Richard Murphy, an accountant arguing for reform of international accounting standards, summarizes the problem as it stands. “A company gets its license to operate in any territory from the government that represents those people. It has a corporate duty to account in return. This is the essence of stewardship and accountability. Instead we have companies pretending they float above all these countries. They don’t.”
If multinationals had to break their financial information down by country and disclose what they do in each place, global markets would immediately become more transparent. A secret trove of information vital to citizens, investors, economists, and governments would come onshore and into view. Country-by-country reporting, as it is known, is already making progress in policymaking circles, particularly for the extractive industries.2 It now needs major support and must be expanded to include all businesses—especially the banks.
Another essential step concerns how governments share information about the local incomes and assets of each others’ citizens. If a person in one country owns an income-generating asset in another country, his or her tax authorities need to know about it. So governments need to share relevant information, subject to appropriate safeguards.
But the dominant standard for exchanging information is the OECD’s “on request” standard: a cheats’ charter whereby a country already has to know what it is looking for before it requests the information from another on a bilateral basis. Developing countries are particularly vulnerable here. The OECD’s standard can be replaced by the far better alternative: automatic information exchange on a multilateral basis, where countries automatically tell each other what their respective taxpayers own and earn. Such a system exists in Europe: It works well and does not leak information (though major loopholes need plugging to defend against the Caymans trusts, Nevada corporations, Liechtenstein foundations, Austrian hidden Treuhands, and various other secrecy facilities that infest the offshore system). Momentum is just starting to build for change here3—and this can now be rolled out worldwide and vigorously supported. Sanctions and blacklists can spur the shift.
As a second major area for reform, we can prioritize the needs of developing countries.
The pattern always seems to be the same. A secrecy jurisdiction comes up with a new abusive offshore structure, and wealthy countries construct defenses against it as best they can. But poor countries, without the relevant expertise, are left wide open to the new drain. In February 2010 Misereor, a German development organization, researched the new information exchange agreements that had been signed between countries after world leaders promised to crack down on tax havens at a G20 meeting in Washington in 2008. Misereor found that just 6 percent of the tax treaties, and zero percent of the tax information exchange agreements, were signed with low- income countries. “While G20 and OECD are promoting DTTs and TIEAs as centre-pieces of a global standard on transparency and cooperation,” Misereor concluded, “statistics show that poor developing countries are simply left out.”4
Tax is the Cinderella in the debates about financing for development. Overshadowed for decades by its domineering sisters—aid and debt relief—tax is now, at last, starting to emerge from the shadows. Tax is the most sustainable, the most important, and the most beneficial form of finance for development. It makes rulers accountable to their citizens, not to donors, and the right kinds of taxes stimulate governments to create the strong institutions they need for getting their citizens and corporations to pay tax.
Three things can now happen. First, developing and middle-income countries can find a voice to articulate their concerns about this global system for transferring wealth from poor to rich and work together. A few countries like Brazil and India are beginning to construct serious offshore defenses, and the time is ripe for this to become a mass movement. Second, official development assistance in this area can rise dramatically: Less than one-thousandth of development aid is currently spent on helping countries improve their tax systems5—and much of that is spent on ideas that may make poverty worse, not better. Third, if citizens and civil society organizations were to stop focusing so exclusively on aid, in order to help revitalize the debates about tax and its role in fostering accountability, things can change. Aid can help—but with ten dollars being drained out of the developing world for every dollar going in, we need new approaches. If there were ever a movement that could unite the citizens of developing and wealthy countries in one cause, this is it.
The third big change to make is to confront the British spiderweb, the most important and most aggressive single element in the global offshore system.
The City of London Corporation—the offshore island floating partly free from Britain’s people and its democratic system—must be abolished and submerged into a unified and fully democratic London. The City’s international offshore spider-web, the mechanism for harvesting and profiting from financial capital from around the globe, however dirty it may be, must be dismantled. It harms the people of Britain, and it harms the world at large. Britain is too thoroughly captured by the City and its offshore sector to do this alone: Pressure from outside is essential. Developing countries in particular need to appreciate how offshore is a somewhat imperial economic system, in which their own elites are deeply implicated. Alongside this new focus we need a greater understanding of the role of the United States as an offshore jurisdiction in its own right and the harm this causes, inside and outside the United States.
Onshore tax reform presents another arena where changes can be made. Endless possibilities exist, and I will focus on just two big, promising solutions that have been almost entirely overlooked.
