Showing posts with label tax avoidance. Show all posts
Showing posts with label tax avoidance. Show all posts
Monday, 24 June 2024
Thursday, 19 September 2019
Why rigged capitalism is damaging liberal democracy
Economies are not delivering for most citizens because of weak competition, feeble productivity growth and tax loopholes writes Martin Wolf in The FT
“While each of our individual companies serves its own corporate purpose, we share a fundamental commitment to all of our stakeholders.”
With this sentence, the US Business Roundtable, which represents the chief executives of 181 of the world’s largest companies, abandoned their longstanding view that “corporations exist principally to serve their shareholders”.
This is certainly a moment. But what does — and should — that moment mean? The answer needs to start with acknowledgment of the fact that something has gone very wrong. Over the past four decades, and especially in the US, the most important country of all, we have observed an unholy trinity of slowing productivity growth, soaring inequality and huge financial shocks.
As Jason Furman of Harvard University and Peter Orszag of Lazard Frères noted in a paper last year: “From 1948 to 1973, real median family income in the US rose 3 per cent annually. At this rate . . . there was a 96 per cent chance that a child would have a higher income than his or her parents. Since 1973, the median family has seen its real income grow only 0.4 per cent annually . . . As a result, 28 per cent of children have lower income than their parents did.”
So why is the economy not delivering? The answer lies, in large part, with the rise of rentier capitalism. In this case “rent” means rewards over and above those required to induce the desired supply of goods, services, land or labour. “Rentier capitalism” means an economy in which market and political power allows privileged individuals and businesses to extract a great deal of such rent from everybody else.
That does not explain every disappointment. As Robert Gordon, professor of social sciences at Northwestern University, argues, fundamental innovation slowed after the mid-20th century. Technology has also created greater reliance on graduates and raised their relative wages, explaining part of the rise of inequality. But the share of the top 1 per cent of US earners in pre-tax income jumped from 11 per cent in 1980 to 20 per cent in 2014. This was not mainly the result of such skill-biased technological change.
If one listens to the political debates in many countries, notably the US and UK, one would conclude that the disappointment is mainly the fault of imports from China or low-wage immigrants, or both. Foreigners are ideal scapegoats. But the notion that rising inequality and slow productivity growth are due to foreigners is simply false.
Every western high-income country trades more with emerging and developing countries today than it did four decades ago. Yet increases in inequality have varied substantially. The outcome depended on how the institutions of the market economy behaved and on domestic policy choices.
Harvard economist Elhanan Helpman ends his overview of a huge academic literature on the topic with the conclusion that “globalisation in the form of foreign trade and offshoring has not been a large contributor to rising inequality. Multiple studies of different events around the world point to this conclusion.”
The shift in the location of much manufacturing, principally to China, may have lowered investment in high-income economies a little. But this effect cannot have been powerful enough to reduce productivity growth significantly. To the contrary, the shift in the global division of labour induced high-income economies to specialise in skill-intensive sectors, where there was more potential for fast productivity growth.
Donald Trump, a naive mercantilist, focuses, instead, on bilateral trade imbalances as a cause of job losses. These deficits reflect bad trade deals, the American president insists. It is true that the US has overall trade deficits, while the EU has surpluses. But their trade policies are quite similar. Trade policies do not explain bilateral balances. Bilateral balances, in turn, do not explain overall balances. The latter are macroeconomic phenomena. Both theory and evidence concur on this.
The economic impact of immigration has also been small, however big the political and cultural “shock of the foreigner” may be. Research strongly suggests that the effect of immigration on the real earnings of the native population and on receiving countries’ fiscal position has been small and frequently positive.
Far more productive than this politically rewarding, but mistaken, focus on the damage done by trade and migration is an examination of contemporary rentier capitalism itself.
Finance plays a key role, with several dimensions. Liberalised finance tends to metastasise, like a cancer. Thus, the financial sector’s ability to create credit and money finances its own activities, incomes and (often illusory) profits.
A 2015 study by Stephen Cecchetti and Enisse Kharroubi for the Bank for International Settlements said “the level of financial development is good only up to a point, after which it becomes a drag on growth, and that a fast-growing financial sector is detrimental to aggregate productivity growth”. When the financial sector grows quickly, they argue, it hires talented people. These then lend against property, because it generates collateral. This is a diversion of talented human resources in unproductive, useless directions.
Again, excessive growth of credit almost always leads to crises, as Carmen Reinhart and Kenneth Rogoff showed in This Time is Different. This is why no modern government dares let the supposedly market-driven financial sector operate unaided and unguided. But that in turn creates huge opportunities to gain from irresponsibility: heads, they win; tails, the rest of us lose. Further crises are guaranteed.
Finance also creates rising inequality. Thomas Philippon of the Stern School of Business and Ariell Reshef of the Paris School of Economics showed that the relative earnings of finance professionals exploded upwards in the 1980s with the deregulation of finance. They estimated that “rents” — earnings over and above those needed to attract people into the industry — accounted for 30-50 per cent of the pay differential between finance professionals and the rest of the private sector.
This explosion of financial activity since 1980 has not raised the growth of productivity. If anything, it has lowered it, especially since the crisis. The same is true of the explosion in pay of corporate management, yet another form of rent extraction. As Deborah Hargreaves, founder of the High Pay Centre, notes, in the UK the ratio of average chief executive pay to that of average workers rose from 48 to one in 1998 to 129 to one in 2016. In the US, the same ratio rose from 42 to one in 1980 to 347 to one in 2017.
As the US essayist HL Mencken wrote: “For every complex problem, there is an answer that is clear, simple and wrong.” Pay linked to the share price gave management a huge incentive to raise that price, by manipulating earnings or borrowing money to buy the shares. Neither adds value to the company. But they can add a great deal of wealth to management. A related problem with governance is conflicts of interest, notably over independence of auditors.
In sum, personal financial considerations permeate corporate decision-making. As the independent economist Andrew Smithers argues in Productivity and the Bonus Culture, this comes at the expense of corporate investment and so of long-run productivity growth.
A possibly still more fundamental issue is the decline of competition. Mr Furman and Mr Orszag say there is evidence of increased market concentration in the US, a lower rate of entry of new firms and a lower share of young firms in the economy compared with three or four decades ago. Work by the OECD and Oxford Martin School also notes widening gaps in productivity and profit mark-ups between the leading businesses and the rest. This suggests weakening competition and rising monopoly rent. Moreover, a great deal of the increase in inequality arises from radically different rewards for workers with similar skills in different firms: this, too, is a form of rent extraction.
