Thursday, November 22, 2007

Kulipa Ushuru ni kulinda Uhuru

This headline refers to a Swahili slogan chosen by the revenue authority of Kenya. It means "Pay your taxes and set your country free." In the words of Michael Waweru, commissioner-general of the Kenya Revenue Authority, "present taxpayers are taking a leading role in freeing their country from donor dependency to economic independence."

As the Financial Times reports today, only five percent of Kenya’s budget is funded by international donors – compared with 50 per cent for some neighbours – and Mr. Waweru said its annual revenues will have more than doubled since he was appointed in 2003 to clean it up. The year to next June would mark a fifth consecutive rise in annual receipts. Waweru sees the KRA’s role as reducing that figure further.

“People in this country value independence. It was one of the earliest in Africa to engage the British government in a war for independence,” he said. “Our motto touched some raw nerves in taxpayers and they have responded well.”

Tax is the sustainable source of finance for development. The long-term goal of poor countries must be to replace foreign aid dependency with tax self-sufficiency. Action on tax has the potential to deliver gains to poor countries that are orders of magnitude greater than what can be achieved with aid.

To meet the Millennium Development Goals, OECD countries have been urged to raise their levels of aid to 0.7 percent of Gross National Income – but this is as nothing when compared to potential tax revenues: in many rich countries, tax constitutes 40-50 percent of GDP. What is more, tax is the nexus between state and citizen, and tax revenues are the lifeblood of the social contract: the very act of taxation has profoundly beneficial effects in fostering better and more accountable government.

Developing nations in Africa, Latin America and elsewhere are especially vulnerable to the offshore world. As corrupt dictators and other élites remove vast sums of private and relocate them to financial centres like London, New York and Zurich, developing countries’ economies are deprived of local investment capital and their governments are denied desperately needed tax revenues – with the result that capital flows not from capital-rich countries to poor ones, as traditional economics might expect, but, perversely, in the other direction. Recent research has shown, for example, that sub-Saharan Africa is a net creditor to the rest of the world in the sense that external assets, measured by the stock of capital flight, exceed external liabilities, as measured by the stock of external debt. The difference is that while the assets are in private hands, the liabilities are the public debts of African governments and their people.

It is astonishing that so many members of the aid community have ignored tax for so long. Action on international taxation is, quite simply, the key to lifting hundreds of millions of people out of poverty.

TJN has been building up material on this for some time. Read more here.


Wednesday, November 21, 2007

Laffer in la-la land

We would like to recommend this latest article on taxation in the New Statesman, about the economist Arthur Laffer. Even Greg Mankiw, former chairman of President George W. Bush's Council of Economic Advisors, scoffs at the Laffer ideology. The New Statesman article is reviewing a book that we have already written about. With a cast of characters including Dick Cheney, the conspiracy theorist Lyndon LaRouche, and a cameo from millionaire lobbyists marching in Washington in hard hats to pretend that they are ordinary Joes, this is a bizarre, funny, and disturbing article. Highly recommended.


Tuesday, November 20, 2007

Private equity: escaping to a parallel universe

It is depressing, but not really a surprise. A code of conduct being introduced by the private equity industry has been watered down, the Financial Times reports today. As the newspaper said:

The UK private equity code of conduct announced on Tuesday comes just as the storm of controversy over the secretive industry has died down. Concerns that buyout groups were profiteering by taking over iconic companies, stripping them of value and laying off employees sparked parliamentary hearings in the spring. By autumn, Northern Rock’s woes and the credit crunch had grabbed the spotlight, and fewer buy-out deals were being done due to higher funding costs.

Defenders of the industry contend that these firms shake up sleepy companies and make them more efficient, which is good for the economy. Whatever the merits or faults of these arguments, the Tax Justice Network has its own beefs.

The first is well-known: private equity partners tend to pay very low rates of tax. In June 2007 Nicholas Ferguson, one of the most prominent figures in Europe’s private equity industry, told the FT that “any common sense person would say that a highly-paid private equity executive paying less tax than a cleaning lady or other low-paid workers, that can’t be right.”

But there are two other fundamental problems that have not been quite so widely noticed.

First, the whole process is subsidised by our tax systems – and this is one of the keys to their profits. Private equity firms load the companies they buy with debt – typically “lent” by a subsidiary of the company based in a tax haven: it will therefore pay little or no tax on its subsidiary’s interest income, and the borrowing company will write its interest costs off against tax. The net result is that the company as a whole cuts its tax bill. Typically private equity companies use very high “leverage” rates – just 20% from the wealthy private equity owners, and 80% in borrowings.

This financial engineering is just that: it does absolutely nothing to improve the efficiency, innovation, or overall quality of the business in question. What it does is abuse our tax system and our democracy: in effect, the rest of us pay their taxes for them.

