Tuesday, March 10, 2009

The FT thinks tax havens are a diversion

There has been a rash of commentary in the Financial Times recently about tax havens. We admire the FT normally. But the newspaper has, it seems decided, that tax havens have nothing to do with the financial crisis. This is a strange conclusion to draw - the newspaper usually hosts all sorts of diverging opinions on various topics. But right now, only one opinion is being allowed to come through, it seems.

And yet despite this position, and the variety of pro-tax haven entries, the newspaper has not offered a single opinion from someone who is an expert in the field and does not have a vested interest to support their argument.

The entire economics profession, across the world, and in all of history, has -- until TJN and friends came along -- never seriously studied the macroeconomic implications of offhore in its history (if you don't believe us - go see if you can find anything). And yet the FT wheels out macroeconomists to make the case.

First, let's look at what they've been writing. Martin Wolf, a formidable economist but a non-expert (given what he's written in the past) on offshore matters, asserts, without any other evidence:

"I note with consternation Europeans’ obsession with regulating hedge funds and tax havens. Did they cause this crisis? No. Europeans also call for regulation of all markets, products and participants, without exception. This is like calling for research into radar while the Titanic sinks. Do they realise that the systemically significant banks at the heart of this crisis are the most regulated institutions we possess?"

Next, we note an especially foolish piece by Avinash Persaud, which we will joyfully dissect, below. Then we have letters: from Geoff Cook (Jersey Finance - vested interest); from David Harvey (Society of Trust and Estate Practitioners - STEP, a particularly nasty vested interest;) from Joly Dixon (Jersey Fiscal Policy Panel - vested interest.)

The FT needs now to turn to expertise and considered analysis, rather than pure assertion and guesswork by non-experts or vested interests. This is the very future of capitalism we're talking about, for goodness' sakes!

This is going to be a longish blog, so we'll split it into sections.

1. Let's start with Mr. Wolf's various points. The first:

"I note with consternation Europeans’ obsession with regulating hedge funds and tax havens. Did they cause this crisis? No."

Well, he's right, but only in a trivial sense. Neither tax havens nor hedge funds "caused" this crisis - in the same way that neither Citigroup, deregulation, macroeconomic imbalances, Lehman Brothers - or any number of other things you might mention - "caused" the crisis. No, they all contributed to it. What "caused" the crisis was processes and millions and millions of decisions taken by public and private bankers, regulators, individuals, hedge funds, mortgage brokers, remuneration committees, and so on. In a very large proportion of these things, tax arbitrage, especially via tax havens, made the key difference. Tax havens provided the enabling environment for these things to happen (more on this below). What is more, tax havens (or secrecy jurisdictions as we often like to call them) cannot be considered in isolation from processes of tax (and regulatory) competition, by which tax havens drive offshore practices into supposedly onshore places like Dublin, Delaware, London, Luxembourg, and so on.

"Europeans also call for regulation of all markets, products and participants, without exception. This is like calling for research into radar while the Titanic sinks."

This is the "straw man," or "Aunt Sally" argument (for non-native English speakers: you build a straw man, knock it down, then declare how clever you are). No: different groups call for regulation of different things. "Europeans" do not speak with one voice. Ask a European. Nevertheless, we concede that there might be the germ of a point here. Europeans probably are calling more strongly than Americans are for tighter regulation. So what?

Next, Wolf says:

"Do they realise that the systemically significant banks at the heart of this crisis are the most regulated institutions we possess?"

Three points here. First, this seems to be an argument that the crisis is not the result of deregulation. He has long focused on the role of macroeconomic imbalances as key factors (he would, he's an economist) -- and while those arguments are powerful ones, they in no way absolve deregulation of responsibility. If this is really what he's saying, he will find few takers. Second, he is wrong about the banks being the most regulated institutions. The banks may be those that appear to be the most regulated institutions - because that is the way they like it. No, the banks have picked and chosen regulation as they wished it from a variety of offshore jurisdictions, to suit themselves and help shift things they do not like off their balance sheets and to other nefarious ends. They have also been major players in pushing the smaller tax havens to engage in regulatory competition. Third, is Wolf suggesting here that the tax haven critics are saying that the degree of "offshore-ness" (if such a thing existed) must correlate directly with how close an institution is to the heart of the crisis? In other words, the more offshore an entity is, the more responsibility it must bear for the economic crisis? If he is, then this is the straw man argument again. No: the correlation comes with size - the bigger they are, the more damage they did. All the major banks at the heart of the crisis were deeply immersed in the offshore world, which provided them with the tools and the escape routes that let them pursue their damaging activities. Fourth, even though we don't need to make the correlation argument Wolf suggests we do, it is not that hard to make in any case. Remember this?