A part of the explanation for weaker competition is “winner-takes-almost-all” markets: superstar individuals and their companies earn monopoly rents, because they can now serve global markets so cheaply. The network externalities — benefits of using a network that others are using — and zero marginal costs of platform monopolies (Facebook, Google, Amazon, Alibaba and Tencent) are the dominant examples.
Another such natural force is the network externalities of agglomerations, stressed by Paul Collier in The Future of Capitalism. Successful metropolitan areas — London, New York, the Bay Area in California — generate powerful feedback loops, attracting and rewarding talented people. This disadvantages businesses and people trapped in left-behind towns. Agglomerations, too, create rents, not just in property prices, but also in earnings.
Yet monopoly rent is not just the product of such natural — albeit worrying — economic forces. It is also the result of policy. In the US, Yale University law professor Robert Bork argued in the 1970s that “consumer welfare” should be the sole objective of antitrust policy. As with shareholder value maximisation, this oversimplified highly complex issues. In this case, it led to complacency about monopoly power, provided prices stayed low. Yet tall trees deprive saplings of the light they need to grow. So, too, may giant companies.
Some might argue, complacently, that the “monopoly rent” we now see in leading economies is largely a sign of the “creative destruction” lauded by the Austrian economist Joseph Schumpeter. In fact, we are not seeing enough creation, destruction or productivity growth to support that view convincingly.
A disreputable aspect of rent-seeking is radical tax avoidance. Corporations (and so also shareholders) benefit from the public goods — security, legal systems, infrastructure, educated workforces and sociopolitical stability — provided by the world’s most powerful liberal democracies. Yet they are also in a perfect position to exploit tax loopholes, especially those companies whose location of production or innovation is difficult to determine.
The biggest challenges within the corporate tax system are tax competition and base erosion and profit shifting. We see the former in falling tax rates. We see the latter in the location of intellectual property in tax havens, in charging tax-deductible debt against profits accruing in higher-tax jurisdictions and in rigging transfer prices within firms.
A 2015 study by the IMF calculated that base erosion and profit shifting reduced long-run annual revenue in OECD countries by about $450bn (1 per cent of gross domestic product) and in non-OECD countries by slightly over $200bn (1.3 per cent of GDP). These are significant figures in the context of a tax that raised an average of only 2.9 per cent of GDP in 2016 in OECD countries and just 2 per cent in the US.
Brad Setser of the Council on Foreign Relations shows that US corporations report seven times as much profit in small tax havens (Bermuda, the British Caribbean, Ireland, Luxembourg, Netherlands, Singapore and Switzerland) as in six big economies (China, France, Germany, India, Italy and Japan). This is ludicrous. The tax reform under Mr Trump changed essentially nothing. Needless to say, not only US corporations benefit from such loopholes.
In such cases, rents are not merely being exploited. They are being created, through lobbying for distorting and unfair tax loopholes and against needed regulation of mergers, anti-competitive practices, financial misbehaviour, the environment and labour markets. Corporate lobbying overwhelms the interests of ordinary citizens. Indeed, some studies suggest that the wishes of ordinary people count for next to nothing in policymaking.
Not least, as some western economies have become more Latin American in their distribution of incomes, their politics have also become more Latin American. Some of the new populists are considering radical, but necessary, changes in competition, regulatory and tax policies. But others rely on xenophobic dog whistles while continuing to promote a capitalism rigged to favour a small elite. Such activities could well end up with the death of liberal democracy itself.
Members of the Business Roundtable and their peers have tough questions to ask themselves. They are right: seeking to maximise shareholder value has proved a doubtful guide to managing corporations. But that realisation is the beginning, not the end. They need to ask themselves what this understanding means for how they set their own pay and how they exploit — indeed actively create — tax and regulatory loopholes.
They must, not least, consider their activities in the public arena. What are they doing to ensure better laws governing the structure of the corporation, a fair and effective tax system, a safety net for those afflicted by economic forces beyond their control, a healthy local and global environment and a democracy responsive to the wishes of a broad majority?
We need a dynamic capitalist economy that gives everybody a justified belief that they can share in the benefits. What we increasingly seem to have instead is an unstable rentier capitalism, weakened competition, feeble productivity growth, high inequality and, not coincidentally, an increasingly degraded democracy. Fixing this is a challenge for us all, but especially for those who run the world’s most important businesses. The way our economic and political systems work must change, or they will perish.
“While each of our individual companies serves its own corporate purpose, we share a fundamental commitment to all of our stakeholders.”
With this sentence, the US Business Roundtable, which represents the chief executives of 181 of the world’s largest companies, abandoned their longstanding view that “corporations exist principally to serve their shareholders”.
This is certainly a moment. But what does — and should — that moment mean? The answer needs to start with acknowledgment of the fact that something has gone very wrong. Over the past four decades, and especially in the US, the most important country of all, we have observed an unholy trinity of slowing productivity growth, soaring inequality and huge financial shocks.
As Jason Furman of Harvard University and Peter Orszag of Lazard Frères noted in a paper last year: “From 1948 to 1973, real median family income in the US rose 3 per cent annually. At this rate . . . there was a 96 per cent chance that a child would have a higher income than his or her parents. Since 1973, the median family has seen its real income grow only 0.4 per cent annually . . . As a result, 28 per cent of children have lower income than their parents did.”
So why is the economy not delivering? The answer lies, in large part, with the rise of rentier capitalism. In this case “rent” means rewards over and above those required to induce the desired supply of goods, services, land or labour. “Rentier capitalism” means an economy in which market and political power allows privileged individuals and businesses to extract a great deal of such rent from everybody else.
That does not explain every disappointment. As Robert Gordon, professor of social sciences at Northwestern University, argues, fundamental innovation slowed after the mid-20th century. Technology has also created greater reliance on graduates and raised their relative wages, explaining part of the rise of inequality. But the share of the top 1 per cent of US earners in pre-tax income jumped from 11 per cent in 1980 to 20 per cent in 2014. This was not mainly the result of such skill-biased technological change.
If one listens to the political debates in many countries, notably the US and UK, one would conclude that the disappointment is mainly the fault of imports from China or low-wage immigrants, or both. Foreigners are ideal scapegoats. But the notion that rising inequality and slow productivity growth are due to foreigners is simply false.
