On "strong" assumptions and other nonsense
A few weeks ago this blogger had the opportunity to debate at the Oxford Union alongside Michael Devereux, director of the Oxford University Centre for Business Taxation. Michael began his discussion by casting doubts on estimates of illicit financial flows, capital flight, tax evasion and secrecy jurisdictions, and generally downplaying the importance of these issues in a developmental context. He followed on by telling the audience that tax avoidance was the same as using tax exemptions granted by government, all of which left the audience (and this blogger) utterly perplexed about where he was coming from.
This begs a rather major question which Michael Devereux might be well placed to answer. Why have the related issues of illicit financial flows, tax evasion, tax avoidance, and the uses and abuses of tax havens been off-agenda for such a long time? Prior to becoming director of the Centre for Business Taxation Michael was associated with the International Monetary Fund, the very agency which should have been researching and combating these problems. And yet they didn't, and still don't. Which has left many of us with concerns about illicit financial flows, tax evasion, secrecy jurisdictions, etc, utterly perplexed about where the IMF is coming from.
As we blogged yesterday, the Oxford University Centre for Business Taxation has issued a report, strictly a review of the literature, on the subject of tax avoidance, tax evasion and tax expenditures in developing countries. And in the absence of any useful research emanating from the IMF, World Bank, and indeed academic bodies far better funded than we are, almost all of the literature under review here originates from civil society organisations, including our own Price of Offshore (published 2005); the 2000 briefing paper by Oxfam on tax havens titled Releasing the hidden billions for Development, to which this blogger contributed; Christian Aid's report on Death and Taxes; and our colleague Raymond Baker's Capitalism's Achilles Heel (reviewed here).
We know from many years of speaking with Raymond Baker and others with concerns about these issues, that we have been forced to produce estimates based on whatever datasets become available to us in order to challenge those institutions which should be taking these issues seriously (IMF et al) to produce estimates of their own. This important point does not come out in the Centre for Business Taxation's literature review, with the result that the authors have been highly critical of the failings of those who have attempted estimates, without stating our intentions (which have been very publicly voiced) of making the case for other institutions - especially the Bretton Woods institutions, to collate the necessary data and prepare studies of their own.
[As an aside, the World Bank is not entirely unaware of the gravity of the impact of tax evasion on developing countries. Its 2006 report on Poverty Reduction and Growth: Virtuous and Vicious Circles, which focuses on Latin America, reported that both on personal income tax and corporate taxation, almost all countries in the region are undercollecting, and it concludes "on the tax front, first item on the agenda would be strengthening anti-tax evasion programes and addressing the existing high level of exemptions." (p117)]
That said, and having re-read the literature review and heard Nadine Riedel from the Oxford University Centre for Business Taxation make a presentation of the findings earlier this week, there seems to be a current running through their work of seeking to downplay the issues, not just the illicit financial flows, or the tax evasion, but also the concerns about tax havens (we prefer the term secrecy jurisdiction, since contrary to the Dharmapala and Hines (2006) definition given on page 46 of the Oxford review, the majority of those who have attempted to define these places, including the OECD, are less concerned about prevailing tax rates for resident trading companies or indeed individuals, and instead focus on transparency issues like banking secrecy and effective information exchange, and ring-fenced preferential treatments directed at non-residents.)
Amongst other matters addressed in her presentation, Riedel spoke about the estimates of offshore holdings of financial assets, namely TJN's The Price of Offshore, which is described in the review itself as a "rough back of the envelope calculation based on ad hoc assumptions." Let me declare an interest: Richard Murphy was the lead author of The Price of Offshore, and I was involved from the outset and provided some of the "low quality data" Riedel refered to. The data came from Boston Consulting Group, and it cost a small fortune. Other data was sourced from the Bank for International Settlements, Merryl Lynch, and Ernst & Young Cap Gemini. None of them back street operators at the "low quality" end of the spectrum, or at least we don't think so.
