What matters about the Paradise Papers

A cursory glance at the World’s leading tax havens illustrates the hypocrisy of politicians getting wound up about the revelations in the recently released Paradise Papers and the Panama Papers before them. Many of the havens are within the direct legislative jurisdiction of nations such as the US (which is itself a tax haven) and the UK, for example. And we should not forget that Luxembourg, Switzerland are key European homes of tax avoidance. Remember that the current President of the European Commission “spent years in his previous role as Luxembourg’s prime minister secretly blocking EU efforts to tackle tax avoidance by multinational corporations” (Source) ably supported by the Netherlands, another nation engaged in the practice. If the politicians were truly worried about this issue they could do something about it directly with the stroke of a legislative pen. Britain could, for example, eliminate Jersey, the Isle of Man, and its Overseas Territories from this corporate scam. The US could do similarly. The EU could bring in new rules to stop Luxembourg. But they don’t stop it, which tells you everything. But, the problem of tax avoidance and evasion is not fiscal. Progressives get stuck on that point. It is largely irrelevant. The real issues are inequality, power and macroeconomic stability. That is what this blog is about.

I covered my view on many of these issues in these blogs (among others):

1. Progressives should move on from a reliance on ‘Robin Hood’ taxes (September 4, 2017).

2. Modern Monetary Theory and Value Capture (November 11, 2015).

3. Governments do not need the savings of the rich, nor their taxes! (August 15, 2015).

4. Off-shore tax havens – be sure we define the issues correctly (July 23, 2012).

5. Robin Hood was a thief not a saviour (April 1, 2010).

The information in the Paradise Papers is shocking – no doubt. But what shocks me and what seems to shock the average progressive (if their voices indicate their impressions) are somewhat different.

The idea that the savings and tax receipts of the rich are in some way important in order for governments to be able to provide high quality services, public infrastructure and jobs to advance the well-being of society is a very dangerous and misguided narrative for progressives to engage in.

Please read my blog – Governments do not need the savings of the rich, nor their taxes! – for more discussion on this point.

I read a report from Canada where a ‘liberal’ senator said that the Paradise Papers showed that the Canadian government was letting “potential revenue slip through tax collectors’ hands … [and] … billions of extra dollars could be put to good use … There’s lots of things the government could be doing … retiring debt, lower taxes, fund new programs … It goes on and on” (Source).

In the same CBC report, another progressive politician said that if the Canadian government closed the so-called “$6 billion a year tax gap” which is a “heck of a lot of money … That might be enough to repair our crumbling infrastructure and sewage plants in Winnipeg, and to invest in a modern transportation system.”

The report presented a table entitled “What could an extra $6 billion buy?” and listed child-care places, affordable housing, MRI machines for hospitals, new water treatment plans, and military jets as options.

The arithmetic might be impeccable but the logic is sadly erroneous when tied to so-called ‘tax gaps’.

These views is representative of the vast majority of commentators on either side of the political spectrum. The Right think, inasmuch as they comment, think that tax cuts could be forthcoming if the governments stopped tax avoidance, while the Left, rave on about better public services etc.

Neither view has any merit.

If there are child-care staff available for hire in Canadian dollars, then the Canadian government can always afford to hire them.

Similarly the rest of the wish list – better housing (presumably there are available carpenters and materials) and the rest of it.

The same logic applies to all currency-issuing governments, which have the capacity to purchase anything that is for sale in the currency they issue – at any time.

The choice is political not financial.

The revelations in the Paradise Papers do not alter that reality.

The Paradise Papers just tell us what we have known for ever. The legal profession is used by corporations and individuals to devise ways in which the rich can get richer – in this case by being able to keep a higher proportion of their incomes than those without access to such expensive legal services.

The difference between the Paradise Papers and the Panama Papers is clear. They both disclose tax avoidance but the latter really only documented how a poorly-governed nation lured corporations and individuals in countries that similarly struggle with regulative capacities (for example, Russia, Latin America).

The Paradise Papers are about the mainstream elites use tax havens that are within nations that have coherent rule of law regimes and which the Peer Review process conducted under the OECD transparency policies do not implicate as being problematic.

The Paradise Papers tell us that the rich siphon a high proportion of their income and store their wealth in these offshore tax havens, even if the haven is still under the legislative remit of the nations they are citizens of.

Many of these schemes operate through financial products, which provide no productive purpose, and which I have long advocated should be made illegal.

The fact they are not made illegal is testimony that, in this neoliberal era, nation states prefer to legislate in favour of the rich at the expense of the poor.

But that is a choice that we can all influence.

I will come back to that.

Modern Monetary Theory (MMT) and tax havens

The Modern Monetary Theory (MMT) argument is outlined in the blogs cited above.

In summary, while the concerns of organisations such as the British-based Tax Justice Network about massive tax avoidance by global companies and individuals using various cross-country schemes is noted, progressives often push the wrong message in all of this.