Every western high-income country trades more with emerging and developing countries today than it did four decades ago. Yet increases in inequality have varied substantially. The outcome depended on how the institutions of the market economy behaved and on domestic policy choices.
Harvard economist Elhanan Helpman ends his overview of a huge academic literature on the topic with the conclusion that “globalisation in the form of foreign trade and offshoring has not been a large contributor to rising inequality. Multiple studies of different events around the world point to this conclusion.”
The shift in the location of much manufacturing, principally to China, may have lowered investment in high-income economies a little. But this effect cannot have been powerful enough to reduce productivity growth significantly. To the contrary, the shift in the global division of labour induced high-income economies to specialise in skill-intensive sectors, where there was more potential for fast productivity growth.
Donald Trump, a naive mercantilist, focuses, instead, on bilateral trade imbalances as a cause of job losses. These deficits reflect bad trade deals, the American president insists. It is true that the US has overall trade deficits, while the EU has surpluses. But their trade policies are quite similar. Trade policies do not explain bilateral balances. Bilateral balances, in turn, do not explain overall balances. The latter are macroeconomic phenomena. Both theory and evidence concur on this.
The economic impact of immigration has also been small, however big the political and cultural “shock of the foreigner” may be. Research strongly suggests that the effect of immigration on the real earnings of the native population and on receiving countries’ fiscal position has been small and frequently positive.
Far more productive than this politically rewarding, but mistaken, focus on the damage done by trade and migration is an examination of contemporary rentier capitalism itself.
Finance plays a key role, with several dimensions. Liberalised finance tends to metastasise, like a cancer. Thus, the financial sector’s ability to create credit and money finances its own activities, incomes and (often illusory) profits.
A 2015 study by Stephen Cecchetti and Enisse Kharroubi for the Bank for International Settlements said “the level of financial development is good only up to a point, after which it becomes a drag on growth, and that a fast-growing financial sector is detrimental to aggregate productivity growth”. When the financial sector grows quickly, they argue, it hires talented people. These then lend against property, because it generates collateral. This is a diversion of talented human resources in unproductive, useless directions.
Again, excessive growth of credit almost always leads to crises, as Carmen Reinhart and Kenneth Rogoff showed in This Time is Different. This is why no modern government dares let the supposedly market-driven financial sector operate unaided and unguided. But that in turn creates huge opportunities to gain from irresponsibility: heads, they win; tails, the rest of us lose. Further crises are guaranteed.
Finance also creates rising inequality. Thomas Philippon of the Stern School of Business and Ariell Reshef of the Paris School of Economics showed that the relative earnings of finance professionals exploded upwards in the 1980s with the deregulation of finance. They estimated that “rents” — earnings over and above those needed to attract people into the industry — accounted for 30-50 per cent of the pay differential between finance professionals and the rest of the private sector.
This explosion of financial activity since 1980 has not raised the growth of productivity. If anything, it has lowered it, especially since the crisis. The same is true of the explosion in pay of corporate management, yet another form of rent extraction. As Deborah Hargreaves, founder of the High Pay Centre, notes, in the UK the ratio of average chief executive pay to that of average workers rose from 48 to one in 1998 to 129 to one in 2016. In the US, the same ratio rose from 42 to one in 1980 to 347 to one in 2017.
As the US essayist HL Mencken wrote: “For every complex problem, there is an answer that is clear, simple and wrong.” Pay linked to the share price gave management a huge incentive to raise that price, by manipulating earnings or borrowing money to buy the shares. Neither adds value to the company. But they can add a great deal of wealth to management. A related problem with governance is conflicts of interest, notably over independence of auditors.
In sum, personal financial considerations permeate corporate decision-making. As the independent economist Andrew Smithers argues in Productivity and the Bonus Culture, this comes at the expense of corporate investment and so of long-run productivity growth.
A possibly still more fundamental issue is the decline of competition. Mr Furman and Mr Orszag say there is evidence of increased market concentration in the US, a lower rate of entry of new firms and a lower share of young firms in the economy compared with three or four decades ago. Work by the OECD and Oxford Martin School also notes widening gaps in productivity and profit mark-ups between the leading businesses and the rest. This suggests weakening competition and rising monopoly rent. Moreover, a great deal of the increase in inequality arises from radically different rewards for workers with similar skills in different firms: this, too, is a form of rent extraction.
A part of the explanation for weaker competition is “winner-takes-almost-all” markets: superstar individuals and their companies earn monopoly rents, because they can now serve global markets so cheaply. The network externalities — benefits of using a network that others are using — and zero marginal costs of platform monopolies (Facebook, Google, Amazon, Alibaba and Tencent) are the dominant examples.
Another such natural force is the network externalities of agglomerations, stressed by Paul Collier in The Future of Capitalism. Successful metropolitan areas — London, New York, the Bay Area in California — generate powerful feedback loops, attracting and rewarding talented people. This disadvantages businesses and people trapped in left-behind towns. Agglomerations, too, create rents, not just in property prices, but also in earnings.
Yet monopoly rent is not just the product of such natural — albeit worrying — economic forces. It is also the result of policy. In the US, Yale University law professor Robert Bork argued in the 1970s that “consumer welfare” should be the sole objective of antitrust policy. As with shareholder value maximisation, this oversimplified highly complex issues. In this case, it led to complacency about monopoly power, provided prices stayed low. Yet tall trees deprive saplings of the light they need to grow. So, too, may giant companies.
Some might argue, complacently, that the “monopoly rent” we now see in leading economies is largely a sign of the “creative destruction” lauded by the Austrian economist Joseph Schumpeter. In fact, we are not seeing enough creation, destruction or productivity growth to support that view convincingly.
A disreputable aspect of rent-seeking is radical tax avoidance. Corporations (and so also shareholders) benefit from the public goods — security, legal systems, infrastructure, educated workforces and sociopolitical stability — provided by the world’s most powerful liberal democracies. Yet they are also in a perfect position to exploit tax loopholes, especially those companies whose location of production or innovation is difficult to determine.
The biggest challenges within the corporate tax system are tax competition and base erosion and profit shifting. We see the former in falling tax rates. We see the latter in the location of intellectual property in tax havens, in charging tax-deductible debt against profits accruing in higher-tax jurisdictions and in rigging transfer prices within firms.
