So, public registers of beneficial ownership. Now what?

White toy-like people lined up with a mganifying glass highlighting a red one in the middle.

On May 1, 2018, the inevitable finally happened and the British House of Commons mandated that the British Overseas Territories, but not the Crown Dependencies, will be compelled to make public beneficial ownership details relating to their companies by the end of 2020. This predictably caused much gnashing of teeth in those self-same territories, some of it justified, and some of it possibly exaggerated. Despite some predictions to the contrary, the sun still came up the following day.

The British Overseas Territories are prickly about imperialism from London. They also feel justifiably betrayed after having reached a consensual agreement with the United Kingdom to finally resolve the issue of access to beneficial ownership information. The system implemented under that agreement is still less than a year old, but the U.K. has now torn it all up and unilaterally tried to impose new rules. The previous agreement seemed fair and reasonable: U.K. law enforcement would have access, within an hour in urgent cases, to beneficial ownership information for any offshore company. However, the public would not.

Notably, U.K. law enforcement have never been in favor of public registers of beneficial ownership, which they do not regard as helpful overall in terms of criminal investigations – a point which was made forcibly by Lord Howard Flight in the debate on the same Bill in the House of Lords.

But whether it was a sensible idea or not, the dice has now been firmly cast. So, the obvious question is what happens next?

The first thing that will probably happen will be legal challenges. The U.K.’s power to legislate for the Overseas Territories is circumscribed. As Labour MP Margaret Hodge has pointed out, crime is an area where the U.K. Parliament still has competence to pass laws directly.

However, there is a sensible question to be asked whether this is really about crime, given that U.K. law enforcement already has full access. This is really about allowing journalists and other third parties to be able to sift through the information and see if they can find anything juicy to publish – an odd position given the concerns expressed by the House of Commons about the propensity of firms to do the exact same thing with people’s electronic data, but there it is.

If there is a legal challenge, there is obviously a wide spectrum of possible outcomes. The challenge could fail. It could succeed, but the U.K. then “tries again,” using a different constitutional route, such as Crown Prerogative. But what is also entirely possible is that both sides sit down and agree a reasonable face-saving compromise that allows both sides to call it a win. Given that the U.K. government itself was not a supporter of the proposals, it should be open to finding common ground. But the U.K. government’s own hands will be tied to a great degree by the will of parliament. It could get very messy, but equally, it could all be very civilized and amenable.

After the legal challenges are over, assuming that the overseas territories remain locked into providing public registers, the next stage will be thrashing out the details. That is obviously going to be much harder if this is an acrimonious process, for all the obvious reasons. And these are not simple issues. “Beneficial ownership” is easy for politicians and journalists to say, but extremely hard for lawyers to define – as we have seen. Those difficulties are not going away. The overseas territories and the U.K. are still wrapping their arms around existing beneficial ownership and discovering the patent and latent flaws in their systems.

And then there is a timeline. As the Premier of the Cayman Islands, Alden McLaughlin, has stressed, Cayman and most of the other British Overseas Territories have already given commitments to introduce public beneficial ownership registers when they became a viable global standard. Although that probably will not happen by December 2020, it might not be too long after that it would have happened in any event. So, it is possible that what this really means is the acceleration of an existing timetable, albeit one made in a hostile and unilateral fashion.

Key with a tag tied to it with "Beneficial Owner" written on it.

But the big unknown for the British Overseas Territories is what this will mean for their offshore industries. Hysterical overreaction is to be expected in the short term. But the actual likely effects are going to be difficult to predict with accuracy. Large areas of offshore business will be unaffected by the changes. And the offshore jurisdictions have always argued, and I think they are correct to say, that their books of business are a great deal cleaner that the readers of The Guardian like to imply. This is not the 1970s. This is a world with the Common Reporting Standard, with strict anti-money laundering requirements, and with open information sharing with law enforcement. But, however clean the book of business is, public registers of beneficial ownership represent a significant intrusion into personal information privacy. The fact that this occurs during the month when the General Data Protection Regulation launches specifically to protect the privacy of sensitive personal data is deliciously ironic. No matter how clear your conscience is, that is both a cost and a burden that many clients will prefer to avoid rather than accept. It is a good bet that we will see some level of contraction.

But these things can be inherently counter-intuitive. After the British Virgin Islands introduced private registers of beneficial ownership accessible by U.K. law enforcement in July 2017, despite similar predictions of doom, the incorporation rates in the jurisdiction increased. It would be foolish to pretend that there are no rotten apples in the basket, but the stereotype of offshore companies as havens for criminal gangs represents yesterday’s thinking from a world before modern financial services regulation.

And then there are the political wildcards. It will not take long for hotheads to call for independence in some places as an appropriate response. There will be elections in most of the relevant territories between now and the end of 2020. Some political party will likely think that promising to take their people out from under the “yoke of the oppressor” is vote-winner. And they might be proved right. Who is to say what strange political twists and turns may occur during the next three years.

But, however it resolves itself, what is sad about the current situation is that it is just so unnecessary. The U.K. tax authorities are very happy with the cooperation they get from CRS. The U.K. law enforcement authorities are very happy with the cooperation they get from the private registers of beneficial ownership. The only people pressing for public access to information are journalists, an admittedly powerful lobby, who love to report on the private dealings of the rich and famous, and transparency campaigners, who are undoubtedly pure of heart, but fairly one dimensional in their view of the trade-offs involved.

Even as parliamentary select committees excoriate Facebook and Google for their use of people’s private information, the House of Commons moves to push ever more private and sensitive data out into the public domain themselves.

The end of this story has not been written but, without doubt, a new chapter has begun.

Cryptocurrencies: Beyond fear and hype

This September will mark the tenth anniversary of the last financial crash. In October, another equally longstanding development will celebrate its first decade: Bitcoin, the original cryptocurrency network.

In just 10 years, cryptocurrencies have become much more than a payments system, the original aim of Bitcoin’s founders, and spawned hundreds of peer-to-peer networks for the exchange of assets, goods and services. They have also grown as a fundraising device.

Text quoted from the main article: By most expert estimations, blockchain technology has only scratched the surface of potential applications.Below we discuss how leading jurisdictions have designed regulatory frameworks to accommodate this promising new technology, and how other financial hubs, such as the Cayman Islands and the United States, can benefit from the growth of cryptocurrencies.

Much more than tulips

When an author or group of authors, writing under the pseudonym Satoshi Nakamoto, published a paper outlining the features of a “Bitcoin: a peer-to-peer electronic cash system,” they were laying the foundations for a broad swath of decentralized applications that promise to enable viable transactions at scale without intermediaries. As of late June 2018, the total market capitalization of cryptocurrencies stood at $250 billion. Bitcoin remains the largest of more than 1,600 coins listed, but its market share of 40 percent is much smaller than the 87 percent it commanded as recently as 2014.

What explains the rapid rise of cryptocurrencies? Skeptics are wont to dismiss it as a modern-day bout of tulipmania, an irrational speculative craze for something that has no use or value.

But a number of events help to explain the enthusiasm of people around the world for a technology whose potential remains largely untapped. First, the idea of a stateless currency – serving as medium of exchange, store of value and unit of account – when sovereign monies have failed to preserve their purchasing power over long periods, attracts many people.

Second, startups’ ability to raise capital by issuing a cryptocurrency – a so-called initial coin offering, or ICO – rather than through more traditional and costlier initial public offerings (IPOs), and without having to restrict their share offerings to wealthy investors, makes capital formation easier. It also democratizes investment.

Finally, even those who doubt the market potential of individual cryptocurrencies share an excitement about the underlying distributed ledger technology. Indeed, the use of blockchains to record transactions appears to have countless applications, from land titles and insurance to shipping contracts and securities trading. What these potential use cases share is the prevalence of high transaction costs among incumbent intermediaries. Proponents of blockchain applications believe that peer-to-peer technology can vastly reduce costs and break up the market dominance of a few large players.

When innovation clashes with regulation

The extent to which the promise of cryptocurrencies and blockchains can be realized depends in large measure on policymakers’ willingness to let them flourish.

Jurisdictions around the world are taking very different approaches. Some are positively draconian, such as the Chinese ban on ICOs and cryptocurrency exchanges. South Korea has also prohibited ICOs since September of last year. Auspiciously, both countries have since made informal statements suggesting that the bans may be relaxed in the near future.

Other countries have sought to accommodate cryptocurrencies within their existing regulatory frameworks. Germany, Japan, the United Kingdom and the USA all fall under this category, although differences in national regulatory regimes mean that the impact of bringing cryptocurrencies under existing rules is not the same in each country.

In the United States, which is the world’s most important cryptocurrency market by trading volume and number of ICOs, regulatory uncertainty has arguably chilled innovation in recent months. From a peak of $2.4 billion in February, monthly funding for new ICOs in May dropped to just over $1 billion, having fallen to as low as $700 million in April.

To be sure, an uncertain policy environment was not the sole driver of this decline. The excitement that drove cryptocurrency prices ever higher at the end of 2017 has all but evaporated, with one bitcoin fetching less than $6,000 at the end of June, compared to $19,300 at its mid-December peak and $9,800 as recently as May. It is not unreasonable to suggest that subdued prices have curbed issuers’ eagerness to offer new coins.

However, cryptocurrency volatility is itself magnified by regulatory instability. When rumors about the Chinese exchange ban started to circulate in September, the bitcoin price took a 10 percent hit. Another drop of similar magnitude followed the official enactment of the ban in February.

Policy uncertainty and expectations clearly play an important role in cryptocurrency markets, which is why equivocal statements by key U.S. financial watchdogs in recent months have kept the industry on tenterhooks.

Jay Clayton, chairman of the Securities and Exchange Commission, has repeatedly claimed that most ICOs to date were securities offerings, according to the definition established by legal precedent. Commissioner Brian Quintenz from the Commodity Futures Trading Commission, America’s other main capital markets regulator, has replied that, even if some ICOs were securities at the time of issue, they could become commodities once the associated network – Bitcoin for payments, Ethereum for computer power, and so on – went live.

The need for regulatory clarity – and openness

The distinction matters. Classifying all or most cryptocurrencies as securities, as some have proposed, would subject their issuers to onerous registration requirements. It would restrict who can buy and hold, and who can act as custodians and exchangers, of cryptocurrencies.

A securities designation would also make it very difficult for ordinary households to buy cryptocurrencies, since issuers would be reluctant to bear the costs – upwards of $1 million – of a public listing and would therefore raise money privately. Yet, such private offerings are open only to accredited investors, typically those with an income greater than $200,000 or net worth in excess of $1 million. Plainly, most households fall below these thresholds, which means they are excluded from private offerings.

The potential negative consequences of overzealous regulation should not deter policymakers from clarifying which rules apply to cryptocurrencies. Despite ebbs and flows in cryptocurrency prices, that Bitcoin has been around for a decade shows that this technology is here to stay. Furthermore, as more cryptocurrencies launch and elicit interest from retail buyers, the need for clear rules becomes greater, both to avoid stunting the growth of cryptocurrencies and to minimize the scope for fraud.

One way for U.S. regulators to provide clarity would be to enshrine into policy the distinction between functional cryptocurrencies – those that can be exchanged and used right now – and promises of future cryptocurrencies financed through ICOs.

The first category are decentralized networks that give users access to goods and services, such as payments, computer power, and electronic storage space. They do not seem to meet the legal definition of a security, which involves an investment of money in a common enterprise with the expectation of profits from the efforts of others. Instead, functional cryptocurrencies resemble traditional commodities, since they serve as inputs into transactions.

Regulators are finally coming round to recognize this. Chairman Clayton has declared that bitcoin is not a security, and recently William Hinman, who directs the SEC’s Division of Corporation Finance, stated that ether, the cryptocurrency of the Ethereum platform, also fails to meet the criteria for a security. Bitcoin and ether represent 60 percent of total cryptocurrency market cap, so this change in stance is a momentous development. It is time to extend it to the remaining 40 percent.

A balanced approach toward ICOs

For cryptocurrencies that are not yet functional, regulators must balance the need to protect against fraud with the desire to promote innovation and capital formation. ICOs cannot become the exclusive province of scammers, but they also must not be regulated out of existence.

The way to achieve both objectives is to accept that some ICOs, in specific circumstances, may qualify as securities offerings. This is likely to be the case where the contracts offered can be traded in secondary markets before the associated application goes live. Because the value of the contracts in the interim depends on the success of those developing the app, they may constitute a money investment in a common enterprise where the work of others leads to expected profits – that is, a security.

In other cases, however, an ICO can look more like Kickstarter. A group of developers want to build an application that delivers a service, say, bike rental. To raise funds to cover the costs of developing the app, they offer tokens that will entitle the buyer to a set number of bike rentals when the app goes live. But until then, the tokens may not be traded.

In that case, the contract is not a security but the advance purchase – presumably at a discount – of a service. The exchange is similar to a coffee farmer who promises coffee beans tomorrow in exchange for money today. Such agreements are known as forward contracts and have for decades been recognized by regulators as distinct from securities and other investments.

This two-tier approach makes possible the supervision by securities authorities of those cryptocurrency projects which are most subject to volatility and asymmetric information: early-stage ICOs. But it gives greater flexibility to those ICOs that give token buyers stability and transparency between the time of issue and the time that the platform goes live.

Learning from the leading jurisdictions

To corroborate why a flexible approach can best secure the benefits of cryptocurrencies while adequately dealing with any associated risks, it helps to examine how other leading financial centers are proposing to regulate them. Switzerland and Singapore stand out for having attracted a disproportionate amount of ICOs, especially among larger offerings. Together, the funding raised in ICOs in these two jurisdictions matches the $830 million raised in the United States so far.

Both the Swiss and the Singaporeans have moved quickly to clarify which regulations apply to cryptocurrencies. They have distinguished between tokens, such as bitcoin, that are used for payments; tokens that entitle the holder to goods and services, like in our bike rental example above; and tokens that are akin to ownership shares in businesses. The first two are not securities, whereas the latter involve rights similar to ordinary stocks and are therefore regulated as securities.

The Cayman Islands have also been fertile territory for ICOs. In an analysis of 100 recent token issues that had raised more than $10 million, Cayman was the home jurisdiction for seven, surpassed only by Singapore and Switzerland. The largest ICO so far in 2018, for blockchain investment platform EOS, was domiciled in Cayman and raised $4.1 billion. The Caribbean jurisdiction will be the site of at least another 16 ICOs this year, according to PwC.

While the Cayman Islands Monetary Authority has warned ICO investors about the risks associated with these offerings, its financial services sector has embraced cryptocurrencies.

As an investment management hub and the home jurisdiction to 85 percent of the world’s hedge funds, the Cayman Islands is in a privileged position to play host to ICOs and cryptocurrency investors. Like Switzerland and Singapore, the comparable clarity of Cayman’s securities rules helps to make it especially attractive.

What about all the fraud?

The rise and popularity of ICOs, admittedly, has attracted scammers aplenty. A recent market study found 80 percent of token issues to be fraudulent. It is important to note that this represents a crude share of the total number of ICOs, rather than of total funds raised. The bigger the ICO, the less likely it is to be a scam – or, indeed, to fail.

Nevertheless, it is reasonable to worry about fraud, not only because of the direct costs to those whose money is stolen, but also because widespread investor deception can undermine the growth of cryptocurrencies and blockchain-based platforms. The two-tier system for ICO regulation outlined above would minimize the chances of successful scams by subjecting those token contracts that were tradable before the platform was developed to securities regulations.

Any booming technology and geography – from railroads to tech stocks, from the South Sea to 1920s Florida – is bound to attract a disproportionate number of opportunists with evil intentions, looking to profit from the greed and gullibility of others. But it would be a mistake to conclude, because some fraudsters are peddling cryptocurrencies, that most cryptocurrencies are fraudulent.

On the contrary, the most popular cryptocurrencies have stood the test of time and trade at prices higher than they did a year ago. Furthermore, by most expert estimations, blockchain technology has only scratched the surface of potential applications across the economy. The willingness of policymakers to allow beneficial innovation to flourish will determine the extent to which the promise of cryptocurrencies can be realized.

Diego Zuluaga is a policy analyst at the Cato Institute’s Center for Monetary and Financial Alternatives.

Robots will not put us out of work; they’ll cause us to fall in love with it

Factory line robots welding.

The New York Times recently interviewed the man viewed as the best baguette maker in Paris, and by extension, the world. Asked about his work, Mahmoud M’seddi referred to his kitchen as his “laboratory” while telling the Times that he sees himself “as an artist, a magician.”

Readers might stop and think for a minute about the happy meaning of the chef’s assertion. So specialized is work in today’s world that what used to be seen as prosaic and rather blue collar is now scientific, and the stuff of artistry.

Better yet, readers would be wise to consider the chef’s assertion through the prism of work history. 150 years ago, few had the luxury of contemplating what they would eventually do for a living. Once able, most everyone knew exactly what the future would look like: backbreaking work six days per week on the family farm, from dawn to dusk. This was the reality for the vast majority of the world’s population, whether rich or poor. Imagine that.

