The best defence is a good offence

Both the US Congress and most of Europe took vacations at the end of the summer, bringing a temporary respite in most of the efforts by the American government, EU, OECD and many European governments; although American efforts to breach Swiss banking secrecy continued despite the August heat. Nonetheless, when congressmen and senators stagger back this fall from their mauling at the hands of constituents angry over soaring deficits and the proposed health care ‘reforms’, the proposed Stop Tax Haven Abuse Act, anti-offshore budget provisions and Sen Max Baucus ‘moderate’ anti-offshore bills will once again find themselves on the agenda.

Across the Atlantic, European leaders from Britain, France, Germany and others will resume their efforts to restrict competition from offshore financial centres. By the time you read this in mid-fall, there will likely be movement on at least some of these initiatives.

Three things are driving efforts to limit competition; all three will continue to be true for the foreseeable future. First, governments in Europe and North America are in desperate need of revenue. Efforts to spend themselves out of the recession have loaded public balance sheets with red ink. At the same time, tax receipts are plummeting as the recession takes its toll on economic activity. All this is horribly inconvenient for the political class.

Democrats in the United States are planning massive new entitlement programs; Gordon Brown’s Labour Party is desperately seeking ways to buy votes ahead of their widely anticipated trouncing at the election they must call shortly; the German ‘Grand Coalition’ has sapped any reforming zeal from both the Social Democrats and the Christian Democrats; and France’s Nicolas Sarkozy has recovered from his initial brief flirtation with capitalism and returned to traditional French views of the role of the state. In short, European and North American politicians agree on the need for more tax revenue.

They don’t need actual tax revenue, of course. What they need are plausible predictions of increased revenue. Past efforts to limit offshore efforts, e.g. the European Union’s Savings Directive, actually produced startling little revenue, but they did produce predictions of more tax revenue. Those predictions are enough to allow politicians to spend the anticipated revenues without publicly admitting to increasing the deficits. Next year, when the shortfall appears, they can always blame the recession – after all, no investigative journalist is likely to dig into how accurate last year’s revenue predictions were. Thus closing ‘loopholes’ is popular with politicians regardless of whether it actually produces revenue so long as it appears to do so.

Second, White House Chief of Staff Rahm Emmanuel’s dictum ‘never let a good crisis go to waste’ is a critical motivator. Every crisis prompts politicians to empty their file cabinets of unsuccessful ideas for legislation that can be strapped together into a package. 9/11 brought America the ‘USA PATRIOT Act’, an amalgam of every item on a law enforcement agency’s wish list that could be claimed to relate to terrorism, regardless of how implausible the claim might actually be. The monstrosity that is Sarbanes-Oxley resulted from this century’s first wave of corporate scandals and, as subsequent research has documented, none of its provisions would have prevented any of the problems at Enron, Worldcom, or Parmalat. Terror attacks in Britain have produced thousands of CCTV cameras, which are estimated by the BBC to have stopped a miniscule one crime per 1,000 cameras. Similarly, the financial crisis has given tax authorities around the world a chance to slap together their wish list into a package they can label as a ‘reform’. The air of crisis thus helps those interested in limiting competition by enabling them to re-label anticompetitive efforts as necessary responses to current events.

Third, the politicians behind anti-OFC measures are not just thinking about today but are focused on tomorrow. The major legislation pending in just the United States includes the Waxman-Markey ‘cap and trade’ bill passed by the House of Representatives and pending in the Senate, which will effectively increase the price of virtually every good involving energy, cutting GDP by U$$200bn in 2012 and by US$500bn a year by 2030 according to Heritage Foundation estimates; the health care ‘reforms’, in August the Congressional Budget Office estimated the price tag on current proposals at US$9.3tr over the next ten years; union ‘card check’ legislation, which would dramatically increase labour costs; the President’s budget proposals to increase capital gains rates to 20 per cent; the top personal marginal rate to 39.6 per cent, at US$200,000 for single people, US$250,000 for married couples; significant limits on personal deductions and a return of the estate tax at 45 per cent rates for estates over US$7m. Moreover, the staggering federal deficits will likely produce tax increases in the future even without any new programmes. The significant chance of serious inflation in the United States from the massive increases in the money supply over the past nine months, once the economy begins to recover, will produce both bracket creep-driven tax increases and reasons to move capital into non-dollar assets. Finally, as the dollar continues its steady decline, investors will be seeking to move assets out of dollar-denominated assets. China has already begun to do so. Each of these individually would shift significant economic activity offshore; collectively they could prompt a mass exodus of investors from the United States. Restricting competition from low tax jurisdictions and enabling the IRS to track Americans’ efforts to protect their capital against the economic consequences of current policies is thus vitally important to future revenue collection efforts.