A 2015 study by the IMF calculated that base erosion and profit shifting reduced long-run annual revenue in OECD countries by about $450bn (1 per cent of gross domestic product) and in non-OECD countries by slightly over $200bn (1.3 per cent of GDP). These are significant figures in the context of a tax that raised an average of only 2.9 per cent of GDP in 2016 in OECD countries and just 2 per cent in the US.
Brad Setser of the Council on Foreign Relations shows that US corporations report seven times as much profit in small tax havens (Bermuda, the British Caribbean, Ireland, Luxembourg, Netherlands, Singapore and Switzerland) as in six big economies (China, France, Germany, India, Italy and Japan). This is ludicrous. The tax reform under Mr Trump changed essentially nothing. Needless to say, not only US corporations benefit from such loopholes.
In such cases, rents are not merely being exploited. They are being created, through lobbying for distorting and unfair tax loopholes and against needed regulation of mergers, anti-competitive practices, financial misbehaviour, the environment and labour markets. Corporate lobbying overwhelms the interests of ordinary citizens. Indeed, some studies suggest that the wishes of ordinary people count for next to nothing in policymaking.
Not least, as some western economies have become more Latin American in their distribution of incomes, their politics have also become more Latin American. Some of the new populists are considering radical, but necessary, changes in competition, regulatory and tax policies. But others rely on xenophobic dog whistles while continuing to promote a capitalism rigged to favour a small elite. Such activities could well end up with the death of liberal democracy itself.
Members of the Business Roundtable and their peers have tough questions to ask themselves. They are right: seeking to maximise shareholder value has proved a doubtful guide to managing corporations. But that realisation is the beginning, not the end. They need to ask themselves what this understanding means for how they set their own pay and how they exploit — indeed actively create — tax and regulatory loopholes.
They must, not least, consider their activities in the public arena. What are they doing to ensure better laws governing the structure of the corporation, a fair and effective tax system, a safety net for those afflicted by economic forces beyond their control, a healthy local and global environment and a democracy responsive to the wishes of a broad majority?
We need a dynamic capitalist economy that gives everybody a justified belief that they can share in the benefits. What we increasingly seem to have instead is an unstable rentier capitalism, weakened competition, feeble productivity growth, high inequality and, not coincidentally, an increasingly degraded democracy. Fixing this is a challenge for us all, but especially for those who run the world’s most important businesses. The way our economic and political systems work must change, or they will perish.
Thursday, 21 January 2016
The hidden wealth of nations
G Sampath in The Hindu
The Hindu
Tax havens such as Mauritius thrive parasitically, feeding on substantive economies like India.India’s biggest source of FDI is India itself, money departing on a short holiday to a tax haven and then routed back as FDI. Will the government muster up the political will to clamp down on the tax-allergic business elite?
This could be a bumper year for the ever-lucrative tax avoidance industry. The 2015 final reports of the Organisation for Economic Co-operation and Development (OECD)-led project on Base Erosion and Profit Shifting (BEPS) — which refer to the erosion of a nation’s tax base due to the accounting tricks of Multinational Enterprises (MNEs) and the legal but abusive shifting out of profits to low-tax jurisdictions respectively — lays out 15 action points to curb abusive tax avoidance by MNEs. As a participant of this project, India is expected to implement at least some of these measures. But can it? More pertinently, does it have the political will?
The BEPS project is no doubt a positive development for tax justice. If India’s recent economic history tells us anything, it is that economic growth without public investment in social infrastructure such as health care and education can do very little to better the life conditions of the majority. Which is why curbing tax evasion to boost public finance is part of the United Nations’ Sustainable Development Goals (SDGs).
However, notwithstanding the BEPS project, MNEs and their dedicated army of highly paid accountants are not about to roll over and comply. Again, if past history is any indication, the cat-and-mouse game between accountants and taxmen will continue, with new loopholes being unearthed in new tax rules.
Empowering tax dodgers
The primary cause of concern here is the quality of India’s political leadership, which has consistently betrayed its own taxmen. All it takes — regardless of the party in power — is for the stock market to sneeze, and the Indian state swoons. We’ve seen it happen time and again: the postponement of the enforcement of General Anti-Avoidance Rules (GAAR) to 2017, and more spectacularly, on the issue of participatory notes, or P-notes.
The primary cause of concern here is the quality of India’s political leadership, which has consistently betrayed its own taxmen. All it takes — regardless of the party in power — is for the stock market to sneeze, and the Indian state swoons. We’ve seen it happen time and again: the postponement of the enforcement of General Anti-Avoidance Rules (GAAR) to 2017, and more spectacularly, on the issue of participatory notes, or P-notes.
Last year, the Special Investigation Team (SIT) on black money had recommended mandatory disclosure to the regulator, as per Know Your Customer (KYC) norms, of the identity of the final owner of P-notes. It was a sane suggestion because the bulk of P-note investments in the Indian stock market were from tax havens such as Cayman Islands. But the markets threw a fit, with the Sensex crashing by 500 points in a day. The National Democratic Alliance (NDA) government, which had come to power promising to fight black money, promptly issued a statement assuring investors that it was in no hurry to implement the SIT recommendations. Given such a patchy record, what are the realistic chances of India actually clamping down on tax dodging?
Let’s take, for instance, Action No. 6 of the OECD’s BEPS report: it urges nations to curb treaty abuse by amending their Double Taxation Avoidance Agreements (DTAA) suitably. The obvious litmus test of India’s seriousness on BEPS is its DTAA with Mauritius. By way of background, Mauritius accounted for 34 per cent of India’s FDI equity inflows from 2000 to 2015. It’s been India’s single-largest source of FDI for nearly 15 years. Now, is it possible that there are so many rich businessmen in this tiny island nation with a population of just 1.2 million, all with a touching faith in India as an investment destination? If not, how do we explain an island economy with a GDP less than one-hundredth of India’s GDP supplying more than one-third of India’s FDI?
We all know the answer: Mauritius is a tax haven. While not in the same league as Cayman Islands or Bermuda, Mauritius is a rising star, thanks in no small measure to India’s patriotic but tragically tax-allergic business elite. In Treasure Islands: Tax Havens and the Men Who Stole the World, financial journalist Nicholas Shaxson notes how Mauritius is a popular hub for what is known as “round-tripping”. He writes, “A wealthy Indian, say, will send his money to Mauritius, where it is dressed up in a secrecy structure, then disguised as foreign investment, before being returned to India. The sender of the money can avoid Indian tax on local earnings.”
