On four decades of tax and wealth creation in the U.S.

By a quirk of chance, the top U.S. income category in the 1961 U.S. Statistics of Income report contained just 398 taxpayers - which makes it possible to compare with data compiled by the U.S. Internal Revenue Service (IRS) on the richest 400 taxpayers. A new article by the U.S. tax expert David Cay Johnston takes a look. One thing he notes, using 2006 dollars as his reference, hardly surprises:

The average income for the top 400 taxpayers rose over the 45 years from $13.7 million to $263.3 million. That is 19.3 times more. The income tax bill went up too, but only 7.8 times as much because tax rates plunged. Income tax rates at the top fell 60 percent.

(Click here for a more detailed table.) Citizens for Tax Justice has more on the top 100 here, including the remarkable fact that the 400 richest income tax filers paid just 17.2 percent of their adjusted gross income (AGI) in federal income taxes.

And the story for those at the bottom?

"In 2006 dollars, the average income of the bottom 90 percent grew from $22,366 in 1961 to $31,642 in 2006. That is a real increase of $9,276 in average income. But it was also after 45 years, longer than the careers of most workers."

Not only that, but inflation-adjusted GDP grew by 227% -- and families worked 45% longer hours than they did in 1961.

Too much of a good thing: the end of the Noughties

It's hard to find anyone with anything good to say about the past decade. Mostly, the positives are expressed in negatives: "the end of neo-conservativism" or "bankers have been revealed as the socially-useless bastards we always suspected they were", or (a personal favourite) "no-one can objectively defend the tax havens any longer." Indeed not. But few amongst my friends and colleagues hold out much optimism that useful lessons have been learned from the catastrophic mistakes made during the decade known by journalists as the 'Noughties'.

From an economist's perspective the decade started with the bursting of the dot.com bubble and ended with the collapse of financial capitalism, which even now, two years after the fall of British bank Northern Rock, survives on a publicly-funded drip feed that sustains equity and property market prices at levels which make little sense on anyone's terms. The period in between was largely shaped by Alan Greenspan's monetary recklessness, rising inequality, and the remorseless increase of personal, corporate and state indebtedness.

After the triumphalism of the Roaring Nineties - the fall of communism in Eastern Europe and the ascendancy of Davos Man - the Noughties ushered in a period of untrammelled corruption, social Darwinism, beggar-thy-neighbour fiscal policies involving endless tax breaks for the rich and well-connected, and the inevitable speculative booms that accompany such feckless clientelism.

Most of the people I've spoken with in the past few months seem to identify 2001 as a turning point. And not just for the obvious reasons related to 9/11 and the War on Terror. This was also the point at which personal and corporate debt began to spiral. In the same year US Secretary to the Treasury Paul O'Neill acted unilaterally to pull the plug from the OECD's harmful tax competition initiative. It was at that stage that the fragile consensus between leading industrialised countries that measures were needed to roll-back the untaxed, unregulated tax haven economy simply dissolved. Weak at the best of times, the political will to take action against the global termites evaporated.

The following year saw some progress, in Monterrey, Mexico, towards an international consensus on the need to help poorer countries finance their own development by strengthening the mobilisation of their own resources. But commitment towards that goal, which will require strong measures to counter illicit financial flows and tax evasion, has seldom risen beyond the mere rhetorical.

Responses to the current crisis suggest that most governments in most countries aim to patch Humpty-Dumpty together again, with a few tweaks here and there to persuade public opinion that what happened in 2008 was an unforeseeable mishap rather than an entirely predictable systemic failure. Deep down, however, most people sense that a consumption-led recovery based on piling debt onto more debt, just won't work. There comes a time when trust in financial engineering evaporates, and at that stage the turbo-charged debt-driven model of aspirational consumerism simply runs into the sand. We have reached that stage.

