Sunday, October 22, 2006

More on Mr Bono

Earlier this year it was revealed that Irish band U2 had switched their financial affairs from Ireland to the Netherlands to take advantage of tax avoidance opportunities. Unsuprisingly this revelation was embarassing for lead singer Mr Bono, especially when the Irish finance minister pointed out the disconnect between what he says: "more taxpayers money should be donated to Africa's poor"; and what he does: avoid paying tax.

An article in this week's International Herald Tribune records that Mr Bono and his colleagues justify their actions on the basis of efficiency: "Of course we're trying to be tax efficient. Who doesn't want to be tax efficient?"

Whenever the term efficiency is used in a financial or economic sense it needs careful deconstruction to understand its meaning in the particular context. In the case of tax it invariably means that one party ends up paying less tax, whilst others have to pay more to make up the loss of government revenue or suffer from declining public services. Of course, the rich, like Mr Bono and his colleagues, can afford to pay corrupt lawyers and accountants to set up tax efficient schemes. How stupid of the poor to not be tax efficient. Small wonder they stay poor.

Mr Bono and his tax advisers should not be allowed to get away with their feeble excuses. They avoided tax because they are greedy and selfish. In Bono-speak, efficiency had f**k all to do with it.

PS I'm delighted to see that Nick Cohen gives Mr Bono short shrift in today's Observer. Many of my African colleagues are indignant about his claim to speak on behalf of Africa. As Nick says: "it is suprising that the rest of the world continues to take (him) seriously."

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Tuesday, October 17, 2006

Capital isn't working

Most economists in the UK agree that we are currently at the peak of the economic cycle. Returns to capital are high by historic standards, but according to our analysis corporation tax paid as a proportion of gross domestic product has remained static at 3.2 per cent over the past 7 years. This is evidence of the fact that an increasing share of national wealth is being retained by the wealthy, and the tax burden is inexorably being shifted to the less well-off.

This has happened during the tenure of Mr Gordon Brown. Today he will be meeting with representatives of the City of London. Last year was the City's most successful to date. 2006 is likely to repeat this success. But instead of sharing their success - and the massive bonuses they pay themselves out of our pension funds - the City will be demanding tax cuts, including abolition of stamp duty on share transactions, lower corporate tax rates, direct consultation on tax changes, and a more benign attitude towards tax avoidance. Ever anxious to prove himself the friend of capital, Brown is unlikely to resist, despite the fact that the City's growth in recent years completely contradicts the case for tax cuts.

In today's FT, Brown talks about the need for a competitive tax environment. In fact the environment is already competitive by international standards. Where the UK does not compete is in the quality of its education - tenth in international league tables according to the OECD - and the remarkably poor quality of its infrastructure. This requires more investment by government, ergo this is not the time to be cutting stamp duties (an efficient tax as William Pitt observed) or conceding lower tax rates to companies enjoying record profit levels. Nor is going soft on avoidance a good idea. Company directors should compete on the quality of their goods and services and the efficiency of their production. Competing on tax is a short term fix, which takes the pressure of directors to perform better.

It becomes increasingly clear that capital is unwilling to pay its way in society. So much for corporate social responsibility.

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Thursday, October 12, 2006

Flat tax - an idea whose time has gone

The final sentence of the International Monetary Fund's new working paper on flat taxes should dampen the enthusiasm of anyone who sees flat taxes as the answer to life, the universe and everything: "While there will no doubt be new members of the flat tax community, in some respects the more interesting question is whether there will be any defections."

Yes indeed. Because the empirical evidence to support the wilder assertions about the flat tax idea just ain't there, as the working paper's conclusions spell out in stark terms.

Drawing on the experiences of a wide variety of Eastern European countries, the authors conclude:

* " . . in no case does there appear to have been a Laffer effect . . And in Russia there is little evidence that the strong revenue performance after the reform was due to the flat tax itself: rather it appears to have reflected wider macroeconomic recovery."

* whilst there is evidence that compliance has improved in Russia "there is no firm evidence that it was due to parametric tax reform rather than to changes in enforcement occuring around the same time."

* There is no evidence that the impact of the flat tax on work incentives has been strong in practice. The only study to date of actual household responses to the introduction of a flat tax - for Russia - "does not detect any significant impact on work effort".

* The introduction of a flat tax system does not significantly reduce the complexities of a tax system. The principal sources of complexity arise from exemptions and special treatments, not from the tax rates per se.

* Rate cutting in some countries has "enabled significant broadening of the tax base through elimination of exemptions and preferential treatments". This has contributed to improved horizontal equity, some efficiency gains and greater simplicity.