"Bank of America Inc., Citigroup Inc. and Morgan Stanley all had more than 100 units in countries that maintain low or no taxes. The three financial institutions were included in the $700 billion financial bailout approved by Congress.

Insurance giant American International Group Inc., which has received about $150 billion in bailout money, had 18 subsidiaries. JPMorgan Chase & Co. had 50 units and Wells Fargo & Co. had 18; both financial institutions received government bailout money."

Does Wolf know - and he has given no indication that he does - that Delaware, where half of the US' Fortune 500 companies are located, is one of the world's most important tax havens? Many banks were located there. And the US Government Accountability Office (GAO), of course, did not include Delaware.

Martin Wolf is a formidable macroeconomist. But he is no offshore expert. Does he know how the offshore system has shaped capital flows around the world, historically? No he does not. How do we know that? Because (aside from work by us and our friends) no independent research has ever been done on it - anywhere, ever. How do we know? The IMF recently commissioned a literature review on this subject. Addressing a meeting in Oslo in October 2008 they identified four studies: TJN's The Price of Offshore, Global Financial Integrity's study on illicit flows (recently updated); Oxfam's Missing Billions, and Christian Aid's Death and Taxes.

The responsibilities of commentators like Martin Wolf are colossal. Is it acceptable that such commentators make assertions like this, based on hunches or theoretical preferences?

Now for some more detailed analysis. Let's turn to Avinash Persaud. (We think that he's got vested interests in supporting tax havens - and we also think he might be a non-domiciled UK resident - but we'd be delighted to be proved wrong.) In any case, here's an excerpt.

"It is easier to blame tax-dodging foreigners. But let us be real. The largest centres of boastfully light regulation and light taxes for non-residents were London, Luxembourg, Dublin, the Channel Islands, Gibraltar, Monaco and many other locations in the European back yard. Yet some Group of Seven leaders would rather play to the gallery by stepping on small developing countries."

This raises two important points: first, that regulation failed most woefully in places like London, Luxembourg, Dublin, the Channel Islands, and other places close to home (though why omit Delaware?), and, second, that it is unfair to “step on small developing countries” in the fight against tax havens. Fine. We don't have a problem with that. But Persaud then goes off with the faeries. He seems to be saying that these places are not tax havens. Does he not know that Luxembourg is a tax haven? And he is being hosted in the FT as an expert?

Indeed, Europe should be cracking down in its back yard. The struggle it has been having illustrates how entrenched these places are. (Let's start with London, and move outwards from there, we say.) But this is no argument - no argument at all -- for absolving tax havens, is it? All he is doing is splitting the tax havens into two groups, then arguing that one set aren't tax havens, and the other are. What kind of woolly thinking is this, in the FT?

Here's another Persaud argument.

"The idea of offshore financial centres is that they offer low tax because taxes are paid before money reaches them and after it leaves them. Imagine a company that builds and sells cars in Britain, Turkey and Japan. If the holding company is based in an offshore financial centre, corporation taxes on earnings will be paid in the British, Turkish and Japanese subsidiaries before they arrive in the holding company. Taxes on dividends are then paid by the shareholders when they repatriate their dividends home – wherever that may be. The offshore centre acts as a “way station” that facilitates complex international trade and investment flows. There are no taxes or low taxes in the “way station” because the money is in transit. Taxes are paid at the beginning and at the end of the journey, just not along the way."

What he is saying is that tax havens are "pass-through" places, but the taxes are paid at the end of the day. Is he serious? Has he heard of transfer and/or trade mispricing? He also assumes that taxes are paid by shareholders in a country of residence, but he, if (as we suspect) is a "non-dom" then he will know very well that all too often this is exactly what does not happen.

Has Mr. Persaud ever heard of tax amnesties? Money swishes around offshore, often for years, waiting for the next amnesty - then - Whooosh! it all comes flooding back, almost tax-free! George W. Bush has been especially generous to his buddies in this way. (See here, for example.) Of course, every day, capital does pay tax despite passing through tax havens. But that does nothing - nothing at all - to dispel the charge that these facilities create loopholes through which the world's wealthiest citizens and largest corporations gleefully jump, leaving the rest of us (that is, you and me) to pay their taxes for them. Read his last sentence again. This man is saying, in the pages of the FT, that tax havens are not being used for abuse. Erm . . . this, Mr. Persaud, is planet earth.