What comes next? For some countries the options seem rather stark. As Warren Buffett has said on several occasions, it's only when the tide goes out that you learn who's been swimming naked; countries like Ireland, Iceland, the USA and the UK fall into this category. Hopelessly over-dependent on tax breaks and lax regulation to anchor foot-loose portfolio capital to their shores, and politically captive to the special interests of financial capitalism, these countries will probably continue to drive the global race-to-the-bottom in both these areas. The coming decade is likely see more of the policies that shaped the Noughties: socialism for the rich and capitalism for the poor.

What the Noughties revealed beyond all doubt is that when it comes to subsidies and special treatment, rich people and powerful corporations can never have too much of a good thing. And despite the post-London G-20 rhetoric, the steps being taken by the OECD against the secrecy jurisdictions are too weak to have any meaningful impact.

But I want to end the decade on a slightly more positive note. Almost everyone I've met in the past two years, during which I've travelled for work related purposes to twenty-four countries in five continents, is agreed that the world of ideas has fundamentally changed. The orthodox economic consensus that ruled the roost for decades has crashed. Homo economicus stands revealed as a naked swimmer. New economic models are required which recognise that unregulated markets (especially financial markets) tend towards imperfect structures and a decidedly sub-prime allocations of resources.

And alongside this recognition that markets perform best when they are effectively regulated to promote public interest over special interest comes another understanding: tax plays an important part in shaping the types of societies we live in. A new tax consensus is emerging which sees tax as playing a positive role in shaping social and economic justice. Tax Justice Network has played a modest role in shaping this understanding, and we will be building on this agenda in the coming decade.

Happy New Decade et Bon Courage

John Christensen

Berlusconi's merry-go-round

The latest Italian tax amnesty has yielded an inflow of €95 billion. This represents approximately 20 per cent of the total volume of undeclared funds deposited outside the country by Italian citizens (source: Bank of Italy). The Italian government estimates that this latest amnesty will yield additional revenues of €5 billion, which whilst helpful is nonetheless a huge windfall for tax evaders who yet again have been treated very lightly by the Berlusconi government.

This latest amnesty is the third in the past decade. In 2002-03, Berlusconi gave an amnesty covering assets held outside Italy. Some €78 billion of personal assets were repatriated at that time. This was followed by an amnesty targeted at undeclared assets held inside the country. That one revealed around €100 billion of assets not revealed to the authorities.

The latest inflow of repatriated illicit funds will provide a short-term fillip to the flagging economy, but we are sceptical about claims by the Ministry of Finance that "the time of tax havens has finished forever. To place or keep money in tax havens is no longer convenient, neither in economic nor in tax terms. The returns are small, the risk is high."

The problem lies with the combination of the low penalty levied (5 per cent is way below norms) and the anonymity granted to tax evaders. This leniency will do little to deter anyone from jumping back on the merry-go-round. What it does demonstrate, however, is how one set of (lenient) rules apply to rich and well-connected people, while those at the other end of the social spectrum, especially immigrants, can expect no leniency whatsoever.

O tempora, o mores.

End of a decade: the Big Zero

From Paul Krugman in the New York Times:

"We got through the first decade of the new millennium without ever agreeing on what to call it. The aughts? The naughties? Whatever."

More important, though, was what happened. And his answer?

"From an economic point of view, I’d suggest that we call the decade past the Big Zero. It was a decade in which nothing good happened, and none of the optimistic things we were supposed to believe turned out to be true."

As John Authers wrote in the FT recently,

"For the US, still by far the world's biggest stock market, the noughties saw worse performance than the depression-hit 1930s, making this the worst decade since equity markets have existed in their recognisable current form."

But more importantly, Krugman also notes, again of the U.S. economy:

"It was a decade with basically zero job creation. O.K., the headline employment number for December 2009 will be slightly higher than that for December 1999, but only slightly. And private-sector employment has actually declined — the first decade on record in which that happened.

It was a decade with zero economic gains for the typical family. Actually, even at the height of the alleged “Bush boom,” in 2007, median household income adjusted for inflation was lower than it had been in 1999. And you know what happened next."

