The Metamorphosis

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When the Cuban people awoke last April 2011, they did not find themselves transformed into giant insects. That change had already occurred. Over the course of the previous 50 years, Fidel Castro had transformed the island into one giant beehive or ant colony laboring single-mindedly for his vision of a Caribbean utopia. What they did wake up to find was something entirely novel: a vibrant options market in 1950s vintage Detroit automotive classics.

In “Cuba: Change We Can Count On?” (Liberty, December 2010), I reported the passage of enabling legislation by the Cuban government to guide the Congress of the Communist Party in implementing far-reaching reforms to the economy. Though the fine print of implementation had yet to be worked out, a big change was decreed. It included the legalization of self-employment in ”dozens” of areas, the privatization of many small state-owned businesses as cooperatives, and the establishment of limited property rights in real estate and some bits of movable property such as cars, boats, and appliances, many of which can now be bought and sold.

The impetus for all this hope and change was money. Cuba’s economic and fiscal health was dire. The reforms hoped to eliminate one-fifth of the government work force (thereby cutting expenditures); incentivize former government employees into joining taxable petit-capitalist enterprises (thereby raising revenue); and — along with liberalized foreign investment reforms — stimulate the economy and improve Cuba’s fiscal prospects.

In April 2011 the details of the new legislation were announced. In a recent paper entitled “Economic Impact of New Employment, Tax and Financial Policies in Cuba,” presented at the XXI Annual Meeting of the Association for the Study of the Cuban Economy (Miami, August 2011), Luis R. Luis, former director, Latin America Department, of the Institute of International Finance and chief economist at the Organization of American States (OAS) in Washington, applied macroeconomic analysis and a crystal ball to predict the effects of the reforms.

To a populace that has never paid taxes, much less dealt with the fine points of business expense deductions and tax accounting protocols, the entireexperience must have been far from “liberalizing.”

Given the market sophistication of the Congress of the Cuban Communist Party — akin to that of the Creation Science Institute, sequencing the malaria genome — the reforms are still a work in progress. They aim primarily at improving state finances, but the use of price controls, size limits on firms, confiscatory tax rates, complicated monthly payment requirements, and petty regulatory activity “could result,” as Luis drily observes, “in even larger evasion than is usual in developing countries by single proprietorships and the self-employed, [and] will also result in many activities taking place wholly or partially underground, limiting tax revenue and fostering operation of undersized and inefficient activities.”

The very first modifications to the April bill were made a scant few weeks later, following a strike by cocheros (horse cart drivers) in Bayamo, Granma Province (née Oriente Province). The provincial capital is immortalized in Cuba’s national anthem as the birthplace of independence. It is a place redolent with symbolism, and a situation best handled with care. Bayamo cocheros, members of one of the newly privatized occupations, discovered that when they added their new tax liability to their clients’ bill, demand plummeted. So they went on strike.

The new self-employment taxes consist of four categories: social security tax, personal income tax, sales tax, and payroll tax. Let’s look at each.

1. The social security tax is levied at 25% of the tax base (in the US, it’s about 13% — with half paid by the employer). So far, so progressive.

2. The personal income tax gives a whole new meaning to “taxing the rich.” Marginal rates rise to 50% for annual incomes of $208! When combined with the social security levies, the personal tax nears 60%. Mindful of the reader’s attention span, I will skip all the qualifying fine print, ceilings, and permutations that complicate the base tax rate — except for business expenditures, aka deductions. These are limited to 20% or 40%, depending on the enterprise.

As Luis notes: “These rates discriminate against enterprises whose cost of inputs exceed[s] 40%, which will lead to curtailment of activity, firm creation, and widespread tax evasion.” Cocheros, for some unknown reason,were limited to a 20% business expenditures deduction.

To a populace that has never paid taxes, much less dealt with the fine points of business expense deductions and tax accounting protocols, the entireexperience must have been far from “liberalizing.” It was reminiscent of a farcical zarzuela, the Spanish version of a Gilbert and Sullivan operetta, with a dose of Monty Python thrown in for gravitas. The Congress responded by raising cocheros’ allowable deductions from 20% to 40%.

