Oops! There Goes Another $20 Trillion

by Lindy Davies

Last week The Economist featured a 14-page special section on “offshore finance,” the booming global industry helping Big Players lower their tax liabilities. The magazine’s cover featured a happy fatcat, parrot on shoulder, standing in front of a tropical island piled high with money and gold. “The Missing $20 Trillion” is, the authors stress, a conservative estimate of the revenue base that this practice denies the world’s governments. The world currently has some 60 active tax havens, which “serve as domicile for more that 2m paper companies, thousands of banks, funds and insurers and at least half of all registered ships above 100 tonnes.”

Switzerland, of course, is famous for its strict confidentiality regarding the source of the billions held in its banks. And, Caribbean islands such as the Caymans, Bermuda and the British Virgin Islands have been known for decades as nice spots to set up shell corporations and hedge funds. But tax havens operate on every continent. London’s financial community facilitates dodgy dealings in various British dependencies, and in the United States, corporate anonymity makes for lucrative business in Delaware and Nevada.

havenSome of the money that passes through these tax havens clearly comes from illegal sources. Much of it, however, does not. “Individuals have a right to financial confidentiality,” states The Economist, “but only as long as they set about their business lawfully.” However, just what constitutes “lawful” in this shadowy world, and how “illegal” dealings can be identified, is a matter of nearly infinite complexity. Every nation has its own tax code — and well-connected, creative multinational accounting firms tend to stay a few steps ahead of these. Some whistleblowing happens, of course — but those who do must take care that in so doing they don’t commit crimes — such as violating the strict confidentiality laws in force in places like Luxembourg and Switzerland.

Meanwhile, the Cayman Islands have become something of the granddad of offshore financial spots. During the “go-go years” of the early 2000s, public-sector spending increased dramatically, but since the financial crisis, receipts have been down. “Cayman bankers expect their annual license fees to rise by up to 50% as officials try to plug holes.” Yet the Caymans have a very favorable climate, and seem to be in for the long haul. The Economist reckons them to be the most diversified of the world’s offshore financial centers.

One tactic for bringing the offshore tax havens under regulatory control is to adopt treaties that require international sharing of tax information. This tactic, encouraged by the Organization for Economic Cooperation and Development (OECD) has, however, encountered resistance. According to the Cato Institute’s Daniel Mitchell, tax havens “should not have to endure the burdensome tax laws of other countries.” And another problem with the attempt to exchange relevant data is its sheer volume. “Information,” The Economist notes, “is not necessarily helpful if the recipient still has to penetrate the web of shell companies, trusts and foundations between the account and the beneficial owner.”

Despite the great analytical and diplomatic resources brought to bear on this issue, The Economist is not sanguine that offshore financial centers will go out of business anytime soon. They admit that “the heart of the problem is that tax collection has failed to keep pace with business as it has globalized.” Well, duh. If one has noticed a sardonic tone in this article so far, it’s just because to a reader of Henry George’s Progress and Poverty, this is, like, the easiest problem to solve, ever. All it requires is a radical application of common sense to public revenue policy.

Our own Mason Gaffney made this point elegantly in a tour de force lecture he delivered in 1998 at the “Adam Smith Forum, Offshore Trust Services, 10th Annual International Trust and Tax Planning Conference.” The OECD had just issued a booming report explaining how international tax competition is harmful, and should be stamped out. What the OECD recommends is “tax uniformity” among nations. This is, of course, a ludicrous notion. Gaffney drives home this utterly obvious point with a sparkling mix of ironic wit and ironclad fact; one wonders what his audience could have made of it. If, after all, the nations of the world are falling over themselves to pull their tax policies as far away from Adam Smith’s Canons of Taxation as they can, what good can come, then, from “tax uniformity?”

The answer, of course, is that rent-seekers and privilege-holders are fine with existing tax regimes. For example, “investment security” provisions embedded in the NAFTA agreement are such that if a country were to degrade the value of real estate investments by, say, imposing a heavy tax on land values, the fell hammer of multilateral trade sanctions would descend upon it. (Alas, this has yet to be tested.)

“The OECD,” Gaffney notes, “says a harmful tax regime is one that attracts mobile activities.” Well, if our rebel LVT nation replaced import tariffs, VATs and income taxes with land value taxation, it would attract all manner of mobile activities, would it not? “Harmful tax competition” would, indeed, rear its ugly head.

International tax competition necessarily involves the creation of “magnetic tax structures.” Gaffney notes that the United States, with its multiplicity of taxing jurisdictions, is a great laboratory for testing such structures.

The extraordinary growth of California from about 1900 to 1976 shook and recast the economy of the USA, and parts of the whole world. It was not done with low taxes and skimpy public services. It was in part the product of a tax structure that was Magnetic…. California’s natural advantages, a mixed bag, did not promote much growth after the Gold Rush and the Civil War, when California growth lagged badly for 20 years or more. Eventually, though, growth-oriented forces prevailed. California provided superior public services of many kinds: water supply, schools and free public universities, health services, transportation, parks and recreation, and others. It held down utility rates by regulation, coupled with resisting the temptation to overtax utilities.

All these things required tax revenue, and what was California’s most prominent revenue source? Not its celebrated resources of oil, timber or wine, nor its huge tourist industry, but ordinary real estate. “Its tax valuers focused their attention on the most immobile part of that, the land, such that by 1918, land value comprised 70% of the property tax base — and on top of that were special assessments on land” [such as those on riparian rights which funded the irrigation systems that made California a national agricultural leader].

None of this caused the slightest harm to anybody; it was not “harmful tax competition.” Nevertheless, it was stopped in its tracks in 1978, when Proposition 13 froze and reduced California’s property tax. California’s tax system — along with its economic health — moved toward “uniformity” with those of basket-case states such as New Mexico, Alabama and Arkansas.

What are OECD nations to do? Gaffney offers them some good advice:

They could reform their own domestic tax systems along the lines demonstrated by California before 1978, by Hong Kong before 1997, and by New Hampshire today. They could lead us to a world of benign tax competition. They could move away from extra-territorial taxation to purely intra-territorial taxation… away from a mobile tax base towards a more immobile tax base. They are not headed in those directions today, but if one or two nations can face them down, they will have no other choice. Freedom anywhere foils tyranny everywhere. Tax tyranny is a balloon: seal every leak, or it collapses

The Economist pulped a lot of trees to bring us its detailed and well-researched report, but it was utterly unable to see this forest. It takes panaceamongerers like us to do that.

Would you like to read the story of what happened when a (fictional, alas) West African nation followed Prof. Gaffney’s advice?

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