A first step in tackling these tax subsidies would be by using transparency: let these companies tell us how much of their profits come from this abusive financial engineering, and then let democratic politics sort out whether or not we want to accept this. Such a transparency requirement would be a fundamental prerequisite of any palatable code of conduct. It is depressing to read this, then, in the Financial Times’ Lex column:

The final version drops a requirement that individual firms disclose how much of their profits came from leverage and financial engineering rather than operational improvements. Instead, information will be published on an industry-wide basis. It goes without saying that details of private equity bosses’ compensation will remain under wraps.

But there is another huge problem with these transactions: they shift large parts of the capital stock of nation states offshore, even if the parent companies are located onshore. Ownership of companies is thus removed from processes of democratic accountability. This highlights one of the most pernicious characteristics of tax havens: not only do they subvert national tax systems, but they also undermine systems of national regulation.

These activities are prime examples of the ability of élites to carve out brave new worlds just for themselves: reaping the benefits of tax and regulation systems in the onshore world, then escaping from their responsibilities to pay their way.

One last thing. All this borrowing – which is wired into the DNA of this secretive industry – should make everyone worried, particularly in the current uncertain environment. Lex again:

Unfortunately, the code also does little to address the next big problem looming on the horizon: what happens when one of these highly-leveraged deals starts to go bad?



Monday, November 19, 2007

Towards a more transparent world

TJN is delighted with recent statements from Transparency International about their latest shift in thinking. But there is something else, more subterranean but at least as important, that we have been watching. For those who don't know much about this seemingly arcane issue, some of the facts described here will be quite shocking.

In a motion submitted on November 14, the European Parliament approved legislation that will have enormous implications for the transparency of multinational companies and for their relationships with nation states and citizens around the world. And almost nobody noticed.

This legislation originated with the International Accounting Standards Board (IASB,) a curious organisation that decides how companies publish their company accounts. Despite its grand-sounding name, the IASB – which takes decisions that will profoundly affect all of us – is a wholly private company based in London and registered in the American secrecy jurisdiction of Delaware. It is funded by the Big Four accountancy companies and by some of the biggest multinationals in the world. In effect, this private company, which is subject to no democratic processes, is writing some of our most important laws. We are not talking about "soft" laws like guidelines or codes of conduct -- but hard European law. In the past, the latest accounting standard would simply have been nodded quietly through, and it would become law. But a few activists have noticed what is happening -- and they are alarmed.

A process of "convergence" is underway - whereby European accounting standards and American standards are being brought into line, with the end goal of truly global, harmonised standards that will enable global comparability. The goal itself is excellent: having different sets of accounting standards around the world enables companies to exploit fabulous loopholes. But in fact, the convergence is pretty much in one direction only: stronger European standards on company transparency are now giving way to lax American ones.

The parliamentary motion concerned an arcane-sounding accounting standard that the IASB produced, known as IFRS-8 (IFRS stands for International Financial Reporting Standard). This is about how companies slice up their company reports – and the implications for transparency are enormous.

Under current accounting rules, a company that earns profits in ten African countries can scoop all those numbers together and publish a single profit figure for "Africa." The poor countries where that multinational operates cannot unpick that "segment" (as it is known) and find out the company's local profit. Sometimes they can't even work out who really owns the companies operating in their terrritory. Mix that opacity with the murky world of tax havens, add an army of clever company accountants schooled in how to shift profits to tax havens -- and you have a system where multinationals can run rings around the countries where they operate – rich and poor.

What we want is very simple: Country-by-Country Reporting. Under this, international accounting standards would require companies to unpick their accounts for each country where they operate. A group called Publish What You Pay has been calling for Country-by-Country reporting for companies in extractive industries (like oil or copper,) partly to boost transparency in places like oil-rich Nigeria or Kazakhstan. TJN's Richard Murphy (see his work on IFRS-8 here) designed their country-by-country accounting standard for them. Now TJN is hunting much, much bigger game: it wants Country-by-Country reporting for all sectors. The sums involved are truly colossal; at a stroke, this simple change in the accounting rules could achieve far more for poor countries than all the world's foreign aid, combined.

IFRS-8 not only fails to secure Country-by-Country reporting – but it weakens current standards. Astonishingly, it is an almost a word for word copy of the American version (think "Enron" or "Subprime"), which only requires that companies publish three quarters of their activity in these broad segments, leaving the remainder undisclosed. And, just as bad, in making these calculations they can use accounting rules that differ from those used for the rest of the accounts – so the numbers need not even add up. This is not just a concern for poor countries. According to a new study, when US accounting standards were weakened and firms were no longer required to report by geographical area, the result was predictable: profitability of companies fell.

