The leaders of the world’s eight wealthiest economies have finished their meetings, headed home, and issued a final communiqué for the G8 summit in Lough Erne. And though emerging economies are not represented at the meetings, there are plenty of reasons they should deeply care about what was said. In general, the G8 communiqué goes a long way to calling out important tax issues, but in particular understands the importance of tax in the context of mobilizing domestic resources, curtailing illicit financial flows, and promoting development. And while the G8 did not go as far as they should have on some issues, they did make a fair number of important promises on tax and transparency to developing countries. Developing countries should take heed of these promises—and hold the G8 accountable to them.
Before I dive down into the specifics, I’ll start with a quote from the G8 communiqué that reiterates the importance of these ideas:
It’s in everyone’s interests for developing countries to be able to: strengthen their tax base to help create stable and sustainable states; improve their ability to fund their budgets through their own domestic revenues; and increase ownership of their own development processes.
This quote is significant. First, it acknowledges that the world is not a zero sum game. In the last few years, the world accepted that a less polarized global economic system, one in which all of the players drive economic demand and where wealth is more diffuse, would benefit everyone. That developing countries should grow their economies is not only in the interest of those in the developing world, but in the industrialized world, as well. Second, this quote draws a strong connection between development, sustainable economic growth, and taxes. In particular, it acknowledges the importance of mobilizing domestic resources in the context of economic development. It’s a simple idea that has gained a lot of traction in the last few years. I’m glad the G8 has paired these ideas together—and taken them as given.
The summit between leaders of the world’s wealthiest economies will get underway next week in Northern Ireland. British Prime Minister David Cameron, leading the summit, has put three things at the top of his agenda: trade, tax, and transparency. There are a lot of issues directly relevant to the Financial Transparency Coalition in there, and I don’t have time to address them all, but one of the most promising, and interesting, is Cameron’s commitment to improving information on beneficial ownership of companies via public registries.
Anonymity is prevalent under the world’s status quo. It is exceptionally easy (and relatively cheap) to set up a company, trust, or foundation anonymously. By that I mean that the process obscures the “beneficial owner” of the entity, that is, the flesh and blood person who has control over or benefits from the corporation. Companies, trusts, and foundations accomplish this by incorporating subsidiaries in a secrecy jurisdiction or by using nominees in place of the true directors.
The injustices that result from secrecy are numerous. Given that other people and organizations have outlined some of these injustices in beautiful detail, I won’t name them all (see, for example, this excellent report by Global Witness). Anonymous companies facilitate corruption and bribery by allowing government officials to transfer money undetected; they ease crime by allowing criminals to launder the proceeds of criminal activity and avoid detection by law enforcement; they facilitate tax evasion, costing American taxpayers alone an estimated $150 billion annually; and they facilitate global illicit financial flows that bleed developing countries of billions of dollars every year.
That Africa is poor is assumed, but rarely well explained. Generally, we—both in terms of those who study these issues and collectively as a society—have accepted the fact that Africa is underdeveloped. Yet this conclusion is neither forgone nor self-evident. Even more infuriating, it is often explained, but never sufficiently explained. That is, there are a lot of competing theories on the subject, but most fail to give a complete picture. Of course, it’s a complicated issue, so it makes sense that no one theory would prove universal. Yet, even with intense academic scrutiny, the picture is incomplete.
The solutions to problems are often implicit in the way they are framed. If I tell you my car won’t start, you might tell me to consult a mechanic. If, on the other hand, I tell you I can’t find my keys, well, we have a completely different problem. In public policy, frames can often conflate symptoms with causes, other times, such as with the example I gave, they just obscure a possible solution.
But frames turn out to be fundamentally important to the problems’ solutions. As Albert Einstein once said, “If I had an hour to solve a problem and my life depended on the solution, I would spend the first fifty-five minutes determining the proper question to ask, for once I know the proper question, I could solve the problem in less than five minutes.”
The U.S. government is not unfamiliar with short-sighted policies, indeed short-sightedness in political systems often seems often more familiar than not. Yet of all the short-sighted policies the United States has engaged in, and especially of those overseas, the recent reports on ghost money in Afghanistan take the cake.
I wish I could say I was surprised.
According to a report by the New York Times, the Central Intelligence Agency has literally been dropping off “bags of cash” at Afghanistan President Hamid Karzai’s office for decades. Karzai called the amounts “small,” but evidence indicates the amounts are anything but—perhaps totaling tens of millions of dollars.
The presidential palace in Kabul said the money has been used “for different purposes, such as in operations, assisting wounded Afghan soldiers and paying rent.” But the truth is that if the means were so honest CIA wouldn’t have bothered delivering it so secretly— often in suitcases. In reality, the agency was using it to buy the loyalty of Afghans and encourage their support in the war against the Taliban. Karzai, in turn, has used it to buy power, fuelling corruption and empowering warlords.