In other words, it appears that India’s biggest source of FDI is India itself. Indian money departs on a short holiday to Mauritius, before returning home as FDI. Perhaps not all the FDI streaming in from Mauritius is round-tripped capital — maybe a part of it is ‘genuine’ FDI originating in Europe or the U.S. But it still denotes a massive loss of tax revenue, part of the $1.2 trillion stolen from developing countries every year.
What makes this theft of tax revenue not just possible but also legal is India’s DTAA with Mauritius. It’s a textbook example of ‘treaty shopping’ — a government-sponsored loophole for MNEs to avoid tax by channelling investments and profits through an offshore jurisdiction.
For instance, as per this DTAA, capital gains are taxable only in Mauritius, not in India. But here’s the thing: Mauritius does not tax capital gains. India, like any sensible country, does. What would any sensible businessman do? Set up a company in Mauritius, and route all Indian investments through it.
India signed this DTAA with Mauritius in 1983, but apparently ‘woke up’ only in 2000. India has spent much of 2015 ‘trying’ to renegotiate this treaty. But with our Indian-made foreign investors lobbying furiously, the talks have so far yielded nothing. Meanwhile, China, which too had the same problem with Mauritius, has already renegotiated its DTAA, and it can force investors to pay 10 per cent capital gains tax in China.
Changing profile of tax havens
Tax havens such as Mauritius thrive parasitically, feeding on substantive economies like India. Back in 2000, the OECD had identified 41 jurisdictions as tax havens. Today, as it humbly seeks their cooperation to combat tax avoidance, it calls them by a different name, so as not to offend them.
Tax havens such as Mauritius thrive parasitically, feeding on substantive economies like India. Back in 2000, the OECD had identified 41 jurisdictions as tax havens. Today, as it humbly seeks their cooperation to combat tax avoidance, it calls them by a different name, so as not to offend them.
The same list is now called — and this is not a joke — ‘Jurisdictions Committed to Improving Transparency and Establishing Effective Exchange of Information in Tax Matters’. Distinguished members of this club include Cayman Islands, Bermuda, Bahamas, Cyprus, and of course, Mauritius.
Today the function of tax havens in the global economy has evolved way beyond that of offering a low-tax jurisdiction. Mr. Shaxson describes three major elements that make tax havens tick. First, tax havens are not necessarily about geography; they are simply someplace else — a place where a country’s normal tax rules don’t apply. So, for instance, country A can serve as a tax haven for residents of country B, and vice versa. The U.S. is a classic example. It has stringent tax laws, and is energetic in prosecuting tax evasion by its citizens around the world. But it is equally keen to attract tax-evading capital from other countries, and does so through generous sops and helpful pieces of legislation which have effectively turned the U.S. into a tax haven for non-residents.
Second, more than the nominally low taxes, the bigger attraction of tax havens is secrecy. Secrecy is important for two reasons: to be able to avoid tax, you need to hide your real income; and to hide your real income, you need to hide your identity, so that the booty stashed away in a tax haven cannot be traced back to you by the taxmen at home. So, even a country whose taxes are not too low can function as a tax haven by offering a combination of exemptions and iron-clad secrecy — which is the formula adopted by the likes of Luxembourg and the Netherlands.
Third, the extreme combination of low taxes and high secrecy brought about a new mutation of tax havens in the 1960s: they turned themselves into offshore financial centres (OFCs). The economist Ronen Palan defines OFCs as “markets in which financial operators are permitted to raise funds from non-residents and invest or lend the money to other non-residents free from most regulations and taxes”. It is estimated that OFCs are recipients of 30 per cent of the world’s FDI, and are, in turn, the source of a similar quantum of FDI.
Such being the case, all India needs to do to attract FDI is to become an OFC, or create an OFC on its territory — bring offshore onshore, so to speak. That’s precisely what the U.S. did — it set up International Banking Facilities (IBFs), “to offer deposit and loan services to foreign residents and institutions free of… reserve requirements”. Japan set up the Japanese Offshore Market (JOM). Singapore has the Asian Currency Market (ACU), Thailand has the Bangkok International Banking Facility (BIBF), Malaysia has an OFC in Labuan island, and other countries have similar facilities. OFCs, as Ronen Palan puts it, are less tax havens than regulatory havens, which means that financial capital can do here what it cannot do ‘onshore’. So every major hedge fund operates out of an OFC. Given the volume of unregulated financial transactions that OFCs host, it is no surprise that they were at the heart of the 2008 financial crisis.
Apart from accumulating illicit capital (in the tax haven role), channelling this capital back onshore dressed up as FDI (in investment hub role), and deploying it to engage in destructive financial speculation (in OFC role), these strongholds of finance capital also serve a political function: they undermine democracy by enabling financial capture of the political levers of democratic states.
It is well known that political parties in most democracies are amply funded by slush funds that would not have accumulated in the first place had taxes been paid. But today, not least in the Anglophone world, global finance’s capture of the state appears more like the norm.
A lone exception seems to be Iceland, which began the new year on a rousing note — by sentencing 26 corrupt bankers to a combined 74 years in jail. Meanwhile in India, we continue to parrot long discredited clichés about the need for more financial deregulation and a weird logic that mandates a smaller and more limited role for public finance.
Tuesday, 13 October 2015
Now the Tories are allowing big business to design their own tax loopholes
Last Monday, as the prime minister rehearsed his Manchester conference speech, a story appeared in this newspaper that showed you who really runs this country – and how. It revealed that one of Britain’s largest companies, AstraZeneca, paid absolutely no corporation tax here in both 2013 and 2014, despite racking up global profits in those years of £2.9bn.
Revealed: how AstraZeneca avoids paying UK corporation tax
At first glance this sounded like an everyday tale of Mega-Business Making a Mockery of Our Tax Laws, to be filed alongside Google, Starbucks – or this weekend’s disclosure that Facebook paid less to the exchequer last year than you probably did. But this story is bigger. It’s less about accountancy than where power lies in 21st-century Britain.
Astra’s tax maestro is called Ian Brimicombe, and he is more than well-known at the Treasury: he is a trusted adviser. Shortly after George Osborne took over as chancellor in 2010, his team began rewriting the rules on how big businesses are taxed. To help, the government appointed senior executives from some of Britain’s giant companies to a “liaison committee”, comprising Astra’s Brimicombe, representatives from Tesco, Santander, BP and others.