Indeed, imagine what life would be like for the majority of us if the global economy were still an agriculture-based one. Think how poor and miserable most of us would be.

Interesting here is that Warren Buffett contemplated something similar in a 2015 Wall Street Journal opinion piece. The legendary investor asked readers to “imagine [if] we lived in a sports-based economy. In such a marketplace, I would be a flop. You could supply me with the world’s best instruction, and I could endlessly strive to improve my skills. But, alas, on the gridiron or basketball court I would never command even a minimum wage.”

Buffett’s counterfactual similarly speaks to our happier modern reality. Buffett was born into a world in which he had choices. He’s most intelligent when allocating capital, but if he presumed to talk the intricacies of basketball with LeBron James, or football with Tom Brady, this most brilliant of men would not look very smart at all. Buffett can fill arenas with his investment genius, but he could not even fill a room if sports were his only option. Thankfully more and more people get up feeling like Buffett, Brady and James. Work is where a growing number of people get to showcase their unique skills, and yes, intelligence.

What brought about this change in the nature of work? Why do people have endless work options today relative to a past in which they were brutally limited? The simple answer is robots.

While the creation of the food necessary for human survival once required most of humanity, primitive robots of the back hoe, fertilizer and tractor variety made it possible for exponentially more food to be grown and raised with exponentially fewer hands. One could argue that these early “robots” were the biggest job destroyers in history, but as opposed to putting the workers of the world in breadlines, they freed hundreds of millions to finally realize their previously undiscovered talents.

As a result, individuals whose intelligence had historically been suffocated on farms were able to set their minds to curing disease, to developing the air conditioner, airplane and automobile, and still others were able to become actors, artists, athletes and musicians. Such is the genius of automation. As opposed to rendering us unemployable, that which erases the work of the past makes us much more employable – and productive – precisely because it fosters individual specialization.

To understand why, we need only remember why free trade among individuals always and everywhere elevates all concerned. Not only does free trade reward us through global competition among producers to meet our needs, the division of labor with the rest of the world makes it much more likely that we will be able to do the work that is most commensurate with our talents. Simplifying what is simple, free trade is the educational equivalent of studying what we love every day while dropping the courses that we cannot stand. And when we do what we love we are much more productive, which means our earnings potential grows by leaps and bounds. Robots and other forms of automation must be considered with all of this in mind.

If the division of labor with other human beings naturally elevates us, and it does, imagine what robots will do to greatly enhance our individual productivity. Precisely because they can “work” seven days a week, 24 hours a day, and precisely because they can replace humans in more and more endeavors, we can be confident of a work future that is going to stagger us in terms of its abundance. Simply put, it is where old forms of work are most rapidly being destroyed that new and more exciting forms are most rapidly revealing themselves.

If human progress were all about “jobs,” our task would be easy. We could abolish the tractor, airplane, computer and ATM machine. If so, we would all have jobs. No doubt we would be incredibly poor, but we would all have jobs. Yet what these technological advances hopefully remind us is that technology by its very name is a happy sign that work of the menial, semi-challenging and complicated variety is being done for us so that we can focus our energies elsewhere.

Interesting about all this is that some who should know better predict in gloomy fashion that automation is set to destroy hundreds of millions of jobs in the not-too-distant future. The pessimists should be smiling, and the optimists rejoicing. If robots live up to their job-destroying promise, the future is going to be amazing.

For one, all the productivity wrought by automation points to wealth creation in the coming decades that will make our abundant present look rather austere by comparison. Crucial about all this is that the immense wealth will free up copious amounts of human and financial capital necessary to make cancer and heart disease life-shortening maladies of the past. The more robots destroy the work of the past, the more time we will have to cure the diseases that take our loved ones from us way too soon.

Robots carrying pallets with cardboard boxes on top.And then we must consider all the commercial advances and comforts that became commonplace with the automation of food production. Previously mentioned were cars, air conditioners and airplanes, among other advances that we could not live without. Can anyone reading this piece imagine life without television? Or Wi-Fi? It is hard to, and because it is we should be cheering the possibility that automation could wholly re-write our present definition of work. That is the case because we humans have not scratched the surface of our potential. Assuming mass automation of what we do, stop and think of the advances we will achieve tomorrow.

If we are freed from much of what do now, the advances of the not-too-distant future will make planes, cars, computers and air conditioning appear pedestrian by comparison. What will those advances be? And what will we do for work? If I knew I would be worth billions, but what is certain is that the more we automate the present the more talent we will be able to direct toward existing problems, other ones we never knew we had, and still more to innovations previously unimagined that we will eventually say we cannot live without. To presume otherwise, as in to presume that we will stop progressing in the face of automation, is to presume that we’ll run out of ideas. That is not serious.

What is serious is that the future will be defined by a four-day work week thanks to robots performing more and more of the work we used to do. With the four-day week, demand for entertainment will skyrocket such that a growing number of us will get to do for a living what we grew up doing for fun. We are already seeing this now given the proliferation of videogaming, video-game coaching, and shopping (yes, shopping!) as remunerative professions.

Even better is that while we will be free to work but four days per week, most of us will choose to put in more time at the office. We will because the automation that has so many so needlessly scared is what is going to cause tens of millions to fall in love with work.

Precisely because “robots” will erase so much of its drudgery, work will be about humans showcasing their unique skills and intelligence. Prosperity does not make us lazy; rather it unearths in us a herculean work ethic we never knew we had. Work becomes fun. Along these lines, watch how robots proliferate amid growing global aversion to retirement.

The main thing is that when people are doing what they love, they are able to work incredibly hard without “working.” That is the future if we embrace the very automation that is set to destroy hundreds of millions of jobs. This rapid change will not put us into breadlines as much as it will cause to race to the office every day.


Longest and costliest Cayman trial goes to appeal

An entire wall of a courtroom was commandeered to hold the thousands of pages of documents that were considered in the Algosaibi case, which was settled on May 31 in the Grand Court of Grand Cayman after a two-year hearing. – Photo: Taneos Ramsay
An entire wall of a courtroom was commandeered to hold the thousands of pages of documents that were considered in the Algosaibi case, which was settled on May 31 in the Grand Court of Grand Cayman after a two-year hearing. – Photo: Taneos Ramsay

The longest and costliest trial in Cayman’s history ended in first instance in June. The trial, which involved more than 40 lawyers from seven Cayman Islands firms, cost more than $100 million in legal fees and took nearly two years from opening statements to the delivery of the final judgment.

An entire wall of a courtroom with boxes golding the thousands of pages of documents for the Algosaibi case.
An entire wall of a courtroom was commandeered to hold the thousands of pages of documents that were considered in the Algosaibi case, which was settled on May 31 in the Grand Court of Grand Cayman after a two-year hearing. – Photo: Taneos Ramsay

Chief Justice Anthony Smellie dismissed claims from the Ahmad Hamad Algosaibi and Brothers conglomerate, known as AHAB, that the collapse of its business empire was the result of a multibillion dollar fraud perpetrated from within by Maan Al-Sanea, who had married into the family and ran its financial services business.

Rather than being a victim in the enterprise, Chief Justice Smellie decided that AHAB had worked with Al-Sanea and was the principal architect of what he described as “an enormous, long-standing Ponzi scheme” which defrauded more than 100 banks of “hundreds of billions of dollars.”

The chief justice ruled that Al Sanea, as director of the Money Exchange, a subsidiary of AHAB, had indeed presented falsified accounts to banks in order to borrow large sums of money to keep the business afloat and to enrich himself personally.

However, the chief justice concluded that Al Sanea had done so with the authorization of the partners of AHAB, who were not only fully aware of his conduct but were the “primary architects” of the fraudulent practices.

“The AHAB partners knew of and authorized the fraudulent borrowing through the Money Exchange and financial businesses,” Chief Justice Smellie wrote in a summary of his judgment, describing it as “a quid pro quo” for the “Money Exchange to procure fraudulent borrowing for the AHAB partners themselves.”

The total flow of cash through the Money Exchange was approximately US$330 billion, the judgment indicates.

He characterized Al Sanea’s behavior as part of a pattern of fraudulent practices established by AHAB over several decades.

“There can be no doubt as to the gravity of the fraud perpetrated by AHAB,” he wrote.
“This was a fraud carried out, with increasing sophistication, from as early as 1981. The total sums borrowed pursuant to AHAB’s fraud numbered in the hundreds of billions of dollars. In short, this was an enormous, long-standing Ponzi scheme which defrauded more than a hundred banks.”

AHAB, which instigated the litigation against multiple defendants, including the liquidators of Al-Sanea’s Cayman Islands companies, in an effort to recoup funds for its creditors, announced that it would appeal.

“AHAB have filed an appeal against the judgment and will vigorously contest the flawed narrative,” said Simon Charlton, acting CEO of AHAB, in a press statement.

He said the court had failed to take into account aspects of AHAB’s evidence and submission, particularly in relation to the partners’ knowledge of Al-Sanea’s activities and the withdrawals that he made from the company’s Money Exchange business.

AHAB also claims the chief justice reached his conclusions about the partners’ conduct based on inferences, which were not supported by the evidence before the court.

“The court accepted propositions and theories advanced by the defendants that were not put to AHAB’s witnesses during cross-examination and were also not supported by the evidence before the court,” according to the statement.

UK instructs its overseas territories to make company owners public

A section in the new U.K. Sanctions and Anti-Money Laundering Act stipulates that Britain’s 14 overseas territories, including the Cayman Islands, will have to introduce public registers of beneficial ownership by the end of 2020. If they do not, the U.K. government will issue an order in council to force Cayman and other territories to do so.

Orders in council, a relic from the colonial days, bypass the devolved democratic process in the territories. Therefore, they have been rarely used and generally only in the introduction of significant human rights issues.

In the Cayman Islands, for instance, the extraordinary measure, was used twice: to abolish the death penalty and to decriminalize homosexuality.

British lawmakers were fully aware that an order in council dictating public registers would disenfranchise elected representatives in the territories in an area of domestic responsibility for their local governments. But proponents of the amendment that introduced the measure claimed money laundering was now a matter of U.K. national security and therefore constitutionally under the jurisdiction of the U.K.

Unsurprisingly, the move provoked ire in the overseas territories, with many territory leaders describing the action as reminiscent of the colonial era.

Cayman Premier Alden McLaughlin said the position of his government is clear. “The attempt by parliament to legislate for this territory … is unlawful and we do not accept it.”

However, the Cayman government will take no legal action until an order in council to amend local legislation is issued, which, the premier said, may never happen.

If an order is made, the premier argued that a legal challenge would be necessary, irrespective of the underlying issue, as it could otherwise open up all kinds of legislation by the U.K. House of Commons in areas of responsibility that are devolved to the territories. Even then, the matter could take years to resolve.

In the meantime, Cayman would not make its beneficial ownership register public, unless it becomes a globally accepted standard, a position that the Cayman Island government has always maintained.

However, rather than being resolved through legal challenges of a potential order in council, the issue may come up sooner. The EU is already planning to add the existence of public beneficial ownership registers as one of the criteria for its blacklist of uncooperative countries in tax matters.

In 2017, Cayman avoided a blacklisting by committing to remedy, before the end of this year, what the EU called a lack of economic substance of Cayman-based entities. Minister for Financial Services Tara Rivers visited Brussels in May to talk to EU policymakers about the details of how economic substance is going to be defined. Even if Cayman can meet EU demands on the question of substance, public registers look set to become the next EU hurdle.

CIMA cautions investors over virtual currencies

The Cayman Islands Monetary Authority issued an advisory in April on the potential risks of investments in initial coin offerings, or ICOs, and all forms of virtual currency.

ICOs are a form of fundraising in which a startup company creates new virtual coins or tokens and sells them to the public to raise capital.

Customers should thoroughly research virtual currencies, digital coins and tokens, and the companies or entities behind them to separate fiction from fact, Cayman’s financial regulator said.

While the recent publicity surrounding virtual currencies, such as Bitcoin or Ripple, and initial coin offerings presents a tempting picture of high returns on investment, they also have a high potential for financial loss and fraud, CIMA advised.

Unlike a share offering, ICOs do not provide any ownership rights in the company, nor are they a loan to the company. In addition, ICOs are frequently unregulated and tend to involve complex, new technologies and products.

Moreover, if regulators consider an ICO in breach of local securities laws, the value and usability of the sold coins or tokens could be severely impaired.

As a result, investors can lose some or all of the money they invest, CIMA said.

Other risks associated with ICOs and virtual currencies highlighted by CIMA are the potential for incomplete information, exaggerated expected returns, price volatility, limited opportunities to resell the virtual currency, hacking attacks, fraud and limited regulatory protection.

The regulator warned that there have been several documented cases internationally where the money raised through an ICO disappeared without a trace. Tracking the funds is made difficult when fraudsters use multiple servers in different countries in combination with tools that mask the true Internet Protocol (IP) address of the users. Founders and promoters of these frauds have also operated under false names.

The regulator also reminded investors that virtual currencies are not legal tender in Cayman and that CIMA as a rule does not endorse investment products or companies.

Appleby, Guardian, BBC settle breach of confidence lawsuit

Appleby, The Guardian newspaper and the BBC settled a lawsuit brought by the offshore law firm against the British media organizations in the wake of the so-called “Paradise Papers” coverage that was based on documents that Appleby said were stolen from the firm in a cyberattack.

In the suit, Appleby claimed a breach of confidence by the media organizations and sought a permanent injunction against further use of the information, as well as the disclosure and return of the documents.

In a joint statement, the companies said “they have resolved their differences in relation to Appleby’s breach of confidence claim against The Guardian and the BBC.”

The offshore law firm maintained that the main objective for bringing the proceedings was to understand which of its confidential and privileged documents had been taken to be able to respond “meaningfully” to clients, regulators and colleagues about exactly what information has been taken.

According to the joint statement, The Guardian and the BBC have assisted Appleby, “without compromising their journalistic integrity,” by explaining which of the law firm’s documents the media organizations used.

In the lawsuit, Appleby claimed the documents used in the Paradise Papers coverage were stolen in a data breach and that there was no public interest in the stories published about it and its clients.

The Guardian and the BBC, in turn, argued that their “serious and responsible journalism” had revealed matters that were in the highest public interest and that otherwise would have remained secret.

Details of the settlement remained confidential, but the settlement statement did not refer to any requirement to pay damages.

Most documents belonged to the trust and fiduciary arm of the group, which was spun off a management buy-out in 2015 and now trades as Estera.

“It is now clear that the vast majority of documents that were of interest in the Paradise Papers investigation related to the fiduciary business that is no longer owned by Appleby and so were not legally privileged documents,” Appleby said in a statement.

Impact on real estate industry of a public registry

Magnifying Glass, Key, House

Clearly, the hot topic right now in the Cayman Islands business community is the U.K. government forcing its overseas territories, Cayman included, to provide a public registry of beneficial ownership by 2020. I believe that Great Britain has behaved very poorly in this regard because it has chosen not to include its Crown Dependencies, i.e., Jersey, Guernsey and the Isle of Man, in this change of legislation, which shows the agenda is disingenuous and is a redirection of business, effectively doing little more than to cast aspersions on offshore jurisdictions.

Harmful to the economy

The Cayman Islands derives much of its revenue from being a tax neutral environment and generates sufficient revenue to be pretty much self-sufficient financially, without the need for financial support from Britain. Impacting Cayman’s financial services industry in this way will surely be to its detriment and will almost certainly damage this important pillar of Cayman’s overall economy.

As far as its impact on Cayman’s local real estate industry is concerned, I believe ultimately that there are a number of reasons why people use companies to hold assets for completely legitimate reasons, including privacy, as a lot of people do not necessarily want others knowing what they own, and also protection from liability. I believe that this is a fundamentally important aspect for investors in Cayman and without it the result will be that people realize that if their property ownership is not kept private then there really is no point in having a company in Cayman at all other than for protection against liability.

I believe that if investors can get over the above issue and accept the fact that their beneficial ownership is being made public, then they will still go forward with their property transactions and the effect will be minimal. But I see a secondary and more impacting effect of the U.K. legislation. If the financial services industry as a whole is impacted detrimentally then there will be a knock-on effect on the real estate industry. The financial services industry and property ownership go hand in hand in my opinion – either people who own property here then use our financial services industry, or people come here for our financial services industry and then end up purchasing property.

But the overall knock-on effect will reach further than just our financial services industry; I believe it will spread to all our industries, with local buying power in general being affected by this U.K. legislation. Local residents have invested heavily in their properties over the past 15 to 20 years, whether those properties at worth $200,000 or $5 million and the industry has been particularly buoyant in recent years, but taking away important business will no doubt impact local home owners.

No reason for change

The Cayman Islands has led the charge when it comes to allowing access to our beneficial ownership information, having introduced a centralized register last year. If a country or regulatory authority has issues with a particular beneficial owner then they have the mechanics to find the owners using qualified legal channels, the results of which will be provided to them within a speedy time frame. While this register is not open to the public it allows for the access needed to deal with problems and at the same time prevents fishing expeditions.

