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Friday

15

January 2016

Privacy Again At Stake in BEPS Fight

Written by , Posted in Taxes
Originally published in Cayman Financial Review

Problems with the OECD’s work on Base Erosion and Profit Shifting (BEPS) are numerous and will likely lead to a variety of negative consequences. Most obvious is the wasted effort put into a massive and costly undertaking seeking to address a problem that the organization’s own data on corporate tax revenues suggests isn’t serious or may not even exist. Also apparent is that the effort is a continuation of the war on tax competition by high-tax nations that resent low-tax jurisdictions that successfully compete for investment, and insofar as tax competition is good for economic growth BEPS is sure to be bad for it. Yet the BEPS project’s impact on privacy might be its most insidious outcome.

The rallying cry of the OECD and its proponents is transparency, e.g. the Global Forum on Transparency and Exchange of Information for Tax Purposes, but they don’t confine the word to its traditional meaning. BEPS in fact represents the latest in a worrying trend that has seen the commonly understood idea of transparency as it relates to public policy completely turned on its head.

Once used exclusively to refer to a key ingredient of good government whereby elected officials and government agencies were open and accountable to the people, tax crusaders have given transparency an Orwellian twist, distorting the idea to mean the elimination of privacy. They want the financial data of citizens naked and exposed to government, which makes their use of transparency an example of upside-down language designed to obscure the evisceration of a basic right.

Privacy’s role

This effort to make transparency an obligation of individuals and private institutions to the state, rather than the other way around, is concerning for a multitude of reasons. In terms of raw power, individuals are vastly outmatched by government. To avoid the kinds of abuses this has led to throughout most of human history, modern and civilized governments are encumbered by legal and democratic constraints, among them strict limits on the degree to which they can access private information.

For those trapped under corrupt regimes, the relationship between privacy and human rights has long been obvious. When your government is able to expropriate your wealth whenever it pleases, you by necessity must understand the importance of financial discretion.

But privacy matters even in Western nations that typically consider themselves above such problems. While outright theft is less likely, it’s not unusual for private information to be exploited by the ruling regime, particularly when it comes to their political opponents. Finally, there is the danger of governments and their typically poor security measures allowing criminals and bad actors inadvertent access to personal data.

Steady erosion of protections

Exploiting what are often exaggerated if not entirely made up crises has allowed governments to gradually erode privacy protections. In other areas – like surveillance and national security – citizens in many nations are starting to fight back, but the continued erosion of financial privacy has seen far less public attention.

When the OECD’s 1998 “Harmful Tax Competition” declaration of war on low-tax jurisdictions met with political backlash, its proponents shifted course to focus more on so-called transparency than low tax rates. The end goal is the same, however, as the elimination of privacy allows for greater use of worldwide tax systems or other back-door harmonization schemes.

The 9/11 terrorist attacks on the United States in 2001 provided an excuse to drastically increase surveillance on financial activities. But even though those involved in the attacks banked in the U.S. and used facilitators in Germany and the UAE, opportunist political rhetoric tellingly singled out tax havens in order to justify the new “transparency” push.

Terrorism quickly gave way to tax evasion as the dominant scare requiring curtailment of rights. What followed was a gradual but persistent effort to chip away at privacy protections, with smaller invasions giving way to bigger and bigger demands and culminating in the United States’ global financial surveillance law, FATCA, along with the current effort to establish automatic exchange of information as the new “global standard.”

Same strategy against new target

BEPS can only be understood as part of the same fight, but the effort also stands apart by focusing on corporate rather than individual taxpayers. This adds an additional economic consequence to its privacy invasions.

Of particular concern are the country-by-country reporting rules, as well as the master and local files. These proposed requirements necessitate that companies hand over information with little to no direct tax relevance, which is very troubling since it presumes that governments have a right to know the internal decision-making processes and strategic technology of companies. To make matters worse, giving this type of info to governments creates a huge risk that proprietary data will be leaked and/or stolen in ways that undermine the competitive edge of companies.

With such information being potentially required in every jurisdiction in which a company does business, improper dissemination is all but certain. It only takes one government with poor safeguards or malicious intent for proprietary information to end up in the hands of competitors. Just imagine what happens when the Chinese and Russian governments have access to sensitive information about the internal workings of Western-based multinationals.

But you don’t even need to assume bad intent. As recent events in the United States have shown, even the world’s largest tax agency can’t protect its citizens’ data from hackers or careless agents. It’s foolish to expect that in the case of BEPS, both it and every other nation will suddenly and without exception provide for the protection of corporate data.

Changing winds?

It’s already common to hear that financial privacy is dead, and given current trends that’s an understandable sentiment, but this isn’t necessarily the end of the story. FATCA, perhaps the biggest of the many current overreaches targeting individual taxpayers, is receiving significant pushback through legal challenges in multiple countries, as well as growing political opposition.

BEPS, too, is beginning to receive long overdue questioning. The process was deliberately rushed to obscure the true extent of its goals and the costs of its questionable means, but it’s not yet a done deal no matter what its boosters may claim.

Key figures in the U.S., including Senate Finance Committee Chairman Orrin Hatch and House Ways and Means Chairman Paul Ryan, have questioned the OECD’s work on BEPS, its ostensible benefit to the United States, and the ability of Treasury Department officials to implement its recommendations without Congressional action. Unless the partisan composition of the U.S. Congress drastically changes in the next election, BEPS is a non-starter in the U.S. for the near future. If other nations follow its lead, the bureaucratic spectacle of the last two years could lead to only limited action.

Conclusion

There’s an ongoing global war between tax collectors on one side and taxpayers and their financial institutions on the other. It is taking place on multiple fronts, and for the time being the tax collectors appear to be winning. If they prevail it won’t just be taxpayers that are defeated, however, but our very understanding of privacy itself.

Thursday

7

January 2016

Why Just Stop With Tariffs on China?

