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The other two Ts at the G8

June 13, 2013
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Tax and transparency are the other two subjects about which G8 ministers will waffle meaninglessly next week. It’s a pity, because  progress in these areas would be among the best ways of helping the developing world.

Tax havens are wrong for three reasons: they drain the tax base of developed countries, making it harder for them to maintain aid and social spending; they suck ill-gotten spoils from developing countries; and they destabilise the global economy.

Tax avoidance in rich countries is currently in the headlines. Using techniques with names almost too exotic  to mention — anyone for a “Dutch Sandwich”? How about a “Double Irish”? — Google funneled payments to tax havens via low-tax countries like Holland and Ireland to minimise tax on its £11.5 billion in UK revenues between 2006 and 2011, paying only £10 million to the UK Treasury. Some have worked out that Google’s overseas tax rate is 2.4%, compared with the 28% it should be paying in Britain.

Apple, Marks and Spencer, Boots, Tesco, HSBC, Lloyds Halifax, Amazon, Starbucks, Vodafone — of course they’re going to minimise their costs. They’re profit-making enterprises. It’s no good berating them about their naughtiness; the only way to tackle these companies is to close down the havens where they hide their earnings. But no single rich country can address the problem alone because if Bermuda closes for business a company will just send its money to the Cayman islands. Action has to be taken in concert, which is why a multi-country group like the G8 is one of the only hopes for progress.

Developing country governments have had it even worse — having been denied billions of dollars in sorely-needed revenues as money is syphoned overseas. Liberia is an example of a poor nation that’s been ravaged by the iniquities of global tax-dodging, as a succession of kleptocrats stashed diamond wealth in hidden Swiss accounts. Switzerland’s at fault, not Liberians, who have a fragile democracy and a history of nasty dictators.

Nicholas Shaxson in his brilliant book Treasure Islands suggests that Transparency International‘s corruption perceptions index has things the wrong way round: we should rank countries on banking secrecy, not graft. The real economic issue is that nations harbour the spoils of corruption, not that Charles Taylor foists himself on Liberia.

Shaxson points out that  tax havens, or what he calls secrecy jurisdictions, have played a starring and hitherto misunderstood role in the untrammelled economic liberalisation of the last few decades, in effect allowing cash to skitter freely around the planet. The market in shares, currencies and bonds is international and therefore difficult to tax — but the profits must eventually end up somewhere. Secrecy juridictions were purposefully set up as places for traders to hide their loot.

Most people ignored the euromarket for years after its birth in the mid-1950s, partly in the hope that it’d go away and partly because the UK and American authorities didn’t want to draw attention to the vast acreages of cash being made by their financial elites.

By the time we’d noticed, it was too late. Banks were among the prime users of tax havens, which played a key role in the credit boom of the 1990s and 2000s. Michael Lewis in The Big Short even argues that the creation of the financial weapons of mass destruction that caused the crisis wouldn’t have been possible without the likes of Cayman and Bermuda.

Some have argued that some of the low-income secrecy jurisdictions benefit so much from their offshore status that it’d be wrong to dismantle them. I worked for two years in Vanuatu, one of Britain’s former colonial havens in the South Pacific. London’s intention when the country gained independence in 1979 was to establish a tax haven which opened for business toward the end of the working day in Hong Kong, four hours west.

All kinds of nefarious activity found its way to Vanuatu. An Indian businessman convinced the government to accept a fake diamond ruby as security for a loan (the last time I saw it, the  ‘diamond’ ruby, actually a lump of rock, was acting as a toilet-paper holder in the Department of Customs bathroom). The director of a local bank was jailed in the US for his involvement in an international lottery scam. A tax cheat was arrested on Vanuatu soil by the Australian Federal Police and last year jailed for eight years over a A$5 million fraud.  I remember him telling me he was a big fan of free trade. Little did I realise at the time quite what he meant.

The damage to Vanuatu’s reputation is huge. Foreigners often think of the country as a bit mickey-mouse, and as a result serious investment is severely curtailed. The absence of income tax creates appalling inequalities. Vanuatu has a Gini coefficient of 58, placing it among the 10 most unequal countries in the world.  None of this is worth the 10% that the financial industry is estimated to contribute to GDP.