Many countries fared similarly. The FT again:

"Britain's economy grew more slowly in each year of the noughties than it did in any other decade since the war. The sluggish economic performance of the past decade took place against a backdrop of rising population - a factor that tends to boost output, not shrink it."

And we've said on a number of occasions how Britain's financial sector, booming for much of the decade, has crowded out other sectors - notably manufacturing. The result?

"Output in manufacturing actually contracted during the noughties, declining by an average of 1.2 per cent each year, according to data from the Office for National Statistics."

And in the 1970s and 1980s (when, as it happens, tax rates were far higher) manufacturing output in Britain. grew at average annual rates of 0.6 per cent and 1.0 per cent respectively.

Back to Krugman who adds, of the U.S. market:

"It was a decade of zero gains for homeowners, even if they bought early: right now housing prices, adjusted for inflation, are roughly back to where they were at the beginning of the decade."

He continues:

"Even now, it’s hard to get Democrats, President Obama included, to deliver a full-throated critique of the practices that got us into the mess we’re in. And as for the Republicans: now that their policies of tax cuts and deregulation have led us into an economic quagmire, their prescription for recovery is — tax cuts and deregulation.

So let’s bid a not at all fond farewell to the Big Zero — the decade in which we achieved nothing and learned nothing."

Time, then, for some genuine new thinking as a new decade begins.

IMF: lobbying is bad for you

This isn't entirely a tax justice subject - it's much more generic than that - but if you can see past the stilted IMF-speak it's interesting anyway. This is another IMF working paper, entitled "A Fistful of Dollars: Lobbying and the Financial Crisis" whose introduction notes:

"Using detailed information on lobbying and mortgage lending activities, we find that lenders lobbying more on issues related to mortgage lending

1. had higher loan-to-income ratios,
2. securitized more intensively, and
3. had faster growing portfolios.
   

Ex-post, delinquency rates are higher in areas where lobbyist' (sic) lending grew faster and they experienced negative abnormal stock returns during key crisis events. The findings are robust to (i) falsification tests using lobbying on issues unrelated to mortgage lending,
(ii) a difference-in-difference approach based on state-level laws, and
(iii) instrumental variables strategies.

These results show that lobbying lenders engage in riskier lending."

Research confirms that capital account liberalisation hinders growth in poorer countries

Mark Herkenrath of AllianceSud (Switzerland) draws our attention to a new working paper originating from the IMF Research Department (but note "not to be reported as representing the views of the IMF") which shows that capital account liberalization has no statistically significant effect on economic growth. In other words, while capital controls may be crucial in preventing contagion from external economic crises, they do not seem to hinder economic growth in non-crisis times:

no clear changes in economic growth take place in the years following trade or capital account reforms

More importantly, table 4 on page 35 of the paper shows that in low income countries, there is a statistically significant negative effect of capital account liberalization on growth:

Interestingly, trade liberalization has no effect on low-income country growth in general, but a negative effect in formerly socialist LICs. Not surprisingly, the text does not mention these extraordinary findings. But they will be of great use for advocacy work for the abolition of capital control restrictions and against trade liberalization.

The paper can be downloaded here. Be warned, however, that the paper is very poorly written and its authors seem oblivious of the fact that the financial reforms (read 'de-regulation') of the past thirty years have caused an explosion of unsustainable debt and an economic crisis of unparalleled proportions.

Netherlands & the Antilles: towards a no-tax zone

From our Dutch correspondent:

It’s been a turbulent period for the Dutch Finance Ministry since they invited comments on a proposal for corporate tax reform last June. Much of that has to do with the soap-like collapse of DSB Bank, triggered by a guest on a TV progamme calling on people to withdraw their savings. And then there were a range of other issues related to the financial crisis. Compared to that, developments on the fiscal side may seem unspectucular, until you learn what’s going on: a no-tax zone being pushed through. Yes, you read it correctly. The Netherlands could have a zero corporate tax zone as of October 2010.