In my opinion, this legislation does nothing to prevent fraud and just mimics the U.S. with FATCA and other KYC legislation whereby criminals can still open bank accounts in the U.S. and also the U.K. with ease. I also fail to see why it is that everyone seems to need to know everyone else’s business. Cayman’s current regulatory framework more than adequately allows for the investigation of problems while balancing the legitimate rights of people seeking privacy and protection when it comes to their investments.

The original sin

US/China shipping containers

The trade war with China has its roots in that country’s manipulation of its currency, its original trade-related sin. On Dec. 11, 2001, China formally acceded to the World Trade Organization, and in the next year, 2002, the United States’ trade deficit with China was “only” $103 billion. By 2017, however, that deficit had more than tripled to $375 billion. What was the problem that created the dreaded “China Price,” typically 30 percent below the U.S. price for the comparable good, allowing China to undersell its American competitors? By 2002, it was clear to all that the primary engine of China’s export explosion was its undervalued currency, the yuan. China was clearly manipulating its currency to obtain an unfair competitive advantage against the United States and other countries.

Yuan/US Dollar

Currency manipulation was being accomplished through a state monopoly over foreign currency run by its State Administration of Foreign Exchange (SAFE). China required that foreign exchange proceeds be handled by SAFE, which resulted in the state’s purchasing the foreign exchange earnings of firms at the established rate of 8.28 yuan to the dollar. SAFE continued to intervene in the forward exchange market by buying dollars with the yuan in order to bid up the price of the dollar and suppress the value of the yuan.

The question was not whether China was manipulating its currency but by how much. At the low end of the scale was the Goldman Sachs calculation, which estimated the undervaluation at 15 percent. The estimate by the Manufacturer’s Alliance and Ernest Preeg was 40 percent.

And the purchasing power parity scale represented by The Economist’s Big Mac index (indicating what a Big Mac served by McDonald’s would cost around the world) was 56 percent, about the same level as the World Bank estimate. According to The Economist, the yuan was the most undervalued currency in the world.

The loss of 2.2 million U.S. manufacturing jobs over the 32 months before 2003 was clear evidence of the burden this unfair trade practice was placing on U.S. commerce.

On Sept. 4, 2004, a group of associations and companies known as the China Currency Coalition filed a complaint against China’s currency manipulation with the Office of the United States Trade Representative pursuant to Section 301 of the Trade Act of 1974. The purpose of a Section 301 complaint is to allow the U.S. government to unilaterally enforce its rights under trade agreements, and to counter the unfair acts, practices, or policies of foreign governments that burden U.S. commerce. The definition of unfair practices under Section 301 includes acts, practices, or policies of foreign governments that are unreasonable or discriminatory. So the legal issue in the 2004 Section 301 currency manipulation case was whether it was “unreasonable” for China to have a dramatically undervalued currency vis-a-vis the United States and to therefore be able to put pressure on one U.S. industry after another, including textiles, wood furniture, paper products, and metal parts.

Section 301 is not the only provision applicable to currency manipulation. Article IV, Section 1(ii), of the Articles of the International Monetary Fund prohibits members from manipulating their currencies in order to gain an unfair competitive advantage in international commerce, and Article XV(4) of the General Agreement on Tariffs and Trade prohibits its signatories from manipulating currency in order to gain a competitive advantage in international trade.

Despite the compelling legal and economic case presented by the China Currency Coalition, the Office of the United States Trade Representative, at the direction of President George W. Bush, summarily rejected this Section 301 petition within 45 minutes of its filing. This failure of the United States to counter the currency manipulation of China was the functional equivalent of waving the white flag of surrender on trade to China. It has led to the hollowing out of many of America’s Rust Belt industries, and indirectly to the election of Donald Trump as president of the United States.

In the years following the rejection of the 2004 Section 301 complaint, China rode the back of an undervalued currency to the largest peacetime transfer of wealth in human history, from the United States to China. Since then, however, China’s currency has appreciated.

Today, the established yuan/dollar exchange rate is about 6.64 yuan to the dollar, an arguably fair exchange rate. The Section 301 train therefore has left the station with regard to the currency manipulation issue, and it would not be appropriate to retaliate against China now based on the grounds of currency manipulation. Section 301 remains in the U.S. toolbox, however, as an implement that can be used to counter other unfair trade practices by the government of China.

On June 20, 2018, President Trump’s Office of the U.S. Trade Representative filed its own Section 301 action aimed at a bevy of Chinese practices related to technology transfer, intellectual property, and innovation. A trade value of $34 billion is covered by this proposed action, which calls for the imposition of an additional ad valorem duty of 25 percent on certain imported products from China. The stakes were raised exponentially on July 10, 2018, when President Trump announced tariffs of 10 percent on an additional $200 billion in Chinese exports to the United States.

The correct approach at this point is a two-track strategy, one relying on unilateral action through a Section 301 complaint based on the valid complaint against forced technology transfers and the theft of U.S. intellectual property, and a second track that would rely on engagement with China through the resurrection of the Trans-Pacific Partnership (TPP).

President Trump withdrew the United States from the TPP negotiations on Jan. 23, 2017. He correctly noted that the TPP was fatally flawed and should not have been approved in its current form. For starters, the agreement does not proscribe currency manipulation, which, as noted above, has been used by China to undermine the United States. In addition, it allows for self-certification of exporters. Thus, Vietnam, for example, could export products duty-free to the United States with 90 percent of the product being produced in China, which is not a TPP member. The TPP, as currently drafted, would actually expand the export possibilities for China into the U.S. market, in effect giving China duty-free treatment with no corresponding concessions on its side.

Fortunately, President Trump has instructed his trade advisors to consider conditions under which the United States can join the TPP.

The suggested two-track strategy, based on pressure and engagement with other nations, is the way to protect American interests and avoid future China trade wars.

Bart S. Fisher is a lawyer in Washington, D.C., and co-author of International Trade and Investment: Regulating International Business.

Should Trump blow up’ the G-7? History says ‘yes’

World map highlighting the G-7 members and their flags.

It was widely reported by the media around the world in mid-June that U.S. President Donald Trump had “blown up” the Group of Seven (G-7) in the wake of their annual summit held this year in Quebec Canada. The president’s post-summit tweet regarding the G-7 stated: “I have instructed our U.S. Reps not to endorse the communiqué.” He added in a second tweet that: “PM Justin Trudeau of Canada acted so meek and mild during our @G7 meetings only to give a news conference after I left saying that, ‘US Tariffs were kind of insulting’ and he ‘will not be pushed around,’ Very dishonest & weak. Our Tariffs are in response to his of 270% on dairy!”

Media headlines frequently used the phrase “blow up,” or variations of, including Politico Europe, The Guardian and The Washington Post. The following tone by New York Magazine was typical: “[Trump] had agreed to sign on to the communiqué traditionally cobbled together by the countries at the end of the summit – previously a formality, now just an indication, however tenuous, that America was still on board with the liberal democratic project it helped build in the ashes of World War II. And, at an impromptu quasi-press conference before his departure, Trump had rated his personal relationship with fellow leaders as a “10,” despite his fierce disagreement with them over just about everything. But then, somewhere over the Pacific on his way to meet Kim Jong-un, Trump blew the whole thing up in two tweets.”

Dan Mitchell of the Center for Freedom and Prosperity provided another viewpoint in his daily blog entry entitled “Trump and the G-7 – Right Outcome, Wrong Reason”: “Trump’s protectionism is deeply troubling. That being said, we shouldn’t shed any tears because a G-7 Summit ended in failure or that Trump didn’t sign the communiqué. The bureaucrats who craft these statements for their political masters regularly use the G-7 to endorse statist policies.”

The G-7 started in 1975. It is nowadays really the G-7+ as the European Union is also a member, along with the nations of Canada, France, Germany, Italy, Japan, the U.K. and the U.S.

So what does the history of the G-7 or G-7+ look like?

A representative sample is provided in the sections to follow, based on extracts from the official communiqués. This sample is from the summits held in the U.S. over the years under Presidents Ford (1976), Reagan (1983), Bush Sr. (1990), Clinton (1997), Bush Jr. (2004) and Obama (2012). The one non-American summit sampled is the recent one hosted by Canadian Prime Minister Trudeau (2018). There is an appropriate mix of both right and left leaders sampled. Each summit section below assesses the support for free market capitalism versus that for big government statism.

G-7 States

Ford (1976)

The G-7 summit of 1976 was hosted by President Gerald Ford (R) in June and held in the U.S. territory of Puerto Rico. The pro-capitalism statements in the communiqué outweighed the pro-statism ones. And the latter were mainly of the Keynesian or democratic socialism kind, rather than the (economic or cultural) Marxist or Green socialism kind. Although, there was the start of some Green Malthusianism on energy. Interestingly, the concept of “sustainability” is mentioned frequently though it is not the current environmental version but the previous economic one. A sample of quotes from the communiqué is provided next, with pro-statism ones on the left versus pro-capitalism on the right:

G-7 Ford (1976) - Statism/Capilatism

Reagan (1983)

The G-7 summit of 1983 was hosted by President Ronald Reagan (R) in May and held in the U.S. state of Virginia. The pro-capitalism statements in the communiqué were approximately equal to the pro-statism ones. The latter were still mainly of the Keynesian variety, although there was some further Malthusian Green statements on energy, as well as new ones on natural resources and the environment. A sample of quotes from the communiqué is provided next, with pro-statism ones on the left versus pro-Capitalism on the right:

Reagan (1983) - Statism/Capilatism

Bush Sr. (1990)

The G-7 summit of 1990 was hosted by President George Bush Sr. (R) in July and held in the U.S. state of Texas. The pro-capitalism statements in the communiqué outweighed the pro-statism ones. The pro-capitalism statements included celebrating the end of the Cold War. And these also included “regulatory reform.” The pro-statism statements included Compassionate Conservative (Com-Con) ones on proactively spreading Democracy to (or Nation Building in) the Middle East and the War on Drugs. And these also included the “mother-of-all,” the Green ones, i.e., “climate change.” A sample of quotes from the communiqué is provided next:

Bush Sr. (1990) - Statism/Capilatism

Clinton (1997)

The G-7 summit of 1997 was hosted by President Bill Clinton (D) in June and held in the U.S. state of Colorado. The pro-Capitalism statements in the communiqué dwarfed the pro-Statism ones. And the majority of the document was devoted to environmental and social issues rather than the more typical economic ones. The Com-Con issue of “terrorism” makes an appearance as well. Interestingly, the concept of “sustainability” is by this stage the current environmental or Green version only and not the previous economic one. And global “climate” action is a significant focus. A sample of quotes from the communiqué is provided next.

Clinton (1997) - Statism/Capilatism

Bush Jr. (2004)

The G-7 summit of 2004 was hosted by President George Bush Jr. (R) in June and held in the U.S. state of Georgia. The pro-Capitalism statements in the communiqué were again dwarfed by the pro-Statism ones. The latter includes those of a Green and Com-Con flavor. The majority of the document was devoted to environmental and security issues rather than the more typical economic ones. Security includes continued focus on “terrorism” but also the rise of the Big Government TSA. Importantly although, the private business sector is encouraged in developing countries. A sample of quotes from the communiqué is provided next:

Bush Jr. (2004) - Statism/Capilatism

Obama (2012)

The G7 summit of 2012 was hosted by President Barack Obama (R) in May and held in the US state of Maryland. The pro-Capitalism statements in the communiqué were once again dwarfed by the pro-Statism ones. The majority of the document was devoted to Green environmental issues along with the return of some Keynesian economic ones centered around recovery from the global financial crisis. A sample of quotes from the communiqué is provided next, with pro-statism ones on the left versus pro-capitalism on the right:

Obama (2012) - Statism/Capilatism

Trudeau (2018)

The G-7 summit of 2018 was hosted by PM Justin Trudeau (L) in June and held in the Canadian province of Quebec. The pro-Capitalism statements in the communiqué were almost non-existent compared to the pro-Statism ones. The majority of the document was devoted to environmental, social and security issues (i.e., Green, Marxist and Com-Con issues) rather than the once typical economic ones (i.e., Libertarian and Conservative ones).

And the Cultural Marxism is readily apparent in this document including lots of Leftist “buzz words.” A sample of quotes from the communiqué is provided next, with pro-statism ones on the left versus pro-capitalism on the right:

Trudeau (2018) - Statism/Capilatism

Buy, sell or hold

Nobel Laureate in economics Edward Prescott appropriately rebooted one of the more famous quotes from Adam Smith about business cartel conspiracies against the public to raise prices: “[P]oliticians of like mind seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise taxes.”

This is largely the story of the G-7, including “some contrivance to raise taxes” in 2004 and 2018. As Geopolitical Intelligence Services recently put it: “Trump shook up the recent G7 meeting in Canada, declining to sign a joint statement with the other countries’ leaders. Considering the content of that statement, the President made the correct decision. … The G7 is promoting a one-size-fits-all approach to tax policy, which unambiguously favors larger, more intrusive governments at the expense of individual economic freedom. … The G-7 summit statement talks about the virtues of freedom, democracy, and the rule of law, but then quickly pivots to policies directly at odds with these valuable and worthy goals.”

The long history of the G7 reveals something even more complex and instructive in terms of “conspiracy against the public.” It was more-or-less pro-capitalist in 1976 and 1983, and it’s pro-statism was mainly Keynesian with the start of Greenism on energy but not yet “climate change.” It becomes more-and-more pro-statist in 1990, 1997 and 2004 combining both Com-Con and Green worldviews especially through “climate action.” Pro-statism of the Green variety rules in 2012 but is supplemented by the return of Keynesianism. The rule of Green-style pro-statism carries on in 2018, and very worryingly is accompanied by Cultural Marxism.

Given all this, President Trump should look to “blow up” or “sell” on the G-7, rather than “buy” or even “hold” on it, as he is reportedly going to do with the likes of the UN Human Rights Council. This is even more so the case when one not only examines the words of the G-7 but their numbers as well. A key number or statistic is that of “Government Spending” as usefully collated in the website Trading Economics. Not only is this statistic common to the G-7+ over time, it largely correlates with and is a driver of government taxes, bureaucrats, regulations, borrowings and money supply. And the picture presented is one of strong growth in government expenditure with the occasional slowing down and the odd decline here-and-there. Perhaps it is time to prioritize creating capitalist-friendly groups of nations pursuing greater not less economic freedom like say the Anglo-Sphere Group (ASG) or better still the Group of Liberty (GL).

Left behind

'Compliance' in the middle, pointing to 'law', 'requirements', 'rules', 'standards', governance', reulations', 'transparancy', 'policies'.

The Cayman Islands has had a busy half year when it comes to regulatory compliance. In addition to the rolling out of registration under the Non-Profit Organisation Law, the reporting under the Beneficial Ownership Regulations went live in June. These observations are being made from the perspective of a service provider to service providers.

When policy and regulations are being developed, focus at industry level is often on the active businesses, and quite a lot of influence is exerted by the “squeakiest wheels,” as it were.

Policy is shaped and legislation follows, but the practical implications of implementation appear to be unevenly considered and the pain unevenly shared.

At minimum, the implementation phase of any new project or regulatory regime requires adequate human resources, a budget and a plan. Those involved on either side of the implementation must know (i) what is the objective? (ii) who are the doers? (iii) who are the thinkers? (iv) who are the facilitators? (v) who will be the overseer, and (vi) who will firefight.
Companies and legal entities in liquidation, whether solvent or insolvent, often appear to be overlooked when new regulatory and compliance requirements are rolled out. Unlike active companies, the harsh reality is that there may be no or very little capacity for the liquidating entity to pay for the implementation of a new regulatory measure or new compliance requirement. In insolvent liquidations, there is often no paying client to whom an additional cost can be easily passed along.

In this context, there are many practical issues. Information flow could be truncated, relevant parties may be unresponsive to requests from liquidators, thus their efforts to ensure compliance with new regulatory measures are frustrated from the start. Additionally, the legal provisions, exemption regimes and implementing regulations are not always framed with liquidations in mind.

Some acknowledgment of this was recently made, culminating in an amendment to the Beneficial Ownership regulations. As a result, companies in liquidation (insolvent or voluntary) now benefit from a longer reporting cycle, being 90 days, instead of the 30 days designated for active in-scope companies. However, and without a doubt, complying with the June 30 deadline for filing the BOR, although highly publicized, was frustrating to some and costly to all.

It is well understood that liquidating entities are a part of the overall risk matrix for the jurisdiction as a whole and may indeed pose unique risk. So, the suggestion being made here is not that such entities get a sweeping exemption from measures aimed at meeting Cayman’s AML/CFT initiatives or other global standards, but instead, that a responsive approach be more closely considered.

What would be ideal, is for companies in liquidation to be specifically considered at the inception of the policy development cycle, and for there to be constructive engagement by all stakeholders to ensure that implementation is painless, that compliance is cost effective and produces the desired output and quality of data the competent authority seeks from such entities.

