This blog post is the second in a two-part blog series. In this post, I survey this year’s progress and momentum in global policy on transparency issues. In the first post, I examined several of the year’s biggest global trends and their relationship to financial transparency.
The European Union has made huge policy progress this year. From anti-money laundering to country-by-country reporting, when it comes to transparency issues, the EU was an all-star.
In perhaps the biggest news out of the EU this year, after months of deliberations, EU nations agreed to national-level registries to collect information on the beneficial owners of companies incorporated in EU nations in the 4th European Anti-Money Laundering Directive. In response, Koen Roovers of the Financial Transparency Coalition commented that “The amount of progress made over the last year and a half is encouraging, and the fact that all EU nations agreed to centralized registers is a significant step.”
Another event of significant importance in the EU also happened late this year: the EU finance ministers agreed on two taxation measures aimed at combating corporate tax avoidance and aggressive tax planning. Those strategies are the anti-abuse clause of the Parent Subsidiary Directive and the mandatory exchange of information between EU tax authorities. Pierre Moscovici, European Commissioner for Economic and Financial Affairs, Taxation and Customs, noted that these decisions “open up a new front in our fight against corporate tax avoidance and aggressive tax planning.”
Finally, in October the EU Commission released a report in favor of country-by-country reporting. The report notes that CBCR is not expected to have significant negative economic effects
This blog post is the first in a two-part blog series. In this post, I observe several of the year’s biggest global trends and their relationship to financial transparency. In the second post, I will examine this year’s progress and momentum in global policy on transparency issues.
Rising Income Inequality
In the United States, policymakers across the political spectrum have become increasingly vocal about the rising income inequality. They include Senator Bernie Sanders (I-VT) who called this the “issue of our time,” Senator Paul Rand (R- KY) who admitted income inequality is a problem, and Senator Charles Schumer (D-NY) and President Obama who have lamented our nation’s dwindling middle class, particularly with the growth of the super-rich.
This issue is a global problem, not unique to the United States. The world’s current wealthiest individual is Carlos Slim Helu, a telecom mogul from Mexico—the same nation where nearly half of the population lives in poverty, including 11.5 million men, women and children in extreme poverty. Likewise, India’s Mukesh Ambani net worth totals $21.5 billion, where nearly one third of the population lives below the poverty line. Meanwhile, income inequality has been on the rise in China. According to Oxfam, the world’s richest 85 people hold as much wealth as the poorest 3.5 million people combined.
Income inequality has bombarded the public consciousness through official reports and the popular media. Of course, this conversation begins with Thomas Piketty’s wildly successful book, Capital in the Twenty-first Century. But others have contributed to a wide discourse, as well. In a successful documentary, Inequality for All, former Labor Secretary Robert Reich called income inequality the civil rights struggle of our time. Meanwhile, the OECD released a report at the end of this year concluding that rising income inequality has weakened economic growth in most developed countries.
The international financial system is both a driver and consequence of inequality. Rising income inequality creates more individuals with the resources and opportunities to send funds abroad, contributing to increasing concentrations of wealth among wealthy tax evaders. Meanwhile tax evasion reduces government revenues and compromises governments’ ability to make investments that alleviate poverty. Illicit financial flows erode governance, constrain domestic investment and economic activity, and reduce governments’ ability to provide social services, such as healthcare and education.
Happy Cyber Monday! In case you are from a country that doesn’t observe holidays devoted to consumerism: “Cyber Monday” is a marketing term for the Monday after Thanksgiving, created to persuade people to shop online.
To those of us interested in banking and financial transactions – Cyber Monday is a fitting symbol for the emergence of online shopping and digital transactions. Over the last few years, e-commerce sales have grown by a stunning 20% annually around the world, and in the United States, e-commerce sales have increased by a steady 5% per year since 2005.
Meanwhile, recent massive data breaches in major retailers like Target and Home Depot have left many shoppers feeling uneasy. After the holiday season last year, Target experienced a data breach that affected about 70 million customers and 40 million credit and debit cards. Earlier this year, about 2,000 of Home Depot’s stores came under attack, affecting about 56 million customers.