The loss of tax receipts to a nation via tax avoidance is not the issue that progressives should focus on.

The notion that the ‘lost taxes’ in some way prevent a currency-issuing government from spending is just an application of erroneous mainstream economics thinking, which thinks governments are financially constrained.

In terms of Modern Monetary Theory (MMT) such terminology is grossly misleading.

The tax receipts foregone (lost) to tax avoidance just represents ‘numbers on a bit of paper’. The only issue that is important is the amount of purchasing power that is embodied in the tax cuts (or the reversal of them) and how it is distributed.

The rich do not provide the funds that allow the government to provide services, jobs and public infrastructure.

If the rich do not spend their incomes (and hide them in various tax havens) that doesn’t reduce the capacity of the government to spend.

In fact, the more income the non-government sector, in general, do not circulate back into spending, the greater is the need for government deficit spending to ensure that productive capacity continues to grow and total spending continually absorbs that capacity and maintains full employment.

In 1946, Beardsley Ruml published his 4-page article – Taxes for Revenue Are Obsolete – in the journal American Affairs (January 1946, Vol VIII, No 1), which carried the sub-title “A Quarterly Journal of Free Opinion”.

At the tine Beardsley Ruml was the Chairman of the Federal Reserve Bank of New York.

His argument was straightforward:

… given (1) control of a central banking system and (2) an inconvertible currency, a sovereign national government is finally free of money worries and need no longer levy taxes for the purpose of providing itself with revenue. All taxation, therefore should be regarded from the point of view of social and economic consequences.

This was the same idea that Abba Lerner advanced in terms of his Functional Finance theories, which provide essential underpinnings to Modern Monetary Theory (MMT).

Please read my blog – Functional finance and modern monetary theory – for more discussion on this point.

Ruml also noted that:

The necessity for a government to tax in order to maintain both its independence and its solvency is true for state and local governments, but it is not true for a national government. Two changes of the greatest consequence have occurred in the last twenty-five years which have substantially altered the position of the national state with respect to the financing of its current requirements.

The first of these changes is the gaining of vast new experience in the management of central banks.

The second change is the elimination, for domestic purposes, of the convertibility of the currency into gold.

So, where the currency issued by the central bank “is not convertible into gold or into other commodity”, then Federal government “has final freedom from the money market in meeting its financial requirements.”

For Ruml, Federal taxes … serve four principle purposes of a social and economic character”:

1. As an instrument of fiscal policy to help stabilize the purchasing power of the dollar;

2. To express public policy in the distribution of wealth and income …

3. To express public policy in subsidizing or in penalizing various industries and economic groups;

4. To isolate and assess directly the costs of certain national benefits, such as highways and social security.

So the government might impose taxes:

1. To control inflation.

2. To redistribute purchasing power from the rich to the poor (high income to low income).

3. To alter the allocation of resources away from undesirable ends – such as tobacco taxes.

4. To provide some hypothecated public transparency for major projects/programs.

So from a functional finance perspective, taxation must be designed to advance these purposes and the public discussion must be about the idea of public purpose and never about raising revenue.

We thus have to view the revelations in the Paradise Papers from that perspective.

The hidden income and unpaid taxes do not alter the basic remit or capacity of the national government in relation to:

1. The need to balance nominal aggregate demand growth with the capacity of the real economy to absorb it.

2. The aims of social policy to ensure that the benefits of economic activity are shared in some reasonable manner (relevant to the distribution of the tax burden).

The two issues are interrelated because different income groups have different propensities to consume which influences the impact of fiscal policy. Which brings the question of inequality to the fore.

Inequality is the issue

At the heart of my concern is that the trends to offshore tax havens coincide with the increase in income and wealth inequality that has been recorded in most nations over the last thirty years or more.

What the Paradise Papers also tells me is that what we know in terms of the macroeconomic aggregates reported by national statistics agencies is only part of the story.

For example, national accounts, which estimate the Gross Domestic Product and Income generating performance of a nation, clearly under-reports such things given that the rich can hide income received (and thus production generated) in offshore tax havens.

These facts then lead to the next conclusion: our empirical understanding of income and wealth inequality is likely to be understated. The rising inequality measures are likely to understate the true degree of inequality.

In other words, if you were concerned on the basis of the official data, then you should be really concerned now.

Inequality is bad for social well-being.

Clearly, it is bad for growth.

Even the IMF these days has admitted this after denying it under the ruse of ‘trickle down economics’ for decades.

The trickle down claims made at the outset of the neo-liberal period are lies. Please read my blogs – Trickle down economics – the evidence is damning and Inequality and growth and well-being – revolutions have occurred for less – for more discussion on this point.

Rising economic inequality undermines the capacity for individuals to invest in education, which is the most reliable source of economic development (skill development).

A redistribution of national income can increase or decrease aggregate demand and the final impact thus depends on the different consumption propensities and the number of people who are affected.