Written by , Posted in Economics & the Economy, Free Markets

Noted scholar and respected intellectual Donald Trump has unveiled another part of his plan to “make America great again:”

Donald J. Trump said he would favor a 45 percent tariff on Chinese exports to the United States, proposing the idea during a wide-ranging meeting with members of the editorial board of The New York Times.

…“I would tax China on products coming in,” Mr. Trump said. “I would do a tariff, yes — and they do it to us.”

Mr. Trump added that he’s “a free trader,” but that “it’s got to be reasonably fair.”

“I would do a tax. and the tax, let me tell you what the tax should be … the tax should be 45 percent,” Mr. Trump said.

Now, I know I’m just a simpleton, but something strikes me as off about this plan. Perhaps The Donald can help a poor confused sap make sense of all this.

Presuming he believes this tariff on goods coming in from China will benefit Americans, why does he not propose similar measures on goods from other countries?

But why stop there. If a tariff on goods coming into the U.S. is good for those within the U.S., then so too must a tariff on goods coming into a state be good for those within that state. Should Florida, then, tax goods made in Texas at 45%, or better yet, do so for goods made in any state other than Florida?

It seems to me that Donald Trump believes taxing goods when they cross borders makes us better off, so I’m having a hard time understanding why he isn’t compassionate enough to want to improve our lot even more by implementing that policy across the board. I mean, it’s all well and good to “make America great again,” but why not make it SUPER DUPER great? Hmm?

Wednesday

11

November 2015

Market Power

Written by , Posted in Economics & the Economy, Free Markets

The Week has a great story (hat-tip: Alex Tabarrok) about how Feeding America, which runs the largest network of food banks and is the third largest non-profit in the U.S., drastically improved its operations by adopting a market approach to solve its food distribution problem.

Supermarkets usually donate food directly to their local food bank. But large food manufacturers often donate to Feeding America headquarters, which then allocates this food across its nationwide network of food banks…

Before 2005, Feeding America allocated food centrally, and according to its rather subjective perception of what food banks needed. Headquarters would call up the food banks in a priority order and offer them a truckload of food. Bizarrely, all food was treated more or less equally, irrespective of its nutritional content. A pound of chicken was the same as a pound of french fries. If the food bank accepted the load, it paid the transportation costs and had the truck sent to them. If the food bank refused, Feeding America would judge this food bank as having lower need and push it down the priority list. Unsurprisingly, food banks went out of their way to avoid refusing food loads — even if they were already stocked with that particular food.

It shouldn’t be difficult to see the warped incentive structure and information shortfalls that would plague such a system. Indeed, the author notes:

This Soviet-style system was hugely inefficient. Some urban food banks had great access to local food donations and often ended up with a surplus of food. A lot of food rotted in places where it was not needed, while many shelves in other food banks stood empty. Feeding America simply knew too little about what their food banks needed on a given day.

After seeking the advice of four University of Chicago economists, Feeding America adopted an internal price and auction system to take advantage of the vastly superior ability of price signals to transmit information.

Here’s how the new system works:

Every day, each food bank is allocated a pot of fiat currency called “shares.” Food banks in areas with bigger populations and more poverty receive larger numbers of shares. Twice a day, they can use their shares to bid online on any of the 30 to 40 truckloads of food that were donated directly to Feeding America. The winners of the auction pay for the truckloads with their shares.

Then, all the shares spent on a particular day are reallocated back to food banks at midnight. That means that food banks that did not spend their shares on a particular day would end up with more shares and thus a greater ability to bid the next day. In this way, the system has built-in fairness: If a large food bank could afford to spend a fortune on a truck of frozen chicken, its shares would show up on the balance of smaller food banks the next day. Moreover, neighboring food banks can now team up to bid jointly to reduce their transport costs.

Note everyone was thrilled with the idea, however:

Initially, there was plenty of resistance. As one food bank director told Canice Prendergast, an economist advising Feeding America, “I am a socialist. That’s why I run a food bank. I don’t believe in markets. I’m not saying I won’t listen, but I am against this.”

But the Chicago economists managed to design a market that worked even for participants who did not believe in it. Within half a year of the auction system being introduced, 97 percent of food banks won at least one load, and the amount of food allocated from Feeding America’s headquarters rose by over 35 percent, to the delight of volunteers and donors.

I can’t help but wish for some follow-up with Ms. Prendergast to see if her experience with the market system, and its superiority over the prior approach, has caused her to rethink her preference for central planning over markets. I argue in my column at EveryJoe this week that greater exposure to functioning markets, such as those popular in the emerging sharing economy, poses a threat to the political left. So her answer could help determine if I’m right.

Thursday

8

October 2015

Getting Better All The Time

Written by , Posted in Economics & the Economy, Free Markets

You wouldn’t know it from the popularity of Thomas Piketty’s anti-capitalism treatise, or the Pope’s routine railing against free markets, but the world is getting ever more prosperous. The dramatic decline in global poverty in the last few decades is nothing short of remarkable.

According to a recent World Bank report, extreme poverty is expected to fall below 10% by the end of 2015, which will be a first in human history. I mentioned a few other improvements in a recent EveryJoe column chastising the Pope for spreading economic ignorance:

Across a variety of metrics, life continues to get better and better. Extreme poverty – measuring those living on $2 per day or less – has been cut in half since 1981 and will be all but eliminated by 2030. Global GDP per person has never been higher. Pick a measure of human wellbeing and it’s virtually the same story over and over again: life expectancy is up, infant mortality rates have plummeted, women are better represented in governments than ever before, etc. etc.

The world is simply not the horrible place the pope describes. It is better than it ever has been and we have precisely those institutions that he savages to thank for it.

Over at Cato, Ian Vásquez ties the decline in global poverty to the spread of economic freedom:

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Using updated methodology, the World Bank recalculated poverty figures back to 1990. The new data track closely with previous Bank figures, which I use in the graph to show the fall in poverty since the early 1980s when 43 percent of the world’s population was extremely poor…The drop in poverty also coincides with a significant increase in global economic freedom, beginning with China’s reforms some 35 years ago and the globalization that followed the collapse of central planning in the late 1980s and early 1990s.

