Are public service cuts justified?

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Are public service cuts justified? Yes No Not sure

See October's Argument: Is it ever right to buy or sell human organs?

Dan Mobley:

Dan Mobley was a senior advisor to the UK Treasury before moving to Standard Chartered Bank in London. He speaks in a personal capacity.

The Western world is awash with debt. The financial crisis originated, and was worst, in places where everyone – people, companies, banks and governments – had borrowed too much. The causes of this indebtedness are many and varied, but governments have been spending far more than they collected in revenue over many years, despite a long period of economic growth with high tax receipts.

The recession, stimulus measures and the cost of bailing out banks have dramatically revealed the problems, but long before the crisis governments had embarked on sustained and unaffordable overspending, including ever-rising entitlements to pensions and healthcare.

There are three ways to eliminate debt: economic growth, which brings rising revenues and reduces the costs of social failure (primarily from unemployment); raising taxes; and cutting spending. We can debate the exact mix, but Western countries will need all three, or face a further deterioration and the need for even more drastic action later.

We should tread carefully on the timing of tax rises and spending cuts over the next few years to avoid tipping us back into recession. Recovery is fragile and growth is likely to be weak for years to come. But we cannot avoid change forever.

Unsustainable public debt is harmful and unfair. We waste valuable resources by paying interest. Ultimately our debts will have to be repaid by future generations who will have more pressing concerns, including the sharply rising costs of climate change we will also bequeath them. We cannot spend more than we earn indefinitely and we should not expect our children and grandchildren to pay our bills.

John Christensen:

John Christensen is a development economist and former government adviser who now directs the international secretariat of the Tax Justice Network http://www.taxjustice.net/

The West is awash with debt because wages have been suppressed for decades and the so-called ‘wealth-effect’ of house-price inflation was used to substitute for rising earnings. Falling property prices squeezed the banks, leading to the massive bank bail-outs which now encumber us. The huge fiscal boosts of the past three years have prevented an all-out crash, but signs of recovery are elusive and private sector investment won’t plug the gaps. What to do?

The cuts will hit poor people, slow down economic recovery and increase unemployment – John

Well, imposing massive austerity on public investment is exactly what not to do at this stage. The cuts will hit poor people, slow down economic recovery and increase unemployment. Radical new measures are therefore required to boost government revenues at a time when public investment is the only way of preventing prolonged depression.

Introducing a financial transactions tax such as the Tobin Tax (see Glossary of financial terms below) would raise significant sums while also dampening harmful speculative activity. Taxing land values (see Glossary) would also raise significant revenues without causing harmful economic distortions. Tackling tax evasion, which runs to hundreds of billions annually across the world, and devastates countries like Greece and Pakistan, would go a long way towards cutting budget deficits. Cutting some of the extraordinary tax exemptions granted to companies would also raise billions without causing pain.

The decision to impose austerity at this stage in the economic cycle is purely political. Alternatives exist which will not victimize poor people for mistakes made by powerful banks. Now is the time to shift towards a tax justice agenda.

Dan Mobley:

If we want to prevent future crises, we need to draw the right lessons from this one. The many incompetent and arrogant bank CEOs and boards deserve the full weight of public fury, but this justified rage should not blind us to the fact that bankers were feeding the addiction of individuals, governments and companies to cheap borrowing, using the glut of savings flowing uphill from Asia to the West.

Macroeconomic policy failed: governments ran massive structural deficits long before the crisis, bribing their electorates with unaffordable promises (with much of the cost hidden off balance sheet). The ‘Great Moderation’ of the 1990s was actually a borrowing and spending spree.

I would love to plug some of the gap by closing tax havens and clamping down on tax evasion. But history teaches us how slow progress is internationally – the G20’s failure here is scandalous but predictable – and how quickly new loopholes are found by rich individuals and companies.

We could fill a magazine debating the Tobin Tax. Even if one believes it works – and if so-called speculative activity was curbed, this would mean little revenue raised – there is no chance of it being agreed by all governments globally.

Campaigning activity would be much better focussed on corporate tax transparency and (internal corporate) transfer pricing (see Glossary).

We should delay spending cuts (and tax rises) until we have stronger signs of economic recovery, to avoid tipping us back into recession. But the day of reckoning cannot be delayed forever.

John Christensen:

Spanish demonstrators march in Madrid in September 2010 as part of a general strike to protest against government spending cuts.

Paul White / AP Photo

We have common ground on tackling corporate tax transparency, transfer mispricing and the scandalous failure of the G20 countries to tackle tax havens, almost all of which are (rich) OECD countries or politically connected to OECD countries. Your point about savings from the South flowing uphill is fundamental: a large proportion of those flows are illicit (embezzled funds, trade mispricing, tax evasion etc). Global macroeconomic imbalances will not be remedied without action to improve cross-border co-operation and information exchange, which bankers are lobbying flat-out to prevent.