About fifteen years ago, the leaders of the world convened at the Millennium Assembly of the United Nations. In the year 2000, at the turn of the century, the world’s leaders adopted the United Nations Millennium Declaration, a commitment to dramatically reduce poverty worldwide. All 193 member states of the United Nations and 23 organizations agreed to achieve the following set of goals:
The nations set a deadline for these goals: 2015. With that year only a few weeks away, it is now time to ask: how well has the world fared in trying to achieve these lofty goals?
California spends about $8,500 per year to educate its public school students. That’s about $3,300 less than the national average. In fact, according to Education Week in a national ranking of states and D.C., California ranks near the bottom, at 49th, in terms of per-pupil spending. There are reasons to believe that one cause of this problem is the system of property taxation in California—and its loopholes.
The biggest player in property taxation and its policy in California is Proposition 13. Approved by California’s voters in 1978, Proposition 13 sets limits on the annual increases of assessed value of real property by an inflation factor. Proposition 13 also prohibits the government from reassessing a property’s new base year unless that property changes ownership. Broadly speaking, this means that in California, unless you sell your home, your property taxes cannot increase by more than a fixed percentage each year.
In fact, the market value of properties in California has significantly outpaced this fixed percentage, leading to a discrepancy between what Californians would have paid in property taxes without Proposition 13 and what they actually pay.
In the United States, the overall noncompliance rate for all federal taxes and individual income taxes stands at about 14 percent. According to studies by the Taxpayer Compliance Research Program and the National Research Program, about 1 percent of wages and salaries are underreported and about 4 percent of taxable interest and dividends are misreported. A study of Germany found that the corporate tax base would have increased by 14% if no income-shifting had occurred. Developing countries lose about $900 billion in illicit outflows per year, which severely undermines these nations’ abilities to effectively raise revenue.
These activities are not merely an inconvenience for citizens and policymakers, but rather they undermine the very core of tax systems around the world. There are many things a good tax system should do, but all tax systems should have the three key goals: provide revenue, distribute costs fairly, and promote growth and efficiency. Tax evasion and avoidance, whether via an offshore tax haven or an anonymous corporation, undermine the world’s ability to achieve all of these goals.
Goal 1: Provide the appropriate level of revenue in a timely manner. The first and most obvious goal of any tax system should be generate revenue. Of course, the level of revenue produced by a tax system should not be arbitrary. The tax system should generate enough revenues to meet the needs of the nation with the appropriate level and in a timely manner.
We often think of tax havens as tropical islands or tiny nations nestled in the mountains. We know most of them are geographically and demographically small. Very small. Given their huge reputations, just how small they are just might surprise you.
Ireland, which is well known for its emerald hills and low tax rates, is about the same size as South Carolina. Luxembourg, a tax haven nestled in Western Europe between France and Germany, is about 2,500 square kilometers, or about a third of size of Rhode Island. Bermuda, a group of islands off the coast of South Carolina, is just over 50 square kilometers. That’s about one third of the size of Washington, DC. Singapore has about the same land mass as El Paso, Texas. Hong Kong is about the same size as Suffolk, Virginia. The notorious Cayman Islands have the same land mass as Shreveport, Louisiana.
These statistics might be surprising. How can nations so small garner such strongly negative reactions in the international community? Any why are so many tax havens so small? Is it coincidence? Or is there something else going on?
If you have had much contact with the disciple of economics in the last year, you’ve heard of the book Capital in the Twenty-First Century, written by French economist Thomas Piketty. And Capital concerns two subjects that are very near and dear to us at the Financial Transparency Coalition: inequality and taxes.
Piketty’s book is all the rage among economists and policy wonks. Perhaps for good reason. In a unique exploration of a new dataset, Piketty parses through literally centuries of tax data to discern long-term trends in inequality and wealth. His conclusions are broad and many, but one of his main findings is this: wealth inequality was high before World War I, it fell after and for much of the century, and it has been on the rise again since the 1980s.
That income inequality is already extreme (and getting worse) should come as no surprise to readers of this blog. We’ve heard that the richest one percent of Americans earn about a fifth of the nation’s income. Central to Piketty’s thesis, inequality is even starker in terms of wealth, rather than income. By contrast to the top earners who make one-fifth of the nation’s income, the wealthiest one percent of Americans hold about one-third of the nation’s wealth.