The first is land value taxation.6 This needs a very brief detour. A street musician who sets up his stall in the middle of the main street will earn far more than if he plays on the outskirts of town. The additional earnings on the best sites, over and above what he would earn on a just-worthwhile site, owe nothing at all to his skill or efforts7—they are pure, unearned “rental value.” If a government builds a major new railway line, property owners near the new stations will see their properties rise in value through no efforts of their own. It is pure windfall: unearned rental value. The correct approach to unearned natural rents like these is to tax them at high rates (and use the proceeds to either cut taxes elsewhere or spend more). This is not a tax on property ownership, but a tax on land: whether or not that piece of prime real estate is owned by a Russian oligarch hidden behind a Liechtenstein anstalt, the bricks of the building sited there are rooted firmly into the soil, and the tax can be levied. Because land cannot move, this tax is insulated against offshore escape. It encourages and rewards the best use of land and keeps rents lower than they would otherwise be.
Not only that, but a huge share of the profits of the financial sector derive ultimately from real estate business and land value. Tax land’s rental value, and you capture a big slice of this financial business, however much it is reengineered offshore. When Pittsburgh became one of the few places in the world to adopt the tax in 1911, in the teeth of massive resistance from wealthy landowners, it had dramatic and positive effects: While the rest of America went on an orgy of land speculation ahead of the Crash of 1929, prices in Pittsburgh only rose 20 percent. Harrisburg’s adoption of the tax in 1975 led to a dramatic inner-city regeneration. The tax is simple to administer and progressive (that is, the poor pay less)—and can be especially useful for promoting growth in developing countries.
Another promising, much-overlooked scheme concerns mineral-rich countries. Tides of looted or tainted oil money sluice constantly into the offshore system, distorting the global economy in the process. A radical and controversial proposal would upend this phenomenon by distributing a large share of a country’s mineral windfalls directly, and without discrimination, to every inhabitant. This has only been implemented in a few places like Alaska, but in many other mineral-rich countries, even poor ones, it is feasible. Doing so could prevent hundreds of billio
ns of dollars of stolen mineral-sourced loot from draining to offshore centers and deliver tremendous benefits for the populations concerned.
A corollary of onshore tax reform is leadership and unilateral action.
After the September 11, 2001, attacks, U.S. legislators tried to insert stronger anti-money-laundering provisions into the PATRIOT Act. In the halls of Congress, civility collapsed, and shouting matches erupted between bank officials and congressional staffers.8 Among other things, the bankers were defending offshore shell banks, which hide behind nominees and trustees so no one can know who their real owners and managers are. Senator Carl Levin who led the charge—after having had eleven transparency bills shot down by Senator Phil Gramm—stuck to his guns, and in the post-9/11 environment he at last got his way: remarkable provisions saying that no U.S. bank may receive a transfer from a foreign shell bank, and no foreign bank may transfer money to the United States that it has received from a foreign shell bank. The result, as Raymond Baker explains, is that “the thousands of shell banks that used to run loose have been reduced to perhaps a few dozen…. With a stroke of the legislative pen, a major threat to economic integrity has been almost completely removed from the global financial system.” International agreement is generally a good thing, in cases like this. But leadership can work wonders too.
Too often, when corporations or individuals threaten to relocate offshore if they are taxed or regulated too highly, or asked to be too transparent, or to submit to criminal laws, government officials quail and give the wealthy owners of capital what they want. Not only that, but efforts to stop people from using abusive offshore loopholes are also greeted with the same cries of “Don’t crack down on that loophole or we will go elsewhere!”
The latest crisis has made clear that much financial services activity is actually harmful. So if certain parts of the financial industry leave town—so much the better. Good projects will always find financing, whether or not your country is stuffed with foreign financiers, and local bankers are better placed to supply it because they know their customers. Tax and regulate the financial industries according to an economy’s real needs, ignore the screams that capital and bankers will flit offshore, and you will tend to drive out the harmful parts, leaving the useful bits behind. The key is leadership. Unilateral action can work.
Another major task is to tackle the intermediaries and the private users of offshore.
Rudolf Strahm, a Swiss parliamentarian, studied every historical episode where Swiss bank secrecy has been loosened in response to foreign pressure and concluded that pressure only works when applied to Swiss banks. Every attempt to pressure the Swiss government was seen as an attack on national pride—and failed.
When a kleptocrat loots his country and shifts the looted wealth offshore, the banks, accountants, and law firms that assist him are just as guilty as the kleptocrat. When a client gets caught and goes to jail, so should his or her relationship manager, accountant, trustee, lawyer, and corporate nominee. A few organizations like London-based Global Witness have sought to call these intermediaries to account—but we now need a sea change in the world’s approach. Get serious with these people at last.
As regards the end users of offshore services, many strategies are needed. I will mention just one. Its awful-sounding name—Combined Reporting with Formula Apportionment and Unitary Taxation—masks a simple, powerful, and straightforward approach to tax, which California already uses successfully to confront transfer pricing abuses.
