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Tax Avoidance and Tax Havens; Undermining Democracy — Global Issues


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  • by Anup Shah
  • This page last updated

We might not like the idea of paying taxes, but without it, democracies will struggle to function, and will be unable to provide public services. This affects both rich and poor nations, alike.

Individuals and companies all have to pay taxes. But some of the world’s wealthiest individuals and multinational companies, able to afford ingenious lawyers and accountants, have figured out ways to avoid paying enormous amounts of taxes. While we can get into serious trouble for evading payment of taxes, even facing jail in some countries, some companies seem to be able to get away with it. In addition, if governments need to, they tax the population further to try and make up for the lost revenues from businesses that have evaded the tax man (or woman).

Why would companies do this, especially when some of them portray themselves as champions of the consumer? The reasons are many, as this article will explore. In summary, companies look for ways to maximize shareholder value. Multinational companies are in particular well-placed to exploit tax havens and hide true profits thereby avoiding tax. Poor countries barely have resources to address these — many have smaller budgets than the multinationals they are trying to deal with.

Yet, companies and influential individuals also pour lots of money into shaping a global system that they will hope to benefit from. If the right balance can’t be achieved, not only will attempts to avoid taxation and other measures undermine capitalism (which they claim they support) they will also undermine democracy (for even responsible governments may find it hard to meet the needs of their population).

On this page:

  1. Corporate Welfare
  2. Corporate Crime
  3. Tax Avoidance
    1. The scale of tax avoidance
    2. Why is tax revenue important?
    3. Why don’t poor countries raise sufficient tax revenues?
    4. What are the impacts of tax havens on poor countries?
    5. Why have tax havens in the first place and who benefits?
    6. How much money is held in offshore tax havens?
    7. How much potential tax revenue is lost through off-shoring?
    8. What is profit laundering?
    9. How much profit laundering is there?
    10. What is Tax competition and why is it bad?
    11. Where did the idea of tax competition come from?
    12. How did tax avoidance come about in the first place and who are the main actors?
    13. Tax avoidance undermines capitalism
    14. Tax avoidance undermines democracy
  4. Tax Shelters and Avoidance in the US
    1. The scale of the problem
    2. Why a rise in tax shelters in the 1990s?
    3. Corporations manage to reduce their tax burden
    4. Powerful interests minimize Congress’s chance of tough action
    5. Sheer amount of money involved implies problem will remain
  5. Transfer Pricing — Intercepting Wealth
  6. Privatizing profits, socializing costs
  7. Tackling the problem, or pretending to do so?
  8. Rich country governments finally acting because it now affects them?
  9. More Information

Corporate Welfare

Corporations and corporate-funded think tanks, media and other institutions are often the ones that loudly cry at the shame of welfare and the sin of living off the government and how various social programs should be cut back due to their costs. What is less discussed though is the amount of welfare that corporations receive.

Corporate welfare is the break that corporations get both legally and illegally through things like subsidies, government (i.e. public) bailouts, tax incentives and so on. Corporations can influence various governments to foster a more favorable environment for them to invest in. Often, under the threat of moving elsewhere, poorer countries are forced to lower or even nearly eliminate certain corporate taxes to these large foreign investors.

This distorts markets in favor of the big players. As such influence spreads globally, it contributes to a form of globalization that seems less like true free market capitalism that they talk of, but more like a modern form of the unequal mercantilism that prevailed during colonial and imperial times.

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Corporate Crime

When we talk about crime, we think of the violations of law caused by individuals, some of which are horrendous. However, almost rarely talked about (especially in corporate-owned media) is the level of crime caused by corporations. Such crime includes evasion of taxes, fraud, ignoring environmental regulations, violating labor rights, supporting military and other oppressive regimes to prevent dissent from workers, including violent crime against workers, and so on.

In the US, for example, back in the mid-1990s it was estimated that corporate crime cost the country about $200 billion a year.