Not only are tax havens harmful to their own people, but allowing companies the freedom to shift their cash offshore makes no sense for the global economy. During an economic downturn governments can’t easily spend more to stimulate demand if they are being held to ransom by the financial industry. Central banks can’t easily cut interest rates if commercial banks immediately just shift their cash elsewhere in search of higher returns. Today’s angst about the cost of financing government debt, as seen in the financial  travails of Portugal, Ireland, Italy, Greece and Spain, is exactly what the economist Keynes feared; it’s why he recommended controls on the movement of capital where necessary, and it’s why they were so prevalent until the 1970s. It’s also why he wanted a much stronger role for the International Monetary Fund and World Bank, which he hoped would help prohibit hot money flows and prevent a global race to the bottom in which countries tried to out-compete each other on tax.

The current financial system is constructed. It isn’t, as most theorists of globalisation suggest, the result of an inevitable and faceless century-long trend toward liberalisation. Britain built its network of secrecy jurisdictions on purpose, with the idea of putting London at the centre of global financial industry after the decline of the British empire. The United States leapt on to the wagon, and today a number of US states are in effect tax havens, notably Delaware, Nevada and Wyoming. These havens came into existence as part of a conscious strategy, not through an inexorable or uncontrollable process. The United States and Britain opposed a co-operative, controlled, post-war economic system because they stood to gain from financial deregulation.

Because the system was constructed in the first place, it can also be dismantled. The chances of this happening next week — or in the next few years — are limited because the world’s corporations and financial industries, literally, have so much invested in it. But it shouldn’t stop campaigners from bringing the issue to attention or enlightened politicians from discussing it at international talking shops. Tax havens make no economic sense, they helped cause the crash and they perpetuate inequality. They should be shut down.

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6 Comments leave one →
  1. June 13, 2013 9:13 pm

    This is indeed a very important issue and thank you for this contribution. I was interested to read your references to Vanuatu. I have lived in Vanuatu for over 16 years so I hope you will feel I can make some meaningful comments in this space. First some corrections, the ‘precious’ stone you refer to was actually not a ruby rather than not being a diamond. I am not completely convinced that that incident is directly related to Vanuatu’s tax haven status – slick con artists ply their trade wherever they can prey on those whose gullibility is informed by personal greed regardless of the jurisdiction. The director of a local bank (who is now an MP in Vanuatu) was jailed only for a very short time upon arrest in the USA and then spent a very long time in pre-trial ‘home detention’ – he did not serve any time in jail on conviction. And the ‘tax cheat’ was arrested in Australia, in connection with that Wickenby operation the AFP certainly did arrive in country and made their presence felt in a number of high profile, jurisdictionally questionable and largely unpleasant ways. The evidence they collected has (in theory) not left the country further to orders made by the Supreme Court of Vanuatu. Second, as you will be aware, further to pressure from OECD countries Vanuatu has tightened up the regulatory frameworks that apply to the work of the Offshore Finance Centre which has had the effect of reducing it significantly in size as well as making the jurisdiction more compliant. I am interested in your point that the secrecy laws make Vanuatu unattractive to ‘serious investment’ – what type of investment are we talking about and is it really the tax haven status that is the main obstacle (what about lack of a large skilled workforce, high labour costs, distance from markets, vulnerability to natural disasters)? As for income tax, this comes up on a regular basis (usually when the IMF are hanging around) – is it really viable when only 20% (if that) of the population is employed in the formal sector? The private sector already bears a very high tax burden (one estimate is around 37%) – the fact that it is indirect taxation rather than direct taxation is not really relevant. The costs of doing business are already high, I would doubt that the private sector in Vanuatu would be prepared to bear much more. I accept your figure of 10% of GDB as the Finance Centre’s contribution to GDP (it would be good to know what the contribution to employment is) but I have yet to see what the ‘plan’ is for replacing it.

    • June 13, 2013 10:31 pm

      Thanks Tess. I’ve made a couple of corrections. Sorry about the diamond reference — my memory must be going as I get older!

      I think that the more transparent and above-board countries become, the fewer con-artists they attract.The problem with tax-havens isn’t just their low tax, it’s that they are secret. Whenever you get a glimpse behind the veil you often see a lot of murky dealings. Cyprus is a recent example, but we probably only know the half of it because secrecy jurisdictions are by their very nature secret. The con artists are attracted to these places because they know they can get away with it.

      I’m in no way defending the heavy-handed behaviour of the AFP and I don’t think it has the right to go plunging around on Vanuatu territory, but said tax-cheat was in Vanuatu because it was a tax haven. He’d have been unable to do his dodgy business in Australia.

      (By the way London increasingly, and unfortunately, looks like a tax haven. Its huge and relatively unregulated financial industry crowds out other economic activity and creates massive geographical and income imbalances.)

      These periodic scandals all tend to lower Vanuatu’s attractiveness to foreign investors. I know that lots of factors contribute to the country’s shortcomings as an investment destination, but reputation is surely one of them.