We expected that the Dutch tax reform outlined in June could set off some true fiscal fireworks. After all, the original plan spelled out a quite fundamental reform of corporate income tax. This included a special 5% tax rate on interest received from or paid to companies belonging to the same multinational, a measure referred to as the ‘group interest box’. Surprisingly, the proposed measure was approved by the European Commission in July – after it had refused to agree on a previous version for almost three years. The Dutch reform plan also included an overall limit to interest deductions (see previous blog).

However, the original proposal has been much watered down since then. To put it in other words, the fireworks got wet. Three weeks ago deputy minister De Jager twittered: ".. But now interest box seems to have more disadvantages than advantages for business climate. And limiting interest deduction vulnerable from European law perspective..." In early December, he sent a more official letter to parliament that in the short term, he could only repair a legal loophole that had allowed Private Equity firms to claim back over €400 million of taxes after they took over Dutch companies (see previous blog). The fundamental reforms will require more time. The Ministry, which seems to have underestimated the complexity of the reforms, has now set up a Study Commission to study the options in more detail and consult, again, all relevant stakeholders (they have already met with Tax Justice NL).

Note that the group interest box was partly intended to attract financial operations of large foreign multinationals and to provide a low-tax facility for Dutch multinationals. However, while this measure would benefit multinationals investing via or from the Netherlands, it would harm multinationals investing in the Netherlands (and, obviously, put smaller companies at a disadvantage). A footnote in De Jager’s letter confirms: “There are signals that the current uncertainty about the introduction or not of the interest box already lowers foreign investments in the Netherlands.” So here’s another piece of evidence, for those who aren’t convinced yet: stimulating tax haven activity harms your real economy!

What about that no-tax zone, then? Well, that comes from a completely different legal trajectory. On 10 October 2010, the Netherlands Antilles will be dissolved. However, this is not the end of a tax haven, the various Carribbean islands that currently make up the Antilles will get a new status. Curaçao and St Maarten will become autonomous territories within the Kingdom of the Netherlands, just like Aruba at present. The other three islands – Bonaire, St Eustatius and Saba, together called the BES islands – will become some kind of special municipalities of the Netherlands (more details here).

Now, here’s the thing. The BES islands will get their own tax code, and the current proposal does not include a corporate income tax. Only the distribution of dividends to shareholders will be subject to a ‘revenue tax’ of 5%. You can imagine that Curaçao, whose financial sector has been shrinking ever since it started phasing out its tax haven regime under pressure from the Netherlands, was not amused. With this special tax code, nearby Bonaire might take over what is left of Curaçao’s financial sector. The Ministry’s explanatory note confirms that tax competition is going on here: “The proposed system for corporate and dividend taxation for the BES islands strengthens the relative competitive position of the BES islands in the Caribbean region.” No, we’re not joking, it really refers to the Caribbean region. The reference group for special Dutch municipalities includes Bermuda and the British Virgin Islands.

To qualify for the no-tax zone, companies do have to meet economic substance conditions. They must use at least half of their assets for business activities on the BES islands, excluding for example loans to overseas entities, and they must employ at least three people. If companies don’t meet these criteria, the normal Dutch tax regime applies. However, the Council of State, which advises the Dutch government and parliament, warned that the proposed legislation is sensitive to tax avoidance constructions and explicitly advised“not to submit the law to parliament before a corporate income tax has been added”. De Jager disregarded this advice and has submitted the law to parliament for approval. So we still expect to see some fireworks soon.

In practice, the new tax code might not make big difference. Currently the tax rate in so-called e-zones on the BES islands is a mere 2%, thus already close to zero. The greatest beneficiary of the current system is probably Valero Energy Corporation, a giant oil company from the US, whose oil terminal occupies a large part of the island St Eustatius. Huge oil tankers from the Gulf call at St Eustatius, as they are not allowed in US ports for security reasons. A Dutch documentary showed in early 2007 that Valero has concluded a 10-year agreement with the government of St Eustatius and the Antilles, fixing its corporate tax rate at 2% (with a minimum of approximately €400,000 per year) and exempting it from a range of other taxes. Despite its sea port, the island with just 3,500 inhabitants and poor administrative capacity is far from prosperous and struggles to manage its public budget.

