I believe that the reform of banking secrecy is one of the most critical issues in international development, but I’m also open to debate on the issue. A couple of months ago, the Tax Justice Network posted excerpts from a debate between Richard Murphy and Dan Mitchell over tax havens. I wanted to know what my accountant buddy thought about this issue (Hint: he works for one of the Big 4, but beyond that he may remain anonymous). Below is our running debate, which I clearly win 
Original article is in black, his comments are in red, mine in blue…
Murphy vs. Mitchell
The Center for Freedom and Prosperity is an enormously wealthy think tank on the fringes of the ideological right in the United States. The CF&P recently issued a news release stating:
Enormously wealthy? Compared to what? I’m quite curious actually.
The Coalition for Tax Competition is sending a strong message to the World Bank explaining why tax competition is important and why the Bank should reject the anti-free market agenda advocated by ideological groups like the Tax Justice Network and statist bureaucracies such as the OECD.
TJN is happy to be the subject of their attention. They give us an opportunity to bring our arguments to a whole new constituency. They simply have no answer to the agenda we are setting. Theirs is a crude strategy: saying things that are manifestly false (for example, arguing that TJN espouses an anti- free market agenda) to win the argument. This is the Straw Man strategy (set up a straw man, then knock it down, and hope that it makes you look good). It is a gambit typically used by those who know they have lost the argument and consequently need to change or twist the facts. If you don’t believe we are right, simply read their points, then see Richard Murphy’s answer on these points here - then judge for yourself.
Hmm. I would say displaying two sentences (with unknown context) from a press release, preparing two pages of rebuttal, and asking the reader to “judge for yourself” is also a rather “crude strategy… typically used by those who know they have lost the argument and consequently need to change or twist the facts.” As a side note, I’m really beginning to like this Richard Murphy.
More dramatically, CFP has also recently been advertising a showdown between its Senior Fellow Dan Mitchell and TJN’s Richard Murphy in Fort Lauderdale, Florida. The debate was entitled: Offshore Financial Centers – Are They Healthy for the Global Economy? As one of the CF&P pre-debate flyers said:
It may not be at the same level as the Lincoln-Douglas debates (though Richard Murphy and Jack Blum want taxpayers to be slaves of government). It may not get the ratings of the Ali-Frazier “Thrilla-in-Manilla” (though we are expecting a knock-out). But when Dan Mitchell (Senior Fellow, Cato Institute, USA), and Richard Hay (International Tax Principal, Stikeman Elliott, UK) square off against Richard Murphy (Research Director, Tax Justice Network, UK) and Jack Blum (Co-Author, Financial Havens, Banking Secrecy & Money Laundering, USA), sparks are sure to fly.
The debate has now happened. Richard Murphy has been blogging the event. Dan Mitchell, apparently, now “looks like he has his tail between his legs.” As Richard said:
Many people at the conference told me Jack Blum and I won the debate - and that I beat Dan hands down on economics, even if they did not like what we said. It was good to have that said publicly in the concluding session of the conference by Lorna Smith, Director of the BVI International Affairs Secretariat - not an obvious ally of ours.
We think it is worth reproducing Richard’s speech in full. Here it is:
Good morning. It’s great to be here. Many thanks to David for organising this debate.
It’s just such a shame it has started so badly. It’s hard to believe that Dan and I are debating the same motion. I’d remind you what we’re talking about. The motion says “OFCs (or tax havens as I’d rather call them) - are they healthy for the global economy?”
Dan has completely failed to address that issue. He’s only talked about micro issues and not the global economy. So if you’ll let me I’ll address that economic issue, and I do so not just as a chartered accountant and tax expert, but as a trained economist.
And as an economist I’ll tell you that the real problem with what Dan has said is that it makes no sense in economic theory, and it does not accord with economic reality.
But let’s get some basics on the table. Markets are good things. They’re the best mechanism we’ve got for supplying the majority of the needs and at least some of the wants of most people.
This, I would surmise, is the basis of Dan’s “micro” discussion. I may not be an economist, but I do have a degree in it, so I’ll take a shot.
