Wednesday, May 06, 2009

How tax havens helped to create a crisis

From the London Financial Times courtesy of the Huffington Post news wire:

Take hedge funds, for example. The tax authorities in the US and the UK have accepted a lax interpretation of residence and source rules, accepting that these funds are resident and their profits sourced offshore (mostly in the Cayman Islands) – even though they are effectively managed from London and New York. Not only are the funds’ gains treated as realised in Cayman, and hence not taxable, but their distributions are not subject to withholding tax – a great benefit for their investors. The funds’ location in a secrecy jurisdiction facilitates tax avoidance and is an open invitation to evasion.

For multinationals and rich investors the point is the same: returns on financial transactions are ultimately taxed at a low or zero rate, making them far more profitable than genuine business endeavours. This distortion of the tax system has greatly fuelled the excess of liquidity channelled into largely speculative financial transactions. The offshore secrecy system has been a main element of the opacity that has undermined corporate and financial regulation.

More here.

Some years back I told a conservative friend whose brother ran a hedge fund that based its corporate "headquarters" in the Caymans for tax reasons, even though it actually operated out of Houston, that doing so was anti-American. Whether it's legal or not is irrelevant, I told him: the net effect is to evade paying taxes, which are dues that all American citizens and businesses owe for the privilege of living and operating in the relatively safe and economically prosperous environment known as the United States. He stuttered in indignation that I would make such an assertion. To him, maximizing profits for investors is a company's only responsibility, and that's as American as apple pie.

Well, maybe. Okay, probably not.

The point is that companies have no national loyalties. Indeed, they have no loyalties at all, except to themselves. Such disloyalty renders severely problematic the notion of corporation-as-legal-citizen, but the more important conclusion we can make from businesses' sense of self-loyalty is that you can only count on them to do the right thing if it makes a better profit--that means that if doing the wrong thing makes more money, businesses will do it, and that happens literally all the time.

Indeed, the only thing guaranteeing that a business will do the right thing is regulation with teeth. And in a political and cultural landscape such as ours where regulation is always strongly suspected as being anti-business, it's extraordinarily difficult to get business to consistently do the right thing.

Case in point: the buttloads of liquidity, that is, free cash, redistributed to the enormously wealthy, via these legal tax havens, ending up creating global financial instability in the form of popped bubbles. In a sane regulatory and tax environment, such free money would be redirected into the real economy, the side of business dealing with making and selling stuff, which creates jobs and long term economic growth, as opposed to the paper economy, which wheels and deals with cash and speculation, often losing the farm in stupid investments.

Two lessons here. First, there are real consequences beyond simple fairness when you allow the rich to get richer while the poor get poorer: when flush with ridiculous amounts of capital, the rich tend to go to Vegas, rather than invest their booty wisely, as conventional wisdom asserts. Second, when you let capitalists do whatever they want to do, they tend to go crazy or moronic. Sometimes so crazy that they bring the whole house down on themselves and everybody else, which is what's happening right now.

I really do hope the ruling class is paying attention to what's going on out there.