Much more could be said on that point, but there are any number of examples demonstrated the superiority of market freedom when it comes to producing wealth (Argentina versus Chile, Venezuela versus Singapore, etc.). Yet the more things get better, the more we seem to worry that they’re not. As the totality of social problems decreases, we devote more energy to those that remain. Which in many ways is healthy. A benefit of being better off overall is that we need not tolerate things which we had no choice but to accept in the past.

But we must be careful not to lose perspective. Exaggerating current problems can lead to poor policy choices if it causes us to disregard the means by which we achieved our current prosperity in the first place.

Tuesday

15

September 2015

FATCA’s Uncertain Legal Future

Written by , Posted in Taxes
Coauthor(s): Dan Mitchell
Originally published in China Offshore
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The United States’ aggressive financial disclosure law, the Foreign Account Tax Compliance Act (FATCA), unquestionably got off to a rocky start. Its implementation has been much delayed as Treasury Department regulators struggled to enforce what has proven to be a fundamentally flawed law from its conception. Now finally entering into force, FATCA faces a new set of challenges as its many unintended consequences begin to blow back on the U.S. government in the form of political uproar and serious legal challenges.

A Troubled Start

FATCA was passed into law as an afterthought to “pay for” unrelated legislation. Members of the U.S. Congress at the time were desperate to find a way to demonstrate competence in the face of a global recession, and to do so without explicitly raising taxes to pay for the effort. Putting the squeeze on tax cheats seemed like an obvious choice. No one likes evasion, so it was thought that the legislation wouldn’t be controversial. And since the Democrats controlled all branches of government at the time, FATCA was simply never granted the careful deliberation such a massive undertaking deserves.

As so often happens with government policy, the FATCA’s goals were not matched by the reality of its methods. It did much more than crack down on tax cheats. It called for complete upheaval of the entire global financial sector in pursuit of the narrow interests of a single country.

Subsequent years have proven FATCA’s tiny projected benefits to be vastly outweighed by its significant costs, a fact which a sober and deliberative legislature would have been able to predict before unleashing it upon the world. The foreign financial institutions and governments inconvenienced by the law don’t have a vote in the United States, however, so the political consequences of this particular oversight would be negligible if not for the presence of other aggrieved parties in the form of law-abiding Americans living, working, or investing overseas.

FATCA Victims Fight Back

It has many practical flaws, but FATCA’s most egregious error is conceptual. It falsely assumes that any American with an overseas bank account is engaging in questionable tax practices and for all intents and purposes treats both them and their institution as if they are presumed guilty. As a consequence of FATCA’s overbearing approach, millions such Americans are being denied – or having to pay much higher costs for – basic banking services, such as the ability to establish savings accounts or secure mortgage loans.

FATCA and similar aggressive efforts to curb tax evasion are sold to the public on the myth that large numbers of wealthy Americans have stashed funds offshore to avoid paying taxes. The reality is far different. Not only is tax evasion extremely rare in the U.S., which rivals Hong Kong, Switzerland, and Singapore for having the highest compliance rate in the industrialized world, but most Americans using offshore financial services do so because that is where they live and work. They are teachers, accountants, and writers. And among the wealthy Americans who do use offshore financial services, they do so primarily for tax-compliant investment reasons.

All of these individuals have been swept up in the FATCA net, but some are fighting back. Americans living abroad have only marginally more political clout than the foreign banks, whose concerns utterly fail to sway the American political class, but they have something those institutions do not: U.S. legal and voting rights.

FATCA’s Legal Woes

Two major lawsuits making their way through the courts are threatening the very foundations of FATCA. One has been brought recently by Senator Rand Paul, a candidate for president in the Republican primary, who argues that the Treasury Department has exceeded its authority during FATCA’s implementation. The other was initiated last year and challenges the Constitutionality of FATCA’s invasive reporting requirements and draconian penalties.

Sen. Paul’s suit could strike a serious blow to FATCA. As written the law requires the IRS to work directly with tens of thousands of institutions that are expected to spy on the U.S. customers on behalf of tax collectors. The information demanded under threat of serious financial sanctions was often more than local privacy laws permitted institutions to divulge, which put them in an impossible position and threatened viability of the legislation.

To circumvent the problem, regulators tasked with implementing FATCA took it upon themselves to rewrite the law. They came up with the idea of signing intergovernmental agreements (IGAs), which would allow institutions to first transmit collected information to their local authorities, who would then share it with the IRS. The agreements, and the subsequent changes to local laws they sometimes required, saved institutions from having to choose between violating privacy protections or suffering serious financial penalties from the U.S.

But to get other governments on board, the United States had to promise reciprocal efforts not authorized by legislative text, and which American lawmakers would be very unlikely to support. Politicians in Washington want other nations to collect information on Americans, but they have no interest in similarly burdening U.S. institutions just to help foreign governments collect more revenue.

The IGAs themselves are the subject of Sen. Paul’s challenge, which asserts that the Executive branch has violated the Constitution by failing to submit the agreements to the Senate, where two-thirds support is required before treaties can become law. The Obama administration insists that the IGAs do not constitute treaties and are instead mere executive agreements, but the substantive policy changes they contain are more characteristic of traditional treaties and demonstrate why legislative input is mandated in the process.

U.S. courts are often reluctant to step into the middle of a dispute between the other two branches of government, so despite the merits of the case it is anyone’s guess how they will come down on the issue. Still, the implication of finding in favor or Senator Paul would be significant for those impacted by FATCA, as it would unravel years of costly work for both those implementing and complying with the law. The current Congress is much more hostile to FATCA and is unlikely to approve the IGA agreements if they are forced through the Senate. Without the agreements FATCA will once again face serious practical impediments, perhaps even forcing Congress to revisit the legislation.

