What the taxman sees

With a bit of good luck, by the time you read this column the world’s financial markets will have recovered from the shock of Brexit, the resignation of David Cameron, and the results of the Parliamentary Labour Party revolt against Jeremy Corbyn. Good luck is in short supply these days, however, so continuing turmoil seems a safer bet. We take a look at some of the impacts of Brexit in this issue.

That turmoil will be occurring in a world where there is already significant upheaval on the horizon from the OECD’s Base Erosion and Profit Shifting (BEPS) initiative and the growth of the bureaucracy needed to implement the various FATCA and FATCA-like measures being adopted around the world. The Panama Papers, also discussed by several authors in this issue, are provoking calls for even more regulatory efforts aimed at international business structures.

To make sense of all this, consider adding to your August holiday reading Yale anthropologist James C. Scott’s books, ‘Seeing Like a State: How Certain Schemes to Improve the Human Condition Have Failed’ (Yale 1998), and ‘The Art of Not Being Governed: An Anarchist History of Upland Southeast Asia’ (Yale 2009). Here’s why they are relevant.

Scott has four big ideas that shape his analysis of why ambitious development plans in Southeast Asia fail (Seeing) and how various tribes escaped incorporation into precolonial and colonial states in the same region (Not Being Governed). First, he argues that the fundamental need of a state is to render people “legible” to it, enabling them to be taxed.

Second, in making people legible, states change the nature of the activities people engage in, their culture, and their society as a whole. Third, the social engineering states attempt in the course of making people legible is due to a “high modernist ideology” that uncritically applies scientific and technical models to societies. Finally, combining that ideology with a state with significant coercive power tends to lead to bad results.

Although I am not sure Scott, who styles himself an anarchist and disavows any connections with libertarian authors like Friedrich Hayek, would agree with the analogy, the OECD’s BEPS proposal seems like a grand example of applying a high modernist ideology to people’s activities in a way that is likely to lead to disasters. And the project of pinning down every transaction using information exchange, beneficial ownership registers, etc, looks a great deal like a legibility project.

Here’s how Scott describes the need to get people to create “state-accessible product” that can then yield state revenue in precolonial Southeast Asia. There states preferred people to grow irrigated rice rather than live in the hills as subsistence farmers, hunters and gatherers. As Scott describes it in ‘The Art of Not Being Governed’: “State-accessible product and gross domestic product are not simply different; they are, in many respects, at odds with each other. Successful state-building is directed toward the maximization of the state-accessible product. It profits the ruler not at all if his nominal subjects flourish, say, by foraging, hunting or shifting agriculture at too great a distance from the court. It similarly profits the ruler little if his subjects grow a diverse suite of crops of different maturation or crops that spoil quickly and are therefore hard to assess, collect and store. Given a choice between patterns of subsistence that are relatively unfavorable to the cultivator but which yield a greater return in manpower or grain to the state and those patterns that benefit the cultivator but deprive the state, the ruler will choose the former every time. The ruler, then, maximizes the state-accessible product, if necessary, at the expense of the overall wealth of the realm and its subjects.”  (pp. 73-74)

It is not too much of a stretch to apply this analysis to efforts to curb tax avoidance by businesses and individuals. The BEPS project itself is a massive effort at legibility. The failure of the OECD or the governments endorsing its project to engage in any serious cost-benefit analysis of the project reflects not simple carelessness but a preference for legibility over any possible benefits of not burdening the world economy with the compliance costs of BEPS (higher growth rates, for example).

Similarly, just as Prussian authorities changed that country’s forests from diverse ecosystems to organized, regimented monocultures by focusing on counting the valuable trees and rewarding those managers who increased the legible products, so our tax codes have induced behavior. Songwriters like U2 shift their copyright holdings to the Netherlands not because the Dutch are musical aficionados but because the tax system makes it profitable to do so. BEPS and other efforts to restructure tax systems globally are likely to have large impacts. For example, BEPS is likely to make firms less entrepreneurial in their international businesses by raising the cost of doing business globally. In turn, this will make firms less likely to lend in developing countries where financial regulations are less developed. It will make firms more likely to adopt costly and bureaucratic systems that document compliance efforts. The result will be a global financial architecture that is a version of the U.S. Transportation Security Administration – a costly, inconvenient system with few benefits and many costs.

Scott defines “high modernism” as “a particularly sweeping vision of how the benefits of technical and scientific progress might be applied – usually through the state – in every field of human activity.” (State, p. 90) This approach is taken equally by those on the left and the right. It is tempered by the belief that there is a private sphere into which the state may not intrude, the belief that the economy is too complex to be managed, and the existence of “working, representative institutions through which a resistant society could make its influence known.” (p. 102)

BEPS makes clear that the OECD has lost any notion that the world economy is too complex for it to manage or that there is a sphere of life into which it may not intrude. Moreover, the OECD is itself the perfect example of an institution that is unrestrained by any institutions. Unaccountable, sequestered in its Paris headquarters, and with a staff drawing tax-free salaries, it is undemocratic, unrepresentative and disconnected from the world economy. The rebellion of British voters against the EU as evidenced by the Brexit vote suggests there is a limit to which people are willing to cede control of their lives to unaccountable institutions.

Looking at the world the way states do can help us understand why they do what they do. As the quest for legibility drives states towards imposing ever higher costs on the world economy, the challenge is developing ways to create vehicles that are resistant to high modernism.

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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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