* In almost all cases the flat tax was adopted by new governments "anxious to signal a fundamental regime shift towards more market-oriented policies. Where no such reputation needs to be acquired, the appeal of a flat tax is consequently less."

The authors also note that "the flat taxes that have been adopted do not provide a coherent framework for dealing with the difficulties that almost all countries now perceive in taxing internationally mobile capital income."

All in all, the available evidence suggests that flat taxes fail to achieve what it says on the can. Time to switch attention back to how to strengthen progressive tax regimes to protect them against predatory and harmful practices.

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Tuesday, October 10, 2006

A little learning is a dangerous thing

Amongst the many nonsenses parading as economic theory these days, the notion of tax competition is probably the most corrupting, especially when it is being touted by an official from a tax haven which specialises in providing offshore mechanisms for tax evasion. Philip Bailhache is Bailiff of Jersey. He is unelected and has no authority to speak on political issues at international fora. His family law firm specialised in offshore tax avoidance. He is quoted in the Jersey Evening Post (9 October 2006) saying: "Lip service is paid to tax competition, but the instincts of larger countries too often rebel against it." This type of talk goes down a bundle amongst tax avoidance practitioners in tax havens like Liechtenstein (where he uttered this nonsense), but Bailhache should be exposed for the charlatan he undoubtedly is.

The theory of competition originates from the micro economic theory of the firm. In theory large numbers of small firms compete to provide goods and services to the public. Competition helps to stimulate innovation, improve productivity, prevent companies from colluding to fix prices, and generally strengthens the efficiency of market mechanisms. In reality, of course, markets are frequently dominated by large companies which do not compete either on price or on the quality of their output, but the theory of competition marks out something worth striving for. Tax competition, on the other hand, distorts markets by subsidising capital, rewarding the larger players (who are better placed to use offshore tax avoidance vehicles) and undermining Ricardian theory of comparative advantage. Not that Bailhache will know anything about such issues.

Trying to apply competition theory to nation states, however, throws up all sorts of issues:

- What evidence is there to support the view that tax competition between nations will stimulate improvements in the efficiency of providing public services, rather than simply forcing cut-backs and inefficient privatisations?

- How can large nations which invest heavily in infrastructure, education, training, research and development, and public welfare, protect their tax revenues from predatory nations which offer businesses and rich individuals the opportunity to free-ride (in the economic sense) by parking their incomes in offshore companies?

- What mechanisms exist to ensure that the public benefits from tax competition, when in practice the only beneficiaries are shareholders who probably live in totally different jurisdiction and probably pay no tax themselves?

- What can be done to prevent tax competition from shifting the tax burden away from capital and onto to labour and consumption - as has been happening over the past three decades?

- What rules need to be enforced to prevent tax competition from eroding the tax base of developing countries, which are already starved of tax revenues?

In practice there is no evidence that tax competition is helpful in any way whatsover, and plenty of evidence that it is harmful. Oxfam has calculated that tax competition (and related tax avoidance by multinational companies) cost developing countries $50 billion annually. That was back in the late-1990s, since when the situation has deteriorated.

Of course, the fact that governments do not compete against one another to provide defence, health, education and other public services to their citizens has not inhibited prominent economists from supporting the concept. Milton Friedman ( a leading member of the Chicago Boys who advised Augusto Pinochet during his dictatorship) is quoted on one right-wing website (funded by offshore banks) saying:

"Competition among national governments in the public services they provide and in the taxes they impose, is every bit as productive as competition among individuals or enterprises in the goods and services they offer for sale and the prices they offer."

The rich love this, but according to FT columnist Martin Wolf (a leading proponent of globalisation theory): "The notion of the competitiveness of countries, on the model of the competitiveness of companies, is nonsense." In practice, competing on tax is akin to competing on dismantling environmental protection. It makes no sense and will only benefit those chasing short term profits at the expense of the future.

Under increased pressure from multilateral agencies and donor countries, some of the world's poorest nations have succumbed to pressures to compete by offering wholly ineffective tax holidays. The recent deal struck between the Mittal steel company (a dominant player in that industry) and Liberia, serves to illustrate the point. In addition to negotiating special terms to undermine that country's labour regulations (who benefits?), Mittal has also negotiated a 5-year tax holiday and a further special treatment which enables Mittal, not the Liberian government, to determine what tax rate will be payable on profits generated once the tax holiday terminates. It is hard to see what benefits will accrue to Liberia even after the tax holiday expires, but why should a dominant company be subsidised in this way?

