Tuesday, 5 March 2013

Efficient Taxation 101: The locust tax of Cyprus

A revolution, like the one that affected Egypt, usually leads to a collapse of the basic functions of the state. This is not surprising: as revenues collapse, the state will focus to maintaining the very basic economic functions, such as keeping Cairo ticking. The countryside will come second: people are mainly in the cities, and they are the ones that can "make or break" the new, post revolutionary regime. The Jacobins understood that well during the French revolution: they managed to takeover the revolutionary government by tapping into the anger of the Parisians, and maintained it their power by keeping Paris as happy as possible.

The effects of the neglect of rural Egypt are materialising in scary, biblical ways. Locust swarms are now making their way through Egypt, re-energised due to the neglect of the past two years, as the revolution reduced the ability of the government to react. Locusts are very dangerous to crops, but especially if they reach the critical mass of swarms: when Locusts swarm, there is really no way to stop their march as they raze all flora in their way. With no flora remaining, fauna is also decimated, causing severe environmental damage over large areas. Swarms change locusts both in how they behave but also in how they look, blackening them while making them very aggressive and mobile. Spraying them with pesticide will only knock out thousands at a time, yet millions are relentlessly pushing forwards towards new land in order to feed. Even with modern technology, locusts, when swarming, are near impossible to stop.

Many people might not know this but Cyprus was traditionally part of the locust migration and swarming problem, with millions of locusts consuming vast amounts of carobs and grain. It seems that the phenomenon was seen as most problematic (perhaps because people thought they could stop it) during the 18th and 19th century. Although the phenomenon is in part a response to the environmental conditions (see the National Geographic article linked above), correct prevention can reduce the possibility of swarming occurring in the first place.

It was quickly found out back then Locust swarms can be prevented by capturing the eggs of the locusts in specially made traps. The trigger to swarm arises from overpopulation of swarms due to high rainfall: thus by keeping the population in check through the collections of eggs, the possibility of swarming was reduced. The Ottoman administration of the island introduced sporadic egg capturing campaigns that were successful;  however the problem would re-occur after the campaigns would wind down.

The new British Administration of Cyprus decided to do something about it. It introduced the Locust Prevention Tax of 1881 (Law 12). It aimed to raise revenue in order to create a systematic,  year-on-year effort to destroy the locust prior to swarming. The history of this tax can be seen here.

The law aimed to correct a problem of negative externalities in agricultural production:  all persons were negatively affected by the swarming, and yet none was willing to pay more than his private benefit in order to eliminate it. In these situations the government has a very positive role to play in raising the revenue to act and eliminate the negative costs of swarming, thus creating a better market outcome.

The tax was ingeniously planned. Firstly the revenue was placed in an escrow account, completely separate from normal government revenue. This guaranteed that an amount was always available: locust prevention would not be sacrificed in order for other, more popular or immediate government projects. This was done on purpose, as the failure of the Ottomans to control the locust on Cyprus indicated that people (and officials) were willing to divert funds to prevention during and after a swarming event, but quickly diverted resources to other areas after the immediate threat passed, allowing the locust time to recover and regroup. By keeping the locust account separate, the government ensured that investment in prevention was ongoing, allowing for funds to attack the locust exactly when it was the weakest, further reducing the ability of the animals to swarm and become destructive.

Secondly the law was careful in should carry the burden. The Locust tax, collected 1% of agricultural  production, 0.1% of the value of property (since at the time a lot of property were trees and land, directly affected by swarming) and a smaller tax on flocks of sheep and goats. As a result all who would loose out by swarms had to pay, and each paid relative to the possible damage he or she would have if the locusts swarmed. That is why flocks were taxed less: although a swarm would cause losses to a flock by reducing the pasture, their cost would be less than the cost of a person who owned an orchard.

Note that the law has cyclical and non-cyclical elements, providing both flexibility and stability. Output is cyclical to GDP and thus the burden would not overwhelm farmers when their output was low (as they were charged 1% of output). At the same time property and flocks are stock concepts, allowing for stable revenue collection, which is less variable than output. Thus there was a basic amount of tax collected that would not vary much (based on taxing those who owned wealth and stock), and this was topped up according to the economic growth of agricultural sector (by directly taxing output).

The effect of the tax was immediately clear. As the locust was brought under check, the cost of prevention fell rapidly, allowing for a healthy surplus in the escrow account. Rather than stop the tax and have the issue of raising revenue if a future locust swarm issue resurfaced, the government kept the law and separate account, and passed a new law that allowed it to spend the revenues (or earmark future revenues) of the tax on infrastructure projects. The pier in Larnaca and other projects that allowed for the opening of markets were undertaken by the revenue collected by this tax. The prevention of locusts remained a priority, but the fund also allowed government to spend on long term projects based on a predicted revenue stream. It is no surprise that one of the few foreign loans that the British administration was able to procure was based on earmarked revenues of this tax, as the creditors felt safer knowing their interest would not be repaid by the general government revenue: as a result the locust tax enabled the largest infrastructure project to date, the construction of Famagusta harbour and the railway to connect it to Nicosia.

By 1926 the abolition of the Tithe brought the tax to abeyance. The funds in the separate account were depleted, and sure enough the Locust returned in 1948, forcing the government to spend £20,000 on DDT and other highly hazardous chemicals in order to try and counter it. The liberal use of such dangerous chemicals has a huge cost to Cypriot wildlife, which was decimated and has never recovered.

What are the lessons that this tax can provide? Taxation can and should be used to correct market failures (in the case failure to prevent Locust swarming) where the private cost is lower that the social cost to society.    Yet such revenue needs to be protected and not allowed to be put in general government revenue, where short term needs will trump long term development issues. Thus I am all for a tax that would collect revenue for the future infrastructure costs of establishing a local and exported gas network, provided it is kept out of general government revenue.

Secondly, all good taxes need to balance revenue flexibility with revenue stability. A tax that is too flexible (such as VAT) will not be able to sustain government expenditure if the economy suffers a severe recession; likewise a tax that is too rigid (such as property tax) will be far too onerous to the taxpayer when his income contracts. The fact that the above tax combined tax flexibility/stability with varying the burden on the taxpayer according to possible future loss due to locusts was a brilliant idea. Each taxpayer contributed relative to the possible loss he would suffer if locust swarms occurred and  thus prevention was shared not equally but according to who had more to loose, making the tax more bearable.

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Fergus Murray said...

Hi Alexander. Excellent blog on the Locust Tax and the re-emergence of locusts in Egypt. Under the British administration Cypriots were obliged to collect 8 oke of locust eggs - about 3.8kg by my calculation. I wasn't sure if this was done by trapping. As I understood it, the trapping operation was a separate activity to catch and bury the locusts at the marching hopper stage before they were able to fly. Best wishes Fergus Murray

Alexander Apostolides said...

It was done in two ways. Picking up live locusts (also acceptable when near swarming season) and digging a hole with a screen to collect the eggs of the locusts. The expenditure of both was covered by the locust tax. You were paid for how many eggs you would bring.