3. Sales taxes for all products are levied at 10%, except for farm products, which are taxed at 5%. Simple enough.

4. The new payroll taxes are not only complex; they (along with the other taxes) actually, as Luis observes, “pose a formidable constraint on employment.” The following summary — through no fault of Luis — is beyond this author’s ability to make intelligible, much less fun:

A new 25% payroll tax is instituted. The base of the tax is the overall wage bill except that there is a minimum taxable amount equal to a multiple of the average wage for specific workers calculated by the appropriate local labor office. The base is made progressive as the minimum taxable amount increases with the size of the payroll. Thus for firms with 1 to 9 workers, the minimum equals 1.5 times, rising to 2 times for those between 10 and 15 workers and to 3 times for those firms that have more than 15 employees.

So much for the new taxes. Will Cuba’s vision of self-employment provide the fiscal salvation the government so desperately needs, or is it just a tempest in a teapot?

If the government succeeds in shifting 250,000 government workers into self-employment, and they pay all their taxes, Luis estimates a $40 million revenue windfall for the government (not to mention all the supplies and material that would not be pilfered or stolen from state companies and offices, as supplements for employees’ meager salaries — a point important enough that Luis footnotes it in his report). But so far, no more than 50,000 state employees have taken the bait.

The eminent French art critic and father of surrealism, André Breton, visiting Cuba in the late 1920s, observed that, “Truly, Cuba is too surrealistic a country to be livable.”

Furthermore, it’s impossible to predict the tax compliance rate, which, worldwide, is low for the self-employed. “However,” Luis observes, “it is expected that the fiscal authorities will enforce the tax code with some vigor. Undoubtedly, the high tax rates will act as an incentive to evasion and to a reversion of business to the underground economy. Sizeable underreporting of revenues is to be anticipated.”

In 2011, Cuba’s population was 11 million. As of mid-May 2011, about 300,000 people were self-employed (excluding farmers); or (with slightly different numbers), never more than 3.5% of the labor force. Though the passage of the new legislation doubled the number of self-employed, a large percentage of them were people who came out of the black market closet and hope to become legal.

Luis’ analysis bears some contextual elaboration because, as Miguel Bretos, author of Matanzas: The Cuba Nobody Knows, has stated, “Those seeking to understand Cuban history in conventional ways are doomed to frustration.” He was referring to the eminent French art critic and father of surrealism, André Breton, who, visiting Cuba in the late 1920s, observed that, “Truly, Cuba is too surrealistic a country to be livable.”

What makes the details of the reforms so surreal is their schizophrenic set of objectives. When first proposed, the reforms were compared to the Chinese model: an infusion of capitalism to build wealth, with the Communist Party retaining absolute power. But, as the Chinese are discovering, when laissez faire markets infect a regime of total power, the liberty virus proves hard to cure.

The Chinese are a practical people with few Maoist ideologues left among them. No one, from the highest party apparatchik to the lowliest peasant, objects to becoming richer. Meanwhile, power is being incrementally ceded through a phenomenon usually foreign to absolutist regimes: limited but sensitive responses to popular dissatisfaction with corruption, judicial arbitrariness, environmental degradation, out-of-control eminent domain, and even — very slightly — the transfer of some political power. (For example, provincial officials in Wukan, Guangdong Province, are allowing local elections to take place.) Moreover, the Chinese are rather comfortable with duality; witness the Taoist concept of yin and yang.

It’s not quite so simple for Cubans.

The competing objectives of raising capital through economic liberalization while retaining absolute power are — in Cuba — complicated by a third factor that tips the reforms from the bipolar into the surreal: an anti-capitalist idealism so fervent that it equates private employment with involuntary servitude, profit with depravity, and self-employment with crimes against society. These attitudes not only saturate the nomenklatura — with their source and apogee in the moralist-in-chief, Fidel — but also pervade the majority of the Cuban population. Cubans are poor and unhappy; they sense that something is wrong with the system; they are starving for change. Yet they idolize St. Fidel’s idealism and venerate him as the conscience of the Revolution.

As the Chinese are discovering, when laissez faire markets infect a regime of total power, the liberty virus proves hard to cure.