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Tax Avoidance

Tax avoidance is sometimes differentiated from tax evasion. Avoidance often applies to legal means (such as loopholes and clever accounting techniques) to avoid paying the full amount of tax, whereas evasion is often applied to more criminal forms of not paying tax.

As tax expert Richard Murphy notes , tax evasion and tax avoidance can happen on the same transaction for different taxes in different places and often involve elaborate trails involving more than one person, company or organization.

The scale of tax avoidance

Through offshore tax havens and fraud, and through transfer pricing, billions of dollars go untaxed. Estimates range from $50 billion to $200 billion of revenue losses.

For example, in 2000, Oxfam made a conservative estimate that tax havens had contributed to revenue losses for developing countries of at least US$50 billion a year. Side NoteAnd they stress that this is a conservative estimate as it did not take into account outright tax evasion, corporate practices such as transfer pricing, or the use of havens to under-report profit.

Individuals too have been involved in huge amounts of capital diversions. For example, former dictator of Nigeria, Sani Abacha, and his associates are said to have diverted over $55 billion to private accounts in foreign banks — Nigeria at one point after that suffered a $31 billion external debt burden.

How much potential tax revenue is lost through off-shoring?

Tax Justice Network reports that because tax authorities continue to be mainly limited to powers within their own countries, the result has been a massive loss of tax revenue. As a result, based on the $11.5 trillion above, they estimate that $255 billion is lost each year to governments around the world because of the no or low taxation of funds in offshore centers . Importantly, they reiterate, this estimate does not include tax losses arising from tax competition or corporate profit-laundering.

What is profit laundering?

Profit laundering is the moving of profit from the countries in which it was earned and where it would incur tax, into tax havens. It is only possible to do this if there is secrecy to avoid the tax authorities noticing it.

Interestingly, Christian Aid notes that:

The UK government estimates that between 50 and 60 per cent of world trade is accounted for by transactions between different parts of the same company, creating ample scope for mispricing and, as a result, the laundering of profits.

The Shirts Off Their Backs; How tax policies fleece the poor , Christian Aid, September 2005, p. 14

Not only is globalization not really global, but a large chunk of world trade may include laundering of profits.

This is one reason you may occasionally hear of mispricing. Some examples Christian Aid noted included how:

  • Some TV antennas from China could be under priced at US$0.04;
  • Rocket launchers from Bolivia could be under priced at US$40; and
  • US bulldozers could be under priced at US$528

But other items could also be over-priced, for example:

  • German hacksaw blades priced at US$5,485 each;
  • Japanese tweezers at US$4,896; and
  • French wrenches at US$1,089.

How much profit laundering is there?

Christian Aid reported in 2005 that the total estimated dirty money flowing into the global banking system is $1 trillion . Breaking that down:

Amount siphoned from the developing world
$500 billion
Amount of profit laundered by multinational companies
$200 billion
Amount of profit laundered by individuals and criminals
$250 billion
Amount lost through corruption
$50 billion

What is Tax competition and why is it bad?

In short, tax competition is about countries out-competing each other to offer the lowest taxes possible to attract foreign investment.

Tax Justice Network describes the negative impact that Tax Competition has on developing countries:

Faced with the pressures of the globalisation of capital movements and the threat that companies will relocate unless given concessions on lower regulation and lower taxes, governments have responded by engaging in tax competition to attract and retain investment capital. Some states with limited economic options have made tax competition a central part of their development strategy. This inevitably undermines the growth prospects of other countries, as they attract investments away from them, and has stimulated a race to the bottom…. a recent empirically based study in the United States has found:

There is little evidence that state and local tax cuts – when paid for by reducing public services – stimulate economic activity or create jobs. There is evidence, however, that increases in taxes, when used to expand the quantity and quality of public services, can promote economic development and employment growth.