Now here we run into a language issue. In their report, Fuest and Riedel say that we "combined" these different sources to arrive at the global figure. The use of the term "combined" is misleading since it implies aggregation, which was not the case. Put simply, by happenstance, in early 2005 we found ourselves with access to some very expensive data which included an estimate of offshore wealth holdings. And that data more or less coincided with data from two other independent sources. Et voila, we found ourselves in a position to do something that had previously not been possible: we could conduct what is known in social sciences as a data triangulation exercise. In order words, we could take three quite separate sources of data and see to what extent they converged on a data range.
Having done this triangulation exercise, and having arrived at a figure for liquid assets held offshore in the range of US$9 to 10 trillion, we still had a data gap to fill relating to other assets held in (highly secretive) entities like trusts. Such assets include real estate, works of art, yachts, private jets, and all sorts of very tangible assets which gain in value and are subject to taxation of one sort or another. There was no data to go by, but based on our own experiences of working offshore we assumed a low-side estimate of US$2 trillion (around 17 per cent of the value of all holdings). We now know from more recent discussions with other practitioners and my former colleague Colin Powell of the Jersey Financial Services Commission, that our figure was way too low: more realistically non-financial assets held in trusts, foundations, etc, are more likely to account for over 40 per cent of an HNWI portfolio.
But having cast doubt over data quality, Riedel also cast doubts (politely termed "caveats") on the assumptions we drew upon in our "back of the envelope calculation".
Assumption number one related to rates of return on a managed high-net wealth portfolio located in an offshore financial centre. We assumed a gross rate of 7.5 per cent a year. This figure was not plucked from thin air. Both Richard and I have contacts in financial centres in London, Jersey, Isle of Man, Monaco, Geneva, New York and elsewhere. 7.5 per cent was a reasonable rate of return to assume at that time. Do Fuest and Riedel want to challenge this?
Assumption number two is that a share of overall assets is owned by (fiscal) residents of developing countries. Now here I have the advantage over Riedel and her colleagues: I have worked as a practitioner in a secrecy jurisdiction (the British Channel Island of Jersey) and had clients from many poorer countries in the South. I have also worked in a number of poorer countries which suffer to a greater or lesser extent from illicit financial flows and tax evasion, including Algeria, Nigeria, and India. And there is no question about it: rich people in these countries use secrecy jurisdictions extensively, and it doesn't matter whether they are motivated by political factors (i.e. fear that appalling levels of wealth and income inequality might one day have terrible consequences) or whatever, the outcome of these wealth holdings being located offshore almost invariably includes tax evasion.
Importantly, in The Price of Offshore we did not attempt to quantify what proportion of the global total originates from poorer countries, partly because (and this is another point which Riedel and her colleagues did not pick up on) the US$11.5 trillion estimate we published has a major gap due to the complete absence of offshore holdings originating from Africa (Boston Consulting Group data scored a blank here).
The third assumption to be dismissed as "strong" (would Riedel et al please clarify whether they prefer their assumptions "weak"? or might the terms reasonable / unreasonable be preferable?) is that none of the income arising from offshore holdings is declared in the resident country. Well here they are just plain wrong. Based on many years of discussions with senior tax officials in many countries (UK, France, Ireland, USA, to name a few) we worked on the basis that some people declare this income (not many though!) and some income is liable to a withholding tax imposition (we applied a net rate of 7.5 per cent). We accommodated this by applying a very low marginal tax rate of 30 per cent, which contrasts with an average marginal rate estimate published by Forbes for fiscal year 2004 of 37.5 per cent. Reasonable? We think so. "Strong"? Whatever!
In other words, The Price of Offshore is not the back of the envelope calculation that Fuest and Riedel imply. It was based on many years experience (at the practitioner coal face) and a great deal of discussion with senior officials, wealth managers and others. If Fuest and Riedel had bothered to pick up the phone we would have been happy to explain how we arrived at our assumptions. But they did not attempt at any stage to discuss anything with us, and this might be indicative of why this literature review, and its recommendations, are so full of holes.
What can we say about the recommendations for future research? Well Richard Murphy's Tax Research blog has already said this. I would add that we would dearly love to have access to firm level data that would allow an estimate of the role of tax havens in corporate income shifting. Having a country-by-country reporting standard might be a major step in that direction. But the latter doesn't get a mention in the Centre for Business Taxation report, and for now we must continue to make use of whatever data comes our way, which is more than can be said for the brigade of nay-sayers who argue that in the absence of robust data there is no issue to be addressed.