Although the group was not widely reported, there was no disguising its purpose. In the Treasury’s own blunt words, the businesspeople were providing “strategic oversight of the development of corporate tax policy”.
Corporation tax alone is one of the biggest earners for the government, worth over £50bn a year – and now companies with millions, even billions of pounds at stake were to be given direct say on how they should be taxed.
The Treasury set up working groups specifically to advise on taxing multinational business – fitted out with directors from 40 multinationals, all with extensive networks of offshore subsidiaries. In his book The Great Tax Robbery, the former tax inspector Richard Brooks records that a Vodafone representative was put on the group “deciding how to tax offshore financing of exactly the sort his company was running through Luxembourg and Switzerland for hundreds of millions of pounds in tax saving every year”.
The new regime for multinationals began in 2013. Within five months,AstraZeneca had set up an unusual and intricate Dutch tax avoidance structure that would enable it to take full advantage of the new loopholes it had so helpfully advised on. To call this a conflict of interests is to miss the point – it’s far too brazen for that. Osborne’s Treasury blithely invited in some of the country’s biggest businesses and asked them to help design their own tax regimes. It’s like trawlermen asking fish to design their nets, or the Highways Agency allowing Jeremy Clarkson to set his own speed limit.
It might even be funny – if all these giveaways didn’t cost hundreds of millions amid a decade of belt-tightening. In their original assessment, Treasury officials calculated that the relaxation of the controlled foreign company rules would cost the public around £840m by this tax year. That’s getting on for the equivalent of three brand-new, fully staffed hospitals. The year 2013 also marked the start of the most severe cuts to social security, including the introduction of the bedroom tax. That particular cut has inflicted panic and upheaval on some of the poorest households in Britain, yet going by academic research it raises less half the amount given away to multinationals by the new controlled foreign company rules.
I write this – but we’re not even allowed to know how much money we’re giving away to Astra, Tesco and the rest. The Treasury’s initial assessment of the new rules came with a vital postscript: “The government would welcome evidence from business to help it refine the estimates of the elements of cost of the CFC reform.” Or, translated from the mandarin: this is guesswork.
When the tax-justice campaigner George Turner submitted a freedom of information request last month to find out how much the new system was costing taxpayers, Osborne’s department told him it would take too much time to find out. Turner persisted: what about the new patent box tax break, originally set to cost the public £900m? No luck there either. So ordinary taxpayers may have kissed goodbye to £1.8bn in school places and Sure Start schemes – or they may have lost a lot more. We won’t be told what’s happened to our own money.
These tax breaks aren’t in aid of struggling small businesses or innovative new tech firms: they are going into the coffers of the biggest companies in Britain, with their platoons of lobbyists and tax advisers and their web of connections into Whitehall.
The year before the government brought in these new tax breaks, AstraZeneca was granted £5m to encourage it to expand its research site at Alderley Park in Cheshire – money that the local MP (one G Osborne of Tatton) played a key role in securing. Just five months later, the drugs giant announced it was closing the centre, with the immediate loss of 550 jobs. From 2007-14, calculates York University’s Kevin Farnsworth, AstraZeneca took £91.3m in joint public funding from the government’s Innovate UK research group.
Britain is in the middle of a cold, austere decade. Ordinary taxpayers are having to tighten their belts – even while multinationals are being lavished with public cash. Osborne and Cameron tell tax-avoiding companies to “wake up and smell the coffee”, yet undercut the rest of Europe on taxes so as to lure Starbucks to put their offices in the UK. Tax avoidance is normally painted as big businesses finding and exploiting loopholes; but the Conservatives are now allowing those same outfits to design their own loopholes.
“Upwards redistribution” is how the Berkeley academic Gabriel Zucman describes it: taking from ordinary taxpayers and giving to the very richest. Zucman is a sometime co-author with Thomas Piketty and his new book The Hidden Wealth of Nations is set to do for tax havens what his colleague’s did for wealth inequality: define and popularise the problem.
“Britain is now engaged in the most extreme form of tax competition anywhere in Europe,” he told me this weekend. “It’s trying to become a tax haven.” This is what economic competence now looks like in the UK: an officially driven attempt to turn a developed country into a competitor to the Cayman Islands, with lavish handouts for those who can afford it, and cuts for those who can’t.
Friday, 13 February 2015
As HSBC shows, we’ve been timid and pathetic in dealing with tax dodgers
Prem Sikka in The Guardian
The parliamentary hearing on HSBC, chaired by Margaret Hodge this week has further exposed the cosy arrangements between big business and those who are supposed to be collecting its taxes. Revelations of organised tax avoidance and even evasion don’t lead to any investigations, prosecutions and fines, it appears. And Lin Homer, the chief executive of HMRC, faced angry questioning from MPs who accused her department of failing to serve taxpayers’ interests.
While the UK dithers, other countries, notably the US, are taking meaningful action against the tax avoidance industry. In 2013 Ernst & Young was fined $123m for its past misdemeanours after admitting “wrongful conduct” over the sale of tax avoidance schemes. Some staff also received prison sentences. In 2005 KPMG was fined $456m after it admitted to a fraud that generated at least $11bn in phoney tax losses for clients. A number of the firm’s former senior personnel were jailed.
And US regulators have targeted lawyers: a former Jenkens & Gilchrist employee received an eight-year sentence and a $190m fine for promoting fraudulent tax avoidance schemes. Another was jailed for 15 years.
There have been other massive fines for tax-dodging schemes: Credit Suisse was made to pay $2.6bn; UBS $780m, and Deutsche Bank $554m. All these illustrate how the US, the supposed home of deregulation and light-touch regulation, deals with organised tax avoidance. Periodic hearings by its Senate committees have led to action by the tax authorities and the department of justice. One programme rewards individuals who expose tax problems at their workplace. Whistleblowers can receive up to 30% of the tax proceeds resulting from their information. In 2013 122 whistleblowers shared awards totalling $53m.
Britain’s efforts to recoup taxes are pathetic by comparison. As Hodge said to Homer yesterday: “One of my feelings of anger with you is that you sit there waiting for people to come. You don’t go out and police in the way other authorities are doing.”
No doubt all those addicted to tax avoidance, in whatever country, are able to game the rules and play cat-and-mouse with the tax authorities. These practices are deeply embedded in contemporary entrepreneurial culture. That’s why strong measures are needed to counter them.