Fortunately, we have powerful allies: some arch-capitalists are alarmed too. A group of institutional investors, representing up to 40 percent of the London Stock Exchange, don't like IFRS-8 either. They understandably worry about the quality of governance of companies they invest in, and want them to publish solid accounts. The European Economic and Monetary Affairs Committee of the European Parliament has spotted the problem too, and was understandably outraged recently when the IASB tried to tell them that the European parliament had no right to amend its work. In a meeting on November 6th, committee members approved the standard but slapped all manner of caveats on its use and demanded the development of an accounting standard requiring Country by Country reporting for the extractive industries as well.

The stealthy IASB juggernaut has been seriously challenged for the first time (despite shabby efforts by groups like the One World Trust to burnish its image.) A parliament has told it to change its methods, and to produce a standard to meet the needs of civil society. It is shaping up for an enormous battle, with enormous implications for democracy, poverty and corruption around the world.


Friday, November 16, 2007

Blogging, transparency and corruption

TJN can be pleased with itself today. For one thing, TJN's Richard Murphy has won blogger of the year award from Accountancy Age magazine. As they said:

Compared to other business fields there is a dearth of decent accountancy blogs out there. However, the best (and best focused) by a distance is that of tax campaigner Richard Murphy. He's embraced the medium to great effect and has carved out a role for himself as the profession's most effective opposition party.

It's nice to be recognised. But something much more substantial has come up too. Transparency International, the organisation that has done more than any other to put corruption onto the international agenda, now appears to be decisively moving towards adopting what TJN has been asking them to do. TI is going to rethink its Corruption Perceptions Index. It will put pressure on onshore and offshore financial centres like London, New York, or Singapore. It will focus more on the responsibilities of western governments and companies. And there is more. We very much welcome these words from Cobus de Swardt, the new head of TI. As the Financial Times put it:

TI's annual Corruption Perceptions Index country ranking is the world's most widely used corruption measure for governments, companies and others, but Mr de Swardt said the impression from the ranking - that poor and developing countries were the most corrupt - needed to be corrected, with greater attention to those "supplying" the financial resources enabling corruption to occur. He said the "political message" of the ranking would in future be that "countries that have less corruption internally very often continue to play a major role to perpetuate corruption in poorer parts of the world". Mr de Swardt plans a review of the CPI and TI surveys next year.

TJN has been critical of TI in the past, particularly of their poorly-designed Corruption Perceptions Index and their definition of corruption. Both these things remain live within TI, so our criticisms remain valid. Please take a moment, and read them here. In the meantime, we very much welcome the signs of real change from the Berlin-based corruption campaigners. TJN, in collaboration with others, will be starting a process of researching, creating and eventually launching a Financial Transparency Index in due course. Watch this space.


Saturday, November 10, 2007

Is tax a cost?

Company directors love to argue that taxes are costs, costs should be minimised, so taxes should be cut. Not so fast.

Is tax a cost? In fact it is not, as any good economist or accountant should tell you. Bear with us, and you will see that this is obvious, really.

When companies look around the world, wondering where to invest, they need to consider many things. Each company is different, but a common mix of needs might include a well-educated workforce, good infrastructure, stable and accountable government, good laws and regulation, and so on. Tax is the basis on which all of these good things are built. Tax rates themselves are, of course, one of the other important things that companies consider. Many companies, and especially their accountants and lobbyists, love to argue that governments should cut taxes relentlessly to attract companies to their shores. (What company lobbyists especially love to pursuse is tax loopholes: that way, the companies still get the benefits of well-funded states, but someone else pays for them, with an end result of loophole-infested tax systems and the long-term erosion of the schools, hospitals and roads that underpin these countries' prosperity, and that of the companies that invest there.)

In fact, tax is typically the fourth or fifth most important factor that companies look at when deciding where to invest - many of these other factors tend to be more important. So, to attract investors, governments must strike a balance: if taxes are too low - roads don't get built, for example, or government isn't held accountable and can go rotten, and the companies won't come. If taxes are high in the extreme - then tax will rise up the list of companies' list of priorities until it overwhelms the other factors.

Let's see how an accountant, and an economist, would phrase this. First, TJN's Richard Murphy, writing in The Guardian newspaper, gives us an accountant's view. He explains:

UK-quoted companies reduced their effective tax rates from 26.6% in 2000 to 22.1% in 2004, compared with an expected 30% in both years. Tax avoidance is rampant, though companies insist they are cutting their costs to benefit their shareholders. This defence is disingenuous.

Tax is not a cost to a company. It is a distribution out of profits. That puts tax in the same category as a dividend - it is a return to the stakeholders in the enterprise. This reflects the fact that companies do not make profit merely by using investors' capital. They also use the societies in which they operate, whether that is the physical infrastructure provided by the state, the people the state has educated, or the legal infrastructure that allows companies to protect their property rights. Tax is the return due on this investment by society from which companies benefit.