If this conclusion applies to a relatively high tax economy like the United States, it is even more applicable to economies in south Asia and sub-Saharan Africa, where social and economic development is held back by under-investment in infrastructure, education and health services. Proponents of tax competition have never answered the crucial question of how far it should be allowed to go before it compromises the functioning of a viable and equitable tax regime. Taken to its logical extreme, unregulated tax competition will inevitably lead to a race to the bottom, meaning that governments will be forced to cut tax rates on corporate profits to zero and subsidise those companies choosing to invest in their countries. This is already happening in some jurisdictions. The implications of this for tax regimes and democratic forms of government around the world are dire.

Tax Us If You Can , Tax Justice, September 5, 2005, p. 5

Where did the idea of tax competition come from?

Tax Network Justice summarizes:

Many in business and pro-business political actors argue that nations should compete with one another to attract inward investment from international business by offering:

  • Lower tax rates on profits
  • Tax holidays
  • Accelerated tax allowances for spending on capital assets
  • Subsidies
  • Relaxation of regulations
  • The absence of withholding taxes
  • Other forms of tax inducement

This process, called tax competition, has been widely adopted across the world and has become a key element in shaping world-wide investment flows. The IMF, World Bank and EU have all, in varying ways, encouraged developing countries to compete in this way for resources.

Tax Us If You Can , Tax Justice, September 5, 2005, p. 17

But the Network goes on to mention that this is fundamentally flawed as a development strategy because it limits the control any country can have over taxation policies and creates harmful distortions.

In addition to being anti-democratic the notion of making nations compete with other this way does not make sense for its citizenry (though it does for multinational companies who can have a choice of which country to invest in.)

How did tax avoidance come about in the first place and who are the main actors?

Tax Justice Network provides a decent summary in the same report mentioned above (see chapter 3). In short, the main players who promote what they call tax injustice are:

  • Accountants
  • Lawyers
  • Banks
  • Transnational corporations
  • Tax haven governments
  • Tax avoiders and tax evaders

In addition, the Network says that this whole idea probably started with the US and the British Empire. The offshore phenomenon probably began in the US when states such as New Jersey and Delaware realised that they could lure businesses from more prosperous states by offering tax advantages on condition that they register in their states. And then, The first real cases of international tax planning occurred in the British Empire in the early twentieth century when wealthy people started to use offshore trusts established in places like the British Channel Islands to exploit the curious British phenomenon of the separation of taxation residence and domicile.

In the 1920s, the UK found new ways for the internationally mobile person to avoid tax when a UK court ruled that a company incorporated in the UK was not subject to UK tax if its board of directors met in another country and it undertook all its business overseas. At a stroke, the concept of the separation of the place of incorporation of a company and its obligation to pay tax had been created. This concept survived in UK law until the 1990s, by which time it had become the basis for the operation of most tax haven corporations throughout the world.

In the 1930s Switzerland offered internationally mobile people residency, only requiring them to pay a fixed, pre-agreed amount, each year, not varying with income, and not disclosed. This concept has been widely copied the Network also noted.

The Network continues by adding that the other major Swiss contribution to tax injustice is banking secrecy, a concept which they developed at the time of the French Revolution (for the benefit of the French aristocracy) but which became enshrined in Swiss law in the 1930s. The Swiss believed at the time that it provided them with a competitive advantage as a small, land-locked state in a hostile European environment.

This all happened not by chance, but, as the Network also notes, by plan: They were thought up by lawyers and accountants and were exploited by them and their bankers for commercial gain.

Tax avoidance undermines capitalism

As Christian Aid notes, tax avoidance distorts markets, undermining capitalism:

The ability of multinationals to take advantage of tax havens to avoid tax and launder profits distorts markets. It gives them an edge over nationally based competitors, which has nothing to do with the inherent quality or price of the goods and services they are selling. This undermines the basic notion of capitalism.

Even in rich countries, multinational companies are managing to avoid paying tax. Recent research suggests that at least 75 per cent of UK-quoted companies do not pay tax at the notional rate of 30 per cent that applies to them. Some pay less than half this rate. In the US, 60 per cent of corporations with at least US$250 million in assets reported no federal tax liability for any of the years between 1996 and 2000.