But Britain lacks effective institutions and the political will to deal with the tax-avoidance industry. Hodge’s public accounts committee hearings have not been followed up with action by any government department.
The UK has a fragmented regulatory system. HMRC, the Serious Fraud Office, the Treasury, the Crown Prosecution Service, the Department of Justice, professional bodies and others are all keen to pass the buck. The overlapping structures result in duplication and waste. With an annual budget of about £35m, the SFO is incapable of fighting banks and giant law and accountancy firms.
Tax courts and tribunals have often declared avoidance schemes to be unlawful, but this has not been followed by investigations, fines or prosecutions. Despite winning some cases, HMRC has not even sought to recover legal costs from any of the parties.
One reason for HMRC’s timidity is the lack of personnel and resources. The economic case for investment to check tax avoidance is unanswerable: evidence suggests that for every £1 spent in 2013/14 by HMRC’s large business service – which deals with the UK’s largest and most complex businesses – an additional £97 was recovered. The local compliance unit, which handles smaller businesses and wealthy individuals, collected an additional £18 for every £1 spent the same year.
But it seems the government is not listening. It has cut HMRC funding, badly denting its efforts to expose wrongdoing. This leads to false economies, such as the HMRC relying on professional bodies to deal with the tax avoidance schemes promoted by big accountancy firms. This has to stop. No such firm has ever been disciplined or fined for peddling abusive tax avoidance schemes, even after the courts declared them unlawful.
We’ve heard ministers announce proposals, but these are rarely fully implemented. For example, in April 2013 the government introduced rules to ban companies and individuals who took part in failed tax avoidance schemes from being awarded government contracts. In practice, no such business has been barred.
This week’s revelations in the Guardian and the House of Commons show how flawed is our policing of tax dodgers. It’s clear these abuses will continue until, like others countries, we send out a tough signal that tax evaders will be caught – and punished severely.
Tuesday, 9 December 2014
PriceWaterhouseCoopers chief Kevin Nicholson denies lying over tax deals
Nicholson stands by previous testimony to MPs, as accountants are accused of mass-marketing tax avoidance schemes
The head of tax at one of the UK’s top accounting groups was accused of lying to parliament about his firm’s role in devising controversial tax deals for clients in Luxembourg.
Kevin Nicholson, PwC UK’s head of tax, who worked as an HM Revenue and Customs tax inspector in the early 1990s, was in front of the Commons public accounts committee for the second time in two years, following last month’s revelations of aggressive tax avoidance by PwC clients published by the Guardian and more than 20 other international news outlets.
In a series of fractious exchanges on Monday, the committee’s chair, the Labour MP Margaret Hodge, said: “We’ve asked you to come back to see us because we’ve reflected on the evidence that you gave us on 31 January 2013, and tried to relate that to the revelations around the Luxembourg leaks that have been in the press. I think I have a very simple question for you: did you lie when you gave evidence to us?”
Nicholson responded: “I didn’t lie and stand by what I said.”
Hodge’s anger stemmed from Nicholson’s previous evidence that PwC did not “mass market” tax products or sell tax avoidance “schemes” to clients, when set against the new evidence of 548 letters – relating to 343 companies – showing how PwC wrote to Luxembourg tax authorities to agree on how their clients structured their businesses for tax purposes.
“It’s very hard for me to understand that this is anything other than a mass-marketed tax avoidance scheme,” Hodge said. “I think there are three ways in which you lied and I think what you are doing is selling tax avoidance on an industrial scale.”
Nicholson again denied that the tax services sold by PwC were mass-marketed schemes and said that around 80 of the Luxembourg rulings related to UK companies, which were all distinct and had been disclosed to HMRC.
He said: “At the heart of the Luxembourg economy now is an economy that is based around businesses going there to finance [and] to hold investments. The tax structure, the system that they have created, facilitates that happening, along with all the other infrastructure. I’m not here to change the Lux tax regime. If you want to change the Lux tax regime, the politicians could change the Lux tax regime.”
Last month’s analyses of the way multinational companies establish businesses in Luxembourg were based on a leaked cache of hundreds of tax rulings secured by PwC Luxembourg that showed major companies – including drugs group Shire Pharmaceuticals and vacuum cleaner firm Dyson – using complex webs of internal loans and interest payments, which have greatly reduced tax bills.
The exposure of these arrangements – signed off by the grand duchy and all perfectly legal – have triggered an emergency debate in the European parliament focusing on the track record of the new European commission president, Jean-Claude Juncker, who had dominated Luxembourg politics as prime minister between 1995 and 2013. Juncker has sought to brush aside criticisms, insisting: “I am not the architect of the Luxembourg model because this model doesn’t exist.” However, Hodge added: “Since I have uncovered all this, I have questions about if Mr Juncker is fit to be the president of the European commission. I think if this had been around during the period of his appointment, it might well be a different decision.”
Appearing alongside Nicholson was Shire’s head of tax, Fearghus Carruthers, who explained how the group had two full-time employees in Luxembourg, who earn a total of €135,000 (£106,200) a year and handle intra-company loans of around $10bn (£6.4bn).
Hodge said: “It is stretching our credulity in suggesting to us that these two employees, who are also directors of umpteen other companies, are seriously the guys taking the decisions on loans totalling $10bn. Let me put this to you, Mr Carruthers, because it is a very serious matter, because if the decisions in substance aren’t taken in Luxembourg, this isn’t just avoidance; for me, it’s fraud.”
Carruthers responded: “Madam chair, I can assure you that the decision-making in respect of that Luxembourg company is made in Luxembourg.”
The executive was also repeatedly asked to explain the commercial rationale behind Shire establishing companies in Luxembourg and his answers included: “The commercial purpose is to allow us to have a treasury operation in Luxembourg which finances our activities”; and “the commercial purpose is for us to reinvest our cash appropriately and efficiently.”
When asked what Shire could do more efficiently in Luxembourg, Carruthers said: “It is not necessarily a question of comparative efficiency, we could have this lending in and lending out in all sorts of other jurisdictions. It’s just a good location.”
Well-known buyout firms such as Blackstone and Carlyle also appeared in the leaked documents, and Luxembourg investment vehicles are commonplace in such investment firms. A 2008 joint venture between private equity group Apax Partners and Guardian Media Group, which owns the Guardian, used a Luxembourg structure after it invested in the magazine and events group Emap, now called Top Right.