On Tuesday this week, six-term Senator Max Baucus (D-MT) announced he would not seek reelection next year. The decision will end his thirty-six year long and influential career in the Senate; one which included over a decade as the top democrat in the Finance Committee and a co-authorship of the 2010 health care law. In his planned retirement, Senator Baucus will join other senior Democratic senators, including Senator Carl Levin (MI) and Senator Tom Harkin (IO).
In the wake of Senator Baucus’ announcement, the pundits, commentators, and even some Democrats have been calling his legacy “mixed.” Democrats are quick to note all of the times the Senator broke rank, for example over gun restrictions, President Bush’s tax cuts in 2001, and the estate tax. He’s even been quick to speak against the party, just this month saying the implementation of the health care law is headed toward “a train wreck.”
Despite a sometimes controversial career within his party, we should recognize Senator Baucus as one of the pioneers of U.S. legislation aimed at reducing what he has called the “tax gap” – the estimated hundreds of billions in legally owed tax dollars that go unpaid each year. As he puts it: “Offshore tax evasion costs the U.S. jobs and billions of dollars each year, and it puts an unfair burden on the average American taxpayer to make up the difference. In an era when budgets are tight, it’s critical for the I.R.S. to have the resources it needs to root out tax cheats.”
Senator Baucus has pursued many routes to reducing that shortfall, from improving voluntary compliance, to sponsoring a slew of relevant legislation aimed particularly at offshore centers and tax havens, to working with the Treasury to manage the issue. One of his most notable successes in this arena was his work (and coponsorship) of the Foreign Account Tax Compliance Act (FATCA). Along with House Ways and Means Committee Chairman Charles Rangel and then-senior Senate Finance Committee member John Kerry, Senator Baucus cosponsored FATCA in 2009 and Congress enacted it in 2010. The law targets non-compliance by U.S. taxpayers using foreign accounts by allowing the IRS and Treasury to require U.S. taxpayers holding financial assets on foreign soil to report those assets. FATCA also requires foreign financial institutions to report certain information about U.S. taxpayers directly to the IRS. Originally, Treasury planned to work with financial institutions to implement FATCA, but has since modified its approach.
This week the world saw a huge leap forward on automatic tax information exchange and, more broadly, the effort to crack down on tax evasion. As the recent investigation by the International Consortium of Investigative Journalists has shown, governments around the world have a big problem, not only with tax evasion specifically, but also the broader use of offshore vehicles for hiding cash and corruption.
Yet this week, the governments of ten European nations have answered this challenge in stunning fashion. Their efforts have ignited momentum on an effort that could be an integral part of not only reducing tax evasion, but also improving economic development and reducing poverty worldwide. Of course, we’re not there yet, we might even not be past the end of the first quarter. But we could get there.
Here’s where we are: On April 10th, the governments of France, Germany, Italy, Spain, and the United Kingdom announced they will launch the first ever multinational system of automatic tax information exchange. Shortly afterwards, the government of the Czech Republic and Poland, followed by Belgium, the Netherlands, and Romania, also signed up, bringing the number of participating countries to 10.
As Raymond Baker, Director of Global Financial Integrity, noted: “This is a resounding victory for taxpayers and transparency groups; it’s not possible to overstate the significance of this news.”
Sarah Petre-Mears controls more than 1,200 companies across the Caribbean, Ireland, New Zealand, and the United Kingdom. Supposedly. Actually Petre-Mears doesn’t know much about the companies for which she passes resolutions and helps set up bank accounts; all she needs to do is sign her name. Because Petre-Mears is actually just a nominee-director, who keep the real owners of her companies secret by selling their names for use on official company documents, whilst giving addresses in obscure places all over the world.
Walk into Madrid’s famed art museum, Thyssen-Bornemiza, and you’ll find the private art collection of Carmen Thyssen-Bornemisza, which includes Monets, Matisses, and Van Goughs. But technically Thyssen-Bornemisza doesn’t own the paintings you see in the museum named for her family. Instead they are owned by secrecy-guarded companies in Liechtenstein, the Cayman Islands, the British Virgin Islands, and the Cook Islands. Not only does this ownership structure give Thyssen-Bornemisza some tax benefits, but it also allows her some flexibility to move the paintings across borders. She’s not the only one; many other of the world’s biggest art collectors use tax havens to buy and sell art.
We wouldn’t know about the antics of Sarah Petre-Mears and Carmen Thyssen-Bornemisza if it weren’t for an investigation by the International Consortium of Investigative Journalists (ICIJ). After a three year investigation into Australia’s Firepower scandal, a case involving offshore abuse and corporate fraud, Gerald Ryle, ICIJ’s Director, obtained a hard drive with a trove of corporate data, personal information, and e-mails on offshore companies and trusts.