A tax cut will inject a certain amount of extra spending into the economy which then induces further spending via the
multiplier process, which I explain in this blog – Spending multipliers.

If you put a dollar of extra disposable income into the hands of the lower paid workers the multiplier effects will be greater than if you put the extra dollar into the hands of high income earner because less will be lost to the rest of the world via imports.

Not only will the low income earners spend more of every extra dollar on consumption per se than the high income earners less income will be lost to the rest of the world because the import propensities are also different and align with their consumption propensities.

Attacking tax avoidance is one path to take in this regard – forcing the rich to declare more of their income and pay more tax. But that path is complex.

A more obvious path is to use the legislative capacity to allow workers who do not use tax havens to increase their share of ‘reported’ national income.

For example, ratios such as the wage share in national income are likely to be overestimated as a result of the off-shore activity.

Given that the distribution of income has been firmly biased in the neoliberal era towards profits (as real wages growth has fallen well behind productivity growth) this means that this redistribution towards profits has been even greater than is disclosed in the official accounts.

The more effective way to resolve that problem is not via tax law enforcement (given its complexity) but through wages policy. The state could legislate to force companies that produce within its borders to share productivity gains with workers via proportional real wages growth.

Sure enough, the vexed issue of measuring productivity growth would arise – as usual. But governments could come up with reasonable estimates that could be used for this purpose.

If the companies didn’t want to play ball then the government has the capacity to stop their productive and sales activity within its borders.

No government in this era has shown the fortitude to do that. But they can and that capacity should be promoted by progressive political forces.

Further, this principle can also extend to specific tax reporting issues.

If, for example, Nike wants to sell its shoes in Australia then it should be required to pay some reasonable proportion of its sales in tax or have its shoes removed from retail outlets under law.

Yes, on-line sales are tricky. But even those can be monitored.

The Tax Justice Network proposal is interesting in this regard (Source):

An alternative system of taxation, called “unitary taxation” instead calculates the tax liabilities of companies based on a proportion of the company’s global profits. The formula used to work out the tax is based on the real economic activities company, for example the sales it books in each country.

See their November 2017 report – Ending multinational tax avoidance through unitary taxation – for further detail.

Further, practices such as the use of intra-group debt and transfer pricing to shift liabilities, while complex are not beyond the legislative capacity of the government to reduce.

For example, tax authorities could simply reject any intra-company loans that pay interest rates that are obviously only set for tax avoidance purposes and bear no relation to reality. If a company can borrow externally at, say, 2 per cent and are creating intra-group loans at, say 10 per cent, then clearly that can be stopped by authorities.

The other obvious path to pursue is to break the link between tax and income. In order for the rich to enjoy their wealth they have to spend it. Spending tends to be localised.

If the government introduced more coherent consumption taxes – with equity parameters such as ‘luxury tax inclusions’ and exclusion of essentials – this would get at the rich more quickly than trying to tax their incomes.

No-one of meagre means buys private jets, luxury ocean-going yachts, cars that belong on race tracks but are driven on city streets, expensive golf club memberships and the like. Most of these things cannot be ‘off-shored’. Consumption is here and now.

By cutting the capacity of the rich to actually realise their hidden incomes in the consumption of goods and services, there is more non-inflationary space for the rest of us to enjoy our material lives.

And if we do not want to spend more, then the public sector has more real resource space in which to spend and provide public goods and services.

Taken together this strategy would reduce inequality and advance the well-being of the lower income groups. It would be more easily to enforce than trying to close down elaborate tax avoidance schemes.

Further, I would substantially increase the penalties for any illegal behaviour by companies and their owners – serious prison time not just fines – which would also provide disincentives to engage in nefarious behaviour.

Inequality is also bad for democracy because it further tilts the power into the hands of the wealthy, who, arguably, have little need to see general well-being advanced ahead of their own interests.

Several reforms are necessary in this regard, including the banning of political donations, breaking up of media empires etc.

I will write more about how progressives have to address power imbalances in societies in a later blog. We address that issue in some detail in our new book – Reclaiming the State: A Progressive Vision of Sovereignty for a Post-Neoliberal World (Pluto Books, 2017)

Conclusion

The Introduction tells us that many of these so-called tax havens are actually within the legislative remit of national governments such as the US and the UK.

These governments could close the tax avoiding capacity of their states, dominions etc whenever they wanted to. Why couldn’t Britain just close down the incentives to hide cash in Jersey for example?

They cry poor in terms of lost tax revenue but then do not do the single most obvious thing they could to stop this practice.

The reason is that the crying poor is about setting up depoliticised justifications to reduce public spending, while enjoying the massive lobbying funding that comes if they make political choices that enhance the rich..

This is the classic neoliberal strategy. Progressives should meet it head on. There are things governments can do if they are so motivated. Our task is to provide that motivation for them, ultimately, via the ballot box.

That is enough for today!

(c) Copyright 2017 William Mitchell. All Rights Reserved.