When the leaked documents were published, a GMG spokesman said: “We partnered with a private equity company which regularly used such structures. A Luxembourg entity was used because Apax already had that structure in place. The fact that the parent company is a Luxembourg company does not give rise to any UK corporation tax savings for GMG.”
Last year, PwC made revenues of £2.81bn, of which £714m came from its tax advisory practice. PwC Luxembourg had turnover of €276m for the year to June 2013, up more than 12% on the previous 12 months. Tax advice accounted for 29% of revenues, up from 24% two years ago. The Luxembourg partnership employs about 2,300 staff – equivalent to one in every 240 people resident in the small country. New offices for the fast-growing practice were officially opened last week at a ceremony attended by the duchy’s prime minister, Xavier Bettel.
Tuesday, 20 May 2014
I'd vote yes to rid Scotland of its feudal landowners
The scoured, scorched Highlands could be brought to life – maybe an independent nation will have the courage to act
‘It is astonishing, in the 21st century, that people are still allowed to burn mountainsides for any purpose, let alone blasting highland chickens out of the air.' Photograph: Christopher Furlong/Getty
Power's ability to resist change: this is the story of our times. Morally bankrupt, discredited, widely loathed? No problem: whether it's neoliberal economics, tax avoidance, coal burning, farm subsidies or the House of Lords, somehow the crooked system creeps along.
Legally, feudalism in Scotland ended in 2004. In itself, this is an arresting fact. But almost nothing has changed. After 15 years of devolution the nation with the rich world's greatest concentration of land ownership remains as inequitable as ever.
The culture of deference that afflicts the British countryside is nowhere stronger than in the Highlands. Hardly anyone dares challenge the aristocrats, oligarchs, bankers and sheikhs who own so much of this nation, for fear of consequences real or imagined. The Scottish government makes grand statements about land reform, then kisses the baronial boot. The huge estates remain untaxed and scarcely regulated.
You begin to grasp the problem when you try to discover who owns them. Fifty per cent of the private land in Scotland is in the hands of 432 people – but who are they? Many large estates are registered in the names of made-up companies in the Caribbean. When the Scottish minister Fergus Ewing was challenged on this issue, he claimed that obliging landowners to register their estates in countries that aren't tax havens would risk "a negative effect on investment". William Wallace rides again.
Scotland's deer-stalking estates and grouse moors, though they are not agricultural land, benefit from the outrageous advantages that farmers enjoy. They are exempt from capital gains tax, inheritance tax and business rates. Landowners seek to justify their grip on the UK by rebranding themselves as business owners. The Country Landowners' Association has renamed itself the Country Land and Business Association. So why do they not pay business rates on their land? As Andy Wightman, author of The Poor Had No Lawyers, argues, these tax exemptions inflate the cost of land, making it impossible for communities to buy.
Though the estates pay next to nothing to the exchequer, and though they practise little that resembles farming, they receive millions in farm subsidies. The new basic payments system the Scottish government is introducing could worsen this injustice. Wightman calculates that the ruler of Dubai could receive £439,000 for the estate in Wester Ross he owns; the Duke of Westminster could find himself enriched by £764,000 a year; and the Duke of Roxburgh by £950,000.
With the help of legislators and taxpayers, the owners of the big estates are ripping apart the fabric of the nation. The hills in many parts look as if they have been camouflaged against military attack, as they have been burned in patches for grouse shooting. It is astonishing, in the 21st century, that people are still allowed to burn mountainsides – destroying their vegetation, roasting their wildlife, vaporising their carbon, creating a telluric eczema of sepia and grey blotches – for any purpose, let alone blasting highland chickens out of the air. Where the hills aren't burnt for grouse they are grazed to the roots by overstocked deer, maintained at vast densities to give the bankers waddling over the moors in tweed pantaloons a chance of shooting one.
Hanging over the nation is the shadow of Balmoral, whose extreme and destructive management – clearing, burning, overgrazing – overseen by Prince Philip, president emeritus of the World Wide Fund for Nature, is mimicked by the other landowners. Little has changed there since Victoria and Albert adopted an ersatz version of the clothes and customs of the people who had just been cleared from the land. This balmorality is equivalent to Marie Antoinette dressing up as a milkmaid while the people of France starved; but such is Britain's culture of deference that we fail to see it. Today they mix the tartans with the fancy dress of Edwardian squires, harking back to the last time Britain was this unequal.
But despite this lockdown, there is, if not quite a Highland spring, the beginnings of something different: on one side of me, here in Boat of Garten, is the bare, black misery of the Monadhliath mountains; on the other, the great rewilding that is quickly but quietly spreading through the north-west of the Cairngorms national park. Across 100,000 hectares, the RSPB, the Forestry Commission, the National Trust and Wildland Ltd (owned by the Danish textiles billionaire Anders Holch Povlsen) are seeking to reverse the destruction, reduce the deer to reasonable numbers, and get trees back on the braes. On Povlson's estates the area of woodland has doubled (to 1,400 hectares, or 3,450 acres) since 2006, solely through the control of deer. It's not land reform, but it's the best that can be done with the current, dire model of Scottish ownership.
The forests at the moment are bright with birdsong. In some places, looking down on lochans surrounded by marshes and regenerating pines, you almost expect to see a moose emerging from the trees. Trees are racing up the denuded hillsides: in Glenmore I've come across young pines, birch and rowan growing at 800 metres. Already people are talking about reintroducing lynx here within 20 years.
As the return of the ospreys to the lakes and forests in this part of the park shows, the potential for ecotourism, which spreads income and employment through the economy, is vast. The contrast with the scorched and scoured grouse moors of the east side of the national park, which employ hardly anyone, concentrate wealth in tax havens and are unmysteriously devoid of most birds of prey, could not be greater.
It doesn't reverse the other injustices, but it begins to undo the centuries of physical destruction. I would vote yes in September if I lived here, on the grounds that it presents an opportunity to do something new, and I furiously hope, despite the evidence, that an independent Scottish government will take it.
It should list all the beneficial owners of the land; impose the taxes Westminster refuses to levy; ensure that only farmers get subsidies and cap them at £30,000 a head; ban burning; control deer numbers; and turn Scotland into a land where you can actually see green shoots of recovery. On Friday the Land Reform Review Group, set up by the government at Holyrood, will publish its report, and it's likely to be devastating. Will Scotland get off its knees at last?
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