration makes an estimated $23.5 million per year and costs only an estimated $10.5 million to administer. That’s an over 100% margin. Sadly, as recently reported, it is under staffed and needs more personal to maintain its license and expand. Similar economics are present in the shipping registration side where shipping registrations make an estimated $4.2 million but cost only $1.9 million to administer.

4. Taxes will have to change. Government is working hard to make Bermuda competitive again. Ultimately attracting more tourism and international business to the Island should improve the economy and increase Government revenue but it is clear that tax rates will have to rise. The trick is raising taxes without hurting the economy and driving more people off the Island. Introducing a value added tax (VAT) may be a fair way to raise revenue on consumption. First of all it should actually help local retailers with cash-flow management as the cost of financing goods with duty is expensive. Essentially a retailer pays the full tax, upfront, even if the good is not ultimately sold with duty taxes. With value-added or sales tax the cost of taxation is extracted only at the point of sale. I understand this would take a massive change to the current system of collecting duty at the border, and there are ways for vendors to “game” the tax, but a conversion to VAT cannot be ignored as an issue worth exploring further.

5. Gradually Reintroducing Tax to Sectors with Concessions. Unfortunately this will eventually need to be done. The hospitality and retail sectors will eventually need to stand on their own as viable businesses with tax cost. Phasing back in these taxes over time can bring in a projected $50 million more in additional revenues. With the inception of a value-added (sales tax) on a purchase price (not the wholesale price), as opposed to an up-front cost of duty the retail sector may be better able to cope with reintroduced payroll taxes through improved cash flow and pricing ability.

The $250 million dollar hole will not be easy to fill. It will take spending cuts and tax raises together to achieve. Space does not permit me to expand on these concepts further. The details are numerous and complex but hopefully this article sparks some healthy debate and discussion.

To contact Nathan Kowalski please e-mail nkowalski@anchor.bm

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Published April 30, 2013 at 9:36 am (Updated April 30, 2013 at 9:36 am)

My advice to the SAGE Commission

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