While the courts hesitate to get in between the political branches, they are willing, depending on the issue, to be more proactive in the defense of citizens’ rights. That could prove decisive for FATCA, as the second legal challenge is being pursued on behalf of Americans living overseas who have been negatively impacted by the law. In addition to also questioning the violation of the Senate’s treaty power as Paul’s suit does, they allege that the law infringes on privacy rights and that its excessive penalties violate the U.S. Constitution’s prohibition against cruel and unusual punishment.

Potential Fallout

These are serious challenges that strike at the core of the law. They are also being argued by an accomplished litigator with an impressive record. Jim Bopp, who is leading the case on behalf of overseas Americans, has won 9 out of the 13 cases he has argued before the Supreme Court, including the high-profile fight over free speech and campaign contribution limitations which resulted in a major piece of legislation being overturned.

Even a partial ruling against the law from either of these cases could prove fatal for FATCA.

The law was too poorly conceived and hastily passed to withstand such a blow without crumbling entirely. Lawmakers will then have to decide whether they want to double-down on the mindless pursuit of revenue at any cost, or whether to admit their error and reverse course before more damage is done.

The U.S. courts aren’t the only ones taking a critical look at FATCA either. A challenge to their government’s FATCA IGA from Canadian citizens – some of whom didn’t know they still held U.S. citizenship after emigrating as young children, or were still considered U.S. tax persons under the worldwide American tax system – alleges the agreement infringes on Canada’s sovereignty and violates their personal privacy rights. The case should see its first ruling soon, and could lead the way to similar challenges in other nations.

There’s no doubt that FATCA was ill-conceived and doesn’t come close to positively balancing its costs and benefits, but an equally irresponsible strategy on the part of Treasury Department regulators to invent new provisions of the law extended that folly. Offshore institutions that have spent millions complying with FATCA, and the governments that have worked to accommodate its invasive demands, may yet find it was all for naught.

2016 Elections

As these court cases are working their way through the process, the United States also is getting closer to a pivotal election year. The Republican Party is well positioned to hold power in the House of Representatives, has a good chance of retaining power in the Senate, and is an even bet to capture the White House. This is important because Republicans are generally hostile to FATCA. The Republican National Committee has even taken the unusual step of adopting a resolution of disapproval, and Senator Paul has also introduced legislation to repeal FATCA.

So while FATCA faces legal threats, it also faces political threats. Total GOP control after the 2016 elections almost certainly would create an environment very favorable to some sort of legislation, either calling for full or partial repeal. Indeed, Senator Rand Paul already has introduced a bill to gut the law.

Conclusion

Ironically, while FATCA is increasingly unpopular with Americans, politicians from other nations, along with their allies at international bureaucracies such as the Organization for Economic Cooperation and Development, want to use the law as a template for a system of mandatory global information sharing.

If successful, a global version of FATCA would severely undermine privacy and create massive opportunities for data hacking and identity theft, not to mention cripple tax competition and provide sensitive information to governments that are either corrupt or venal.

Depending on legal or political developments in the United States, however, these plans may run into a huge obstacle. It’s very difficult to have OPEC without Saudi Arabia and it’s very difficult to impose a worldwide tax cartel without the United States.

Wednesday

19

August 2015

BEPS Pivotal in Fight Over Tax Competition

Written by , Posted in Taxes
Originally published in Cayman Financial Review
Download PDF

At first glance the OECD’s Base Erosion and Profit Shifting (BEPS) project is difficult to understand.

There has been no decline in corporate tax revenues in recent years, and nations already possess a variety of tools to respond to erosion when needed. BEPS is thus drawing an inordinate  amount of global attention and resources for apparently low expected returns. The only way to thus explain the project is to recognize that it represents a new front in the OECD’s long running war on tax competition.

The BEPS project has proceeded swiftly following the initial 2012 communiqué from G20 leaders encouraging OECD action on BEPS. In just eight months the OECD returned a report declaring that, “Base erosion constitutes a serious risk to tax revenues, tax sovereignty and tax fairness for OECD member countries and non-members alike.” Only four months after that it followed up with an “Action Plan on Base Erosion and Profit Shifting” that identified the specific areas it intended to address.

Reports for about half of the items identified in the Action Plan were delivered in 2014, with the rest expected in fourth quarter 2015. What has already been released reveals an aggressive agenda clearly aimed at striking a blow against tax competition.

Why the rush?

Political processes typically move slowly, and it might be expected that a project as massive as BEPS with participation from across the globe would require a more deliberate pace. But BEPS has advanced with relative speed. The reason is that the OECD has learned from its past mistakes.

When the OECD released its infamous 1998 paper excoriating “Harmful Tax Competition,” the organization was caught by surprise at the backlash that developed. But it took time for that resistance to coalesce, and it was given a major boost when the United States presidency switched from a Democrat to a Republican in 2000.

A U.S. presidential election is again approaching in 2016, and with Barack Obama finishing his second term there is guaranteed to be a transition, with at least a fair chance of a similar party swap.

Such an outcome could turn the influential United States from a supporter of the OECD’s efforts to an opponent. The agency would rather advance the project beyond the presumptive point of no return before that can happen. Moving quickly likewise provides less time for the business community and other besieged parties to react with organized opposition.

It’s important to note that base erosion, if it really constitutes a problem, is fairly correctable through unilateral action. Transfer pricing rules offer governments considerable power to restrict corporate tax planning if desired, yet the OECD plan goes well beyond providing assistance in developing these rules. The most powerful tool, however, comes from the simple ability to set competitive tax rates.

Were the OECD merely providing tools and recommended practices to assist nations looking to address their own tax systems, they wouldn’t need to hurry the process. In that scenario individual governments could decide for themselves and without coercion whether to heed the BEPS recommendations whenever they happened to be ready. Because the OECD’s aims are much broader, they require not only for the recommendations to be successfully crafted, but eventually for them to be universally adopted as well. And that means getting to the finish line before the opposition even realizes what’s happening.

Homing in on tax competition

The OECD’s animosity toward tax competition by now has been well documented. To put it simply, politicians resent restrictions on the ability to tax and spend as they please.
As capital has grown increasingly mobile, the negative economic feedback from excessive taxation has simultaneously become sharper and more immediate.