Fourth, ‘tax havens’ make marvellous domestic villains. Who can argue, after all, with a proposal to ‘stop tax haven abuse’? ‘Abuse’ is certainly bad and ‘tax havens’ sound like locales from John Grisham novels full of shady characters. As I write this at the end of August, many members of the US Congress have gone home to their districts to face constituent anger over soaring deficits, many features of the health care ‘reform’ being debated and a hundred other issues. This has produced scenes of angry citizens shouting down their representatives, including the spectacle on YouTube of Stop Tax Haven Abuse Act sponsor Rep. Lloyd Doggett (D. Tex.) fleeing his constituents. In Europe, British MPs are still struggling to explain why the UK’s taxpayers are footing the bill for cleaning moats in the parliamentary expense scandal. What politicians like Doggett and Gordon Brown desperately need is someone to attack to divert their constituents from attacking them. Unfortunately OFCs fit the bill.

As a result, still on the agenda are measures that threaten to cripple legitimate offshore financial centres like Cayman. These include the Stop Tax Haven Abuse Act’s proposed blacklisting of Cayman as an ‘offshore secrecy jurisdiction’. Cayman is not alone – the proposed list includes other reputable jurisdictions like Bermuda, Hong Kong and Singapore and a host of others. Crucially, this list is not based on evidence of wrongdoing occurring in these jurisdictions but simply imposed by Congressional fiat.

Whether a jurisdiction stays on the list depends on an annual determination whether the jurisdiction has “corporate, business, bank, or tax secrecy rules that, in the judgment of the Secretary, unreasonably restrict the ability of the United States to obtain information relevant to the enforcement of this title, unless the Secretary also determines that such country has effective information exchange practices.” What’s an “effective information exchange practice”? One that provides “prompt, obligatory, and automatic” exchange of information that was in fact adequate to prevent tax avoidance as well as tax evasion.

These anti-OFC efforts in Washington, Brussels, London, Paris and Berlin cannot be taken lightly. The forces propelling these measures are not going away, regardless of when the world financial crisis is officially declared ‘over’. Cayman, and other legitimate OFCs, need an aggressive, continuous effort to counter this campaign. As an American citizen concerned that my economic freedom is being lost without much opposition from anyone within the United States, I’m dependent on people in Cayman and elsewhere to defend the free movement of capital, financial privacy and regulatory competition. Here’s what I’d like to see in the debate over offshore finance:

CEOs of non-profit hospitals in the United States speaking out on how efficient captive insurance laws in Cayman, Bermuda, and elsewhere enable them to provide more medical care for the poor by lowering their cost of insurance. Hopefully, religious leaders from denominations sponsoring charity hospitals would be standing shoulder to shoulder with their hospitals’ CEOs, making the moral case that offshore jurisdictions are not just about tax competition.

Public pension fund and non-profit endowment fund officials explaining how right-sized regulation of hedge funds enables them to earn higher returns in offshore funds, helping public pension funds avoid deficits and universities and other non-profits boost their earnings so deliver more services.

Airline executives defending offshore funding vehicles for lowering the cost of travel for people around the world by enabling airlines to purchase new planes at lower costs.
Shipping company executives showing how offshore vessel registries reduce transportation costs by lowering operating costs for cargo ships and oil tankers.
CEOs of companies tapping into international finance pointing out that OFCs help channel billions in investment dollars into North American and European economies, boosting employment and lowering the cost of products built with lower cost financing.

It’s a cliché that ‘the best defence is a good offence. It’s well past time for OFCs like Cayman to play offense. If they don’t, we’ll all soon suffer the consequences.

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Andrew P. Morriss

Andrew P. Morriss, Chairman, is the D. Paul Jones, Jr. & Charlene Angelich Jones – Compass Bank Endowed Chair of Law at the University of Alabama School of Law. He was formerly the H. Ross & Helen Workman Professor of Law and Business at the University of Illinois,Urbana-Champaign. He received his A.B. from Princeton University, his J.D. and M.Pub.Aff. from the University of Texas at Austin, and his Ph.D. (Economics) from the Massachusetts Institute of Technology. He is a Research Fellow of the N.Y.U. Center for Labor and Employment Law,and a Senior Fellow of the Institute for Energy Research, Washington,D.C., as well as a regular visiting faculty memberat the Universidad Francisco Marroquín,Guatemala. He is the author or coauthor of more than 50 scholarly articles, books, and bookchapters, including Regulation by Litigation (Yale Univ. Press 2008) (with Bruce Yandle and Andrew Dorchak), and is the editor of Offshore Financial Centers and Regulatory Competition (American Enterprise Institute Press 2010).

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