To be fair, he moves on to undo his last assertion:

"The potential for abuse is whether the way station becomes a hiding spot, either to reduce taxes at the end of the journey or to launder criminal money. The problem is not the tax rate but Swiss-style bank secrecy."

Has Mr. Persaud ever come across a quaint little British legal notion called trusts? Every offshore expert and practitioner knows very well that trust structures provide for the possibility of far stronger and more devious forms of secrecy than "Swiss-Style bank secrecy" can (and has he been reading the newspapers about UBS recently?). Does he not know this? We could recommend a few books, if he's interested. Or he could turn to the back of The Economist magazine where a few sleazy-looking offshore operators advertise every week.

Now Persaud says:

"One of the first institutions to fail in this crisis was Northern Rock, a very British bank where supervisors appeared to overlook the niggling detail that funding long-term mortgages of more than 100 per cent of the value of homes in a mature boom, with short-term deposits and money market funds, is highly risky. A German savings institution, IKB, was next."

Perhaps he'd like to read Jim Stewart's lead article in this edition of our newsletter, Tax Justice Focus. What Persaud is saying here is this: the fault lies with the supervisor - and nobody else is to blame!

Now here's an old chestnut from Persaud, related to Northen Rock and Co. (The Center for Freedom and Prosperity likes this argument a lot):

"Regulators did nothing about the exponential growth of mortgage-related financial derivatives, not because they were hidden in offshore financial centres – they had the discretionary powers to raise bank capital charges for any additional risks they perceived . . . "

No: in the real world the regulators did not have these discretionary powers. For two reasons. First, in many cases, capital can escape beyond the reach of regulators - to tax havens, which exist to provide this service, causing regulatory fragmentation in the process. Second, where regulators are technically able to exert regulatory oversight, over, say, a parent company, they find their hands are tied - for the companies will threaten to move offshore! (Here's an example.) Tax and regulatory competition stops jurisdictions from acting decisively.

It gets worse, however. Persaud then airs another rotten old chestnut:

"The solution is what Bermuda, Barbados and other responsible offshore financial centres do, which is to have information agreements that allow tax authorities to share information. The presence of standardised tax information agreements applicable to all countries would be an objective measure of responsibility."

Persaud is talking about Tax Information Exchange Agreements (TIEAs). Is he serious? These agreements typically require a country's tax authorities to know what it is looking for before submitting a request to a tax haven for the information (that they already know). TIEAs are marginally better than nothing, but in general they are not far off a joke. Does Persaud know that the TIEA that in 2008 Jersey Finance admitted that:

"A high threshold therefore exists before the Jersey authorities will accede to a request under a TIEA. For example in the past year, there have been just four requests from the US under the terms of the TIEA. There is no automatic exchange of information under any circumstances and no ‘fishing expeditions’ for information. Strict confidentiality provisions in the agreement preclude any information being passed to third parties without the express written consent of the requested country."

Four requests? Only? Richard Murphy reckons that

"I hate to say it, but TIEAs are hardly worth the paper they are written on."

And that's not all. TIEAs are bilateral - and it is almost always the rich countries that use them. Developing countries are almost entirely left out of this network. They haven't a chance. Is Persaud as interested in the interests of developing countries as he claims he is?

This has been a longish blog, and it's probably time to stop, for now. We have dealt here mostly with regulation and tax. The two are intertwined. We have not dealt with an entirely different set of factors behind the economic crisis. Another factor is the direction of flows through tax havens. Geoff Cook, one of the pro-tax haven lobbyists in the FT, notes that:

"In Jersey’s case, much of the £200bn of deposits held is upstreamed to the City of London."

Let's doubt his numbers - TaxAnalysts, without a vested interest in this, and using official Jersey numbers, estimated that in 2006:

"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."

(and these tax-evading deposits are just a small part of a bigger picture) Yes, tax havens have helped channel funds into London and other financial centres, contributing powerfully to the macroeconomic imbalances - although often in illicit ways that are not measured in conventional statistics. But there's no space for that right now. Read more here.

Oh, and Richard Murphy's take on these issues provides a whole set of other insights. Look here.

E for Effort to the FT writers and comment editors. You'll need to sharpen your pencils and do much, much more research into how tax havens impact on global trade and investment flows (The Guardian seems to be ahead of the field here). And we, of course, will have more to say on this important subject in due course.


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