The responsibility is a shared one. Regulators and those affected, along with those who represent those affected, should continue to collaborate on the development of new regulatory measures more meaningfully. Failure to engage when there is a useful opportunity may result in the implementation of a measure in a way that is unsuitable for reasons never-before discussed, envisaged or explored. With the proliferation of regulatory compliance obligations, testing for those entities in liquidation must continue be contemplated and prioritized. Those responsible for an orderly winding up should not be left behind.

Canada: Economic trouble is brewing

Canada Flag

Doug Porter, chief economist at BMO Financial Group weighed in on Canada’s investment woes. “The bottom line is there really is a need for more urgency on the competitiveness front,” he said. “We’ve got a sluggish picture for business investment in 2018 and now a report showing record net outflow of FDI. It all suggests that even before we had the U.S. tax changes, there was a challenge facing Canadian business investment.”

Porter continued by suggesting that something else might be in play. “Usually late in the cycle when the global economy is doing well, you tend to get large inflows into Canada not the opposite. That’s why this number is disappointing. There is a problem here. Some of it does reflect ongoing concerns in the energy sector but I think there’s something else at play here as well,” Porter said.

And he might just be right.

Canada’s investment woes did not just appear all of the sudden. Canada has seen a considerable drop in foreign investment since 2014. Fraser Institute President Niels Veldhuis and Vice President Jason Clemens provide a sobering analysis of Canada’s troubling investment climate:

“And unfortunately investment data bears out these anecdotes. Since peaking in the fourth quarter of 2014, total business investment –excluding residential housing and adjusted for inflation – is down almost 17 percent. Private-sector investment in factories and other structures is down 23.3 percent. And investment in intellectual property is down 13.3 percent. Investment by foreigners has collapsed. Foreign direct investment (FDI) in Canada was $31.5 billion in 2017, down 56.0 per cent since 2013 when it totaled $71.5 billion.”
For years, Canada has been a solid competitor to its southern neighbor in the United States, but now it is seeing its economic fortunes reverse.

What exactly gives?

Ever since President Donald Trump signed tax reform into law, the once notable tax advantages that Canada held are no longer present. Now that the United States has the edge on Canada in various aspects of tax policy, Canadian policymakers have tough choices to make.

One thing is clear: To remain economically competitive with its neighbor, Canada must consider reform.

Toronto, Canada - tall buildings and sky reflecting in water.

The nature of U.S tax reform

To understand why Canada’s trend of declining investment may become even more pronounced, we must first look at what the Trump administration’s latest tax reforms have accomplished.

Kicking off 2018 with a bang, the United States government undertook a series of tax reforms that saw certain taxes rates brought down.

While not far-reaching from a free market standpoint, these reforms have still made the United States considerably more competitive on the international stage, especially against its rival and long-time trading partner Canada.

President Trump’s latest tax reforms notably dealt with reductions in corporate taxes from 35 percent to 21 percent top individual income tax rates were slashed from 39.6 percent to 37 percent.

For years, Canada has enjoyed a considerable corporate tax advantage. In 2017, the United States marginal corporate income tax rate stood at 35 percent, whereas the Canadian rates were at 21 percent. The most high-profile case where Canada exploited this advantage was when Burger King merged with Tim Hortons and moved its headquarters to Canada as a means of reducing its corporate tax burden.

On the other hand, Canada’s top income tax rates were already considerably higher before the American tax reform, with the top federal-provincial rates at approximately 54 percent, while the United States topped out at 46 percent. It should also be noted that Canada’s top rate covers a considerably lower income level.

A Fraser Institute report provides a sobering picture of how the Canadian government, both at the federal and provincial level, is making the country less competitive:
“Ottawa and several provinces have undermined Canadian competitiveness with an assortment of policies that discourage investment. This includes higher tax rates on personal income, corporate income and payroll; persistent budget deficits, which risk future tax increases; new regulations on carbon, resource projects and labour; and higher costs of doing business through minimum wage and energy price hikes. And now, as we’re seeing with the Kinder Morgan Trans Mountain pipeline expansion, increased uncertainty about the rules and policies affecting economic and resource development. The cumulative effect of such policies, along with strong anti-business rhetoric from many governments, has struck a harsh blow to Canada’s investment climate. U.S. tax reform, plus uncertainty surrounding NAFTA renegotiations and access to the U.S. market, only rubs salt in Canada’s self-inflicted policy wounds.”

Although the effects of investment will take time to manifest themselves in the United States, Canada will now be operating in an environment where it no longer has a leg up on the United States in tax policy.

The effects could be harmful for Canada, as companies will opt to the more business-friendly United States.

Canada’s anti-middle class tax policy

Canada must now come to grips with the new reality of a more tax-competitive United States If Canada maintains it high-tax status quo, it will continue to remain unattractive to foreign investors.

To keep pace with the United States, should Canada consider its own tax reform program?

Tax-wise, Canada has embarked on the wrong path to tax policy since Prime Minister Justin Trudeau arrived in office in 2015. Ostensibly campaigning under the banner of cutting taxes for the middle class, the Liberal Party’s tax reforms have done the exact opposite.

A paper by Charles Lammam, Milagros Palacios, and Hugh MacIntyre exposes the unsavory truth behind this tax plan. For starters, this report initially found the following: “[I]ncome tax changes have resulted in 60 percent of the 3.88 million families with children covered in this paper (representing 13.9 million individuals), paying more in taxes. The average tax increase amounts to $1,151 each year.”

But it gets even juicier: “Among middle income families – the group of families the federal government claims to want to help – 81 percent are paying more in taxes as a result of the federal income tax changes. The average income tax increase for this group of middle income families is $840.”

And to top it all off: “For the subset of middle income families consisting of couples with children, an even greater share (89 percent) pays higher income taxes ($919 on average).”
No matter how much the Liberal Party claims to be pro-middle class, the tax reforms they have recently spearheaded do not bode well for their constituents. In many regards they have violated their trust by doing the exact opposite they campaigned on.

Time will tell if the Canadian middle class will eventually come to their senses and push back against any more tax hikes.

Mandatory pension contributions: A domestic investment bottleneck

Foreign investment is not the only form of investment in potential trouble.

In an article for the Financial Post, the Fraser Institute warns how increased contributions to the Canada Pension Plan (CPP), which is slated to go into effect in 2019, could stymie domestic investment. Simply put, mandatory increases in contributions are a non-starter for a country that is already going through a questionable investment climate.

The Fraser Institute recognizes how vital investment is for economic growth: “A decline in investment within Canada will have negative effects on the Canadian economy, as investment is critical to making workers more productive, increasing wages and improving living standards,” the report said.

It continued: “The decline in investment will also come at a time when business investment in Canada is already decreasing and lagging behind other industrialized countries.”

Starting in 2019, money that would otherwise be allocated to productive activities like domestic investment will then be siphoned into a government-run pension scheme notorious for its costs and inefficiencies.

In the end, Canadians get a raw deal. Every dollar that Canadians can pocket makes all the difference in the quest to grow Canada’s wealth. When the government continues to embark on a confiscatory route of taxation or forced contributions, economic stagnation will follow.

It’s all about jurisdictional competition

Economic growth remains king in discussions about reducing poverty.

The most proven method to attracting the investment necessary to boost economic activity is having low fiscal and regulatory barriers. High taxes and out of control spending generate economic uncertainty and makes investors and businesses think twice about setting up shop in countries like Canada.

This will be especially pronounced now that the United States is at least beginning to embrace certain tax reforms, as is the nature of tax competition between different jurisdictions.

When pushed against the wall, countries will seek whatever competitive edge they can get – be it lower taxes, lower regulations, or easier steps to start up a business. As fierce as this competition maybe, it yields positive results for workers worldwide.

Historically speaking, citizens around the world were bound to their birthplace and had to serve some type of overlord. Thanks to tax competition, citizens worldwide now have the ability to take their skills to jurisdictions that are in line with their financial and political values.
Both countries and skilled laborers win out in this arrangement.

Now Canadians policy makers must consider fiscal policies that make Canada attractive to businesses and investors alike.

They can start by cutting income taxes and considering a move to privatized pension scheme in the mold of Chile, where voluntary contributions are emphasized and the state’s role in the process is reduced.

A tax-competitive North America is a win-win for both American and Canadian workers.

Spain’s fiscal outlook

Spanish Flags

Spain’s fiscal and economic development over the period from 2007 to 2017 reflects two different and politically opposed governments: that of socialist Jose Luis Zapatero, whose term in office faced the adverse effects of the global financial crisis from 2007 to 2011, and conservative Mariano Rajoy’s administration from 2012 until June 1, 2018.

Rajoy’s government, to its credit, made significant efforts in turning the inherited declining economy into a steadily growing one. Still, Spain needed six years to shift from negative to positive GDP growth, compared with an average of three years spent by the U.S., U.K. and the euro area.

Spain, the fifth-largest economy in Europe and a highly decentralized state, is not formally federalist. But with significant budgetary powers bestowed to the governments of its 17 autonomous communities, it can be considered de facto federalist.

The nation has paid a big toll since the financial crisis of 2008.

The distinctive factors that shaped the Spanish economic crisis included declining GDP, rising unemployment (peaking at 25.8 percent in year 2012, which subsequently declined to 16.7 percent at the end of 1Q 2018), as well as the collapse of fiscal revenues and skyrocketing indebtedness (114.9 percent of 2017 GDP).

In addition, the financial sector was bailed out to the tune of US$400 billion, which required a taxpayer capital injection of US$66 billion that still has to be recovered in full.

And rating agency Moody’s steeply downgraded Spain’s sovereign rating from AAA to Baa3.
However, there is some good news. It is widely recognized that despite remaining structural economic and fiscal imbalances, the Spanish economy performed well above that of its European partners and the average of OECD countries during the past four years.

In dealing with the economic crisis, the conservative-led government, that took office at the end of 2011, pursued an aggressive fiscal policy that was not very conservative, at least if conservative means small government. The government more than doubled public borrowing from 41 percent of GDP before the crisis to 114.9 percent at the end of 2017.

At the same time, from 2012 to 2014, the Spanish government applied shock therapy by raising the rates of value added tax, personal income tax and, to a lesser extent, corporate income taxes.

In 2014, six years after the crisis and after four years of drastic fiscal policies largely aimed at curbing the mounting budget deficits, both public accounts and the overall economy started to show tangible signs of recovery. GDP grew at an average of 3.3 percent and public deficits dropped from a peak of $164 billion in 2009 (10.9 percent of GDP) to $41 billion in 2017 (3.1 percent of GDP).

In 2015, after profiting from the upswing of the economy, the government decided to significantly cut personal and corporate income tax rates.

Tax changes, 2007 to present

Personal income tax is the primary contributor to the budget, representing on average 38.7 percent of total tax revenues or 7.1 percent of GDP. The main components of the taxable base include salaries, savings and capital earnings, income from professional activities, pensions and unemployment cash subsidies.

Following the general elections in March 2008, the new government gifted personal income taxpayers almost $17 billion in tax breaks. These were allocated to the years 2008 and 2009 to fulfil an electoral promise made in 2007, when the Spanish economy was growing at 3.8 percent, and early warning signs of a forthcoming economic crisis were ignored.

But this generous tax allowance was short-lived as the crisis proved to be more persistent than expected and a $7 billion package was passed to further squeeze households’ pockets in 2009 and 2010.

Still, the fiscal policy focus of offsetting rising deficits by targeting personal income and VAT, the main consumption-based tax source, was actioned by the Conservative government that took office at the end of 2011.

Graph showing Personal Income tax, Corporate tax, Value Added tax, from 2007 to 2017.In all, the 2008-2009 $17 billion tax rebate stimulus was reduced during the following years to a meagre $1 billion due to tax hikes of 2010 to 2014.

Once the economy started to grow from 2014 onwards, personal and corporate income tax were reduced, while leaving VAT tax rates untouched, confirming that, like in other jurisdictions, VAT rates remain high once they are increased.

Ultimately, the government managed to reduce the households’ financial burden in 2015 and 2016 by providing tax breaks worth $9 billion thanks to the tail winds benefiting the economic recovery.

Corporation tax

The corporate income tax reflects the devastating effects of the financial crisis. Despite lowering tax rates, and thus boosting tax collection, this has not translated into tax higher receipts.

Current annual corporate tax revenues are only half of the US$47 billion peak in 2007 as companies accumulated crisis-driven operational losses of about US$1.6 trillion. These losses generate an estimated deferred tax claim of $300 billion that can be deducted from future profits.

Graph showing Unemployment numbers and Corporate Tax revenue from 2007 to 2018.On the positive side, the corporate income tax incentives introduced from 2013 to 2015 had a positive effect on employment.


In 2012, the VAT general and reduced rates increased by 3 and 2 percentage points to 21 percent and 10 percent, respectively. This contributed an estimated $13.5 billion in tax revenue to the Treasury from 2012 to 2016, whereas the tax changes enforced by the government during the two crisis years (2008-2009), drained $11.9 billion.

This tax hike in conjunction with a 3.7 percent annual growth in household consumption over the last six years up to 2017, pushed up VAT collection to its highest level over the last 10 years, despite weak demand in the real estate market (housing purchases at 0.4 times the volume invested from 2007 to 2011) and a 2.5 percent decrease in public expenditures.
Spending changes, 2007 to 2018

Three key drivers govern Spain’s public expenditures policies. Firstly, Spain is a welfare state whose social policies are enshrined in the Constitution. Secondly, the highly decentralized governmental structure, and, thirdly, the high degree of autonomy granted to the regional governments in deciding their own policy choices in allocating resources to meet the people’s needs for public services.

Graph showing Central government expenditure, Regional government expenditure, Local government expenditure from 2007 to 2017.Public expenditures represent 43.9 percent ($498 billion, 2017) of GDP. The central government manages about 23.6 percent ($98 billion) of total expenditures without taking into account those related to the $199 billion social security funds – pensions, unemployment and other social benefits payments. The regional governments, including city councils, control the remaining 76.4 percent ($317 billion).

To meet the expenditure bill, the regional administration is funded through a complex distributive scheme of taxes collected by the central government, namely personal income, VAT and other taxes associated with consumption.

Central government meanwhile retains the power to impose additional taxes on personal income, property, net wealth, financial and capital transactions, inheritance, etc.

As for welfare state-related social expenditures, pensions, healthcare and education made up 68.2 percent ($418 billion) of total public expenses for the year 2017.

During the financial crisis, public finances suffered from dramatic fiscal deficits that had not been seen in the past 40 years.

Graph showing Fiscal deficit (surplus) %GDP from 1992 to 2017.
Data sources: Banco de España, OECD, Instituto Nacional de Estadística, World Bank Eurostats

The most acute deficit was in 2009, when borrowing jumped to 11 percent of GDP and, with three successive years of fluctuating from 9.4 percent to 10.5 percent of GDP, Spain was pushed to the brink of intervention. The country finally took a milder-than-expected solution by undertaking the restructuring of an ailing financial sector and significant tax increases.

Finally, the trend of declining fiscal deficits since 2013 to date appears to consolidate its downward path to restore the equilibriums after a long period of adverse economic cycle.
The way forward
The costly and often redundant bureaucracy of the Spanish administration is becoming a growing concern among the citizenship. It causes the inadequate management of public funds at the cost of rising taxes, unserved public services, and growing indebtedness that will be paid by the current and future generations of taxpayers.

The quasi-federal regime has proven highly expensive and inefficient, particularly during troubled economic cycles that leave the central government largely without any capacity to influence expenditure and rebalance regional finances.

In the years to come, the government should further strive to achieve aggressive fiscal consolidation efforts to keep the public accounts aligned with the EU’s Maastricht convergence criteria thresholds, of sound finances with government deficits not exceeding 3 percent (3.1 percent, 2017), and the sustainability of the public debt within the limit of 60 percent (103.4 percent, 2017), both ceilings as percentages of GDP.

To meet this purpose, and against the traditional appetite of left parties for raising taxes, decisive actions need to be taken to reduce the size of the general government, by fighting expense redundancies, eliminating subsidies to recurrent losses of government organizations, and privatizing entities whose purpose the private sector might serve more efficiently. This would ease the tax burden actually borne by the citizenship and open new spaces for wealth and employment creation.

The untenable compulsory public pension system is threatened under current and foreseeable scenarios of an ageing population and the dawn of the technological progress that entails the fourth industrial revolution and its related companions in the fields of robotics and technologies.

The expected reduction in the number of future paid jobs contributing to the social security system, prompts for a thorough reform of the current worker-based financial contributory regime that over the last five years has become gradually insolvent – the social security accounts show a technical bankrupt institution with a negative financial net worth of $10.3 billion (8.6 billion euro) at the end of 201. This is due to the growing mismatch between the number of contributing workers needed to pay per pensioner – actually 1.9 workers per pensioner – and the inadequacy of the current contributory scheme to fulfil its financial obligations.

The underlying threats of interest rates, oil and commodities prices hikes together with the stability of the euro and an emerging trade-tariffs war, as well as the raising complex problems of migration flows, should also be present on the agenda of any government, whatever its political ideology.