Move over, Cayman. Step aside, Switzerland. The world’s next offshore powerhouse won’t be in the Caribbean or the Alps. It won’t be an island surrounded by water, a peninsula in Asia, or a tiny nation barely larger than a city. It won’t be in New York, Delaware, or London. Because it won’t be anywhere. It will all be a figment of our imaginations—and of course the internet.
I’m talking about internet currencies, and specifically, the largest of them all: Bitcoins. And I firmly believe they will pose the next great challenge for stemming money laundering, corruption, and illicit financial flows.
Bitcion is money, but Bitcoins are issued by complex computer algorithms rather than a government. They exist completely online, using peer-to-peer networks rather than a centralized system. And they serve, like all other forms of money, as a medium of exchange. Like the U.S. dollar or the euro, you can buy and sell them on markets. You can also use them buy things like an upgrade on Reddit, blog services in Wordpress.com’s store, and pizza deliveries from Domino’s through Pizzaforcoins.com. You can use them to transfer money to a friend overseas or you can use them to buy drugs, sell illegal arms, and launder money. I’ll get to those in a second.
Until now, I would have said the challenges that Bitcoins face overwhelmed its potential to replace other currencies as criminals medium of exchange in the future. That’s because it faced three very real impediments: its size, its stability, and its security. Like I said, until now.
In the words of two of my personal heroes: “Economists love incentives. They love to dream them up and enact them, study them, and tinker with them.”
For good reason; incentives make the world go round. They are the reason we get up in the morning, the reason we go to work, and definitely the reason we brush our teeth. They are dictate the speed we drive, the groceries we buy, and the pace of our work. Sometimes they are negative (the prospect of getting a cavity or a speeding ticket) and sometimes they are positive (a raise, or a hug from a child). But they are always at work in hundreds of ways, sometimes conscious and sometimes not.
Politicians like incentives almost as much as economists do. Federal and state governments incentivize all sorts of things, from milk production to renewable energy, and everything in between. The problem is though, that incentives are often difficult to design and, even more importantly, result in a whole new set of incentives that the designer never intended.
These are called perverse incentives and history is replete with them. Take nineteenth century China, for example, when paleontologists looking for dinosaur fossils paid peasants for handing over pieces of dinosaur bone. Later they discovered the peasants were digging up the bones, smashing them into many pieces to maximize their payments, and greatly diminishing their scientific value in the process. Others have pointed out that structuring bonuses for company executives around earnings encourages them to artificially inflate profits and make decisions targeting short-term gains at the expense of long-term profitability.
Yesterday, the nation’s top intelligence official, James R. Clapper Jr., briefed Congress on the most important security threats facing our nation. Clapper didn’t bother to hide his disdain for the annual event, calling an open hearing on intelligence matters a “contradiction in terms.” In a more subtle critique, Clapper also noted that it is virtually impossible to “rank—in terms of long-term importance—the numerous, potential threats to U.S. national security.” In that vein, Clapper said it is the “multiplicity and interconnectedness of potential threats—and the actors behind them—that constitute our biggest challenge.” On that critique, I couldn’t agree more.
One of the starkest examples of these dynamic forces are in Clapper’s testimony on money laundering, illicit financial flows, and the dangers of an opaque financial system. As Clapper notes in his statement for the record, “Criminals’ reliance on the U.S. dollar also exposes the U.S. financial system to illicit financial flows. Inadequate anti-money laundering regulations, lax enforcement of existing ones, misuse of front companies to obscure those responsible for illicit flows, and new forms of electronic money challenge international law enforcement efforts.”
Understanding how these forces weaken U.S. national security is, per Clapper, multifaceted. It’s also quite important.
In December of last year the U.S. Department of Justice discovered that HSBC, a large British bank, “willfully failed” to apply money laundering controls to at least $881 million in drug trafficking proceeds from Mexico and covered up illegal transactions for Burma, Iran, Sudan, Cuba, and Libya. To escape criminal charges, HSBC admitted to wrongdoing and paid a record $1.92 billion settlement. Yet despite this massive offense, not a single person went behind bars as a result.
This wasn’t just a failure of the system or the anonymous bureaucracy of a massive corporation. The investigation revealed that senior HSBC officials were complicit in the illegal activity. They did not go to jail. According to court documents, individuals at HSBC went out of their way to allow the bank to act as a financial clearing house for these criminals. They will did go to jail. Other bank officials at HSBC made a “knowing calculation” that they would rather do business with criminals and “make a profit from those illegal transactions” than fulfill their obligations under U.S. law. They did not go to jail.
While critics pointed out the hypocrisy and inconsistency of this message, U.S. government officials called the fine a success. For example, U.S. Attorney Lynch, one of the architects of the settlement, said: “That’s a very short-sighted view, I think, because in this case they’re obviously paying a great deal of money, but they also have to literally had to turn their company inside out.”