A perfectly efficient market results in the optimum number of goods being produced, and an optimum price that maximizes the overall benefit received by buyers and sellers. Assuming everyone is greedy (the basis of all economics), buyers will only buy if their perceived benefit for the good or service is more than the cost to purchase, and sellers only sell if the sales price is greater than the cost to produce.
Any time a tax is imposed on a good or service, then, the effective price of the good increases, and therefore the overall quantity sold decreases. The result is what is called a deadweight loss. No benefit at all is derived by people who would purchase the good without the tax but not with it, and sellers do not get the extra benefit provided by those additional products. A higher tax rate results in a greater the effect on the market price and quantity and a larger deadweight loss. Taxation, therefore (with a few notable exceptions in imperfect markets; not really relevant to this discussion), reduces the number of goods and services produced, therefore harming the “overall economy” for a single good.
Extending this to the macro arena of economics, one would need to further factor in what the government does with this tax revenue. Keep in mind that all tax revenue would have otherwise gone to the buyer and seller for their benefit, who arguably would have kept it functioning in the economy. However, if the government does a better job of using the money than the private sector would (in terms of helping the overall economy), it would be possible that it would create a net benefit for the overall economy. Most economists believe, however (and apparently Murphy does as well), that open and efficient markets are the best mechanism for improving the overall economy.
This line of thinking is generally accepted among economists – efficient markets create the largest possible economy. However, as you would likely argue, they do nothing to promote fairness or the general well-being of people. Therefore, this entire debate depends on how you define “the economy.” If I define the economy in terms of the largest amount of goods and services produced, and the largest possible economic benefit for people as a whole, saying that tax havens are good for the global economy is a no-brainer.
It’s also a fact that government is good thing. The evidence is unambiguous. We seem quite unable to live without it, anywhere and at any time. That means we need a mechanism to pay for it. That’s called tax.
Of course, how much government involvement and how much market participation is needed to create a good economy is open to debate. This is not that debate. The point that is indisputable is that we need both government and effective markets to create a well functioning economy.
A rather specious argument in this context, but I’ll agree here.
But government and markets are very different. Market theory does not apply to governments. The reason is obvious. Market theory and practice requires that participants can and do fail, and go out of existence. But we know that when government fails in this way the consequences are painfully apparent, and catastrophic for the state and people involved.
That’s why we tolerate the existence of what is the perpetual monopoly of government. It’s the best option we have, and we all recognise it. But let’s be clear: monopolies pose problems and have to be controlled. That’s why we have created a system to do that in the case of government. That process is called democracy. It is not called competition. It’s very definitely not called tax competition.
Tell Hillary and Obama that there is no competition in democracy, buddy.
Despite which let’s also be realistic: it’s obvious that governments do compete to attract capital. I know that. But to pretend that the major economies compete in this way because of the existence of pin-prick states called tax havens is to live in a world of make believe. It’s like saying that KPMG and Pricewaterhouse compete because of the existence of small town accountants, and what’s more that it’s the small town accountants who set the Big 4’s prices. That’s just not true.
Another shameless KPMG plug. I love this guy!
Nor is it true that tax rates have fallen over the last twenty or thirty years except for the very rich. They have benefited from cuts, but ask absolutely any middle class person anywhere about tax right now and they’ll tell you they’re paying disproportionately more, and they’re right. That’s because the scale of government activity has not reduced. Far from it. Partly because of the demand from business for better quality public services, in the OECD as a whole in the last decade the tax to GDP ratio went up in a significant majority of countries and overall by 1.3%. That was the democratic choice people made. So, if tax havens are meant to reduce tax rates for all, and limit the scope of government universally then there’s just one thing to say based on this evidence. They’re dismal failures. And if this is the criteria for their successful contribution to a healthy global economy that Dan is using I could stop now and my case would be proven.
Oh, come on. Let’s say I operate a pregnancy advice center pre Roe v. Wade that emphasizes adoption instead of abortion. I expand to multiple cities, advertise heavily, and persuade many women to give up their children for adoption. Roe v. Wade is decided, and the number of abortions in the United States skyrockets. My advice center, still expanding and reaching more women, is now a “dismal failure” through no fault of its own. Then, he goes on to set up…wait for it…a straw man! Tax havens can only help the global economy if the global tax rate goes down. The global tax rate has gone up. I win!!! Richard, I was expecting a little better from you.
