The Vatican speaks out on tax havens

A few weeks ago this blogger had the good fortune to take part in a remarkable meeting of the Pontifical Council on Justice and Peace at the Vatican. It was remarkable in several ways, but above all because of the quality of discussion about how market economies depend upon trust and personal integrity. When these personal qualities are removed from the equation the efficiency of markets is diminished and savers and investors become more cautious.

Worse still, when people and companies start to exploit legal loopholes, and the secrecy and lax regulation provided by tax havens, corruption creeps into the market place and law-abiding citizens start to lose confidence in the integrity not just of markets, but also the rule of law and democracy itself.

This is the situation we find ourselves in today. Capitalism v2.2, defined by the extreme market fundamentalism of the past three decades, has torn social values to shreds, undermined the protective mechanisms patiently built up in democratic countries between the mid-19th century and the late 1970s, and given licence to anything (no matter how socially corrosive or environmentally harmful) so long as it maximises profits in the short term. In the process the idea of duties towards others, which Cicero thought were "certainly the greatest" of all duties which an individual is required to fulfil (Offices, I, lxiii) fell by the wayside. As wealth inequality increased, wealthy people increasingly isolated themselves from normal society, convinced themselves and others that they were a breed apart, and created an offshore system designed for the single purpose of enabling them to evade their financial duties to the societies from whence they derived their wealth in the first place.

Capitalism v2.2 died in March 2008. It is not clear yet what will replace it: George W Bush and his supporters have gone for the quick fix and lick of paint approach; others are calling for something rather more profound, see here, for example, and here. TJN is amongst those who see v2.2 as wholly beyond repair and therefore supports calls for comprehensive reform, including drastic measures to improve market transparency and tackle the regulatory race-to-the-bottom.

The Vatican has now weighed into the discussion, arguing that any re-design of the international financial system must have the "definitive and universal legitimacy" that only the United Nations General Conference can provide. But in the Reflection Paper released last week in the run up to the International Conference to review the implementation of the Monterrey Consensus (held in Doha from 29 November to 2 December), the Holy See went much further, making strong comments on a number of issues of great interest to TJN and its supporters.

Here, for example, is what the Reflection Paper says on capital flight:

"Today, financial flows between developed and low income countries display at least two paradoxical elements.

The first paradox in the global system is that 'poor' countries finance the 'rich' countries, either through the flight of private capital or through government decisions to invest official reserves in financially developed markets or in offshore accounts. (note the reference to offshore accounts, we will return to that theme in a few moments)

The second paradox in the global system is the issue of the remittances of emigrants which remains one of the least 'liberalised' elements of the globalisation processes and which at the macro level largely exceed the flow of Public Aid for Development. In other words, the poor of the South fund the rich of the North through the transactional cost of remittances, tax revenues, and through human capital while simultaneously being obligated to support their families in the South."

All of which is unarguable and close to our core concerns. But look at what the Reflection Paper has to say about Offshore Financial Centres:

"To achieve a new financial agreement, a necessary first step should be to study carefully the hidden but crucial role of the offshore financial system in light of the emergence of the global financial crisis and the inadequacy of development funding.

Offshore markets were a significant factor in spreading the current financial crisis, as they have given support to imprudent economic and financial practices. But they have also played a significant role in the imbalances of development, allowing a gigantic flight of capital linked to tax evasion. Offshore markets could also be linked to the recycling of profits from illegal activities."

TJN has previously blogged on the issue of tax havens and the financial crisis, and this was something we discussed at length in Rome, but it is equally gratifying to see the link being made between capital flight, tax evasion and the harm these phenomena impose on the poorer countries. And there's more -

"The amount of wealth held in offshore centres is difficult to estimate but must be substantial if reports currently in circulation are to be confirmed. The total fiscal deficit caused by offshore activities could amount to approximately US$255 billion: this is more than three times the amount of the entire sum of Public Development Aid contributed by the OCSE countries.

Since public financing of development can only come from taxation, both in donor and recipient countries, offshore activities become increaingly critical in a time of globalisation. The present globalisation process has contributed to a shift in the composition of taxation, both from direct to indirect taxation, but it has also reduced the progressiveness of direct taxation and, above all, it has shifted the tax charge from taxation of capital to taxation on work."

This analysis lies at the heart of TJN's economic case for tax justice: tax evasion has both social and economic impacts, and the latter are of great importance to countries with high unemployment - if the tax charge is switched from capital to labour, then the latter becomes relatively more expensive than the former, and hence fewer jobs are created. The Holy See is spot on in this analysis, and also in the analysis of how tax avoidance schemes distort market competition to the disadvantage of small companies, workers, and ultimately consumers:

"The fiscal share of the large scale companies, which are the most mobile and therefore best placed to access offshore centres, becomes reduced, while less mobile entities that cannot easily evade taxes, such as workers and small businesses, are subject to higher taxation."

Again, this analysis gets to the heart of the matter. Tax havens favour the transnational corporations against the interests of nationally based small and medium enterprises, precisely because the latter can't take advantage of the opportunties provided by tax havens for tax evasion and avoidance: this leads to distorted markets that favour the sneaky and surreptious over the transparent and ethical. Hence the concluding remarks in the Offshore section of the Reflection Paper:

"Due to the political sensitivity and complexity of these issues, as they touch directly on the sphere of national fiscal sovereignty, it seems of utmost importance to enhance international cooperation in tax matters, in particular the need to address offshore financial activities."

Well hear, hear to that, but I'd like to dwell on the issue of national fiscal sovereignty for just a few moments. For many years, some governments have blocked efforts to enhance international cooperation in tax matters precisely because, in their words, it would undermine national sovereignty in this area. They couldn't be more wrong: tax evasion and avoidance, and the race-to-the bottom efforts of tax havens undermine national tax systems, and efforts to counter these phenomena, which of necessity require international cooperation, enhance national sovereignty. It is not coincidental that the countries that are most vociferous in blocking international cooperation efforts (on the bogus grounds of protecting national sovereignty) include the United Kingdom, Liechtenstein, and Switzerland. 'Nuff said?

And finally, I'd like to return to the issue of trust, which was also discussed at length in Rome. This is what the Holy See has to say about trust and the financial crisis:

"Notably, trust disintegrated precisely in the sector that was considered most 'secure', namely transactions between banks; but without this trust everything became blocked, including the possibility for productive companies (meaning, of course, the 'real' economy) to function normally.

. . . Financial markets cannot operate without trust: and without transparency and regulations there can be no trust. Therefore the smooth functioning of the markets demands that the State and, where appropriate, the international community play an important role in establishing and enforcing respect for rules of transparency and caution."

Remarkable stuff. It was a pleasure and privilege for me to take part in the discussions that led to this Reflection Paper. Hopefully others, especially those who will take a lead role in designing the new architecture for Capitalism v3.0 will take a few moments to read the paper and reflect on its meaning. Well we can only live in hope on this point . . .

John Christensen