Action must be taken to reduce personal and corporate debt. Since housing costs are responsible for a majority of household debt in most countries, priority must be given to providing affordable, energy-efficient housing. This would form part of a Green New Deal investment programme, providing the stimulus to boost economies and reduce energy consumption. Public investment of this type can be partly funded from new taxes (a land value tax is especially suitable for this purpose) which will raise significant sums without stalling economic recovery or worsening inequality.

Excessive corporate debt needs urgent action. One of the reasons why private equity investors have loaded companies (and football teams) with so much debt is because tax relief is given to loan capital, but not equity capital, creating a bias in favour of the former. The solution is to withdraw the tax relief on interest payments.

None of which precludes immediate public spending cuts, which should focus on the obscene sums spent on weapons programmes.

Dan Mobley:

We are in danger of furious agreement! Abolishing tax relief on debt interest is long overdue but technically challenging (I watch in despair at the debt laden onto my beloved Liverpool FC). Criminal activity by tax evaders is illegal and immoral. Increasing land taxation is a great idea. But...

Tax evasion represents only a tiny proportion of the ‘uphill’ capital flows from East to West that drove the borrowing binge and bubbles. The global economy must rebalance – with the West spending less and saving more while Asia does the opposite (driving down poverty as governments spend more at home on welfare). Banks could become part of this solution, not the problem – helping develop capital markets in poorer countries and facilitating flows ‘downhill’ from the rich world.

The spending supertanker can only be turned around if we include cuts to public services – Dan

Rebalancing requires reduced spending in the West. We must slash socially or economically useless expenditure, whether defence or export subsidies. But the spending supertanker can only be turned around if we include entitlements and public services. The US, UK or France spend two to four per cent of GDP on defence – yet face a ‘demographic shock’ of unfunded pension and welfare entitlements of around 450 per cent of GDP. Governments should concentrate our limited resources on the poorest in our societies while insisting the majority of us consume less and save more.

John Christensen:

Yves Logghe / AP Photo

Hang on a second: illicit flows from poorer countries running at upwards of $1 trillion a year contribute significantly to these macroeconomic imbalances – and tax havens sit centre-stage as villains of the piece. Irritatingly, I don’t see either the G20 or bankers queuing up to support civil society efforts to tackle this glaring fault-line in the globalized financial markets.

But the issue at hand is one of public spending and how democratic societies respond to the crisis. The far right sees this as the opportunity to move forward with their project to kill off public services. This will worsen existing inequalities: poverty, which jumped worldwide in 2009 – not least in the US – will inevitably deepen. Look at the other end of the spectrum and around the world you’ll find extraordinary concentrations of wealth and income. Forget about trickle-down theory, wealth has cascaded upwards to tiny élites who evade hundreds of billions of tax dollars every year.

So, no, I don’t agree that this is the time to abandon universal welfare provision and slash and burn the public sector. We, as societies, must decide whether such things as publicly funded education, healthcare, pensions, environmental protection and suchlike take precedence over frivolous and conspicuous consumption. We also need to take steps to force our politicians to take action against the scandal of tax havens and all who use them. This is why the time has come for a tax justice agenda.

Photo by: William Murphy under a CC Licence

Glossary of financial terms

Loan capital:

A long-term loan which finances a company’s everyday operations.

Equity capital:

Money invested by individuals or entities into a company in exchange for an ownership interest in that company.

Tobin Tax:

Small tax of 0.1-0.25% on financial transactions in the stock market and on foreign exchanges. Proposed, not implemented.

Land value tax:

Annual tax on the rental value of land, ignoring buildings, properties or other works.

(Internal corporate) transfer pricing:

Establishing the price for a transaction of goods and services between two entities owned by the same company.

Transfer mispricing:

Abuse of the above.

Can pay.. won't pay!

Illustration by *Kate Charlesworth*

It was a hot, windless afternoon in August 1995 and the atmosphere in my office in Saint Helier, Jersey, was stifling. I was economic adviser to this Channel Island tax haven, one of many offshore satellites of the City of London, and I was sitting opposite a multi-millionaire and his wife and their six financial and legal advisers. I asked him why he had not paid a penny of income tax in five years. His defence was this: my millionaire friends pay no tax and my financial advisers told me I do not need to pay tax – so why should I?

His defence could almost be a manifesto for the world’s wealthy: ‘We’re rich, we’re different – and taxes are for the little people.’