Average corporate tax rates among OECD nations have been slashed by more than half since the 1980s, down from around 50 percent to almost 24 percent today. More nations have also switched to territorial systems. Of the 34 current members of the OECD, the number taxing corporations on a territorial basis has doubled since 2000, up to 28 of 34 in 2012.

Although these reforms have benefited the global economy, members of the ruling class tend to be firm believers in the power of government to direct economic growth. The more politicians have to spend, in this backwards view, the stronger will be the economy. The lack of decline in corporate tax revenues as a share of GDP despite major rate cuts, thanks to the dynamic growth effects of better tax policy, is met with denial. Revenues, they believe, would be even higher if rates had not been reduced.

On this understanding the OECD declared itself with the 1998 report to be the primary tool through which international tax collectors and bureaucrats would seek to mitigate tax competition’s impact on domestic policymaking. But because it initially faced political backlash, the OECD has waged the campaign against tax competition through various proxies – money laundering, tax evasion, and now base erosion and profit shifting.

OECD learns from past mistakes

Combating tax competition, unlike base erosion, requires governments working together in what amounts to a tax cartel. This is why it’s essential for the OECD to build a narrative of inevitability surrounding BEPS, and to conclude its work before opposition has time to puncture the narrative. It’s also why the eventual recommendations will be anything but suggestions.

Past efforts prove that when the OECD makes recommendations, they tend to be of the variety that cannot be refused. When developing policies to combat tax evasion, a previous but still popular stand-in for tax competition, the OECD has used a combination of blacklists, intimidation, and threats of sanctions to compel adoption of its preferred tax policies. Those policies naturally reflect the preferences of the OECD’s membership – primarily high-tax welfare states – and the G20 nations pulling its strings.

Although the OECD isn’t advertising the role of BEPS in restricting tax competition, they aren’t exactly hiding it either. The Action Plan lists the “Harmful Tax Competition” report as one of its only four references, alongside the G20 letter and the first BEPS report.

And shortly after the Action Plan notes without substantiation that “Globalisation means that domestic policies, including tax policy, cannot be designed in isolation,” its authors make the following stunning admission:

“While it may be difficult to determine which country has in fact lost tax revenue, because the laws of each country involved have been followed, there is a reduction of the overall tax paid by all parties involved as a whole, which harms competition, economic efficiency, transparency and fairness.”

That single passage includes two significant revelations. The first is that they don’t care whether or not there exists evidence of actual erosion. The second is that the OECD has staked out a normative position regarding nations’ domestic tax policies. Namely, that lower tax burdens reflected in “lost revenue” are presumptively harmful and even somehow unfair.

Conclusion

Corporate taxes are widely understood to be among the most economically destructive forms of taxation, providing just one of many reasons why rational policymakers might choose to find other sources of revenue. The BEPS project has as one of its core assumptions that they are wrong to do so because high corporate taxes are the ideal policy – a policy to which tax competition has become the primary obstacle.

Before the recent campaigns against tax competition, international cooperation on tax policy primarily focused on eliminating double taxation and ensuring that government greed didn’t choke the private sector and kill the goose that laid the golden egg. The OECD even assisted by helping facilitate these efforts.

Now, the OECD wants to turn back the clock and undo the tremendous gains brought about by tax competition.

At the same time as nations are negotiating historic new trade agreements to knock down barriers and further liberalize global commerce, the OECD is running in the opposite direction. BEPS threatens to erect substantial and costly new barriers to global commerce, and its proponents clearly hope that no one will notice until it’s too late.

Saturday

15

August 2015

Third Time Won’t Be the Charm in Greece

Written by , Posted in Big Government, Economics & the Economy, Foreign Affairs & Policy, Free Markets, Taxes

Greece is getting bailed out for the third time in just five years, proving yet again that lessons from political mistakes are rarely heeded. As I wrote last month in a column for EveryJoe:

The simple explanation is that Greece tried socialism and it predictably failed, as socialism is wont to do… More specifically, Greece has saddled its economy and its people with heavy taxes to fund a corrupt government weighed down by excessive pensions for their bloated workforce. A byzantine and oppressive regulatory system further stifles growth and prevents the economy from keeping up.

To put some numbers on the problem, Greek debt exceeds 177 percent of its GDP. That means Greeks would have to work almost two years to produce an equivalent amount of goods and services. It’s unfunded future liabilities, which includes generous pensions, tops 875 percent of GDP! Its yearly spending on pensions alone accounts for a whopping 16 percent of Greece’s GDP, and overall the government spends upwards of 50 percent.

If all this proves that Greece is suicidal, it was its entrance into the European Union that gave it the rope needed to hang itself. When it joined the EU, Greece suddenly had access to levels of credit it never had before thanks to the implicit backing of stronger EU economies like Germany. Creditors determined – correctly, apparently – that if Greece couldn’t pay its debt then they would be bailed out by the larger economies. And like a kid that got his hands on his parent’s credit card for the first time, Greece went nuts. In economic terms that’s called a moral hazard, and the latest bailout has only reinforced it.

This week’s announcement of yet another bailout will only exacerbate the moral hazard, and demonstrates the continued folly of the EU’s grand experiment with a common currency without a common fiscal policy.

Continuing to prop up Greece’s bloated government will not solve the problem. There are no good solutions, but the least bad option is for them to go bankrupt and solve the root of their problem, which is excessive government spending.

Instead, Germany and the rich EU nations are offering yet another loan to the demonstrably irresponsible, on condition that they raise taxes and cut spending. Unfortunately, only one of those conditions will help while the other will prove counterproductive. Leftist bleating about ‘austerity’ conflates tax hikes with spending cuts, but the former is bad for growth and saps the political will for belt tightening, while the latter is a proven path toward fiscal solvency.

What Greece needs is to tear down its bloated bureaucracy and insane regulatory regime, but that won’t happen so long as the EU continues acting as enabler.