The Shirts Off Their Backs; How tax policies fleece the poor , Christian Aid, September 2005, p. 15

Tax avoidance undermines democracy

Today, of the 72 tax havens, almost half are British territories, dependencies or Commonwealth members. Britain alone loses some £100 billion (approx. US $170 billion) a year in avoided taxes. Even for a wealthy nation, this is a reasonable sum when public funds are scarce and people are reluctant to see the government spending more money on various programs.

In effect then, tax avoidance is also a threat to democracy, according to Prem Sikka, a professor of accounting at the University of Essex, UK:

The tax avoidance industry is on a collision course with civil society. Elected governments take months and years to develop tax laws, but in pursuit of private profits accountancy firms can undermine them within hours of a chancellor’s budget speech.

… The [accountancy] firms also peddle a range of avoidance schemes in the UK, which are estimated to cost the state £100bn each year in possible tax revenues.

… The government continues to award lucrative public contracts to the big accountancy firms. Their partners advise government departments on legislative design and enforcement. There has as yet been no public investigation into the tax avoidance industry.

Major casualties of the tax avoidance industry are ordinary people, who are forced to pay higher taxes while corporations and the rich avoid theirs. Individuals on the minimum wage have to pay income taxes, but some 65,000 rich individuals living in the UK are estimated to have paid little or no income tax. The top fifth of earners pay a smaller proportion of their income in tax than the bottom fifth. Corporate tax payments now account for just 2.5% of national income, the smallest share ever.

… Without adequate tax revenues no government can deliver its legislative program, provide public goods or redistribute wealth.

We can be persuaded to vote for governments that promise to invest public revenues in education, healthcare or public transport. But the tax avoidance industry exercises the final veto by shrinking the tax base and eroding tax revenues.

Prem Sikka, Accountants: a threat to democracy, The Guardian, September 5, 2005

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Transfer Pricing — Intercepting Wealth

Transfer pricing provides a multinational corporations’ tax-avoiding dream. It allows the ability to set up offshore accounts and paper companies through which most transactions occur, without having to pay as much taxes. Internal accounting and costing is therefore adjusted to minimize the costs and maximize the profits.

Much needed revenue for social needs in a country is therefore lost this way.

The following quotes summarize this quite well:

The post-Second World War period witnessed not merely a rise in TNCs’ control of world trade, but also growth of trade within related enterprises of a given corporation, or intra-company trade. While intra-company trade in natural resource products has been a feature of TNCs since before 1914, such trade in intermediate products and services is mainly a phenomenon of recent decades. By the 1960s, an estimated one-third of world trade was intra-company in nature, a proportion which has remained steady to the present day. The absolute level and value of intra-company trade has increased considerably since that time, however. Moreover, 80 per cent of international payments for technology royalties and fees are made on an intra-company basis.

A Brief History of TNCs, CorpWatch.org

(Note in the above quote at the sheer amount of intra-company trade as a percentage of world trade. Bear this in mind the next time corporate-media talk about the growing trade and prosperity for all.)

In this continuing battle over the world’s wealth, transfer pricing becomes a crucial aspect in the interception of the wealth of both Third World and First World countries. The multinationals either manufacture in a low-wage country or purchase cheaply from a local producer. The product, is then, theoretically, routed to an offshore corporation and invoiced (billed) at that low price. There the export invoice is increased to just under the selling price of local producers. However, the offshore company is nothing more than a mailing address and a plaque on the door. No products touch that offshore entity; even the paperwork is done in corporate home offices.