But the issue is more complex than that. (All right!!! He’s back on my good side) The reality is that economic theory provides the clearest evidence that tax havens must harm the health of the global economy. You see even the most basic understanding of neo-classical market economics says that three things are needed to ensure an optimal outcome results from the operation of a market. Those things are equal access to capital, equal access to markets and the availability of perfect information to ensure the optimal allocation of economic resources to efficient activity.
Nope, don’t remember “equal” as part of the equation in any of the “neo-classical” (now there’s a buzzword for ya) definitions of efficient markets. Why should I have access to the same amount of capital at the same rate as Bill Gates? I shouldn’t. There’s competition for capital, just like everything in the market. The second you mention the word “equal” you’re moving away from the definition of an efficient market. Again, capitalism doesn’t make one person equal to another person (that’s the capitalism/government dichotomy this guy was explaining earlier). Equal access would only apply to efficient markets if the two players in question were themselves equal from a market perspective – same credit rating, same assets, etc.
And the fact is that tax havens deliberately set out to subvert all three of these requirements. They do this by exploiting the one, so called, competitive advantage they have. That advantage is not low tax rates. Indeed, the tax rates for many ordinary people who live in tax havens are not that low when compared to middle classes elsewhere and some tax havens, such as Jersey, have very robust laws to make sure that their residents cannot take advantage of the tax haven services they provide, or that are supplied by their near neighbours such as Guernsey. Jersey’s general anti-avoidance provision designed to tackle what they see as such abuse is, I’d suggest, a model of its type.
Mr. Murphy directly contradicts this statement – “That advantage is not low tax rates” - later in the piece. And how does different taxes for different people (however unfair it may be) negate the fact that it is an advantage for people who can use the tax havens, who therefore use them for this purpose? That seems like a competitive advantage to me.
So low tax rates are not the thing that provides tax havens with their supposed competitive advantage. It’s the secrecy that they provide that gives that advantage. It’s secrecy and the fact that only some, highly selected groups of people are legally allowed to hide behind that secrecy veil to claim that they locate their activities in tax havens that gives them their advantage.
Secrecy is another benefit, no doubt. However, I’d much prefer the lower tax rate. I’m guessing both are a competitive advantage. Can you have more than one competitive advantage, though? Apparently not, according to Richard. If I had to pick one, it’d be lower taxes.
Note I say that people claim to locate their activities in tax havens. They don’t actually, of course. An absence of any economic substance is the reality of these places. I’m always amused by a friend of mine who advises a Cayman registered hedge fund. The rule is, he says simple. The advice he provides goes to London, where it’s used. It’s just the bill that goes to Cayman. That’s the tax haven world, in a nutshell.
No argument here. Pretty obvious. It also has little to do with his point. Companies are taking advantage of tax havens. If he knows all about this, though, how can he claim it is a secret? Every company will tell you where it is headquartered. If one is headquartered in a tax haven and does most of its business elsewhere, it probably does it to take advantage of the tax status. Not really a secret.
So how is the secrecy that characterises this world used?
Well, first of all it’s used to ensure that those who can use these places, legally or illegally, have access to capital at lower rates than those who do not have that access. This lower cost of capital results from the fact that those who can hide behind the veil of tax haven secrecy accumulate their capital faster because it’s in a tax free environment.
Wow. Let’s see if I can follow this logic. Because tax havens are secret, people get capital at lower rates, because tax havens are a tax free environment. Nope. I’m missing a critical link. What does secrecy have to do with this? Let’s say the tax haven information becomes public (and just for fun, assume that the company is doing this legally). Does a company still get access to capital at lower rates? I would think so. Why? Because “it’s in a tax-free environment”! So, really, the users’ advantage (legally only, I understand), and therefore the competitive advantage for tax havens, is the tax free environment. Well, maybe it’s not a direct contradiction (you have to take out “hide behind the veil of tax haven secrecy”) to the above, but it’s darn close.
Second this limited access to tax haven secrecy is used to deny access to markets on an equal footing. Of course this happens in the tax havens themselves: in most such places tax haven operations are ring fenced from the local economy for fear they will undermine local markets and tax revenues. The irony should not be lost on you.