To be continued.
This begs a rather major question which Michael Devereux might be well placed to answer. Why have the related issues of illicit financial flows, tax evasion, tax avoidance, and the uses and abuses of tax havens been off-agenda for such a long time? Prior to becoming director of the Centre for Business Taxation Michael was associated with the International Monetary Fund, the very agency which should have been researching and combating these problems. And yet they didn't, and still don't. Which has left many of us with concerns about illicit financial flows, tax evasion, secrecy jurisdictions, etc, utterly perplexed about where the IMF is coming from.
As we blogged yesterday, the Oxford University Centre for Business Taxation has issued a report, strictly a review of the literature, on the subject of tax avoidance, tax evasion and tax expenditures in developing countries. And in the absence of any useful research emanating from the IMF, World Bank, and indeed academic bodies far better funded than we are, almost all of the literature under review here originates from civil society organisations, including our own Price of Offshore (published 2005); the 2000 briefing paper by Oxfam on tax havens titled Releasing the hidden billions for Development, to which this blogger contributed; Christian Aid's report on Death and Taxes; and our colleague Raymond Baker's Capitalism's Achilles Heel (reviewed here).
We know from many years of speaking with Raymond Baker and others with concerns about these issues, that we have been forced to produce estimates based on whatever datasets become available to us in order to challenge those institutions which should be taking these issues seriously (IMF et al) to produce estimates of their own. This important point does not come out in the Centre for Business Taxation's literature review, with the result that the authors have been highly critical of the failings of those who have attempted estimates, without stating our intentions (which have been very publicly voiced) of making the case for other institutions - especially the Bretton Woods institutions, to collate the necessary data and prepare studies of their own.
[As an aside, the World Bank is not entirely unaware of the gravity of the impact of tax evasion on developing countries. Its 2006 report on Poverty Reduction and Growth: Virtuous and Vicious Circles, which focuses on Latin America, reported that both on personal income tax and corporate taxation, almost all countries in the region are undercollecting, and it concludes "on the tax front, first item on the agenda would be strengthening anti-tax evasion programes and addressing the existing high level of exemptions." (p117)]
That said, and having re-read the literature review and heard Nadine Riedel from the Oxford University Centre for Business Taxation make a presentation of the findings earlier this week, there seems to be a current running through their work of seeking to downplay the issues, not just the illicit financial flows, or the tax evasion, but also the concerns about tax havens (we prefer the term secrecy jurisdiction, since contrary to the Dharmapala and Hines (2006) definition given on page 46 of the Oxford review, the majority of those who have attempted to define these places, including the OECD, are less concerned about prevailing tax rates for resident trading companies or indeed individuals, and instead focus on transparency issues like banking secrecy and effective information exchange, and ring-fenced preferential treatments directed at non-residents.)
Amongst other matters addressed in her presentation, Riedel spoke about the estimates of offshore holdings of financial assets, namely TJN's The Price of Offshore, which is described in the review itself as a "rough back of the envelope calculation based on ad hoc assumptions." Let me declare an interest: Richard Murphy was the lead author of The Price of Offshore, and I was involved from the outset and provided some of the "low quality data" Riedel refered to. The data came from Boston Consulting Group, and it cost a small fortune. Other data was sourced from the Bank for International Settlements, Merryl Lynch, and Ernst & Young Cap Gemini. None of them back street operators at the "low quality" end of the spectrum, or at least we don't think so.
Now here we run into a language issue. In their report, Fuest and Riedel say that we "combined" these different sources to arrive at the global figure. The use of the term "combined" is misleading since it implies aggregation, which was not the case. Put simply, by happenstance, in early 2005 we found ourselves with access to some very expensive data which included an estimate of offshore wealth holdings. And that data more or less coincided with data from two other independent sources. Et voila, we found ourselves in a position to do something that had previously not been possible: we could conduct what is known in social sciences as a data triangulation exercise. In order words, we could take three quite separate sources of data and see to what extent they converged on a data range.