In 1980, there were eleven thousand such corporations registered in the Cayman Islands alone, which has a population of only ten thousand. [Many of these funnel a lot of money out of Central and South America] … These corporations are doubly insulated from accountability. …

These secret maneuvers of multinationals, and the huge blocks of uncontrolled international finance capital, make many of the statistics on world trade questionable. If the sales of offshore American production facilities had been treated as exports, the 1986 American trade deficit of $144 billion would have become a trade surplus of $57 billion. (Emphasis Added)

J.W. Smith, The World’s Wasted Wealth 2, (Institute for Economic Democracy, 1994), p. 138.

As an example of corporate evasion, the following is about Rupert Murdoch’s News Corporation:

In March 1999, the Economist reported that in the four years to 30 June of the previous year, News Corporation and its subsidiaries paid an effective tax rate of only around 6 per cent. This compared with 31 per cent paid by Disney. The Economist notes that basic corporate-tax rates in Australia, America and Britain, the three main countries in which News Corporation operates, are 36%, 35% and 30% respectively.

The article points to the difficulties of finding out about the specifics of News Corporations’ tax affairs because of the company’s complex corporate structure. In its latest accounts, the group lists roughly 800 subsidiaries, including some 60 incorporated in such tax havens as the Cayman Islands, Bermuda, the Netherlands Antilles and the British Virgin Islands, where the secrecy laws are as attractive as the climate.

The article continues, This structure, dictated by Mr Murdoch’s elaborate tax planning has some bizarre consequences. The most profitable of News Corporation’s British operations in the 1990s was not the Sunday Times, or its successful satellite television business, BSkyB. It was News Publishers, a company incorporated in Bermuda. News Publishers has, in the seven years to June 30th 1996, made around £1.6 billion in net profit. This is a remarkable feat for a company that seems not to have employees, nor any obvious source of income from outside Mr Murdoch’s companies.

Tax Havens; Releasing the hidden billions for poverty eradication, Oxfam, June 2000

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Privatizing profits, socializing costs

One of the quotes above, is from J.W. Smith. There he describes the cost of transfer-pricing. He goes on to explain quite well the effects and points out that both high-wage and low-wage countries lose out as the wealth is siphoned to offshore accounts to avoid taxes. This is historical mercantilism to perfection by intercepting both the foreign country’s wealth and one’s own.

However, as he goes on to point out, there is a difference in that today’s corporations don’t have any loyalty to any nation, due to greed.

The last 20 years has seen the wealth of the United States reduced as corporations seek out cheaper and cheaper places where wages are less and environmental, safety and other regulatory measures are less or non-existent. (This has the effect of depressing wages and labor rights in industrialized as well as developing countries and therefore affects the wealth of those countries.)

Disparities between the wealthy and poor continue to rise, in the most powerful nation as well as all other countries. As Smith continues to point out,

Looking only at their bottom line, and listening to their own rhetoric, the managers of capital are unaware they are moving society back towards the wealth discrepancies of the early Industrial Revolution; this return to quasi-aristocratic privileges is a recipe for eventual contraction of commerce and destruction of their own wealth along with that of labor.

J.W. Smith, The World’s Wasted Wealth 2, (Institute for Economic Democracy, 1994), pp. 164-165.

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Tackling the problem, or pretending to do so?

While Smith wrote the earlier piece in 1994, it is applicable today as well, with wave of news about corporate crime around the start of 2000 and fascination of some CEOs and other executives as some major American companies have faced bankruptcy or have collapsed.

Yet, the media, while offering an outpouring of news and analysis have by and large concentrated on individual characters and looked for scapegoats (CEOs being the current flavor!). The impacts of the underlying system itself has been less discussed and when it has, often been described as basically ok, but just affected by a few bad apples. As media critic Norman Solomon describes,

On the surface, media outlets are filled with condemnations of avarice. The July 15 edition of Newsweek features a story headlined Going After Greed, complete with a full-page picture of George W. Bush’s anguished face. But after multibillion-dollar debacles from Enron to WorldCom, the usual media messages are actually quite equivocal — wailing about greedy CEOs while piping in a kind of hallelujah chorus to affirm the sanctity of the economic system that empowered them.