Tuesday

30

June 2015

Don’t Cry Wolf on Religious Liberty Infringements

Written by , Posted in Culture & Society, Liberty & Limited Government

Respect for religious freedom has deep roots in American society. Many of those who came to America did so to escape religious persecution, and they brought with them a profound understanding of the importance of protecting such personal rights from oppressive rule, be it by the hand of monarchy or democratic majority. Thus why Constitutional protections for religious freedom were included in the First Amendment.

Yet many areas where religious freedom is said to be under attack are actually examples of a different sort of problem. No one should be forced to make a gay wedding cake, for instance, simply because they make their living as a baker (assuming they are their own employer). The idea that one must sell to all in order to sell to any contradicts basic Constitutional tenets, yet is an idea that has wormed its way into Constitutional doctrine thanks to the misguided idea of “public accommodations” in non-discrimination law, and long eviscerated protections for economic liberty. Focusing on the subset of cases where objections are made on the grounds of religious sensibilities misses the larger issue, which is that the freedom of association and basic liberty should allow all the right to choose with whom they do or do not engage in commercial exchange – for any reason, be it religiously motivated or not, that the individual sees fit.

But there are also ways in which religious freedoms are actually in danger of being undermined today. Under the direction of Houston’s first openly gay mayor, Annise Parker, the city last year subpoenaed sermons and other pastoral communication from local churches. They were ordered to turn over any communication relating to a contentious local non-discrimination law, as well as “all speeches and sermons related to Mayor Annise Parker, homosexuality and gender identity.” She backed down after national uproar over the flagrant abuse of power, but the episode is both illuminating and disturbing.

Religious concerns from the fallout of Obergefell are also not without merit, as admitted by U.S. Solicitor General Donald Verrili when he acknowledged during oral arguments that tax-exempt status “is going to be an issue” with the Court’s potential (and now real) ruling that the exclusion of same-sex couples from marriage (rightly) violates Constitutional protections. The ACLU has also decided that it’s no longer on board with the whole religious freedom thing now that Christians might be the ones in need of legal protections. And given the proven vindictiveness of today’s cultural winners, more attacks ought to be expected.

Which is all the more reason why it’s a shame that some Republicans, along with the Texas Attorney General, are insisting that county clerks in Texas or elsewhere ought to be able to be able to “opt out” of issuing same-sex marriage licenses if they have religious objections. This is a misapplication of religious liberty.

Look, we’re not talking about clergy or non-state wedding officiators here, who like bakers ought to be able to decide whether they wish to take part in a same-sex wedding or not. These are people whose job it is to process paperwork and issue wedding licenses. County Clerks are municipal employees, be they elected or appointed, and therefore agents of the state. And agents of the state don’t get to dictate actions of the state based on personal whims. If they won’t or can’t do the job required of them and fulfill their duties as public servants then they ought to resign.

Individuals have every right to not work at a place that requires issuing same-sex marriage licenses, but what they don’t have is the right to insist that they not be replaced by someone who will do the entire job and not just part of it. Anyone with true convictions should understand that sometimes upholding those beliefs means making sacrifices, including not working at places that as a fundamental part of the job necessitate violating those beliefs.

There are real threats to religious freedoms, and those who might wish to meet those threats with robust Constitutional protections shouldn’t try to expand the concept to its breaking point. I’m sure it’s not easy to have to choose between honoring ones principles or performing a duty that one currently under obligation to perform, but there’s no Constitutional right to not have to make tough choices.

Wednesday

3

June 2015

Reducing the Government Footprint to Improve Airport Infrastructure

Written by , Posted in Free Markets, Taxes
Originally published in Human Events

Political hand-wringing about the state of infrastructure in America is common, with chatter recently spiking thanks to the Amtrak derailing in Philadelphia. The complaints are typically without merit, and more often than not are simply arguments of convenience to justify higher taxes and increased government spending. That doesn’t mean improvements can’t be made, however. A simple market-oriented change to how airports are funded would go a long way toward improving an essential mode of transportation.

Air travel is understandably popular within a country so large as the United States, yet the state of American airports doesn’t always reflect that reality. Donald Trump once likened New York’s LaGuardia to a “Third World airport,” and it’s only going to get worse. The FAA expects a record-high 775.8 million passenger trips in fiscal 2015. As traffic continues to grow, so too must the capacity to handle that traffic. The question is how best to fund needed improvements. Market-oriented reforms would improve the current outdated and inefficient approach.

In a proper market services are paid for by the users who benefit from them. This contrasts with political mechanisms where costs are borne by taxpayers who may or may not receive any direct benefit from expenditures.

Several taxes are currently levied on airline passengers, including a domestic passenger ticket tax, a domestic flights segment tax, and an international arrival and departure tax, among others. These taxes go through the IRS and into the Airport and Airway Trust Fund, some of which then goes into the Airport Improvement Program to fund federal grants to individual airports.

Shuffling funds through multiple agencies and programs before returning them back to airports creates unnecessary bureaucratic waste. In addition, airports that produce the vast majority of the revenue receive a much smaller fraction of the funds, leading to market inefficiencies as improvements are not concentrated where they would provide the most benefit to consumers.

There is a better alternative. A recent paper from the Tax Foundation makes the case that funding granted by the federal government would be better spent directly by airports through greater use of the Passenger Facility Charge (PFC). The PFC is a user fee, which economists prefer over taxes because they more closely resemble the functioning of a market system.

The PFC is a fee on each passenger used to fund airport infrastructure improvements. Rather than going through the federal treasury, the PFC stays with the airport that collects it. This reduces bureaucratic waste while ensuring that funds are spent where consumers derive the greatest benefit.

Airlines objected to the first PFCs – like the government, they would prefer the full costs of air travel be obscured from passengers – but were defeated in their legal challenge in 1972. They had better luck lobbying Congress, however, which outlawed the fees. In 1990 Congress finally allowed PFCs, though highly restricted and capped at three dollars per passenger (airports can charge less, or nothing, if they choose). In 2000 the cap was raised to $4.50, where it stands today.