Having done this triangulation exercise, and having arrived at a figure for liquid assets held offshore in the range of US$9 to 10 trillion, we still had a data gap to fill relating to other assets held in (highly secretive) entities like trusts. Such assets include real estate, works of art, yachts, private jets, and all sorts of very tangible assets which gain in value and are subject to taxation of one sort or another. There was no data to go by, but based on our own experiences of working offshore we assumed a low-side estimate of US$2 trillion (around 17 per cent of the value of all holdings). We now know from more recent discussions with other practitioners and my former colleague Colin Powell of the Jersey Financial Services Commission, that our figure was way too low: more realistically non-financial assets held in trusts, foundations, etc, are more likely to account for over 40 per cent of an HNWI portfolio.
But having cast doubt over data quality, Riedel also cast doubts (politely termed "caveats") on the assumptions we drew upon in our "back of the envelope calculation".
Assumption number one related to rates of return on a managed high-net wealth portfolio located in an offshore financial centre. We assumed a gross rate of 7.5 per cent a year. This figure was not plucked from thin air. Both Richard and I have contacts in financial centres in London, Jersey, Isle of Man, Monaco, Geneva, New York and elsewhere. 7.5 per cent was a reasonable rate of return to assume at that time. Do Fuest and Riedel want to challenge this?
Assumption number two is that a share of overall assets is owned by (fiscal) residents of developing countries. Now here I have the advantage over Riedel and her colleagues: I have worked as a practitioner in a secrecy jurisdiction (the British Channel Island of Jersey) and had clients from many poorer countries in the South. I have also worked in a number of poorer countries which suffer to a greater or lesser extent from illicit financial flows and tax evasion, including Algeria, Nigeria, and India. And there is no question about it: rich people in these countries use secrecy jurisdictions extensively, and it doesn't matter whether they are motivated by political factors (i.e. fear that appalling levels of wealth and income inequality might one day have terrible consequences) or whatever, the outcome of these wealth holdings being located offshore almost invariably includes tax evasion.
Importantly, in The Price of Offshore we did not attempt to quantify what proportion of the global total originates from poorer countries, partly because (and this is another point which Riedel and her colleagues did not pick up on) the US$11.5 trillion estimate we published has a major gap due to the complete absence of offshore holdings originating from Africa (Boston Consulting Group data scored a blank here).
The third assumption to be dismissed as "strong" (would Riedel et al please clarify whether they prefer their assumptions "weak"? or might the terms reasonable / unreasonable be preferable?) is that none of the income arising from offshore holdings is declared in the resident country. Well here they are just plain wrong. Based on many years of discussions with senior tax officials in many countries (UK, France, Ireland, USA, to name a few) we worked on the basis that some people declare this income (not many though!) and some income is liable to a withholding tax imposition (we applied a net rate of 7.5 per cent). We accommodated this by applying a very low marginal tax rate of 30 per cent, which contrasts with an average marginal rate estimate published by Forbes for fiscal year 2004 of 37.5 per cent. Reasonable? We think so. "Strong"? Whatever!
In other words, The Price of Offshore is not the back of the envelope calculation that Fuest and Riedel imply. It was based on many years experience (at the practitioner coal face) and a great deal of discussion with senior officials, wealth managers and others. If Fuest and Riedel had bothered to pick up the phone we would have been happy to explain how we arrived at our assumptions. But they did not attempt at any stage to discuss anything with us, and this might be indicative of why this literature review, and its recommendations, are so full of holes.
What can we say about the recommendations for future research? Well Richard Murphy's Tax Research blog has already said this. I would add that we would dearly love to have access to firm level data that would allow an estimate of the role of tax havens in corporate income shifting. Having a country-by-country reporting standard might be a major step in that direction. But the latter doesn't get a mention in the Centre for Business Taxation report, and for now we must continue to make use of whatever data comes our way, which is more than can be said for the brigade of nay-sayers who argue that in the absence of robust data there is no issue to be addressed.
To be continued.
posted by TJN at 2:11 am
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