Now let's see what an economist would say. Let's start with this article in the same newspaper, by TJN's John Christensen, which said this:

Tax havens warp the foundations of market capitalism. David Ricardo's theory of comparative advantage says that production should gravitate towards geographically relevant areas: cheap manufactures come from China and France or Chile produce fine wines. But now we have thousands of companies operating from one building in the Cayman Islands, and a former Thai prime minister avoids paying tax on a $1.9bn sale through a British Virgin Islands company called Ample Rich Investments. Small wonder that people lack confidence in the global economy.

Think about it like this. For an economist, costs are very specific things, which relate to production. One of the great strengths of market capitalism and market competition is that it puts pressure on directors to innovate and improve the efficiency of production, including by bringing down costs and improving the quality of the goods or services they produce. But tax is entirely different: it is about overall profitability, not about production costs. A company that uses a tax loophole may be able to use that to bring down its prices and steal a march on its competitors - but in the process it has done absolutely nothing to improve its efficiency or the quality of what it provides. The company has cut its tax bill, but the economy overall has seen no net gain in efficiency or productivity. The company has more profits, but that is offset by what the country loses in terms of fewer teachers or whatnot.

All of which starkly exposes the short-sightedness of the libertarian free-marketeers, who argue that tax is simply a cost to be minimised and that tax-cutting -- always -- is the route to a brighter future.


Tuesday, November 06, 2007

Tax Justice Goes Bananas

As he was growing up in his native Jersey, TJN’s director John Christensen used to stare at the ships in harbour and dream of the adventures of the great English explorer Walter Raleigh, who established the second English colony in the New World.

The Boyhood of Walter Raleigh, by J.E. Millais, 1870.
"Is that a banana boat?" (John Christensen is in the black jacket)

Later, in the 1980s, John became economic adviser to the states of Jersey, and, among many other things, he helped handle negotiations for the introduction to Jersey of a new exotic breed that was being imported from the Cayman Islands and other outposts of the New World: the International Business Company (IBC).

IBCs effectively allow companies that use them to negotiate their tax rates – in Jersey’s case: between one half of one percent and two percent of profits. Multinational companies then engage in tax gymnastics to shift their profits into these jurisdictions – and so cut their tax bills. The Guardian newspaper today has filled its front page with a first-rate story that quotes John (and TJN's Richard Murphy) and describes how big banana companies – three of which control over two thirds of the world banana trade between them (and generated over $50bn in the last five years) – are:

creating elaborate structures to move profits through subsidiaries to offshore centres such as the Cayman Islands, Bermuda and the British Virgin Islands, to avoid handing money over to tax collectors in the countries where their goods are produced, and in those where they are consumed. Governments at both ends of the chain are increasingly being deprived of the ability to raise tax for development or services.

If you follow the paper trail of some of the banana companies, you might be forgiven for thinking that Jersey is a substantial exporter of bananas to the UK. But how could this be? Jersey, a chilly place in winter, is subject to the full force of Atlantic gales, and you would be mad to try and grow bananas there. Read this second excellent Guardian article, and this handy interactive guide to transfer pricing, to get an idea of what is really going on in our increasingly complex and dysfunctional global economy.

Richard Murphy helps explain more about this in his blog on this issue, here, and fills in a couple of details that the Guardian didn't include. If you can, buy the hard copy of the newspaper - it's got some excellent graphics accompanying the stories.


Thursday, November 01, 2007

The selfish isles and the MDGs

The high-brow tax research organisation TaxAnalysts has published some remarkable data in new reports about Jersey and Guernsey, mostly drawn from these jurisdictions’ own databases. Note this paragraph, for example.

At the end of 2006, there were $491.6 billion of assets in the Jersey financial sector beneficially owned by non-Jersey individuals who were likely to be illegally avoiding tax on those assets in their home jurisdictions. We estimated the comparable figure for Guernsey to be $293.1 billion.

That’s a total of $784.7bn. Applying the same simple calculation used by Richard Murphy to this data:

Earning 7%, that much money would generate annual income of $54.9bn. Taxing that at a modest 30% rate would yield $16.5bn. That is between a quarter and a third of the sum that the World Bank estimates would be needed to tackle the Millennium Development Goals to "reverse the grinding poverty, hunger and disease affecting billions of people." Now there's no proof (these are, after all, secrecy jurisdictions) that all that tax is indeed being evaded. But why else put your money there?

And remember: these are just two small islands, near Britain, whose financial sectors are closely intertwined with the City of London. There are more than eighty tax havens around the world. Just think of all the harm caused to democracy, and all the extra poverty and inequality, that such places generate.