      On the private sector: I never felt that it was exactly put-upon; in fact it gets an easier ride than in a lot of countries. And yes, there is a benefit to direct over indirect taxation. It’s more predictable, often easier to collect and fairer. Countries which take a disproportinately large sum of revenue from indirect taxation tend to suffer an amplified effect on government revenues as the economic downturn hits consumer confidence. Ireland found this out in 2008. GST is also by its nature more regressive than income tax. I sometimes wonder whether elites in developing societies actually *want* a lot of people to remain in the subsistence sector. It provides a reserve army of labour and keeps wages low, not to mention allowing elites to retain their privileged position. I’m a great admirer of the kastom economy, but I also think that the expansion of the cash economy in certain areas would carry a lot of advantages, among them an expansion of the tax base.

      I don’t have all the answers about Vanuatu’s future economic transition, but I do think that services have a lot more potential — especially ecommerce, given the right infrastructure. All countries can change their economic structures — in fact that’s what development is about — and I can’t think of a nation that has developed in a balanced, healthy way solely on the back of its tax haven status.

      • June 15, 2013 9:13 am

        Thanks for such a detailed response Dan, at the level of principle I am pretty much in agreement with you. It is how the application of principle plays out in practice that I think informs my caution. It is too easy to say that everyone who is an expatriate resident and a member of the private sector is involved in something nefarious – I, my husband, our friends are all members of the private sector but we are not tax cheats or money launderers. Yes we have the ‘privilege’ of no direct taxation but by the same token we bear the burden of being unable to influence political representation or policy (because we can’t vote), high labour costs (employment conditions in Vanuatu are extremely good with the bulk of the costs borne by employers) plus being indirectly affected by the impact on the reputation of Vanuatu by virtue of its tax haven status (and, possibly more significantly, by virtue of how this is portrayed by AFP/ATO and others). Your point about the inherent regressive nature of GST may well be true but it doesn’t address the fact that direct taxation, in the absence of serious reductions in government charges paid by businesses at present, would have the effect of deepening an already very narrow tax base, almost certainly to the point of making continued participation in the economic development of the country unfeasible given all the other costs (I realise I haven’t mentioned interest rates – 13% is an indicative figure for commercial finance) . As you are aware, Vanuatu’s economy is not grown ‘solely on the back of its tax haven status’ and in reality its contribution is much reduced as of late. But it would, in my opinion, be irresponsible to just close it down ‘overnight’ with no means of replacing its contribution to employment and generation of public revenue in place to pick up the slack.

  2. June 17, 2013 10:42 am

    Hi Tess, good point about the vote. A phrase about taxation and representation springs to mind. I quite understand that most of the private sector is legit.

    I definitely wouldn’t advocate closing down the tax haven overnight but I think that Vanuatu and small island states in general need to think innovatively about enhancing productive capacity in areas where they might realistically prosper in future and which have a chance of future dynamism. To be honest, I can’t see tax-haven status as delivering on any of these counts. Rich countries will continue to crack down on them.

    Too often national politicians and donors have lacked imagination and an ability to look to the future. I’d say Vanuatu needs to diversify further into services, building on its success in tourism. In particular it should use the Internet to trade more. The challenges of fragmentation, distance from markets, lack of economies of scale. All of these things can be overcome online. It took many years to dismantle the telecoms monopoly but the results were dramatic.

    No recent example of successful development in a small island developing state has involved simple rent-seeking or reliance on tax-free status. Mauritius was quick to recognise the importance of the Internet and Cape Verde is beginning to do so. Cape Verde has been one of the most successful small island LDCs in recent years, largely based on the tourism boom, but politicians and policymakers know that they need to remain nimble.

    So in a roundabout way i’m saying completely understand the the challenges of running a business in such a difficult environment, and it would be a bad idea suddenly to tax the private sector yet further, but that future growth relies on diversification and enlarging productive capacity in a forward-looking and imaginative ways (possibly this is over-optimistic, but you never know), with a view to eventually introducing more a more equitable taxation system.

    • June 18, 2013 5:34 am

      Which brings us pretty much to a place of harmony & agreement!! Diversification is essential I agree and hopefully improved ICT infrastructure will allow for new opportunities – at the moment we are hampered by lack of bandwidth and high prices but hopefully that will change in the near future.
      Thanks for an interesting and good-humoured exchange!

      • June 18, 2013 11:07 am

        But this is the Internet! We’re supposed to be firing ad hominem nasties at each other!

        Seriously, thanks to you too. I’m grateful for the discussion. Look forward to the arrival of the (underwater, fibre-optic) cable…

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