See above. Perfect markets don’t require equality.
More importantly though, given the inevitable and appropriate nationally based measures to tackle tax avoidance and evasion that countries must implement if they are to fulfil their democratic mandate, most ordinary people and almost all small and medium sized businesses in the world cannot use the offshore structures to access the markets that the wealthy, law breakers and multinational businesses can access at lower cost using tax haven facilities. This does put the ordinary person, the law abiding person and small business at a deliberately constructed competitive disadvantage.
This just gets better. Tax havens give capital at a lower cost because they’re tax free. This results in a competitive disadvantage for people who don’t use them, and a competitive advantage for those who do. But somehow, the existence of these tax havens is not a competitive advantage for the tax havens themselves.
Third, the secrecy that allows this to happen also undermines all the principles of open access to information that are essential to ensure that the effective decision making resulting in optimal allocation of resources in market economies takes place.
Point taken. Any time you keep a secret, somebody else doesn’t have access to that information. But wow, this is a weak argument. I’ve never met anyone that freely gives away their financial information. It is inherent in people to capture whatever “competitive advantage” they have in the marketplace. In that sense, it’s part of how the market works. This is certainly not what economists mean when they say that everyone needs to have perfect information in an efficient market.
Let’s say you buy a donut from Dunkin’ Donuts®. That donut is worth more to you than the fifty cents you paid for it. But how much more? Let’s say you would pay a dollar. Would you tell the cashier that, or keep it a secret? Would the cashier tell you how much it actually cost to produce that specific donut? Never. Yet, the market can still work efficiently.
In economics, perfect information refers to something else altogether. Let’s say you want to buy a used car, but don’t know whether the car you’re buying is a good car or a lemon. This leads to imperfect information. You, as a person or an entity, can’t make an informed decision in the marketplace regarding your situation because you don’t have all the variables.
Now, let’s say you’re bidding for a company against another that is located in a tax haven. The fact that they have access to lower capital means they can offer a higher price than you can, all other things equal. It doesn’t matter whether or not you know what they have, it won’t affect your situation – your cost of capital will limit the potential purchase price you an offer. The market can still be perfect and operate efficiently.
Someone who is financially sound has access to a lower cost of capital than someone who just went through bankruptcy. It’s not secret, but it’s the same situation. All other things equal, he will be able to pay a higher price for a good or service that is financed through debt.
The result is obvious. Tax havens set out to undermine effective markets, and that’s the goal they succeed in achieving. In saying that I make clear that tax havens don’t extend liberty, as some would claim, they’re actually designed to grant monopoly rights to a privileged few, and that is exactly what they do.
This is the way the market works, for better or for worse. The rich also have monopoly rights to yachts and multi-million dollar mansions. What’s so different about this? You get a better bank account if you give them $10,000 than you do if you give them $1,000. The rich have more opportunities than the poor. Again, I’m not arguing that it’s right, but how is it different?
Those few are the wealthiest of the world, the largest businesses of the world and the lawbreakers of the world. Those groups exploit that monopoly advantage as all monopolists do, to close down effective competition. The result is simple. The richest get wealthier at the expense of the middle class and the poor who have to pay the taxes to provide the services multinational business demands. Multinational business meanwhile squeeze out medium and small nationally based business that have an unfair higher cost structure than their larger rivals. The poorest nations of the world that do not have the resources to challenge the hemorrhage of illegal and mispriced money from their shores subsidise the tax take of the richest nations of the world. Throughout all this democracy is undermined, as is the rule of law.
But the market is not undermined. People use the competitive advantages they have. This is one thing that kills me with these arguments. Big businesses squeeze out medium and small businesses by offering lower prices to the consumer. Wal-Mart squeezes out local competition and their employees, but they provide the general public (and more often than not, the poorest in our country) with drastically lower prices for needed goods. And I also take umbrage with the zero-sum game. Every single economy in the world grew over the last 100 years. The rich can get richer without taking away from the poor and middle class. It’s actually possible.
And you might also note that tax havens were used to create most of the securitised debt that has resulted in our current global credit crunch. That’s some contribution to a healthy economy.
