Panama Papers: Fresh Questions About Tax Evasion
Does crime pay if the proceeds are invested legally and profitably?
By Thomas G. Donlan
The Smell of Money
If you wonder about high taxes in the U.S. and around the world, take a look at some of the lessons of the so-called Panama Papers. The easiest one is that bank- and corporate-secrecy laws make it possible to hide income and wealth—whether earned in criminal enterprises or legitimately—from local tax collectors.
As President Barack Obama observed recently, when some people evade taxes, other taxpayers have to make up the lost revenue, so the rates go up. The president, of course, was not talking about gardeners and housekeepers working for cash, especially not in Beverly Hills, Chicago, or Washington, D.C. His attention was fully focused on international businesses.
“It’s not that they’re breaking the laws; it’s that the laws are so poorly designed that they allow people, if they’ve got enough lawyers and enough accountants, to wiggle out of responsibilities that ordinary citizens are having to abide by,” Obama said. He should have said that the laws are well designed by politicians and the people who pay them to make taxes easy to evade.
It’s a problem that is worse in poor countries. The Organization for Economic Cooperation and Development has estimated that developing countries lose three times as much to tax evasion as they receive from foreign aid. No matter where it happens, kleptocracy may have a lot to do with it: Tax evasion can be a breeze for a politically connected businessman, a central banker, or a finance-ministry official in a place where bribes take the place of taxes.
All the money isn’t stashed abroad: A ripe smell rises from the available U.S. statistics. Zillow, the online database of real estate, reports that 58% of real estate transactions in the last quarter of 2015 worth more than $3 million were made by limited-liability corporations, many of which are registered anonymously.
There are many legitimate reasons to use such a corporation, and there are several states where they can be registered as anonymously as in foreign tax havens. But extreme concern for privacy can be a sign of extreme attempts to hide ill-gotten gains.
Another bad sign is an high affinity for cash deals: RealtyTrac, another database, says 58% of property purchases in New York City were done for cash last year, as were 56% in Miami and the surrounding county.
The fuss over the Panama Papers should underscore the suspicion that underground economies are like icebergs—bigger than they seem. Unfortunately, the president and many others refuse to understand that there’s more to the shadow economy of secret offshore shell corporations than just tax evasion, political corruption, and money laundering.
A lesson of the Panama Papers is that business income-tax rates in many important countries—led by the U.S.—have met the Laffer curve. Rates that are too high are providing powerful incentives to do business under the table to evade tax collection.
Such rates are in part the result of the earnest desire of generations of politicians, from Woodrow Wilson to Obama, to have a “fairer” tax code—meaning, of course, a tax code that extracts more from business and the wealthy so that the government can invest more on its priorities. They see no virtue in a code that gently treats all income—or wealth or consumption—alike.
On one tax issue, the president says that corporate rates should be reduced. But he’d only cut the top rate from 35% to 28%, intending to leave the U.S. corporate tax as one of the highest in the world and to toughen the tax on foreign-source income. We say the right rate is zero—to leave taxes on business income to those who receive it as dividends or capital gains, and to force legions of tax lawyers and accountants into more productive work.
Let’s not forget to think about what happens to the wealth—maybe $5 trillion, or some say as much as $30 trillion—stashed in tax havens and shell corporations. Set aside for the moment the sources of the funds and consider the uses.
Even serious criminals—drug dealers and the like—are trying to increase their wealth, so they must launder their ill-gotten gains and then invest them. As the U.S. Treasury explained last year, it’s a three-step process of placement, layering, and integration.
“First, the illegitimate funds are furtively introduced into the legitimate financial system. Then, the money is moved around to create confusion, sometimes by wiring or transferring through numerous accounts. Finally, it’s integrated into the financial system through additional transactions until the ‘dirty money’ appears ‘clean.’ ”
Once laundered, it’s a fairly safe bet that most of the money goes into closely held legal investments, such as real estate, art, investment partnerships, and hedge funds.
Since the banks and shell corporations pay interest to the depositors, we can assume that they invest the money. Although we can’t be sure what goes on behind the secret curtains, we may assume that they invest the money profitably, if not always in complete compliance with every law.
Now comes the question that most people never ask: Will owners controlling, say, a billion dollars deposited in Bermuda, the Bahamas, Luxembourg, or wherever, invest that money more profitably than the government that would like to tax it?
Is that a tough question? Let’s see: Which type of investor is trying to create more wealth, and which type of investor is spending money to create jobs?
After eight years of governments around the world trying to invest their taxpayers’ money to create jobs to recover from the Great Recession, we should stop wondering. The results have been dismal in the U.S., Europe, Japan, and China.
Many politicians and political economists say that governments just didn’t do enough spending to stimulate their economies. Another possibility is that their countries taxed too much, borrowed too much, and didn’t allow enough homegrown private investment.
Tax evasion is never patriotic, but it can be more practical than the tax collector.