And nowadays, the foreseeable political instability fueled by a weak parliament and the emergence of an opportunistic new government that owes its support to the convergence of socialist and communist-oriented populists, patronized by regional nationalist political parties whose outspoken intentions, from secession tentatives to vaguely formulated regime-changing proposals, are some of the key threats that Spain is going to face short-term.

The above challenges deserve robust, long-term thinking and resolute leaderships with shared visions aimed to protecting the social and economic fundamental rights of the Spanish people that are strongly rooted in their individual liberties and democratic values represented today by Spain’s vibrant, earnest and committed society.

The future of the Italian government in Europe

EU and Italian flags outside Italian government building.

Graphic of Italy with the Italian floag colours with the EU ring of stars hovering over top.The Italian elections of March 4 marked an unprecedented turning point both for Italy and for the European Union. Two populist parties, the Five Stars Movement and the League, interrupted the historical alternation between the center-left, represented by the Democratic Party, and the center-right, which over the last twenty years was represented by Silvio Berlusconi’s Forza Italia. The victory of the so-called “yellow-green” government represents an absolute novelty also for the European Union, which has never dealt with the election of an anti-establishment government in one of its founding states. From this perspective, the League and the Five Stars Movement succeeded where Marie Le Pen’s Front National failed in France.

The League and Movement Five Stars won their battle against the establishment by launching vehement slogans against the European Union, in particular Germany, which were deemed guilty of having increased the poverty level in Italy as a result of the austerity measures imposed in the last years by the German-led European Commission, with the objective of reducing the Italian public deficit and the huge mountain of public debt, currently equal to 2.3 trillion euros ($2.7 trillion). They also attacked Brussels on the migrant issue, accusing the European institutions of leaving Italy alone in activities such as the rescue at sea, first aid and management of migratory flows, also underlining the scarcity of European funds allocated by the European Union to cover the costs of migration policies.

The resulting increase in the fiscal pressure, which has led Italy to be the European country with the highest tax burden, especially on businesses, and the discontent that has ensued, has created a fertile ground for the proliferation of populist messages. Another keyword used by the two parties during the electoral campaign was “sovereignism,” which was exploited as a synonym for reducing the EU meddling in Italy, a communication strategy already used successfully in Hungary by Viktor Orban, by whom the League was inspired.

Since the draconian economic policies imposed by the European Union have been presented by the two parties as the direct consequence of the liberal and capitalist vision of the globalized economy, the proposed recipe has been the total break with the spirit of rigor and control of public finance. This break was expressed in a clear socialist economic program, all stuffed with welfare measures and statism. The proposal for the introduction of a citizenship income and pension for all taxpayers is the best example.

But winning the election in one thing, another is keeping the promises made during the electoral campaign. The yellow-green government led by Giuseppe Conte, an academic and a lawyer without previous political experience, realized it very soon. The government program signed by the two coalition leaders, Luigi Di Maio and Matteo Salvini, contains an economic plan worth more than 100 billion euros, with very expensive measures, such as a flat tax with a 15 percent tax rate, a citizenship income, a loosening of the previous pension reform, measures to reduce poverty and the reduction of taxes. Such an expensive program is evidently incompatible with respect to European rules for public finances. Previous Italian governments had made commitments to the European Commission to eliminate structural deficits by 2020, and to bring down the debt-to-GDP ratio, which is currently above the 130 percent threshold. The leaders of the League and Five Star Movement have repeatedly declared that they are ready to disregard European rules and want to use a deficit spending strategy to cover their ambitious program. Some members of Conte’s government, such as the Minister for European Affairs, professor Paolo Savona and two influential League economists, Claudio Borghi and Alberto Bagnai, declared their willingness to exit from the single currency in some of their academic publications. The response from European economic institutions and from financial markets was obviously negative. Yield on Italian sovereign bonds jumped when investors realized the danger of having anti-euro economists at top seats.

The risk of observing an unprecedented clash between Italy and EU institutions is high, and Italy has much to lose from it. The rating agencies have already warned Italian policy-makers that, in case of abandonment of the deficit and debt reduction strategy, the sovereign rating of Italy would be revised downwards. If so, borrowing on markets would become much more difficult and expensive by the Treasury, which would pay a higher yield on the issued bonds.

Another very important issue on which Conte’s government will have to demonstrate its ability is the reform of European economic governance, which is being discussed in the Economic Council. Germany and France have been working on it for a long time and they agreed to propose the creation of a European Monetary Fund (EMF), based on the International Monetary Fund (IMF) model, which should replace the current European Stability Mechanism (ESM), the fund created in 2012 to help member states in financial distress.

The aim of German Chancellor Angela Merkel and French President Emmanuel Macron is to create a concessional mechanism, which would grant financial aids to heavily indebted countries, in exchange for structural reforms, such as those on labor markets, productivity and spending review of public administration. Since the decisional mechanism will be based on a majority which will depend on the share of underwritten capital, instead of unanimity, Germany and France would have a de facto veto power, as their quotas would be worth around 47 percent. Furthermore, France and Germany agreed upon the creation of an EU economic minister and broader European fiscal powers. These proposals are evidently not in the Italian interest, as Italy could indeed be the first victim of the EMF, running the risk to lose its freedom to decide economic policies. Secondly, we must bear in mind that in 2019 Italy will lose three top seats in the European institutions: the presidency of European Parliament (Antonio Tajani), the presidency of the European Central Bank (Mario Draghi) and the High Representative of the EU for Foreign Affairs and Security Policy (Federica Mogherini). Other member states will remind that Italy has had too many top seats over the last years and they will claim them. Germany and France are serious candidates to win the ECB top seat, with Bundesbank’s governor Jans Weidmann sponsored by Berlin, and the new minister of economy, a seat which could be taken by France. If this scenario should occur, Italy would be subject to the German-French axis, with their dreaded mix of restrictive fiscal and monetary policies. For all these reasons, premier Giuseppe Conte will have to negotiate with his EU colleagues, to prevent the German-French position, without forgetting he is not in a position to ask without giving something in return. Especially after his ministry of economy, professor Giovanni Tria has already asked European institutions to allow a higher deficit to postpone the balanced structural budget goal beyond 2020. From this perspective, France and Germany could grant Italy some leeway for deficit spending in exchange for the Italian assent to their economic governance proposals.

The other big trap that the Franco-German axis is preparing for Italy concerns the completion of the European Banking Union, to be implemented through a maximum clearing of the banks’ balance sheets, especially on the part related to the non-performing loans (NPL). The Franco-German agreement was given birth at a recent meeting held in Mesemberg, Germany, where Paris and Berlin agreed on the need to introduce the goal of reducing gross impaired loans to 5 percent and net impaired loans to 2.5 percent of total loans held. Should this proposal pass, the Italian financial institutes, which currently hold gross NPLs share of 11 percent and net share of 6 percent, would have to make a huge effort to respect the parameters. It is almost certain that, to achieve the goal, they will be forced to reduce their lending activity to households and businesses. This choice that would be punished by financial markets through a selloff in shares, making the institutions themselves prey to foreign acquisitions. It is a widely held belief in Italian society that it is France’s goal to continue in its campaign to conquer Italian savings, which started with the acquisitions of Pioneer, taken over by Amundi, and Banca Leonardo, taken over by Credite Agricole.

The next goal is the conquest of Unicredit through a merger into Société Générale. From this point of view, France had the ability to name Daniel Nouy at the helm of the supervision arm of the European Central Bank. Nouy, the most strenuous proponent of the NPL reform, will clash with ECB’s governor Mario Draghi and the President of the European Parliament Antonio Tajani, who claimed responsibility for legislative power on this topic. The proposal was also backed by another prominent French representative, Christine Lagarde, director general of the International Monetary Fund. For the moment, the Italian front has won its battle, but things will change inexorably starting next year, when the mandates of Tajani and Draghi will expire. At that point, France, which currently does not hold important roles within the Union, is ready to launch the assault on these two seats. At that point, it would find very few obstacles to get through the reform of bank overdrafts, from a profitable perspective. For the Italian banking system, this would be a catastrophe. Strangely, in the Franco-German proposals there is no mention of the question of illiquid securities, of which 75 percent are held by French and German banks. Italy has never put forward a proposal on this subject, and it would have good reasons to do it. In short, if the model of banking union proposed by Macron and Merkel were to pass, risk sharing would exist only for France and Germany. The weaker ones would not be guaranteed at all, on the contrary, the saving of their citizens would easily fall prey to the Franco-German colossus.

Defending Italian interests in Europe will be the first goal of Conte’s government. It is perfectly in line with the anti-establishment slogans launched during the electoral campaign. Nevertheless, the new government will need more than slogans to convince the other European superpowers that it is time to reform European Union according to what people, and not bureaucrats, desire.

Everyone is a millionaire

Man in suit holding paper with 'Who wants to be a millionaire?' printed on it.

Do a thought experiment. Think back to the year 1979 if you were born before 1964 or, if not, just think back to the year you turned 16. How many hours did you have to work to buy the goods and services you purchased? There has been considerable discussion about so-called “wage stagnation” in recent years in the U.S. and some other countries, even though after-tax wages now seem to be rising again.

The common measures of inflation, such as the Consumer Price Index, provide a reasonable indicator of the change in price of the same goods over time. With standard commodities, such as wheat, corn, oil, steel and aluminum, the product is essentially identical over long periods. The nominal price usually increases due to changes in the money supply. The real price change reflects both the change in the price level but also the change in productivity. On average, the nominal price of aluminum is now about double what it was 40 years ago, but the average nominal wage is about three times what it was 40 years ago. So where it took the average person about an hour and half of labor to buy a pound of aluminum, it now only takes them about an hour. This means that the real cost of aluminum has declined because of improved manufacturing technology and a real drop in the cost of energy (which is a major component – 40 percent – of the cost of aluminum).

Most manufactured items and agricultural products have had much bigger increases in productivity. The “Human Progress” division of the Cato Institute, directed by Marian Tupy, produced an info graphic of how many hours it took to earn enough money at an average wage in 1979 as compared to the average wage in 2015 to purchase a number of common items. Some examples are in the table below. It shows the reduction in the number of hours from 1979-2015 to produce some common products.

Table comparing hours of labor for creating products in 1979 and 2015These products may have the same name and function today of those made decades ago, but most things have vastly improved in quality and safety. A 19-inch TV used to be a screen with a fat back that contained a cathode ray tube producing a greatly inferior picture compared with today’s flat screens. And quality and reliability is vastly superior at one-tenth of the real cost.

In the 1980s, I was a member of a U.S. government panel that was trying to improve the measures of inflation. One of the problems we were dealing with was to measure and value improvements in products. For instance, we knew the price of a standard 1954 Ford and the price of the standard 1984 Ford; but over the years, many quality, device and safety improvements had been made so they were not the same product and merely looking at the price change was of limited use. That problem was easy compared to the increasingly rapid rate of change in virtually all products now.

The Ford Model T was produced from 1908 to 1928 and set the record for the number produced (15 million) until it was dethroned by the VW Beetle a few years ago (which is also no longer in production). Trying to compare the Model T with a new Ford to obtain a measure of productivity gain and price inflation is a fool’s quest because they are not even close to being the same product. The Model T in terms of performance and utility has much more in common with a high-end golf cart than a modern automobile. The Model T Runabout had open sides like a golf cart, was slow with a limited range, and had about the same payload that a modern high-end golf cart has. In terms of the average wage in 1920 and now, the golf cart (according to my crude, back of the envelop calculations) takes about a third as many work hours to purchase than the Model T.

The traditional “market basket” approach, whereby changes in prices of a standard set of products is measured to determine inflation and real incomes, is less and less useful in a high-tech, rapidly changing environment. The problem is compounded as the typical person spends an ever declining percentage of his or her income on physical manufactured products and more on services. Many physical products are becoming less and less standardized as new technologies allow for much greater customization – each product being specifically tailored to the wants, needs, and desires of each customer. If every product is different, it becomes almost impossible to compare changes in real costs over time.

The problem with services is even worse. Was a haircut in 1918 the same as in 2018? Well, basically yes, and we can measure the price change. But how about a newspaper? Physical newspapers have only slowly evolved, but now most people get their news from some electronic source – and increasingly those who “provide the news” tailor their product so each customer receives only the news (and even opinions) which are of interest to them – as determined by an algorithm.

Medical services that are provided today have little resemblance to those provided a couple of decades ago. Imaging technology and the ability to measure human chemistry and electrical activity are growing at an exponential rate. Body parts are now routinely replaced by both physical devices and biological constructs. They may cost a considerable amount of money, but they also enable people to live longer, more productive, and happier lives.

Given that the average person spends considerably less labor time than in previous times to buy the products they perceive they need even when their real wage (inflation adjusted) has not increased – the question remains as to where they spend the extra money. Note that the relative price of products changes so people tend to substitute the ones that have become relatively less expensive for the ones that have become relatively more expensive.

For example, the smartphone did not exist two decades ago but now most people have them. The smartphone allows a person to access a huge number of apps, often for free, or at little cost.

Going back to our mind experiment – what would have been the cost of each of those apps you now use if you had purchased them as standalone products in 1979? For example, how much would it have cost to buy a camera with all the features found in a standard modern smartphone (realizing that the most expensive cameras in the world back then had nowhere near the resolution of the new smartphone cameras?) Add up the costs of all those things that you now buy or acquire for almost free – goods and services that you could not afford in some past time period or were not available at any price – that number is the true measure of the change in your real income.

Because of Google, your smartphone has virtually all of the world’s information in it. The best library in the world (the Library of Congress) with the largest collection of material is now available at virtually no charge to anyone. How much is that worth? Smart students who are diligent and have a basic command of English and mathematics can now get themselves a world-class education for free because many of the leading universities have put their courses online – along with all the necessary material for free. How much is that worth?

Online maps and directions save people countless hours in trying to get from point A to point B. How much is that worth? Everyone now has access to the latest medical developments.

How many lives has that saved? And how much is that worth? The examples are endless, but the point is everyone has free access to stuff that would have cost them millions of dollars even 20 years ago.

What are we trying to measure and why? For many reasons, it is useful to know at what rate living standards are improving, and it is vital to know at what rate the purchasing power of government currencies, like the U.S. dollar, is being eroded.

As explained above, merely looking at the real reduction in cost of producing and acquiring goods and services today in comparison with some earlier time period only provides limited and incomplete information about individual well-being. Perhaps the best that can be done to answer the question of how much living standards have increased from a previous time period is to look at the consumption pattern of a typical person with an average income and then try to determine the cost of what those purchases would have been in the previous period in inflation-adjusted dollars.

As also explained above, there are many problems in determining how much inflation (erosion of the purchasing power of the dollar) there has been from any previous time period. U.S. dollars (USD) serve as the global measuring stick as to the value of production and consumption, and wealth. For instance, most of the world’s major commodities, such as oil, are stated in U.S. dollars. Global economic statistics are reported by the leading international organizations in U.S. dollars.

A meter, a liter, a gram, and the speed of light are all constants (except in the world of quantum physics) and thus are useful for measuring and comparing, even over very long time periods. In contrast, the dollar and all other government fiat currencies are not constants – they are ever-changing rulers, which also change at variable rates. Over the last half century, the value of the dollar has changed between an estimated plus 0.4 percent to minus 13.5 percent per annum.

When the world was on the gold standard, there was not the persistent inflation, and, in fact, there tended to be a small, but variable, amount of deflation per year – because the increase in gold supply did not keep up with the increase in world output. Many argue that the world should go back to the gold standard – but an agreement among the world’s major economic powers would be needed to bring it about.

The great distinguished economist, F.A. Hayek, in his 1976 book “Denationalization of Money” argued for non-government money – perhaps use a commodity basket as a backing. My own research into the area over the last few decades has led me to conclude that using aluminum as a backing to a global currency is the best solution (see Rahn, “The Future of Money: How Cryptocurrencies with Real Backing will Become the Ultimate Disruptive Technology” Cayman Financial Review, October 2017). Whether gold, aluminum, or a commodity basket, etc., the evidence is that the private sector can create a better money (a less variable measuring stick) than the USD, or any other government fiat currency. A more stable stick, can give us a tool to obtain improved measures of inflation, but as noted above, it in itself cannot solve the problem of how to measure the changes in national and individual economic well-being.

There is no limit to technological progress – and thus there is no limit to mankind’s ability to reduce the real cost of virtually all goods and services, and create new ones to make life better and more enjoyable. Several decades ago there was a TV program “The Millionaire.” Each week the representative of a very rich man would give some ordinary person a million dollars – and the rest of the story would be how it changed his or her life for good or bad. As they say, a million dollars is not what it used to be because of inflation. But in reality it is much more – because a million dollars today can buy you what could have barely been imagined a half century ago. In terms of times past, most people are de-facto millionaires today; and within the next half century, most people will be enjoying things that only billionaires can today.

Good news about redistribution?

Click to enlarge.

Economists, investors and business leaders devote considerable effort to peeling back the layers of causality that impede economic growth. Among the causes are high taxes that divert money from productive investment. High taxes, in turn, are caused by large government redistribution, which is justified as a countermeasure for income inequality and poverty.