Philip Bailhache is a lawyer by training. He has no qualification as an economist and no experience in life beyond the narrow confines of a tax haven. He was brought up with all the privileges and arrogance of his upper middle class background and private education. He has never had to confront the harsh realities of poverty, unemployment, discrimination and alienation. In chastising major nations for seeking to protect their tax revenues from predatory tax havens, he reveals both his ignorance of economics and the true nature of his politics (despite being an unelected Crown appointment, Philip is a deeply political animal). Like many lawyers engaged in the tax avoidance industry, he belongs to the hard-right of the political spectrum and promotes Jersey's role as vehicle for profiteering from promoting tax dodges for the wealthy and the powerful.

So here's a challenge to Philip Bailhache: Let's see whether your ideas can survive critical scrutiny from real experts. Provide answers to the above questions and I will have them published in the next issue of Tax Justice Focus, which as it happens will have tax competition as its principle theme and me as its guest editor.

John Christensen

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Friday, October 06, 2006

Ukraine - shattering those flat tax myths


There was a fascinating story in the Kyiv Post yesterday (and yes, it always surprise me quite what it's possible to find on the Internet). The Ukraine is, of course, one of the so-called 'flat tax' states. It's had a 13% flat tax since 2004. But all is not well.


First of all, the rate is going up to 15% in 2007. Second, and more importantly, as the paper says:



As a result of Ukraine's still complicated and cumbersome tax system - often cited as a major reason why foreign investors avoid the country - specialists say that employers continue to declare lower official salaries to the authorities for tax purposes while paying their employees higher salaries under the table.



Which somewhat shatters two myths. The first is that flat taxes simplify things, and the second is that they end tax avoidance. Far from it, it seems. The explanation is obvious:


According to Ukraine's tax legislation, employers currently pay 36 percent of their employees' salaries to a social fund used for pensions, workers compensation, etc. In addition, employers contribute to a social insurance fund, the rate of which varies from 0.67 percent to 2.5 percent.


As a result, employers currently pay up to 51 percent of their employees' salaries [in direct taxes], and starting in January, that rate will be as high as 53 percent, according to Ksenya Lyapina, the head of the Council of Entrepreneurs under the Cabinet of Ministers.


"Therefore, they [employers] prefer to pay low salaries officially, and market-based salaries in envelopes," she said, adding that the 2 percent tax increase is unlikely to affect what people are paid in the workplace.


"It's well known that people really have incomes double those that are declared," she said.



So, no flat tax miracle there then. Which is exactly as I predicted in my report on flat taxes for the ACCA.


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Wednesday, October 04, 2006

Après moi le deluge

Earlier this year Richard Murphy and I met with senior European Commission officials to discuss - amongst other things - the EU Code of Conduct on Business Taxation. During the course of these discussions, we raised various concerns that the tax changes proposed by Jersey's government(generally referred to as the Zero/Ten proposals) were not compliant with the spirit of the Code, which is based on principles rather than rules, and would therefore fail. We were told, emphatically, that the proposals of the Jersey government, had not been referred to ECOFIN either in broad principle or in their detailed provisions.

Returning from Brussels we alerted colleagues in Jersey to our concerns that fiscal reforms which will shape the island's destiny for years if not decades, were uncertain and could fall foul of the Commission. Our concerns were strongly refuted by the island's chief minister, Frank Walker, and the finance minister, Terry le Sueur, both of whom sought to reassure the local finance industry that ECOFIN had been advised of the policy proposals and - via the UK Treasury - had agreed the principle and detail.

Mr Walker declared on BBC Radio Jersey that he had received confirmation in 'black and white from the UK Treasury that our commitments have been agreed by ECOFIN.'

He has not produced the black and white evidence, and it is clear from his subsequent statements to the Island's Corporate Services Scrutiny Sub-Panel that he lied (I feel under no obligation to give him the benefit of the doubt since I have known him for many years and know his weaknesses in this respect). The Scrutiny Panel confirms this in its report when it states: "that the general approach of zero/ten had been accepted by Rt Hon Dawn Primarolo MP, (who as well as being the UK’s Paymaster General is also Chair of the EU Code of Conduct Group), but that the more detailed provisions had not been discussed in any detail."

The problem with the Zero / Ten proposals arises in the detail. And the fact that Terry le Sueur has had to implicitly concede our critique by radically reshaping the proposals in their original form, confirms our analysis.

Which still leaves open the question of how large the budget deficit will be once the proposals come into force within just a very few years. Walker will retire shortly. Ditto Le Sueur. Both seem to have adopted the classic political stance of 'après moi le deluge.'

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