National character, along with its kinfolk — ethnic, religious, cultural, and racial character — has fallen into disrepute as a way of defining a population. Whatever validity it might once have possessed has evaporated. It has been dismissed for its oversimplification, unscientific methodology, racist undertones, and complete absence of political correctness. But it retains a great deal of insight and literary utility, when considered informally. Hedrick Smith was definitely onto something when he described the Russian character as a cross between German and Mexican temperaments.

Cuba was ruled by Spain for over 400 years — longer than any of its other colonies. During the Latin American wars of independence in the 1820’s, Cuba remained staunchly Spanish. By the time it won its independence in 1902, it was considered an integral part of Spain. That date is so recent that in 1966 the last surviving Afro-Cuban general of the War for Independence, Generoso Campos Marquetti (by then living in the US, in exile from Castro’s revolution), was asked to testify before the US Congress during hearings investigating the nature of the Castro Revolution. It’s as if Nathanael Greene or Henry Knox had still been alive within our living memories, to comment on US current affairs.

The Cuban character is a diversely spiced mélange. Settled by immigrants from Galicia, Asturias, Catalonia, and the Basque Provinces in northern Spain, Cuba was infused with a strain of rigid, dour, doctrinaire, and humorless temperament. Fidel Castro is a second-generation Galician — he can’t dance, carry a tune, or tell a joke. Though he would reject the comparison (in spite of his early flirtations with Falangism and Fascism) Castro has much in common with the long-lived and long-ruling Francisco Franco and his Minister of Propaganda, José Millán-Astray — both Galicians.

General Millán-Astray was a serious parody of himself. Founder of the Spanish Foreign Legion and a decorated war hero who’d lost an arm and an eye, he personified Spanish fascism. He was obstinate and ruthless, yet impulsive; flamboyant, reckless, and self-aggrandizing. At rallies he resembled the mad Dr. Strangelove. Wearing one white glove and a black eye patch, he would exaggeratedly throw out his one arm in the Nationalist salute, while shouting his telltale mottoes, “Viva la muerte!” ("long live death") and “Death to intelligence!” ("death to the intelligentsia").

Cubans are poor and unhappy; they sense that something is wrong with the system; they are starving for change. Yet they idolize St. Fidel.

Ladino and Canary Islands immigrants added cunning, perspicacity, and some levity to the Cuban national character; Andalucians, Valencian gypsies, and West African slaves tempered the whole with rhythm and a wry sense of humor. Provincial and (in the case of the West Africans) tribal clubs, mutual aid societies, and other ethnic affiliations lasted well into the 1960s.

The Spanish component of the Cuban character alone suffices to explain the paradoxes inherent in holding multiple contradictory perspectives. Pepe Azcarraga, a 91-year-old Spaniard from a small village in Aragon (but now a retired college professor living in the US), personifies this Weltanschauung. He recounts that once, as a teenager, he accompanied a friend to the dry goods almacén to buy towels. On the way back, he helped her carry the goods, stacked on his doubled arms. As he passed by his own house, his mother, perched on the second-floor balcony, spotted him on the cobbled street below supporting the pile of towels in front of him as if they were the Blessed Sacrament and he was leading an Easter procession. She beckoned to him angrily. Puzzled, he detoured into his house.

Once inside, she asked him what the diablo he thought he was doing carrying a pile of towels for all the world to see. Before he could answer, she walloped the fear of propriety into him, moaning that “the whole town will think the Azcarraga family needs towels!”

Pepe tells the story without a hint of irony, as if his failure to anticipate the finer etiquette of towel buying in a gossipy small town were an obvious sign of his stupidity. At different times, depending on the context of the conversation, he’ll call himself a socialist, a capitalist, a libertarian, or simply a man of the left. He and his immediate family sided with Franco during the Civil War — for the sake of order and stability. Yet as members of the local militia guarding the frontier against infiltration from Republican guerrillas holding out in the French Pyrenees after the war, Pepe and his friends, when off-duty, would cross over and (avoiding politics) socialize with the enemy, many of whom were friends, family, and acquaintances. They shared snacks, smokes, stories, and beer. A devout Catholic who attends Mass every Sunday, he is nonetheless skeptical of the existence of an afterlife — and he harbors a sense of unworthiness that keeps him from communion.