This paper summarizes new research that peels back one more layer of the causal chain and shows that in the United Sates, official portrayals of income inequality and poverty are overstated by factors of five or more. One cannot generalize these results directly to other advanced nations, but some of the underlying mechanisms that created the overstatements likely exist elsewhere. Until further research shows otherwise, official claims with respect to the extent of poverty and income inequality in advanced nations should be treated with some skepticism.

Counting all income and taxes

Calls for more redistribution cite differences in money income as measured by the Census Bureau Current Population Survey (CPS). Money income includes earning from work or business, Social Security, some retirement plans, cash public assistance, dividends, and interest. The first data column in Table 1 shows the distribution of household money income by income fifths or quintiles. See table 1

Table showing distribution of household income by source, United States, 2015
Click to enlarge.

Differences in the average money income are offered as proof of significant inequality. For example, the ratios section of the table shows that average money income for the top quintile is 16.2 times larger than for the bottom quintile. But these comparisons exclude $1 trillion in government transfer payments to lower-income households and do not account for taxes that reduce the spendable income for higher-income households by as much as 50 percent.

These missing elements are not mistakes; they are documented exclusions with known but largely ignored features. If the government were to raise taxes on the wealthy and transfer all the additional money to the lowest income group through more food stamps, the official metrics of inequality would not change because neither the new taxes taken from the top nor the additional money given to the bottom would be used in the calculations.

The “More complete estimates” columns in Table 1 are the result of research that enhances the Census data to fill many, but not all, of the gaps in the money income measure.

The improved estimates begin with the distribution of market income across its quintiles, followed by the distribution of Social Security, other transfers, and taxes across those same households and then the resulting distribution of final net income. For example, the lowest income fifth makes only 2.2 percent of the total market income. Their income is augmented by a 34.3 percent share of Social Security and Medicare and 41.5 percent of other transfers.

These households contribute only 1.1 percent of all taxes. The result is that the lowest quintile receives 12.9 percent of spendable income available for consumption and savings.
The highest income quintile earns 57.7 percent of all market income, receives only 10.4 percent of Social Security and Medicare payments, pays 65.3 percent of all taxes, and is left with 39.3 percent of the final net income.

The ratios in the last three lines of Table 1 show the degree of inequality in the components. Average market earnings in the highest income group are 26.6 times those in the lowest. But the lowest income group gets 3.3 times more in Social Security and Medicare. It also receives 41.5 percent of other transfers while the highest group gets essentially none. The highest income group pays 61.2 times more taxes. The net result is that the highest group averages only 3.0 times more spendable income than the lowest. As in the next-to-last column shows, government redistribution has cut the ratio gap between the top and bottom quintiles by 88.6 percent. The last column shows that the gaps in more complete statistics are 81.3 percent smaller than in the Census money income. See figure 1

Average income, transfers, and taxes by income groups, 2013
Figure 1

Figure 1 illustrates the dynamics of redistribution. On average, households with $63,136 in earned market income get to keep it all. They pay taxes averaging approximately $17,000 per year but on average also get an equal amount of government transfers. Households with earned income less than $63,136 constituted 52.5 percent of all households and on average received net benefit payments from government. Some of the 47.5 percent of households above the break-even point also got transfer payments, but they paid more taxes than the transfers they received.

Net taxes from the top 47.5 percent of households raised average spendable incomes for the lower groups to near the median earned-income level and also to pay for all government services.

The Gini coefficient measurement of inequality

Advocates to reduce income inequality use a computation called the Gini coefficient to claim that income inequality in the United States is greater than in other developed democracies. The Gini coefficient has a theoretical minimum of 0.000 that represents no inequality, with everyone having exactly the same income. Its theoretical maximum is 1.000, representing total inequality with one person having all the income and everyone else having nothing.
Figure 2 displays Gini coefficients from the Organization for Economic Cooperation and Development (OECD) for seven large economies plus Denmark and Sweden, the two OECD nations with the smallest (least unequal) Gini coefficients. (For now, ignore the USA Complete bar.)

But the OECD explicitly excluded Medicaid transfers and state and local taxes from the United States calculation. These exclusions constitute a significant upward bias in the United States coefficient. The “USA Complete” Gini coefficient in Figure 2 corrects for these omissions, thereby reducing the coefficient to 0.23, lower than any of the comparison countries. See figure 2

Graph showing Gini coefficients of spendable income in advanced nations, including more complete USA coefficient
Click to enlarge.

The incidence of poverty has fallen significantly

Measuring the incidence of poverty starts with a poverty threshold, below which people are designated “poor.” The U.S. government stipulates poverty thresholds in terms of money income. They were first calculated for 1963 at three times the cost of an adequate economical diet. Since then, each threshold has been escalated by the rate of change in the Consumer Price Index for All Urban Consumers (CPI-U).

The Census Bureau uses the CPS family money incomes to identify families with incomes below their relevant thresholds. For 2015, it reported that 13.5 percent of the population lived below their poverty thresholds, the same as the average for the preceding 48 years. See figure 3

Graph showing percent of population below poverty threshold, 1947-2015

During the 15 years before President Lyndon B. Johnson called for the War on Poverty, the measured poverty rate had fallen from 34.8 percent to 19.0 percent. Two years after his speech and before most of the new programs were fully implemented, the rate had dropped to 14.7 percent, well within the range that would prevail for the next 48 years.

The apparent failure to reduce the incidence of poverty and the end to the systematic improvement trend of the mid-20th century is at least in part the result of flaws in the way poverty is measured.

In 1963, almost all welfare benefits were monetary payments which were counted in the CPS money income. But the War on Poverty and subsequent programs were excluded from the CPS measure of money income because they were considered “in-kind” aid. The $1 trillion-plus in annual transfer payments that are not counted in the official inequality measurements are also omitted from the income used to measure poverty. In effect, the new programs, by definition, could not improve the official measure of poverty, even as they were raising the spendable incomes of low-income people.

Escalating the poverty thresholds by the CPI-U overstates the money needed to maintain the standard of living established by the 1963 poverty benchmark. This excess is not the result of some mistake. It arises from well-known, but widely ignored, technical methods used in price-index construction. The Bureau of Labor Statistics publishes an alternative research estimate of consumer price change, the CPI-U-RS, that avoids some of these limitations. Bruce Meyer and James Sullivan have integrated the CPI-U-RS with other research to estimate poverty rates using a reduced-bias calculation of price change.

The official poverty measure stopped declining in the 1960s. Reduced-bias measures continued to decline for another 30 years until the turn of the millennium. The bias-adjusted poverty measure stabilized just below 5 percent, less than half the minimum 11.1 percent achieved by the official number in 1973.

Figure 4 shows the average annual income for the lowest 20 percentiles for 2015. The lower curve is the CPS money income used to calculate poverty. The official threshold line intersects the CPS money income curve at point A, the official poverty rate of 13.5 percent of the population.

The “CPS + Excluded Transfers” curve reflects the higher actual incomes resulting from a fuller accounting of transfer payments. It intersects the official poverty threshold just below 3 percent of the population, point B. Omitting transfer payments has caused poverty to be overstated more than four-fold. See figure 4

Graph showing incidence of poverty adjusted for excluded transfers and biased CPI

Point C identifies the 4.5 percent result from applying the reduced-bias poverty threshold to the official money income definitions. Finally, point D shows that using both the improved threshold and the more complete income estimates yields a 2 percent incidence rate, almost seven times smaller than the official measure.


More than 50 years after the United States declared the War on Poverty, poverty is almost entirely gone. Government spends more than $1 trillion annually in the name of reducing poverty. Yet the measurement system continues to report no reduction in poverty, and substantial taxpayer dollars go to people who are not poor.

Public understanding has also been misinformed by similar false signals about income inequality. The official estimates are deficient on several dimensions and exaggerate the degree of income inequality.

The misleading official measures continue be cited in efforts to increase transfer payments and raise taxes. A new, informed debate is needed on the size and structure of redistribution that comport with the facts. The good news is that the challenge is much smaller than we had been led to believe.

Breaking the ‘Medici Vicious Circle’ – monopolization trends in advanced economies

Competitive markets form the very foundation on which the edifice of the modern liberal economy rests. The neo-classical proposition, under which competition arbitrages away monopolistic advantages and costs, ensures in theory that (1) consumers receive improved value-added offers priced at zero economic profit; (2) entrepreneurs can avail themselves of feasible options to enter the markets with better offers; (3) resources used in production are priced to reflect their true value-added, and consistently with their efficient use; and (4) no firm can have a market power to engage in rent-seeking vis-à-vis the state in the long run.

Street sign with 'Perfect Competition' pointing left and 'Monopoly' pointing up.As such, this proposition provides for productivity-linked wages, and sustains the perpetuation of the long-cherished American Dream of social mobility based on merit, as opposed to an unfair advantage derived from proximity to and abuses of state power.

Put simply, the existence of competitive markets is one of the core checks and balances on both corporate and government-instigated abuses of power, and a corner stone of the liberal democracy, underpinning the basic doctrine of the post-World War II liberal order.

Alas, Theodon, the Greek god of reality, is a very distant relation to Metis, the Titaness of thought. While competitive in theory, our modern economy is becoming increasingly monopolistic and monopsonistic, with significant implications for the sustainability of our democracies. In this process, the U.S. is a proverbial canary in the mine, heralding the trend for other advanced economies.

Rent-seeking in the government ‘swamp’

A recent paper by Luigi Zingales of the University of Chicago deals with the growing evidence that the U.S. companies are engaging in aggressive and persistent rent-seeking behavior in an attempt to influence political processes to their advantage. As Zinglaes notes, neoclassical theory in economics assumes that firms have no power beyond the ordinary market contracting, and, thus, cannot “influence the rules of the game.” In reality, however, firms exert real power to define and shape policies that benefit their bottom line. In a way, companies not only ‘fish’ in the proverbial political swamp but cultivate it. “The more firms have market power, the more they have both the ability and the need to gain political power.” Accordingly, Zingales warns that market concentration can easily lead to a ‘Medici Vicious Circle’ where “money is used to get political power and political power is used to make money.”

A report by Global Justice Now from 2016 shows that 69 of the world’s largest 100 economic entities were corporations, not sovereign states. Ten companies appear in the ranks of the largest 30 entities in the world, all with annual revenues higher than the governments of Switzerland, Norway, and Russia. In many cases, these large corporations have private security forces that rival governments’ secret services, vast legal support that make the U.S. Justice Department jealous, and, as Zinglaes notes, “enough money to capture (through donations, lobbying, and even explicit bribes) a majority of the elected representatives.” The only powers these corporations lack are the power to wage legal wars, the power of judiciary and the power of taxation. However, in many cases, the aforementioned large corporations have recourse to state resources by proxy, as exemplified by the U.S. government’s active lobbying on behalf of larger American corporations, as well as by the Russian and Chinese corporates direct access to the security apparatus of their home states.

Product markets concentration

The trend over the last few decades clearly points to the rising power of the larger corporations across a wide range of metrics.

One example is the dramatic increase in the stock markets concentration in the U.S. over time. Since 1926, only 4 percent (or 1 in 25) of all publicly traded stocks accounted for all of the net wealth earned by investors, according to the research by Hendrik Bessembinder of the Arizona State University.

Four stylized facts well-established empirically describe today’s markets:

  1.  An increase in Tobin’s Q ratio to a level permanently above 1, so that the stock market value of the firm exceeds the productive value of the firm. Monopolistic powers and/or rent-seeking accounts for this disconnect between financial and economic valuations;
  2.  A relatively constant average rate of return on capital, even as the real rate of interest falls, suggesting that larger companies earn abnormal returns on investment;
  3.  An increase in the pure profit share, with a decrease in the capital and labor share, implying that firms transfer value added from technology, capital and labor to shareholders – a classical sign of monopoly power-linked profits; and
  4.  A decrease in investment-to-output ratio, even given historically low borrowing costs, which means that physical/technological investment and innovation are running low, even as the capital costs fall.

In simple terms, all four facts support the hypotheses that the U.S. economy is witnessing increased monopolization, and that this trend toward rising power is generating abnormally high returns consistent with rent-seeking.

On the product markets side, since 1997, more than 75 percent of the U.S. sectors experienced an increase in concentration levels as measured by the Herfindahl-Hirschman Index rising more than 50 percent on average across the U.S. economy. In line with the stock markets concentration evidence mentioned earlier, the size of the average publicly listed company in the U.S. as measured by market capitalization, went from $1.2 billion to $3.7 billion in constant dollars.

Three factors drive the above figures.

One: Entrepreneurship is on a decline. The rate of new company formations has fallen from 15 percent in 1975 to 14 percent in the 1980s, to 11 percent in 1995. In 2015, the rate was just above 8 percent. The quality of the new company formations, as measured by life expectancy of the firms and tangible returns on investment, have also deteriorated.

Two: Firms are getting larger not through organic growth in revenues, but through M&As. Over 1997-2017, average annual volumes of global M&A activities amounted to roughly one half of the entire nominal global GDP growth. At the end of May, global M&A deal flow was running double on the same period of 2017 to reach a total of $1.5 trillion of announced deals. U.S.-only deals account for about 37 percent of the global total in M&A transactions – a share that is more than 2.5 times greater than the relative share of the U.S. economy in global GDP on PPP-adjusted terms.

Three: The demise of the medium-sized firms. In the 1980s, only 20 percent of mid-cap companies had negative earnings per share. By 2015, that number stood at 50 percent.

As Zingales notes, “by separating the return to capital and profits, we can appreciate when profits come from non-replicable barriers to entry and competition, not from capital accumulation.”

A February 2018 study by Gauti Eggertsson, Jacob A. Robbins, Ella Getz Wold traced out the emergence of a non-zero-rent economy (or put differently, the monopolization of the supply side), along with persistent long-term decline in real interest rates. The study is flawed in some of its conclusions , but the empirical results on rising concentration of market power in the U.S. economy are indisputable.

In his interview with Pro-Market, Angus Deaton decries the rise of monopolization of the U.S. as being responsible for simultaneously diminished entrepreneurship, weakened innovation, dramatically lower labor force participation and structurally lower productivity growth. These are the same arguments that inform the twin secular stagnations hypothesis, the proposition that advanced economies are suffering from structural or permanent growth slowdown on both the supply and demand sides of the economy. A February 2018 note from the Federal Reserve Bank of San Francisco confirms this hypothesis for the U.S.

Monopsonies in the labor markets

As Deaton notes, “Both monopoly and monopsony contribute to lower real wages (including higher prices, fewer jobs, and slower productivity growth)… But there are things like contracting out, which are making it much harder at the bottom, or local licensing requirements—mechanisms for making rich people richer at the expense of stopping poor people starting businesses and stifling entrepreneurship. There are also more traditional mechanisms other than rent-seeking, like the tax system.”

Zingales and other researchers confirm this. For example, Simcha Barkai of the London Business School finds that the decrease in labor share of value added is not due to an increase in the capital share, but due to an increase in the profits, which jumped from 2 percent of GDP in 1984 to 16 percent in 2014. If company mark-ups (the difference between the cost of a good and its selling price) are fixed, as would be the case in a competitive environment, any change in relative prices or in technology that causes a decline in labor share of profits must cause an equal increase in the capital share.

This is not happening. Goldman Sachs’ Wage Tracker shows that the U.S. wages growth has been declining since the start of the Millennium, just as the capital share of profits has also shrunk. Consider some simple arithmetic: Prior to 2000-2001, longer-term wages growth was averaging above 3 percent per annum. Since then, excluding the depths of the Great Recession, we have an average of around 2.2 percent. Even assuming wages growth rises to 2.4 percent over the longer term implies that the life cycle earnings for workers who have entered the workforce post-2002 will be lower, cumulatively, by 6.4 percent, compared to the preceding generations.

Of course, if both labor and capital shares dropped, there must be a change in mark-ups – that is, the pricing power of the firms must have risen. As the U.S. economy becomes more monopolistic, the corporate engines of technological innovation switch to differentiation through less fundamental, and more incremental R&D. This means that new technology is enabling new investment in capital and skills at a slower rate, reducing the forces of creative destruction and lowering entrepreneurship and labor productivity growth.

Some of these trends relate to another aspect of the rising market power of the firms: monopsony in the labor markets, or the market power of the employer over the employees.

An NBER paper from December 2017, written by José Azar, Ioana Marinescu and Marshall I. Steinbaum, shows that labor market concentration in the average market is high, and is associated with significantly lower posted wages. These findings link up, among other things, to the aforementioned trends in M&As. Specifically, the authors argue that, “given high concentration, mergers have the potential to significantly increase labor market power … and can create anti-competitive effects in labor markets.”

Since the start of the age of computerization, we were taught to believe that technological innovation should be empowering workers to achieve greater competitiveness, and social, professional and personal mobility. In fact, when it comes to the promise of technologically-enabled workforce, competition, productivity and merit-based pay are the stuff of mythology.