As for Curaçao and St Maarten, these islands will maintain their fiscal autonomy, but they are bound to the EU code of conduct on business taxation. For further details, including about the e-zones on other islands, see the answers to parliamentary questions from the Socialist Party, which has been pressing the Dutch government about the tax regime on the BES islands for three years now.

Finally, one more thing from the Finance Ministry to watch for. On the initiative of the Green Party, the parliament recently requested an assessment of the Dutch fiscal system for multinational corporations regarding tax avoidance and evasion at the expense of developing countries. This is highly welcome. With a fundamental reform of the tax system being prepared, it not a bad idea at all to have a look at how one’s tax system might just have an impact on others as well.

The Climate is dead. Long live the Climate!

Our climate died in Copenhagen, falsely renamed as Hopenhagen, as the COP15 climate talks arrived to no binding agreement on either emissions targets or financing that go along with them.

While a target of 2C (instead of a safer 1.5C ) serving as a reference point in the Copenhagen Accord along side with a US$ 30 billion financial support for developing countries (article 8):

" The collective commitment by developed countries is to provide new and additional resources, including forestry and investments through international institutions, approaching USD 30 billion for the period 2010 - 2012 with balanced allocation between adaptation and mitigation. "

The trick to read here is that the US$ 30 billion is split between adaptation and mitigation: only adaptation is used to help the vulnerable to recover their livelihoods, where as the mitigation (a much bigger financing need) will go towards reducing emissions in developing countries. The sums needed are much bigger (US$ 50 bn for adaptation, and US$ 200-400 bn for mitigation, as noted by the IBON primer on Climate Change, a Philippines-based think-tank.

However a previously leaked so-called 'Danish text' had much more in terms of binding targets and financial mechanisms. This text called for peak of emissions by 2020, and reductions of 80% by 2050, that apparently is enough to keep even Tuvalu and the Maldives in the registry of nations.

However this ' Danish text' was rejected by the develoing nations on two grounds: (1) no legally binding targets as in the (thence broken) Kyoto Protocol, and (2) sidelining the UN in the process by establishing an 'International Climate Financing Board under the UNFCCC' (article 24), which would be under World Bank and the IMF supervision. This 'Danish text' had important targets also for developing nations (article 9):

"The developing country Parties, except for the least developed nations which may contribute at their own discretion, commit to nationally appropriate mitigation actions, including actions supported and enabled by technology, financing and capacity-building."

The target to be negotiated never happened, as this was subsequently rejected by the G77 countries, on grounds that it would lock them into underdevelopment forever. While, the 'Danish text' had good points too, e.g. stricter targets on the maritime industry (article 13), it was inconsistent in omitting aviation from targets. It short, despite fanfare, the Danes were imbalanced in favour of the rich nations.

So lessons for the COP15 process:

- Don't sideline the UN -- if you want to get a binding agreement from developing nations, who were branded as the 'deal busters' by the rich and the powerful nations, then involve the UNFfD and the other UN agencies.

- Make sure you have domestic resource mobilisation on the agenda -- only this will ever give developing countries the confidence to start reducing their own emissions and get involved in mitigation efforts. If African nations stop cutting reducing their overall forest coverage that provide carbon sinks (which doesn't mean sustainable forestry couldn't continue as in Scandinavia), they need to know that they can cover the lost revenues via taxing the resident companies and individuals more effectively.

- Funds towards climate change adaptatin should come from global taxation. Adaptation for climate change is equally important as mitigation, one cannot come before or after the other, as if we increase temperatures, we'll end up with a much larget bill to foot for adaptation in terms of resettling an ever increasing number of 'climate refugees', and ensuring livelihoods and food sovereignty for millions displaced.