Pepe stands on the shoulders of giant, original, way-outside-the-box thinkers: surrealist artist Salvador Dalí, whose melting clocks epitomize the persistence of memory; philosopher Miguel de Unamuno, who introduced doubt to faith, and found that they got along just fine; writer Miguel de Cervantes, whose Don Quixote — the patron saint of hopeless causes — made tilting at windmills not only intelligible but honorable; and Grand Inquisitor Tomás de Torquemada (literally, twist and burn), whose auto da fés melted heretics in order to save them. To an Anglo-Saxon who can only shake his head in perplexity, like a mental centrifuge spinning to separate the conflicting strains, little of this intellectual anarchy makes sense.

Fidel Castro, the Cuban Communist Party, and their recent economic reforms embody this cognitive dissonance. Luis’ assessment is not sanguine: “It is evident from the multiple constraints, prohibitions, regulations and high taxes involved in the new measures the authorities are striving to maintain tight control over the liberalization process. These controls will dampen or even fully contain the output and consumption gains from market opening.”

And the controls are extensive. One-hundred-and-seventy-eight self-employment occupations have been legalized (up from 157); most require little or no capital (animal caretaker, hairdresser, locksmith, plumber, mason, mattress repairman). A few others, such as room renting (though not to foreigners, and no subletting) and transportation services (truck and taxi driving) imply greater use of property or equipment. Restaurants are now allowed 50 tables, up from 20. Capital investment is capped at $800.

Even the most touted reform, the buying and selling of real estate, is less than meets the eye. Ownership is limited to domiciles — one residence and one vacation home — and possession is limited to citizens or foreigners permanently residing in Cuba.

Additionally, the domestic portion of the reforms requires that all transactions take place in nonconvertible pesos. (Cuba has dual currencies: convertible and non-convertible pesos — one for tourists, the other for Cubans — both highly controlled.) Foreign investment in the newly allowed enterprises is forbidden; as are family and personal remittances (also subject to taxes), which must only be used for personal consumption. Wholesale activities, inter-provincial trades, and most intermediation among firms are also forbidden.

“Intermediation” — a fancy word to describe the place that banks (among other entities) hold between savers and investors: they take deposits, then lend them out to entrepreneurs. Cuba’s (official) private savings rate for the last six years is about 2% of income — not an important source of financing for new enterprises, though probably understated because of non-bank and in-kind savings. As Luis again drily notes, “Most bank loans are made to state enterprises. A vibrant self-employment sector would be helped greatly by access to credit from the banking system. This would require building-up a credit system, with an important role for micro-credits by local branches of banks with appropriate credit expertise . . . [as in] Asia.”

Fidel Castro is a second-generation Galician — he can’t dance, carry a tune, or tell a joke.

Any reforms along those lines are unlikely, because they would undermine the institutionalized apartheid system that attempts to minimize economic fraternization between Cubans and foreigners. Very few of the newly approved occupations affect the export or tourist sector, and the government monopoly on labor for joint venture and foreign enterprises has not been affected. It is surprising that the new employment and tax measures do not address Cuba’s external accounts, even though more foreign investment — under the pre-existing framework — is being attracted.

Luis boldly sums up his report with an estimate of the impact of the reforms on Cuba’s GDP. He admits he’s on shaky ground — with disclaimers, caveats, weasel words, and the assumption that many more black-market enterprises will come into the open. Despite the effects of government controls, he broadly predicts a 2% GDP increase as a low estimate, with a 6.4% GDP increase if all the hoped-for 250,000 state employees become successful entrepreneurs, make lots of money, and pay all their taxes.

The Cuban reforms are a tug-of-war among various conflicting objectives: on the practical level, increasing state revenue while maintaining total state power; on the philosophical level, allowing enough “human action” (in the Misesian sense) without diluting the “social justice” objectives of the Revolution by introducing greed, ambition, and a subversive focus on individuality.

On that last point — to paraphrase Charles Darwin, who, at the conclusion of The Origin of Species, foretold that “light will be thrown on the origin of man” — the Cuban reforms will shed much light on how far the capitalist goose that lays the eggs of prosperity can be starved, strangled, and robbed, without killing it.




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