Two recent NBER papers provide empirical evidence to support the thesis that monopsony powers are actually increasing thanks to the technologically enabled contingent employment platforms. In one of these studies, the authors find that in online workplaces employers are paying workers less than 20 percent of the value-added. This reflects a surprisingly high degree of market power even in large and diverse on-line spot labor markets. The other study shows that on average, U.S. labor markets are highly concentrated with Herfindahl-Hirschman Index at 3,157, which is above the 2,500 threshold for high concentration according to the Department of Justice/Federal Trade Commission horizontal merger guidelines.

In simple terms, the evidence on monopsony power in web-based contingent workforce platforms dovetails naturally into the evidence of monopolization of modern economies. Technological progress, that held the promise of freeing human capital from strict limits on its returns, while delivering greater scope for technology-aided entrepreneurship and innovation, is proving to be delivering the exact opposite.

Breaking the ‘Medici Vicious Circle’

Zinglaes offers a somber assessment as to what, historically, follows a systemic rise in the markets concentration by drawing an analogy to the “Medici Vicious Circle,” or the risk of corporate dominance over democratic institutions. In a recent study, myself and a co-author provide evidence to show that concentration of corporate power in the economy accounts, in part, for the structural decline in younger voters’ preferences for liberal democratic values.
Reducing the adverse effects of these activities, while sustaining a resilient, competition-based market economy requires a complex balancing act. Contrary to the knee-jerk reaction of the traditional state-centric view, promoting the power of the state over and above the private sector rights is not a panacea to restoring a more functional balance between the markets and the policymakers. Neither is higher taxation. Expanded state powers simply increase incentives toward more political rent-seeking by the monopolistic competitors.

Instead, the focus in regulation and policy reforms should shift toward improvements in corporate democracy, increased transparency in political and corporate activities, reducing the risk of capture of the media, and economic and policy analysts and academia by both the state and the corporate sector. The state institutions should be focused on creating a simpler, more transparent tax and regulatory systems, backed with robust enforcement, that are free from select exemptions. The U.S. and Europe must move away from providing direct subsidies to specific sectors and players – subsidies that can be gamed by the powerful corporates. The system of bankruptcy and insolvency at the corporate level must apply to all firms, irrespective of their size and systemic significance – the automakers, heavily connected to the traditional Democratic Party, the military-industrial complex, strongly linked to the Republican Party, and the banks, who have been able to capture both sides of the political spectrum.

Free markets, good regulation and efficient enforcement sustain our liberal democracies. Monopolistic and monopsonistic powers corrupt the very fabric of our society and render markets ineffective at rewarding the most efficient use of all scarce resources. We need to rebalance the power of the State and the powers of the larger corporations to free our entrepreneurs, smaller enterprises, and human capital to challenge the monopolization trends in advanced economies.

Policy solutions for demographic change, growing government liabilities and slowing economic growth

Graphic illustrating the idea of people making up various demographics by showing a pie graph made up of many people standing in pie wedge shapes

The summer of 2018 began with disagreement among EU leaders. At the top of the agenda: should EU countries take in more migrants?

The debate over immigration policy seems to have reached a boiling point throughout the United States and many European nations. Building “the wall” to restore control over immigration and protect American jobs and wages has been Donald Trump’s rallying cry since his successful presidential campaign began.

Meanwhile, in Europe, debates over immigration have reached a fever pitch. In 2016 voters in the United Kingdom voted in favor of the Brexit movement, while Marine Le Pen gained support in France, and the Alternative for Germany (AfD) party made its parliamentary debut garnering 13.3 percent of the vote and securing 94 seats. Most recently, Italy announced it would be closing ports to migrant rescue boats this summer.

This wave of anti-immigrant sentiment coincides with a period of declining birth rates in the West. As the population ages and women are bearing fewer and fewer children, many economies are finding themselves short on a key economic resource: people. A slowdown in the growth of the working age population in developed economies can partly explain why economic growth has been slowing. Immigration can help to mitigate our people problem.
A comparison of the current economic expansion (2010-2017) with the 1992-2000 period reveals that economic growth – measured by growth in real gross domestic product (RGDP)- slowed in the United States, Canada, Japan, the United Kingdom and the euro area’s most populous countries – France, Italy, Spain – but not in Germany where growth increased. A slowdown in economic growth has many important implications for living standards and government finances. See figure 1

Figure 1, graph showing average annual growth rate of RGDP
Figure 1

Why long-run economic growth matters

Most developed economies are facing similar demographic challenges: their populations are aging, and in the near future, many countries will be facing population decline as a result of a deficit of births in comparison to deaths.

Demographic change will have important implications for government finances. As populations age, the number of workers per retiree falls, economic growth stagnates and tax revenues fail to keep up with the projected cost of human services, social security, Medicare, pension obligation not to mention large budget deficits.

Given that government outlays are growing in real terms, the higher the growth rate of RGDP, the lower will be the average tax rate on households and businesses that yields the revenue required to finance promised spending. Lower tax rates increase the incentives for market activity, resulting in even higher long-run economic growth. On the other hand, sluggish economic growth means that taxpayers will face higher taxes to cover the growing liabilities.

Only Germany, Italy and the UK experienced increases in the growth rate of the working-age population compared to 20 years ago.

Why economic growth is slowing everywhere but Germany

Analyzing long-run economic growth requires deconstructing the growth in real gross domestic product (RGDP) into its primary contributions: labor inputs and labor productivity. Growth in RGDP can be broken down into growth in labor productivity, measured as growth in GDP per hour worked, and changes in the extent of labor utilization, measured as changes in hours worked per capita.

Following Kliesen (2012)1 in decomposing growth in real gross domestic product (RGDP) during the last three global economic expansions, the following identity links labor inputs with productivity to produce real GDP:

Formula for calculating real GDP

Where Population refers to the working age population (ages 15+).

The data reveals a slowdown in labor productivity growth in every country in our sample. In Italy, productivity growth even turned negative for most of the post Great recession era.

Labor productivity growth has led to gains in compensation for workers and greater profits for firms. High labor productivity growth can reflect greater use of capital, and/or a decrease in the employment of less skilled workers, or general efficiency gains and innovation. Even when labor productivity declines, the growth rate of the economy can increase so long as growth in total hours worked offsets the decline in productivity.

Germany is the only country in our sample to see in an increase in the pace of economic growth despite falling labor productivity growth.

Germany experienced a 8-fold increase in the growth rate of her working-age population and civilian employment growth more than offset the substantial decrease in labor productivity growth.

During the 1990s and into the 2000s, Germany’s economic outlook was bleak, sporting a double-digit unemployment rate. However, Germany’s economy relative to her peers has been improving since 1995 when union coverage began to decline, perhaps in part due to a more relaxed wage setting structure that allowed employers to deviate from union contracts. The nation began to turn around even further in 2003 when the nation enacted labor market and welfare reforms which included reducing and capping unemployment benefits.2

Germany has run a budget surplus each of the last four years and has experienced continued success while taking in over 1 million refugees since 2015.

Why is labor productivity growth declining?

Now that we’ve looked at some specific details for various nations, let’s zoom out and look at the big picture.

A decline in productivity growth for the countries in our sample indicates that: either 1) the capital stock is not increasing fast enough to accommodate new workers, 2) there have been no substantial recent improvements in technology or, 3) labor quality has declined because new workers (the young) are less productive than old workers (those entering retirement).

New businesses require less investment than in the past

Economists refer to a situation where the capital per worker is increasing as “capital deepening.” Capital deepening means that more equipment, machines and tools are available to workers, thus making them more productive. A decline in labor productivity can partly be explained by a falling capital per worker ratio.

Economist Robert J. Gordon3 of Northwestern University highlights that despite a tidal wave of new internet services, new inventions pale in comparison to old ones. Professor Gordon points out that since 1750, most of U.S. economic growth was caused by three industrial revolutions. The first featured the creation of steam engines and railroads. The second featured electricity that led to air conditioning, home appliances, running water, indoor plumbing and the interstate highway system. The most recent one was the computer and the internet revolution. Since this latest revolution, innovations in the past 15 years have been smaller and smarter devices that require little investment and thus causing little growth in capital per worker.

Rising monopoly power hinders growth

Business dynamism and competition raises economic growth. Higher monopoly power, and thus higher pure profits tend to decrease GDP through a lower capital stock and labor supply.

The rise in monopoly power is well documented (Karabarbounis and Neiman4, 2014, Elsby, Hobijn and Sahin, 20135, Dorn et al, 20176 , Grullon, Larkin and Michaely, 20177).

Eggertsson, Robbins and Wold (2018)8 show that imperfect competition, barriers to entry that are consistent with a rise in firm market power can explain 1) increasing financial wealth-to-output despite a stagnant capital-to-output ratio, 2) an increase in the market value of corporations relative to the replacement cost of their capital, 3) the decrease in the labor share and capital share and 4) a decline in the investment-to-output ratio, despite historically low borrowing costs. This decline in investment is consistent with the slowdown in labor productivity growth.

Demographic change contributes to lower investment

The reason societies invest is in significant part to provide capital for new workers and to provide housing for new families. If the growth rate of new workers and new families slows or even declines, one should expect the share of gross domestic product (GDP) dedicated to investment to decline. A decline in investment makes capital scarce.

A slowdown in the accumulation of productive capital will cause output per worker – a measure of labor productivity – to decline, thus having a negative impact on economic growth and on living standards.

Demographic change reduced labor quality

Human capital increases labor quality, thus raising labor productivity. Workers accumulate human capital over their lifecycle. The accumulation of human capital comes from schooling, and experience.

Vandenbroucke (2017)9 shows that baby boomers retirement has played a role in the productivity slowdown. As the share of younger less experienced workers is expected to increase, labor productivity growth is expected to slowdown.

How to boost growth: The role of government policy

The sobering analysis in the previous section underscores the need for government policies that reward productive behaviors such as work, saving, investment, and entrepreneurship. Fortunately, there are some answers.

Tax policy

Incentives matter. Much of the persistent productivity differences across economies can be explained by differences in fiscal policies (see Prescott, 2002, 2004, Ragan, 2006) and labor policies that affect work incentives. That means that countries can raise productivity by removing barriers that hold back R&D and market activity and by improving the design of their tax system. Policy can help by pushing out the production frontier.

Using data from the United States, Canada, Australia, Belgium, Finland, Germany, Norway and the United Kingdom, Cassou and Lansing (1999)10 show that declining stocks of public infrastructure capital alone are not enough to explain a slowdown in productivity that began after 1973. Rising average tax rates also played a large role in explaining the productivity slowdown.

Using industry-level data from a set of OECD countries, Vartia, L. (2008)11 examines how industries are affected differently by taxation. Investment responds negatively to an increase in the corporate tax rate and a decrease in capital depreciation allowances. The paper finds evidence that corporate and top personal income taxes have a negative effect on productivity. In contrast, tax incentives for research and development (R&D) are found to have a positive effect on productivity. These effects are stronger in those industries that are more R&D intensive.

Misallocation of resources can arise when government policies favor one type of market activity over others. Examples include tax incentives that depend on firm size or type of investment, tariffs applied to particular goods and market regulations that limit market access. Preferential tax treatment and tax disparities across market activities steer economic agents towards tax-favored assets. Tax incentives for large businesses give them an unfair advantage that leads to rising market power.

Immigration policy

Bove and Elia (2017)12 found that mass migration that increases diversity boosts economic growth. Their empirical findings suggest that cultural heterogeneity, measured by either fractionalization or polarization, has a discernible positive impact on the growth rate of GDP over long time periods. For, example, from 1960 to 2010, when the growth rate of fractionalization increased by 10 percentage points, the growth rate of per capita GDP increased by about 2.1 percentage points. (This is the average effect across all countries in the world).

Diversity leads to specialization. A number of studies have found that immigration increases the level of specialization in the economy and hence productivity (Barone and Moretti, 201113, Foged and Peri, 201614). Jaumotte et al. (2016)15 find that a 1 percent increase in the migrant share of the adult population results in an increase in GDP per capita and productivity of approximately 2 percent. Using evidence from the United States, Peri (2012)16 finds that a 1 percent increase in immigration raised total factor productivity by 0.5 percent.

Immigration can also boost labor quality. Migrants tend to be younger, more skilled and more likely to be in the labor force than non-migrants. A decline in the migrant share of the population can also have contributed to declining labor quality in the U.S. (Gordon, 2018).17 From 1990 to 2000, the college-educated immigrant population increased by 89 percent and a further 78 percent between 2000 and 2014 compared to only 32 percent and 39 percent respectively for the native-born population.18 College-educated immigrants are also more likely to have advanced degrees than their U.S.-born counterparts.

U.S. university departments that have more foreign graduate students produce more academic publications and have their work cited more frequently (Stuen, Maskus, and Mobarak 2010).19 Once they graduate, U.S.-educated foreign workers patent at a significantly higher rate than U.S.-born workers (Hunt 2009).20 U.S. cities that attract these workers produce larger numbers of patents in electronics, machinery, pharmaceuticals, industrial chemicals, and other technology-intensive products (Kerr and Lincoln 2010).21 Simply put, high-skilled immigration promotes innovation and improves labor quality (Hanson, 2012).22

While U.S. universities still attract the best and brightest, many highly skilled immigrants are working in low skilled jobs or return to their country of origin because of visa limitations.

Immigration restrictions and non-recognition of foreign academic and professional credentials limit access to the labor market leading to a brain waste.23 Transitional temporary-to-permanent visas that allow employers and workers to “test the waters” would reduce the underutilization of highly skilled foreign-born workers.

Even low skilled immigration is good for the economy. When immigrants complement natives and they accept lower paying jobs that means lower business costs that make small businesses more sustainable and viable.

An increase in surviving establishments leads to higher market competition, higher wages for workers and lower prices for consumer households (Ottaviano and Peri 200824; Ottaviano and Peri 201025; Cortes 200826). Empirical evidence further suggests that immigration does not negatively affect employment or wages for natives; further eroding the narrative that immigrants pose a threat to the employment and wages of the native born population.27

Concluding remarks

Immigration can raise the growth rate of RGDP by doing two things: 1) immigration can boost the growth rate of employment by increasing the size of the labor force and by reducing labor costs, and 2) immigration can boost labor productivity growth by improving labor quality.

In light of the empirical evidence on the effects of immigration, it seems that the economic concerns over immigration that has swept throughout the West may be unjustified.


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2 Dustmann, Christian, Bernd Fitzenberger, Uta Schönberg, and Alexandra Spitz-Oener. “From sick man of Europe to economic superstar: Germany’s resurgent economy.” Journal of Economic Perspectives 28, no. 1 (2014): 167-88.
3 Gordon, Robert J. Why Has Economic Growth Slowed When Innovation Appears to be Accelerating?. No. w24554. National Bureau of Economic Research, 2018.
4 Karabarbounis, Loukas, and Brent Neiman. “The research agenda: the evolution of factor shares.” The Economic Dynamics Newsletter 15, no. 2 (2014).
5 Elsby, M.W., Hobijn, B. and Şahin, A., 2013. The decline of the US labor share. Brookings Papers on Economic Activity, 2013(2), pp.1-63.
6 Dorn, David, Lawrence F. Katz, Christina Patterson, and John Van Reenen. “Concentrating on the Fall of the Labor Share.” American Economic Review 107, no. 5 (2017): 180-85.
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9 Vandenbroucke, Frank. “ Boomers Have Played a Role in Changes in Productivity.” The Regional Economist (2017).
10 Cassou, Steven P., and Kevin J. Lansing. “Fiscal policy and productivity growth in the OECD.” Canadian Journal of Economics (1999): 1215-1226.
11 Vartia, Laura. “How do taxes affect investment and productivity?.” (2008).
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13 Barone, G, and S Mocetti (2011), “With a little help from abroad: The effect of low-skilled immigration on the female labour supply”. Labour Economics 18(5): 664-675.
14 Foged, M and G Peri (2016), “Immigrants’ effect on native workers: New analysis on longitudinal data”, American Economic Journal: Applied Economics 8(2),: 1-34.
15 Jaumotte, F, K Koloskova and S C Saxena (2016), “Impact of migration on income levels in advanced economies”, Spillover Task Force, IMF.
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17 Gordon, Robert J. Why Has Economic Growth Slowed When Innovation Appears to be Accelerating?. No. w24554. National Bureau of Economic Research, 2018.
18 Zong, Jie, and Jeanne Batalova. “College-educated immigrants in the United States.” Migration Information Source(2016).
19 Stuen, E. T.; Mobarak, A. M.; and Maskus, K. (2010) “Skilled Immigration and Innovation: Evidence from Enrollment Fluctuations in U.S. Universities.” Center for Economic Policy Research Discussion Paper No. 7709.
20 Hunt, J. (2009) “Which Immigrants Are Most Innovative and Entrepreneurial?” NBER Working Paper No. 14920.
21 Kerr, William R., and William F. Lincoln. “The supply side of innovation: H-1B visa reforms and US ethnic invention.” Journal of Labor Economics 28, no. 3 (2010): 473-508.
22 Hanson, Gordon H. “Immigration and economic growth.” Cato J. 32 (2012): 25.
23 Batalova, Jeanne, Michael Fix, and Peter A. Creticos. Uneven progress: The employment pathways of skilled immigrants in the United States. National Center on Immigrant Integration Policy, Migration Policy Institute, 2008.
24 Ottaviano, G.I. and Peri, G., 2008. Immigration and national wages: Clarifying the theory and the empirics (No. w14188). National Bureau of Economic Research.
25 D’Amuri, Francesco, Gianmarco IP Ottaviano, and Giovanni Peri. “The labor market impact of immigration in Western Germany in the 1990s.” European Economic Review 54, no. 4 (2010): 550-570.
26 Cortes, Patricia. “The effect of low-skilled immigration on US prices: evidence from CPI data.” Journal of political Economy116, no. 3 (2008): 381-422.
27 Friedberg, Rachel M., and Jennifer Hunt. “The impact of immigrants on host country wages, employment and growth.” Journal of Economic perspectives 9, no. 2 (1995): 23-44.