The millionaire’s team were stunned by my pugnacious attitude: this was not the Jersey way. I asked him: ‘Which of your advisers said you need not pay tax?’ I saw a banker flinch, and hold his hands up to his face. It was him.

Later, out of curiosity, I checked his claim about Jersey’s super-wealthy – and he was largely right. Many, I found, paid astonishingly little tax or, in more than half the cases I examined, nothing at all.

The world’s super-rich have set themselves apart from the rest of society and have created a vast offshore economy from where they, and powerful corporations, can disengage from regulation and taxes, leaving the rest of us to pay the bills. This was the secret parallel universe I set out to research in the 1980s: living in Jersey gave me the perfect cover.

Mind-boggling

A few figures help illuminate the rot. Since financial market deregulation in the 1970s, the number of tax havens has more than trebled. Over $600 billion – nearly three times today’s external debt – has leaked from sub-Saharan Africa in capital flight since 1975, almost all disappearing into secret bank accounts and offshore companies in places like Jersey, Luxembourg, Switzerland and London.

The scale of this scandal is mind-boggling. Conservative estimates suggest that the world’s wealthiest individuals have parked $11,500 billion offshore – allowing them to dodge over $250 billion dollars each year in tax. That alone far exceeds what the UN asked for in its Millennium project to tackle global poverty.

But that is just part of the picture: tax dodging by corporations is much bigger. The World Bank has reported that cross-border flows of the proceeds from criminal activities, corruption and tax evasion range from $1,000 billion to $1,600 billion per year, with half (or $500 to $800 billion) coming from Majority World economies.

The rich countries currently spend about $100 billion dollars on aid. So for every dollar of aid in, five to eight dollars flow out under the table. The tax evasion component of the global sum is by far the biggest, with commercial tax evasion making up $700 to $1,000 billion of the global figure. Historically there has not been such a large gap between rich and poor – ever.

Why has the tax haven racket been allowed to flourish this long? Havens lie at the heart of global financial markets – with over $2,000 billion flowing daily through their circuits. Yet their role in undermining regulation and destroying the integrity of national tax systems is poorly understood. Efforts to tackle the problem have been pitiful and fiercely resisted.

Lawyers, accountants and bankers working for the super-rich have helped develop new legal and financial structures and have strong-armed governments into setting up lax regulatory and tax frameworks. Meanwhile major nations, notably Britain and the United States, have actively hindered reform, while civil society has mostly shied away from the issue because of its complexity.

The Turmoil, registered in George Town, Cayman Islands, moored outside Citigroup’s office in Dublin, 9 June 2008.

Photo: JOHN CHRISTENSEN

London calling

London has become the largest offshore financial centre. In the 1950s, during decolonization, Britain was trailing on competitiveness and investment and the City was stagnant. Decolonization allowed Britain to create a network of quasi-autonomous states to funnel capital flows towards London. Almost half the world’s tax havens, including the Cayman Islands, the Channel Islands, the British Virgin Islands and Bermuda, have close political ties to Britain, and they host some of the most substantial offshore financial centres, largely staffed by expatriate specialists originating from the City. But Britain denies it is a tax haven.

By encouraging its overseas territories and Crown dependencies to become tax havens, the British Government set in motion a global financial octopus with the City as its head, heart and mouth, and the satellite tax havens as its tentacles, scooping up vast sums of money from around the world and feeding it into London.

Britain is not the only culprit, of course: we all know about Swiss banking secrecy, for example, or the criminal monies stashed in Liechtenstein. Singapore is energetically attracting dirty money from Asia and Europe. The US has tax haven characteristics, which allow wealthy people, especially from Latin America, to disguise their identity when they invest in US Treasury Bonds. With more countries getting in on the act, a process of ‘tax competition’ between jurisdictions has emerged, as each competes to offer incentives to footloose capital. Secrecy and lax regulation serve as the major lures. In April this year, for example, Jersey set up its first unregulated hedge fund. Others will follow. In the 1990s the OECD tried to address the scandal with its ‘harmful tax competition’ project, but the initiative was neutered by financial lobbies and President George W Bush’s incoming administration.

Powerful companies and super-wealthy people – backed by a pinstripe infrastructure of financial intermediaries – have ruthlessly exploited this race to the bottom. Even the most powerful nations cannot resist the pressures. ‘Cut our taxes,’ company directors demand, ‘or we will move to Ireland, or Switzerland.’ ‘Give us special treatment on capital gains,’ the private equity magnates warn, ‘or we will invest our wealth elsewhere.’ National governments quail before these threats – and concede to the plutocrats. And so the race continues.