- Tax carbon dioxide and other green house gas emissions from all sources. While developing countries would be more penalised on a maritime fuel tax (as they are exporter nations), it's the rich nations (who do the bulk of flying) who would be penalised by an aviation fuel tax. Taxing only carbon-intensive coal-fired power production is something that would only penalise China and potentially Australia (with the largest coal reserves), but the US would be penalised on high-polluting buildings, industry and aviation. Let's put some balance to the proposals.

- Finally, legally binding targets need to be coupled with legal sanctions, this was the weakness of the Kyoto Protocol, where targets were broken. To have the confidence of agreeing to targets we need an International Climate Court, which has powers to give sanctions for countries not living up to their promises. Sanctions could be in forms of higher carbon taxes levied on produce and financial transactions from such countries, or any other effective manner.

Rescuing the dead corpse from the bay of 'Hopenhagen' will require much more than diplomacy, it will need public pressure, this is what we should build for the next round of climate talks in Mexico end of the year.

Illicit Money: Can it be stopped

The New York Review of Books has published an article on illicit financial flows by our friends Raymond Baker (Global Financial Integrity Program) and Eva Joly (European Parliament, Development Committee). The link to the article is here, but unless you already have a subscription you will need to purchase the article for $3.

Usefully for readers who have not previously encountered the offshore economy and secrecy jurisdictions, Raymond and Eva locate these phenomena in an historical context that broadly coincides with the period of decolonisation in the 1960s:

Minor parts of this system were in existence earlier, but the 1960s marked the take-off point for two reasons. First, from the late 1950s through the end of the 1960s, forty-eight countries gained independence from colonial powers. Many leaders in these new countries, sometimes influenced by domestic instability and cold war politics, wanted to take money abroad: bankers in Western countries responded by devising creative strategies such as the use of secret accounts and false invoices for moving such large sums across borders. . .

Second, during the 1960s a number of large corporations became multinational, establishing hundreds of locations across the globe, sometimes even moving corporate headquarters offshore. "Tax planning" - devising creative ways to reduce or avoid corporate taxes - became a normal practice.

Thus decolonization and the growing international reach of corporations propelled the development of a whole system of offshore finance that was designed to avoid taxes and regulation. In the process, the system also obscures the origin and destination of the increasingly large sums of money passing through it.

The article proceeds by exploring the implications of the creation of a system which was turbo-charged by the financial market de-regulation initiated by Margaret Thatcher and her American best friend Ronald Reagan. The consequences are clear for all to see: combining secrecy with unimpeded capital mobility and uneven regulation has made financial markets that are criminogenic in nature and almost purpose-built to support illicit financial flows.

Read the article.

Bank of England: bankers' departure price worth paying

For our quotations page:

There is not so much as a scintilla of evidence of bigger being better in banking is the truth of it. A lot of the noise around that really is rhetoric," he says.

This would not be unusual, except for the fact that it comes from the Bank of England.

"If some of that were to migrate overseas that would be unfortunate but given the costs of carrying that financial system around, it may be a price worth paying."

It's just as we have been saying.

Jersey says it hopes to undermine British democracy

Britain's democratically elected representatives have decided to try and respond to voters' wishes and to make a stand against some of the excesses that will, according to the FT's Martin Wolf, have cost the UK almost three times 2007 GDP by the year 2030, assuming a pre-2008 growth trend rate. One such response is a tax on bankers' bonuses; another is higher tax rates which are, inevitably, needed, to pay for the mess.

What is Jersey's response? Undermine the UK's efforts! As the Jersey Evening Post notes:

"Housing Minister Terry Le Main sees a ‘huge benefit’ to the Island if British financiers, angered by Labour’s new 50% tax rate and one-off 50% levy on all banker bonuses over £25,000, move across the Channel."

The idea appears to be that a section of Britain's wealthy élite, many carrying responsibility for this appalling mess, will use Jersey to shrug off the costs of the clean-up they helped create, and leave everyone else to clean up.