This week the Treasury Department began assembling administrative options for deterring or preventing U.S. companies from inverting—or reorganizing overseas to avoid paying federal taxes. This move follows on the heels of a strong statement from President Obama who accused inverting firms of “cherry-picking the rules.” As he put it: “My attitude is I don’t care if it’s legal, it’s wrong.”
Particularly common among pharmaceutical and life-sciences companies, inversions are primarily a means for U.S. companies to avoid corporate taxes. In an inversion, a smaller foreign company “acquires” a large U.S. firm, allowing the domestic firm to reincorporate overseas and pay a lower foreign tax rate. Usually, this process does not change the operational or functional structure or location of the company – it just changes the way that company has to pay taxes.
Historically, these tax inversions haven’t been all that common. In fact, according to the Congressional Research Service, only been about 76 companies have inverted or planned to do so since 1983. The practice has become much more frequent, however, which is why inversion has garnered the spotlight from Treasury. Of the 76 inversions since 1983, 47 occurred in the last decade, and 14 occurred just this year.
Last week the White House wrapped up the three-day U.S.-Africa Leaders Summit, which President Obama convened to strengthen and enhance relations between the United States and African nations. One of the stated missions of the Summit was to advance America’s “commitment to Africa’s security, its democratic development, and its people.”
As such, a core promise of the Summit was more American investment in the African continent. Specifically, the Summit set the stage for more than $33 billion in new commitments to support economic growth across Africa. President Obama pledged $7 billion in new financing; U.S. companies announced $14 billion in deals in a variety of sectors, including energy and construction; and alongside the World Bank and Sweden, the United States also promised an additional $12 billion in investments for the President’s Power Africa initiative.
Foreign investment can play an important role in economic development. One study, for example, found that foreign direct investment (FDI) promotes economic growth in developing countries by increasing the transfer of advanced technology and creating higher productivity in those nations. Other studies suggest that recipient nations of FDI can also benefit from increases human capital as their residents receive employee training through the investing company. Finally, and perhaps most importantly, several studies note that host nations benefit from FDI to the extent that it contributes to increased corporate tax revenue.
This week several analysts reported that the European Union is considering regulating and taxing the digital currency, Bitcoin. Specifically, the EU is looking to impose a Value Added Tax (VAT) on trades in bitcoin. Meanwhile, its plans to regulate the digital currency—whether imminent or not—are still unclear.
Bitcoin presents short- and long-term risks to financial crime. Like tax havens and other jurisdictions with lax laws on beneficial ownership, Bitcoin presents criminals with an opportunity to keep their money and their transactions secret. Specifically, Bitcoin users don’t need to present an ID to receive a Bitcoin address—or key—so they are not necessarily tied to a flesh and blood person. This means Bitcoin transactions unidentifiable as long as the user takes care to anonymize his or her IP address.
In the United States law enforcement officials have early and often expressed deep concerns about the digital currency. Both the Financial Crimes Enforcement Network (FinCEN) of the U.S. Department of the Treasury and the U.S. Department of Justice have released official statements regarding the regulation of virtual currencies. FinCEN has also already imposed money laundering controls on Bitcoin usually reserved for traditional wire transfer services, like Western Union. These controls include bookkeeping requirements and mandatory reporting for transactions of more than $10,000.
This week the Organization for Economic Cooperation and Development released the full version of its new standard for automatic tax information exchange. Under the standard, governments would collect data from financial institutions on investment income, financial assets, and account balances paid to non-resident accountholders. On an annual basis, participating governments would exchange that information automatically with other jurisdictions.
In a statement, OECD Secretary-General Angel Gurria said the launch “moves us closer to a world in which tax cheats have nowhere left to hide.”
This impetus for this new standard came from a mandate by G20 nations and the OECD will formally present the plan to the next meeting of the world’s leaders in September. The standard also follows from a great deal of bilateral and multilateral progress made by the United States and European Union on automatic tax information exchange.
For any of these efforts to have a real impact on economic development and reductions in poverty, it must translate to action in the developing world. That’s because tax revenues are, and will continue to be, the world’s most sustainable source of development funds. Yet if these systems and agreements exist only between developed nations and tax havens—and until developing countries participate in a similar system or agreements of their own—the progress we’ve made will have little effect on economic development and acute poverty.