…Corporate theology about the free enterprise system readily acknowledges bad apples while steadfastly denying that the barrels are rotten. … (Let’s hold people responsible — not institutions, a recent Wall Street Journal column urged.)

…Basic questions about wealth and poverty — about economic relations that are glorious for a few, adequate for some and injurious for countless others — remain outside the professional focus of American journalism. In our society, prevalent inequities are largely the results of corporate function, not corporate dysfunction. But we’re encouraged to believe that faith in the current system of corporate capitalism will be redemptive.

Norman Solomon, Renouncing Sins Against the Corporate Faith, Media Beat, Fairness and Accuracy In Reporting, July 11, 2002

In some countries, the business community shouts a lot about government interference (in their profits) and recommends that the government be reduced in bureaucracy. While many governments are plagued with inefficiency, some is due to the powerplay of groups including various industries.

However, without the various governments, entire industries and market economies wouldn’t have got started in the first place. In the US, for example:

  • The pharmaceutical industry received research and development funds from the US government.
  • The Internet was created with public funds, but is now handed to corporations to profit from.
  • Most major industries receive some support or bailout, including:
    • Energy industries
    • Agriculture
    • Biotechnology
    • Information Technology
    • Telecommunications
    • Weapons/arms/military industrial complex
    • and so on.

While the private companies profit, any costs, such as social problems resulting from environmental degradation, resulting social degradation and so on, are all socialized. Privatizing profits, socializing costs is a common phrase heard in critical circles.

And politics has gotten even murkier since the aftermath of the September 11, 2001 terrorist attacks on the U.S. Some industries have used the September 11th incident to say that has led to loss of business and to try and ask for government assistance as a result. While it has surely had an effect, for example, in the airline industry, as the UK’s BBC 24 news program on September 27, 2001 at about 8:30pm in an interview, said that before the tragic terrorist attacks some of the airline companies such as British Airways were already suffering quite badly, and this tragedy provided an excuse to get out of it.

Of course, this doesn’t mean all companies were using the excuse, but it does highlight the difficulty of addressing these issues during highly emotional times. Companies are understandably going to try and use this to their advantage, if possible.

Economist and professor at MIT, Paul Krugman highlights this with the case of the highly publicized Enron collapse, in a piece that appeared in the New York Times, quoting here at length:

Enron’s illusion of profitability rested largely on mark to market accounting. The company entered into contracts that would yield profits, if at all, only over a number of years. But Enron jumped the gun: it treated the capitalized value of those hypothetical future gains as a current profit, which could then be used to justify high stock prices, big bonuses for executives, and so on.

…the Bush administration has turned to the political equivalent of another increasingly common accounting trick: the one-time charge.

According to Investopedia.com, one-time charges are used to bury unfavorable expenses or investments that went wrong. That is, instead of admitting that it has been doing a bad job, management claims that bad results are caused by extraordinary, unpredictable events: We’re making lots of money, but we had $1 billion in special expenses associated with our takeover of XYZ Corporation. And of course extraordinary events do happen; the trick is to make the most of them, as a way of evading responsibility. (Some companies, such as Cisco, have a habit of incurring one-time charges over and over again.)

The events of Sept. 11 shocked and horrified the nation; they also presented the Bush administration with a golden opportunity to bury its previous misdeeds. Has more than $4 trillion of projected surplus suddenly evaporated into thin air? Pay no attention to the tax cut: it’s all because of the war on terrorism.

Paul Krugman, Bush’s Aggressive Accounting, New York Times, February 5, 2002

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Rich country governments finally acting because it now affects them?

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More Information

I have not even scratched the surface of this issue here, at it is large and complex. Since the September 11 tragedy, this issue has ballooned incredibly and I have hardly discussed any of the issues arising since then. However, there are a number of organizations doing more research on this, and critics have pointed out these issues for a long time. You could start off at the following links to learn more:

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