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July 29, 2012, Sunday

The perverse effects of tax evasion (1)

Last week a report prepared by James Henry, former chief economist at consulting firm McKinsey, revealed that the global super-rich have at least $21 trillion hidden in tax havens like Luxemburg or the Cayman Islands.

 In case you’ve forgotten, a trillion is 1,000 billion. That money is put beyond the reach of local tax authorities. Part of that staggering amount is the $158 billion stored in offshore bank accounts by Turkey’s wealthiest individuals and businesses. As a result of this tax evading behavior, Turkey and other countries involved lose billions of tax revenues that most states desperately need to make ends meet.

The study was commissioned by the Tax Justice Network (TJN), an organization that promotes transparency in international finance and opposes secrecy. On its website the TJN explains why: “We promote tax compliance and we oppose tax evasion, tax avoidance and all the mechanisms that enable owners and controllers of wealth to escape their responsibilities to the societies on which they and their wealth depend.” The TJN is especially keen on fighting tax havens that “allow big companies and wealthy individuals to benefit from the onshore benefits of tax -- like good infrastructure, education and the rule of law -- while using the offshore world to escape their responsibilities to pay for it. The rest of us shoulder the burden.”

As most of you probably do, I knew tax havens existed and was aware of the fact that some very rich people made use of these facilities to pay less or no tax at home. I had no clue how much money was involved and how sophisticated the infrastructure is that designs and operates the offshore sector. Henry’s report was a real eye-opener for me, not only because of the incredibly vast amounts of money involved. Henry’s focus on what he calls a “black hole in the world economy” also reveals that tax dodging is not run by “shady, no-name banks located in sultry islands, but by the world’s largest private banks, law firms and accounting firms headquartered in First World capitals like London, New York and Geneva.” The three private banks handling the most assets offshore are UBS, Credit Suisse and Goldman Sachs. Detailed analysis of these banks, Henry subtly underlines, shows that “the leaders are the very same ones that have figured so prominently in government bailouts and other recent financial chicanery.”

For good reasons, Henry’s report on tax evasion got some attention in the media worldwide. Accompanying his groundbreaking research was another study by the TJN, titled “Inequality: You Don’t Know the Half of It,” which got little coverage. That is very unfortunate because the authors convincingly make the point that in many countries economic inequality has reached extreme proportions, far worse than we have understood until now. One of the reasons is directly linked to Henry’s report: In all studies into inequality, the hidden assets in offshore banks and the income they produce are not counted in the statistics.

I will not bother you with all the figures underpinning that conclusion. Two basic propositions in the report should, however, be highlighted: One is the growing acceptance of the correlation between income equality and a range of social and economic problems such as life expectancy, mental illness and drug abuse as well as social mobility and levels of education. Other studies have shown that inequality is strongly associated with political instability. In other words: Extreme economic inequality is bad for moral, social and economic reasons and when that inequality is even worse than we realized, that is extra bad.

The second idea from the TJN study worth remembering is the conclusion that inequality is a “political choice: A choice about how much inequality in outcomes a society is willing to tolerate, according to its beliefs about how important that may be to provide incentives, and how much damage it may do to social cohesion, economic growth and so on.” There is no “right” answer and each society needs to determine how much inequality it wants to tolerate.

Cynics might say that there is nothing new here. There has always been inequality in every society and the rich always managed to get away with immoral behavior. These questions were and still are part of the classic quarrels between the right and the left, between the employers and the trade unions and between the rich countries and the developing world.

I believe, however, that we are entering a new phase in which these traditional differences will no longer be grudgingly accepted, not within countries and not between states. More about that in my next column.

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