The current cap, which due to inflation is worth less in real dollars than when it was last raised, leaves airports dependent on taxpayer funded grants, and all their downsides, to fund improvements. The Tax Foundation report argues that raising the cap to $8.50 and indexing it for inflation would better accommodate the needs of airports. Even better would be granting local authorities power to set the cap themselves.

Coupled with reductions in excise taxes on air travel, these reforms would also reduce waste without increasing the overall burden on travelers. A similar approach has helped revitalize the Canadian airline industry while reducing central government control.

Politicians like to pretend that services are free, and they use taxes to hide the true costs to consumers. As we have seen in health care, this can significantly distort the market and reduce the overall quality of service despite increasing total costs. User fees are more transparent for consumers and provide a better alternative than taxes and central control. Allowing the PFC to cover a larger share of airport improvement costs will go a long way toward reducing the government footprint in air travel.

Friday

1

May 2015

The Implications for International Tax Planning From the Looming Fiscal Crisis

Written by , Posted in Economics & the Economy, Taxes
Coauthor(s): Dan Mitchell
Originally published in China Offshore
Download PDF

The international financial sector faces a perilous future. Major challenges loom over an uncertain global economy, while a decidedly negative political climate poses an existential threat to the offshore financial community. With each passing year, thanks to demographic changes and poorly designed fiscal policies, politicians from high-tax nations will be increasingly fixated on halting the migration of jobs and investment to lower-tax jurisdictions. Individuals and jurisdictions that benefit from free international capital flows must act now if they wish to weather the coming storm.

A Bleak Onshore Economic Outlook

Decades of irresponsible spending have left many developed nations with obligations they cannot hope to meet, while demographic trends threaten to push their floundering economies over the edge. Falling birth rates and climbing life expectancies are combining to transform the world’s major economies, turning population pyramids – where the young and healthy vastly outnumber the old and infirm – into population cylinders.

Consider some basic data: In 1970 the birthrate across the OECD was 2.76 children per woman. By 2010 it was 1.74, which is below the replacement level of 2.1. At the same time, positive advances in healthcare are helping people live longer than ever, but that also means an increased burden on workers to provide for the retired or infirm. As welfare states can only function when there are many more workers than dependents, this transformation poses serious fiscal challenges.

Simply stated, the burden of government spending is projected to dramatically increase in developed nations. And because budget will grow much faster than the private sector, this is a recipe for lots of red ink. If current trends continue, nations like France, Germany, Belgium, the United Kingdom, and the United States are all projected to see debt levels rise to 300 percent-500 percent of gross domestic product (GDP) over the next few decades. It’s a recipe for many more Greek-style fiscal collapses.

Don’t forget that nations such as Greece, Italy, Spain, Ireland, and Portugal got into trouble with debt levels between 80 percent-120 percent of economic output. This doesn’t mean the world’s major economies will be attacked by “bond vigilantes” when their debts reach that level. After all, Japan is still stable with debt levels exceeding 200 percent of GDP. But it does suggest that the world’s big nations are heading for trouble in the absence of significant fiscal reform.

Politicians Fan the Flames

Adding to the coming calamity are politicians who have conveniently misdiagnosed the fundamental problem as one of insufficient tax revenue instead of excessive spending. Contrary to claims of widespread austerity, for instance, taxes have been climbing since the 2008 financial crisis. Average top personal income tax rates in the EU have steadily increased in recent years. So has the average standard VAT rate. But if politicians think that endlessly rising taxes will solve their fiscal problems, then they are in for disappointment.

Revenue increases do nothing to solve a problem caused by a spending burden that climbs faster than private economic output. Consider that the European tax burden as a percentage of GDP has grown 10 percent over the last 40 years, but debt grew by more than 20 percent of GDP over the same period. In other words, additional revenue simply enables a higher spending burden. Until they correctly recognize that more spending is the source of their problem, politicians can be counted on to exacerbate their fiscal problems with higher tax rates.

Another challenge is that higher tax rates don’t necessarily translate into higher tax revenue. That’s especially true if politicians impose class-warfare tax hikes on the so-called rich. Simply stated, people with lots of business and investment income have considerable ability to alter the timing, level, and compensation of their income. So when their tax rates increase, they figure out ways to reduce their taxable income.

Yet these higher tax rates almost certainly will dampen economic performance. In other words, fiscal policy in many OECD nations is in a downward spiral. Politicians seek to buy votes with more spending, particularly for income redistribution programs. These policies hurt growth by discouraging participation in the economy’s private sector. Politicians also impose higher tax rates, ostensibly for purposes of fiscal balance. Yet these higher rates further discourage productive behavior, leading to less work, saving, and investment. And as the private sector languishes, there is even more political pressure for additional government spending, which then leads to more taxes and even weaker growth.

At some point, a fiscal crisis occurs because there is too much debt and so much stagnation.

Notwithstanding this destructive cycle, the political class is still agitating for more taxes. Not only do they want increases in existing taxes, but they’re also looking to institute new taxes on financial transactions and carbon emissions, and even to revive old wealth taxes.

These trends do not bode well for the global economy. Achieving real growth is difficult with a shrinking work force and other unfavorable demographic changes. Boosting investment and deepening the stock of capital might be able to make up the difference, but not with politicians squeezing the life out of the productive sector through excessive taxes, particularly discriminatory taxes on income that is saved and invested.

Blocking the Escape 

Knowing that high taxes are likely to spark an exodus of jobs and investment, politicians in high-tax nations are compounding the problem with anti-tax competition policies aimed at hindering mobility of labor and capital. More specifically, in a misguided attempt to prevent citizens (and their money) from fleeing high tax nations, they are using international bureaucracies and institutions such as the G-20 and the OECD, to attack low-tax jurisdictions and the service providers that help protect taxpayers from excessive fiscal burdens.