Instead of the current approach of trying to tax each separate bit of a multinational as if it were a free-floating entity, tax authorities could treat the multinational group as a single unit, then “apportion” its taxable income out to the different jurisdictions where it operates, under an agreed formula based on real things like sales, payrolls, and assets in each place. Each jurisdiction can tax its portion at whatever rate it wants. So consider a U.S. multinational with a one-man booking office in Bermuda, with no local sales. Current rules let it shift billions of dollars in profits there to skip tax. But under the alternative system based on sales and payroll, the formula would allocate only a minuscule portion of the income to Bermuda—so only a minuscule portion of its overall income would be subject to Bermuda’s zero tax rate. The rest would get taxed properly based on the substance of what it does in the real world, rather than on the gymnastic legal form its accountants have created for it. Several U.S. states already use it quite successfully. Countries can do this unilaterally—and if this happened widely a vast part of the tax havens’ business model would disappear. Again, developing countries could be particularly helped by this.
In this context, the financial sector needs special mention as a vast area to reform. Severe pundit fatigue has already set in on this topic, so I will just make two short recommendations that have not been a part of the general clamor.
First, policymakers, journalists, and many others can start to understand and accept how tax havens have become the fortified refuges of financial capital, protecting it from tax and regulation and in the process contributing to the latest crisis in many and varied ways. The veil of silence and ignorance can be lifted and the message spread.
Second, countries worried about the safety of their financial systems could compile blacklists of financial regulatory havens based on the Jersey-Delaware notion of the captured state: a place that seeks to attract money by offering politically stable facilities to help people or entities get around the rules, laws, and regulations of jurisdictions elsewhere. This blacklisting will be easy enough, technically speaking, once we understand what we are looking for. With these blacklists, appropriate prohibitions and regulations—many of them very simple—can be put in place to help countries reclaim their sovereignty and respect voters’ wishes once more. Along with this another benefit would flow: Once these berserkers in the international regulatory system are out of the picture, international cooperation on financial reform will become much easier. This proposal will also help us guard not only against repeating the errors that led to the latest crisis but also against those of the next one, whose causes we may not even be able to imagine yet.
Next, we should rethink corporate responsibility.
Societies grant corporations immense privileges, such as limited liability, which lets investors cap their losses and shift outstanding debts onto the rest of society when all goes wrong. They have also been granted the right to be treated as artificial legal entities that can relocate to different jurisdictions almost at will, irrespective of where they really do business. In exchange for these remarkable privileges, corporations were originally held to a set of obligations to the societies in which they are embedded: notably to be transparent about their affairs and to pay tax.
The offshore system has undermined all this. The privileges have been preserved and enhanced, but the obligations have withered. Tax must now be brought squarely into corporate responsibility debates. Corporate managers are taught to think that they are accountable only to shareholders. From this perspective, escaping tax seems to be their duty. But we have forgotten the fundamental truth that corporations get their license to operate, and the tools and confidence to do so effectively, from society. Seen this way, tax is not a cost to shareholders, to be minimized, but a distribution to the stakeholders in the enterprise: a return on the investment societies and their governments make in infrastructure, education, law and order, and the other basic prerequisites for all corporate activity. The shareholders must get their due, but the societies they depend on must too. When we start to make corporations feel they are accountable not only to shareholders but to societies too, a whole new arena will have been created in which the offshore system can be questioned and challenged.
We can also reevaluate corruption. I have already indicated how predominant corruption rankings of countries rate many of the world’s top tax havens—the repositories of trillions of dollars of corrupt, stolen loot—as the world’s “cleanest” jurisdiction
s, and how a new Financial Secrecy Index, which I mentioned in chapter 6, has started the process of setting the record straight.
But we can move beyond rearranging the geography of corruption and reassess what corruption is. At heart, corruption involves insiders abusing the common good, in secrecy and with impunity, undermining the rules and systems that promote the public interest, and undermining our faith in those rules and systems. In the process it worsens poverty and inequality and entrenches vested interests and unaccountable power.
Bribery does all these things. But many of the services tax havens provide also do these things. This close analogy between bribe-paying and the business of secret offshore escape is no coincidence: We are talking about similar underlying processes. Some people have praised bribery as a way of getting around bureaucratic obstacles: Without that bribe, that company won’t get its container through the port. They are wrong, of course: Bribery may benefit the bribe-payer, but it damages the system as a whole. Similarly, the defenders of secrecy jurisdictions argue that their services help private actors get around “inefficiencies” in mainstream economies, smoothing the way for business to proceed. And they do. But what are those “inefficiencies”? They are, most importantly, tax, financial regulations, criminal laws, and transparency—all of which are there for good reason. To help someone get around the obstacle is to corrode the system and trust in the system. Bribery rots and corrupts governments, and tax havens rot and corrupt the global financial system.
Treasure Islands: Dirty Money, Tax Havens and the Men Who Stole Your Cash Page 30