The outcome has been disastrous. Lax regulation in tax havens has been a major factor behind the current financial crisis: it is not coincidence that most of the structured investment vehicles and securitized debt obligations behind the banking crisis have been created in places like Jersey and Grand Cayman. Across the world the tax charge has been shifted from those who can afford it, powerful companies and rich people, on to workers and consumers; the inevitable outcome has been less job creation, greater inequality and rising poverty rates.

This is especially a curse on poor countries, but not only on them: former US Treasury Secretary Larry Summers recently noted that if the income distribution in the US were the same today as in 1979, the poorest 80 per cent of Americans would have about $670 billion more – or about $8,000 per family – while the top one per cent would have about $670 billion less, or about $500,000 per family.

The economics profession and the aid industry, among others, have largely ignored this vast offshore economy. Most orthodox economists don’t even identify the offshore economy as a political or economic phenomenon, let alone ask why over half of world trade passes on paper through tax havens. The World Bank and the IMF have failed to incorporate into their analyses how tax havens destabilize financial markets by allowing risks to be disguised in complex offshore structures, or to explore systematically their role in driving inequality and poverty. They have ignored how tax havens encourage criminality by offering secrecy to fraudsters, tax cheats and embezzlers: providing the supply-side of the grand corruption that has decimated so many countries.

Mood shift

For half a century the cancer of tax havens has metastasized through the global economy, causing turmoil, increasing inequality and insecurity, and undermining democracy and national sovereignty. Removing this cancerous growth must now, urgently, be made a global priority.

Thankfully, we detect signs of a global mood shift. US presidential candidate Barack Obama’s proposed Stop Tax Haven Abuse Act suggests many Americans have had enough. Emerging scandals in places like Liechtenstein have hardened attitudes, and the financial crisis has abruptly ended the free-for-all financial deregulation that puffed so much air into the offshore phenomenon. The Tax Justice Network is sounding the alarm, and non-governmental groups are waking up and joining the protests. An epic struggle is now set to emerge, between the super-rich offshore operators and the rest of us.

Returning home to Jersey, I find that dark clouds are gathering. Young islanders cannot afford the high cost of living, and are leaving to find jobs elsewhere. Poverty rates are astonishing for an economy with almost the highest GDP per capita in the world. Jersey’s economy now depends almost entirely on its tax haven status, and measures to tackle tax havens will cause major disruption. Jersey people, now learning more about their island’s role in impoverishing the world, increasingly feel ashamed.

John Christensen is a development economist who went undercover in Jersey’s banking sector to discover how tax havens operate. He also worked as the island’s economic adviser from 1987 to 1998. Since leaving Jersey in 1998, he has helped launch the Tax Justice Network and directs its International Secretariat in London. www.taxjustice.net

TOP DODGERS!

*Leona Helmsley* - Queen of mean

Already a successful ‘condominium broker’ in New York, Leona married real-estate magnate Harry Helmsley and thereby became the owner of a chain of hotels and the Empire State Building. In 1988 Harry and Leona were indicted by US Attorney Rudy Giuliani (later Mayor of New York) on tax charges related to the refurbishment of a luxurious weekend retreat. Harry’s health had deteriorated so much during his marriage to Leona that he escaped the courtroom – but died shortly afterwards. Leona did not. During the trial Elizabeth Baum, a former housekeeper, testified that she had once commented to Leona that she ‘must pay a lot of taxes’. ‘We don’t pay taxes,’ Leona had replied. ‘Only the little people pay taxes.’ Leona became known as ‘The Queen of Mean’. She was sentenced to 16 years, though she served just 18 months in a federal jail. She died in 2007. Her $4 billion estate left $12 million to her Maltese dog, Trouble.

 

TOP DODGERS!

*The Prince of Liechtenstein* - High haven

Though Hans-Adam II has delegated many of his sweeping powers to his son Alois, he remains the titular head of an Alpine principality of just 35,000 souls but 75,000 registered companies. Liechtenstein is the world’s largest manufacturer of false teeth – and its most secretive banking location. At its heart is the LGT banking group, now controlled by Prince Alois but still making Hans-Adam II one of the world’s richest heads of state. As a haven for Nazi gold during World War Two, Liechtenstein refused to hand over any money until a whistleblower proved that millions were being held there. Now another whistleblower, indicted property fraudster and ex-LGT employee Heinrich Kieber, has spilled the beans. The tax authorities of Britain, Germany and the US have reportedly paid Kieber large sums for access to a computer disk he smuggled out of LGT that lists its account holders. So far, the head of the German post office has been charged in Germany with stashing a mere $20 million in Liechtenstein. More revelations should follow, though Hans-Adam II himself will doubtless remain immune.

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