This is unfortunate since tax competition between jurisdictions has served an important role by making it at least somewhat more difficult for politicians to impose bad policy. It also means that one nation’s fiscal mistakes can be another’s opportunity to attract investment, thereby mitigating the economic harm of bad policy. Thwarting tax competition by erecting barriers to cross-border flows, on the other hand, will ensure maximum negative impact from the poor policy choices seen in recent years.

The G-20 and OECD continue to serve as the primary vehicles through which high tax nations seek to undermine tax competition. The anti-tax competition campaign began in the 1990s as a response to globalization. Politicians from high-tax nations resented the fact that some governments were lowering their tax rates to attract more jobs and investment. And because it was increasingly easy for labor and capital to cross borders, this created a virtuous cycle, at least from the perspective of taxpayers.

But high-tax welfare states weren’t happy. So they decided to use international bureaucracies to fight back. The campaign became public with the release of a 1998 report called, “Harmful Tax Competition: An Emerging Global Issue.” In the years since, the OECD has grown increasingly bold in its reach.

First came the blacklists, where jurisdictions with low tax rates and attractive policies were singled out and pressured into counterproductive reforms. Among other things, they were required to sign Tax Information Exchange Agreements with a certain number of countries in order to be taken off the OECD’s naughty list.

When that proved insufficient to stop the flow away from high-tax nations, bureaucrats unveiled the Multilateral Convention on Mutual Administrative Assistance in Tax Matters. It would require signatories to enforce the bad tax laws of other nations, while granting the OECD power of judge, jury, and executioner over any disputes.

At the same time, the United States began a unilateral effort at global tax enforcement. Under the threat of protectionist tax penalties, the Foreign Account Tax Compliance Act (FATCA) conscripts financial institutions throughout the world, as well as their governments, to act as American tax enforcers. The OECD’s tax collectors apparently saw the pain caused by FATCA and got jealous. If the United States could demand that other nations and foreign institutions enforce bear the cost and responsibility for enforcing US tax law, why could others nations not do the same?

The latest Common Reporting Standard takes all the work jurisdictions have put into placating the OECD for the last decade by meeting TIEA requirements and throws it out the window. The idea that a jurisdiction should sit back and wait for another nation to request the financial information of a resident – based on a reasonable suspicion – is now scoffed at. The new standard of automatic exchange instead obliterates the presumption of innocence that formed the foundation of past cooperation and treats international investors and low-tax jurisdictions alike as little more than resources of high-tax nations to exploit at will. Due process legal protections no longer apply.

This has all sorts of disturbing implications. Until now the United States has, with narrow exceptions, been the most aggressive perpetrator of worldwide taxation. Not only worldwide taxation of capital income, but also corporate income and labor income. But it is not through generosity or sound principles that politicians elsewhere refrain from reaching into their citizens’ pockets regardless of where they live or work. Rather, they lack the institutions and resources to operate at a global scale. With a regime of automatic exchange in place, however, more can be counted on to soon follow in American footsteps and adopt destructive worldwide tax systems.

Offshore Must Be Proactive

Politicians have always resented the ability of the private sector to adapt and dodge their most destructive policies. In today’s economic climate, they are more desperate than ever to contain and harvest revenue from the productive sector of the economy. They are also politically emboldened to take radical steps in a misguided quest to mitigate the damage from decades of profligate spending and unsustainable welfare systems.

Their efforts will ultimately backfire economically at both the national and international levels, but not before doing serious harm to onshore economic performance and the offshore tax-planning community. To mitigate the damage, low-tax jurisdictions and offshore service providers must come together and defend their right to exist by advocating for the principles that have allowed it to thrive.

Globalization provided opportunities for low-tax jurisdictions. If they were willing to implement pro-growth policies, they could capitalize on the mistakes of high-tax nations. But if the G-20, OECD, and high-tax nations are successful, low-tax jurisdictions will no longer be allowed to benefit from the free flow of labor and capital.

Those jurisdictions, as well as the private sector in those nations, must now decide whether meek acceptance of a harsher climate dictated by the whims of high-tax nations is the wise approach. At best, acquiescence means slow death.

Resistance might seem difficult, but it’s not without precedence. When the OECD first pushed its Harmful Tax Competition initiative, pushback from the US and others forced the global tax collectors to retrench. Though they returned to pursue their goals through other, more indirect means, they nevertheless suffered a serious setback.

Today, resistance is already taking shape against one pillar of the global tax crackdown. FATCA not only faces growing political opposition within the US in addition to widespread international hostility, but it will soon be subject to major legal challenges. Its significant practical obstacles also continue to reveal the folly of prioritizing enforcement of bad laws at the expense of all other considerations – like cost, privacy and international comity.

FATCA was acknowledged as a precipitating force for the OECD’s current push for automatic exchange. If it fails, it may provide opportunity to push the OECD back as well. Doing so will require an offshore community organized around a common understanding of principles for international finance such as respect for privacy and recognition of sovereign boundaries.

Conclusion

Most people in offshore jurisdictions, whether in government or the private sector, don’t appreciate their perilous situation.

Onshore nations, particularly members of the OECD, have very dismal fiscal outlooks. This unambiguously will give them big incentives to seek out new sources of tax revenue. Yes, they will impose higher taxes inside their borders in order to prop up their welfare states.

But they will have an even greater incentive to attack the offshore world in the search for new revenue.

And this isn’t just an issue of financial privacy and so-called tax evasion. The OECD and G-20 now explicitly are seeking to undermine and cripple tax avoidance and other forms of legal tax planning. The OECD’s Base Erosion and Profit Shifting initiative is just one example.

From an economic perspective, one hopes the offshore world will survive these attacks. There aren’t many constraints on the greed of the political class. And if they succeed in destroying tax evasion and tax avoidance, politicians will feel even further emboldened to implement destructive tax laws.

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About Me

profileI serve as Vice President of the Center for Freedom and Prosperity, a non-profit think tank dedicated to preserving tax competition and free markets. This site features my personal views, which are not reflective of CF&P.

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