Hilarious. Pick out one example, blame it on tax havens (as if it wouldn’t have happened without them), completely ignore the benefit that the securitized debt provided before the global credit crunch, and then use it to characterize all activity in tax havens. And these guys are complaining about straw men?
The economics of this then are simple, and unambiguous. Tax havens must, and do, harm economic well being for all but the minority who can use them because they do wrongly allocate economic resources and inappropriately allocate the reward of economic activity.
But does it help the few more than it harms the many? Overall, does it generate more overall wealth or less?
But it’s more than economics. If you believe monopoly is harmful and law breaking is wrong, if you believe in small enterprise and the need to foster it, if you believe in national pride and the state you live in, if you believe in democracy, and if you believe that markets can best meet our needs then you can’t believe that tax havens deliver a benefit for the world economy as a whole.
Holy cow. Now it’s a matter of belief. If you believe that the sky is blue, if you believe that the sun rises in the east, if you believe that chickens lay eggs, then you have to believe that tax havens are the best thing since sliced bread for the economy. I win the debate!!!
Unfortunately, my silence on your last email is not a signal of consent I owe it a good thrashing, but honest-to-pete I’ve had a big wrist brace on for two weeks after I shoveled gravel for 5 hours back in April. Apparently, and much to my chagrin, I have sacrificed some part of my ability to carry out physical labor over the past 5 years.
Anyway, trust that I will give it a line-by-line soon. In the meantime, I’ll let Larry Summers do the talking:
http://taxjustice.blogspot.com/2008/05/lawrence-summers-on-tax-justice.html
Please, man – not Larry Summers. Just saying his name leaves a bad taste in my mouth.
There are so many things wrong with this from my end. In the interest of time, I’ll just tackle the implicit assumption. I may be “willfully blinded by ideology,” but I have yet to hear an effective argument for why corporations should pay tax at all.
In the United States, federal revenue from corporate taxation amounts to a little over 10% of gross receipts. Why not eliminate corporate taxes altogether, and raise taxes on the wealthiest individuals to compensate for the loss? The result:
1. A more progressive tax system – in addition to a higher income tax rate on the wealthy, corporations would be able to distribute more income in the form of dividends (pre-tax), increasing the savings and retirement plans of middle-income earners, while allowing the government to still heavily tax the wealthy (whose vast majority of wealth resides outside of retirement plans).
2. Greater investment by corporations in R&D, capital improvements, and a larger employee base
3. Elimination of the billions spent by corporations on tax preparation, tax compliance, and tax avoidance (including this nifty little problem).
4. Removal of that pesky “taxation without representation” moniker.
To me, therefore, the entire premise of this discussion is flawed, and only the discussion of individual avoidance of taxation is relevant.
I could continue, but honest-to-pete, I’d rather wait for that wrist to heal.
Nice try. We could have the domestic tax policy debate, and it may be fruitful, but in both your emails you’ve avoided the question, which is essentially not economic, but political-economic: Will any of the poorest states on the planet be able to _raise_ taxes on corporations or wealthy individuals by even a modest amount (say 1 or 2%) without causing massive flight?
In other words, does the international offshore tax system thwart the development of effective sustainable states in the poorest parts of the developing world?
Your earlier arguments (in red) all assume that taxation only serves to generate revenue. The actual import of tax is broader:
http://www.taxjustice.net/cms/front_content.php?idcat=2
My sincere apologies, my good sir - I had no idea that was the topic of conversation.
We’ve been talking about the global economic impact of the Big 4 and the investment banks for several weeks…no? I agree with you insofar as we should make US tax policy more progressive (a splendid idea!) but we can take that up later, when Obama is president and McCain is Commander in Chief at Sunnydale Assisted Living…
Your references tend to ramble a bit into other topics.
Thank goodness I’m around to keep things on track…;-)
I also reject the notion that I dismissed the benefits of taxation. They are numerous, though in unintended ways in many developing nations, where fraud and corruption absorb a hefty percentage of the takings.
Precisely…and this lethal drain is abetted by purveyors of services of corruption…
So given that I haven’t spent much time on this particular issue, I shall do some reading. Hopefully I will be able to reply with a more reasoned and knowledgeable response than I could now. Rest assured, I will do my best to find a point of contention.
My wrist is feeling better now, so don’t hold back.