Three lessons in international taxation

It was “one of these days” at the office. I was writing a transfer pricing memo for defending one of my clients against a challenge made by some rather aggressive tax auditor, when I looked at my bookshelf and noted that my copy of Henry Hazlitt’s classic “Economics in One Lesson” had gathered its fair share of dust. I have always enjoyed reading Hazlitt’s attack of economic policies based on Keynesian economics (exposing the many variants of broken window fallacy, etc.) but could not readily recall specific examples on fallacies in the realm of taxation. Shame on me, but easily remedied. I decided to reread selected chapters of Economics in One Lesson and to apply its insights to some contemporary issues of international taxation: BEPS, CCCTB and most recently “digital taxation.”

The special pleading of selfish interests of high tax government are driving recent tax reforms

Hazlitt starts his lesson by emphasizing that the inherent difficulties in economics are multiplied a thousandfold by the special pleading of selfish interests. This is a timeless truth and should not be underestimated. Regarding taxation the interests driving the debate on the side of tax authorities, the European Union and non-governmental organizations seem clear: maximize tax revenues – to the effect that the beginning of Chapter 4 could be written in 2018: “There is no more persistent and influential faith in the world today than the faith in government spending. Everywhere government spending is presented as a panacea for all our economic ills … we can examine here the mother fallacy that has given birth to this fallacy …. The world is full of so-called economists who in turn are full of schemes for getting something for nothing. They tell us that the government can spend and spend without taxing at all, that it can continue to pile up debt without ever paying it off, because ‘we owe it to ourselves.’”

That statement constitutes an appropriate narrative of the Leitmotiv of the economic policies of the EU. In respect to taxation, the EU no longer suggests that tax is unnecessary, it rather emphasized that the tax needs to be “fairer.” Based on tax gap estimates (see previous CFR contributions for details) they argue that by eliminating these “tax gaps,” i.e., taxes avoided by multinational enterprises (MNEs) through transfer pricing and other “legal but immoral” tools, the level of government spending could be sustained (enhanced). Aside from ballooning the tax gap estimates, the advocates of fair taxation also resort to obscuring the distinction between tax avoidance and tax evasion to dramatize the extent of tax avoidance and to mobilize public support for stricter tax regulation. As thankfully pointed out by Maya Forstater, such a narrative “bundles together a large swathe of international investment, finance and professional services as being ‘by definition’ on the same side as drug cartels, kleptocrats and money launderers.” Alas, very few commentators recognize the importance of delineating between concepts such as tax avoidance and tax evasion. The effect is that the political anti-avoidance measures of the OECD and EU enjoy wide support. The extent to which the cartel of high tax governments succeeds to advocate every stricter tax regulation is amongst others evidenced by the Common Corporate Consolidated Tax Base (CCCTB) and the proposals for digital taxation (see below).

By cautiously hiding under the weasel-word “fair,” the advocates of higher taxes have indeed convinced the general public that their case is sound and convinced policymakers that they need not even attempt to follow the reasoning of opposing arguments because they are only “capitalist apologetics.”

One-sided anti-abuse policy proposals overlook secondary consequences

As pointed out by Hazlitt (Chapter 1, Section 3) the success of high tax bureaucracies to dominate the agenda in international taxation ought not to be mysterious.

“The reason is that the demagogues and bad economists are presenting half-truths. They are speaking only of the immediate effect of a proposed policy or its effect upon a single group. As far as they go they may often be right.”

It is perhaps the most important part of Hazlitt’s work to expose the detrimental effects originating in the fallacy of overlooking secondary consequences. In the case of Base Erosion and Profit Shifting (BEPS), the OECD focused on modernizing the transfer pricing guidelines (based on the arm’s length principle) to improve the alignment between the place where value is created and where taxes are paid. That Apple and Starbucks utilized aggressive legal structures to take advantage of the existing regulations and that the reforms were arguably overdue shall not be contested here. The point is rather that the BEPS Action Plan was a targeted (mostly proportionate) measure for improving the practical application of the arm’s length principle. BEPS comprised 15 complex Action Points and was completed between 2013 and 2015 with some actions still being followed-up on.

The reforms resulting from the BEPS process are currently being integrated into national tax laws and will doubtless have a substantial impact on transfer pricing in the years to come. There cannot be any doubt, at least none that is supported by any empirical assessment, that the BEPS project will largely succeed in facilitating a closer alignment between the place where value is created and where taxes are paid.

The EU, however, is not content to merely implement BEPS reforms and evaluate the success based updated, more realistic, tax gap measures. Instead, the EU continues to push for the adoption of the CCCTB. The CCCTB is presented as a panacea to effectively close all tax gaps (i.e., by abolishing transfer pricing) and thus to ensure “fair taxation” and (obviously most importantly from the perspective of its advocates) secure public spending. According to the proposals advanced the competences to tax should ideally be enhanced and delegated to the EU level. Eerily, the effects of the CCCTB on MNEs are scarcely discussed. Apparently, the MNEs are merely assumed to pay the tax they owe (us) anyway. End of story? What about those MNEs whose subsidiaries are not only located within the EU but globally? They would have to apply two conceptually irreconcilable paradigms of taxation, i.e., CCCTB (formulary apportionment) within the EU and arm’s length-based transfer pricing throughout the rest of the world. In other words, double-taxation will be systemic; i.e., unavoidable and endemic. It is further unclear whether the introduction of CCCTB will really be efficient in counteracting aggressive tax-planning by MNEs. Based on what we can observe for intra-U.S. trade this seems to be far from guaranteed and will require far reaching harmonization (additional regulation) of accounting practices. For the taxpayer’s perspective, the announcement of the EU to couple the CCCTB with the adoption of minimal tax rates and link the proceeds to the EU budget might well sound “alarming.” To be clear, some member states which embrace the concept of tax competition such as Ireland or the Netherlands oppose the CCCTB. The most influential one of those member states, the U.K., is, however, merely watching from the sidelines from now on. As soon as Macron & Co. manage to open taxation to “qualified majority voting,” and the adoption of the CCCTB no longer requires unanimity, the CCCTB will become a reality in the EU, sounding the death knell for tax competition and any restraint on hiking tax rates. In sum, the secondary consequences of adopting the CCCTB do not look appealing at all and perhaps it is time people took a much closer look and voice their opposition against the CCCTB.

Digital taxation, the pinnacle of fairness?

The measures proposed by the EU Commission for reforming digital taxation are explicitly aimed to “ensure that all companies pay fair tax in the EU.” The figurehead of the new initiative, Valdis Dombrovskis (vice-president for the Euro and Social Dialogue), emphasizes the drastic lack of fairness and the pressing need for action when rationalizing the need for the EU to, once again, act as a forerunner of stricter tax regulations: “We would prefer rules agreed at the global level, including at the OECD. But the amount of profits currently going untaxed is unacceptable. We need to urgently bring our tax rules into the 21st century by putting in place a new comprehensive and future-proof solution.”

Text quoted from the main article: "There cannot be any doubt ... that the BEPS project will largely succeed in facilitating a closer alignment between the place where value is created and where taxes are paid."His sidekick Pierre Moscovici, Commissioner for Economic and Financial Affairs, Taxation and Customs, merely evokes the image of the tax gap mutating into a new dimension (“black hole”) when talking about digital business: “Our pre-internet rules do not allow our Member States to tax digital companies operating in Europe when they have little or no physical presence here. This represents an ever-bigger black hole for Member States, because the tax base is being eroded ….”

Digital companies generally pay their taxes and Dombrovskis and Moscovici do not, at least not explicitly, accuse these companies of engaging in tax avoidance. One cannot help the impression of two well-fed toddlers screaming at their mother to give them a piece of the pie that is sitting on the plate of their older sister. Both seem to agree that the digital business is ripe with juicy profits and they really do not care about anything but securing a larger share of the pie. It goes without saying that the alleged tax gap has not been quantified, nor have the value creating (taxable) activities taking place in the EU been clearly delineated. At the core of the proposals is the notion that “profits made through lucrative activities, such as selling user-generated data and content” are based on the “activity” (data) of the “users,” i.e., not the economic activity of the digital businesses is to be taxed here, but rather the mere fact that we have a Facebook or LinkedIn account.

Pursuant to the European Commission, the policy proposal to “reform corporate tax rules” will enable member states to tax profits that are generated in their territory, even if a company does not have a physical presence there – based on a “digital presence” or a “virtual permanent establishment” that is deemed to exist as soon as one of the following criteria is fulfilled:

  • It exceeds a threshold of €7 million in annual revenues in a member state
  • It has more than 100,000 users in a member state in a taxable year
  • Over 3,000 business contracts for digital services are created between the company and business users in a taxable year.

The profits attributable to this virtual permanent establishment would then be allocated among the member states (or the EU budget?) – in this context the EU Commission already point out that the measure could eventually be integrated into the scope of the CCCTB – in other words economic activity in the sense of “significant people functions” would not be required to attribute profits to a digital presence (quite opposed to the rules applied to conventional permanent establishments). It is also not addressed, why this proposal is deemed superior to waiting for (and contribute to) a less restrictive but consensual solution at the OECD level – with the secondary consequences being highly ominous (like for the CCCTB).

Anticipating that the proposal to “reform corporate tax rules” will take some time to gain traction, the European Commission also proposals an immediate interim taxation. The tax will apply to revenues created from activities where users play a major role in value creation and which are the hardest to capture with current tax rules (e.g. selling online advertising space and sale of data generated from user-provided information). The EU Commission concludes by outlining the tasty spoils of “estimated 5 billion euro in revenues a year could be generated for Member States if the tax is applied at a rate of 3 percent.” To sugarcoat this proposal, the EU Commission proposes to apply thresholds that apply only to comparatively big companies, but how often have you seen that such a threshold is sustained? Who will prevent that the applicable rate is adjusted to 6 percent at a later point in time (especially in case there is no competition within the EU) – would the member states not realize 10 billion euro? And, more importantly, how likely is it that the tax is truly temporary?

The proposed interim tax is nothing but arbitrary expropriation – at least for those who do not succumb to the lullaby of fair taxation. What we can learn from Hazlitt here is that we must question and expose the selfish interest of high tax governments and bureaucracies. We also should not tire of pointing to secondary consequences of the proposed policies.

While the additional tax intake must be enticing to policymakers, we need to bring to their attention that taxes discourage production. The proposed taxes will ultimately divert investments and further erode the competitiveness of the EU in the digital economy. As pointed out by Hazlitt:

“When the total tax burden grows beyond a bearable size, the problem of devising taxes that will not discourage and disrupt production becomes insoluble.”

STEP Cayman: A three-year snapshot

Photograph of a pen and pocket watch sitting on a will with 'Last Will and Testament' written in nice script.

In 2016, driven by the vision of branch chair Alan Milgate, the Cayman Islands branch of the Society of Trust and Estate Practitioners embarked on a three-year plan to ensure that it could better support its membership base, and that the Cayman Islands as a jurisdiction stayed at the forefront of the trust industry. The key drivers of this plan were to build momentum, embrace change, and to increase the branch’s visibility, ensuring the continued growth and success of STEP Cayman. At the recent annual general meeting of the branch, Milgate as outgoing chair reflected on the success of the plan and the bright future of the branch.


The focus of the first year was to gain momentum and re-energize the branch’s objectives and purpose. To avoid stagnating in the ever-changing global market, the branch was eager to remain alert to and proactive in respect of the challenges facing the industry. Re-energizing the branch’s marketing, and increasing its overall visibility were of critical importance. The organization and structuring of the branch’s sub-committees was also a key focus. At the end of year one, the branch had successfully achieved many of our action points and got the ball rolling towards achieving STEP’s wider objectives.


Flowing from this gained momentum, year two focused on change. With a strong understanding of what challenges needed to be addressed, the work of the branch’s sub-committees was fundamental in driving this change forward. The Legislative Sub-Committee was and remains actively engaged with the government and Cayman Finance in dealing with requests and consultation papers that are relevant to Cayman’s trust industry. The work of the Legislative Sub-Committee has ensured that we maintain a healthy dialogue with the voices enacting legislative change, and to that end are working together towards positive development and growth. The ultimate success of this can be seen by the recently updated Trust Law, together with the passing of the Foundations Companies Law. The Legislative Sub-Committee is continuing its efforts by working on the development of the Family Office legislation, which would increase the overall appeal of the jurisdiction to Family Offices.


The focus in the third year has been on visibility. The new Communications and Marketing Sub-Committee has been instrumental on this front with the on-going development of our branch microsite, promoting the branch online and in print, and overall improving our dialogue with members and relevance as a jurisdiction. In addition, and in response to evolving compliance requirements from FACTA, CRS and global reporting, the Global Transparency Sub-Committee has become a permanent and essential fixture to our organization. Their work has been integral for us to provide our members with the information they need to ensure understanding of the ever-changing requirements we must meet; and this Sub-Committee is in regular communication with the Cayman Islands Department of International Tax Cooperation to ensure that Cayman financial institutions can work effectively to provide accurate reporting within prescribed timescales. The branch has also focused on the public registers initiative coming out of the United Kingdom, which is proposing orders in council by 2020 and is currently assessing the implications of the public registers and considering the appropriate steps forward. Education and the advancement of members is of utmost importance to the branch and there will be more initiatives on this front in the coming year.

Finally, the inaugural STEP Cayman conference was one of the branch’s major achievements in recent times. With 246 attendees and an extremely high caliber of international experts, the conference shined a brilliant light on Cayman’s trust industry. Following the success of this year’s conference, the save the date for next year’s highly anticipated conference has been sent for Jan. 31, 2019. It is expected to be a further great success.

The Future

Over the past three years, the focus on momentum, change, and visibility has clearly propelled the branch forward and increased lines of communications with the branch’s membership base. STEP continues to build strong relationships with the Monetary Authority, the government, and Cayman Finance, ensuring the trust industry has the right voice within these key sectors. The branch is proud of what it has accomplished and hopes to continue proactively moving forward to ensure the Cayman Islands remains a premier trust jurisdiction. Thanks to the support of council and committee members, branch members, and other parties who have contributed their hard work over the years, the branch’s accomplishments continue to grow.

The need for an insolvency fail-safe in Cayman

Gavel and block on a table with a name plate in front with 'Insolvency' written on it.

Directors of Cayman companies owe fiduciary duties to the company to act in the interests of the company as a whole. When the company is able to pay all of its creditors, those interests are reflected in the interests of the shareholders, who stand to receive a share of its surplus assets. But when a company is no longer able to pay its creditors in full, as they fall due, the directors must treat the interests of the creditors as paramount. Where the solvency of the company is doubtful, in order to discharge their duty to the company, directors must put the interests of creditors as uppermost while remaining cognizant of the need to preserve the prospect of a return to shareholders. When a Cayman company is in troubled waters, the directors will often have to weigh the interests between those who stand to gain from continuing to pursue a risky venture (the shareholders) and those who may prefer to take a certain return on their current claim (the creditors).

The current legislation in Cayman prohibits directors of Cayman companies from presenting a petition for the winding up of the company, unless expressly authorized by a provision in the company’s articles or a special resolution of the shareholders of the company. This legislative position, affirmed by the Grand Court in the China Shanshui case, can be problematic. For instance, a winding up petition is currently the necessary first step in invoking a moratorium within which a formal restructuring can be pursued. Successful restructurings can increase the return to creditors but often will involve a dilution of shareholder interests in the company.

The necessity for shareholder consent for filing a winding up petition either provides a hostage to fortune, or a bar to the directors being able to achieve the best outcome for creditors; the directors can find themselves unable to act in the interests of creditors fettered at the very moment they need to exercise it.

This difficulty exists not only in the restructuring context (for which a legislative fix is under construction), but also when the clear and obvious need is for the company to be placed in official liquidation to preserve value and protect creditor interests.

While it is the case that the company’s creditors can initiate winding up proceedings on the ground that the company is unable to pay its debts (and other just and equitable grounds), it is a fundamental contradiction to have those appointed as the custodians of the company and imposed with duties to protect creditor interests can have their pathway to doing so blocked by parties (the shareholders) with little or no economic interest.

This article suggests a rethink to Cayman companies law and the inclusion of an “insolvency fail-safe” power for directors.

The cause

The Companies Law provides that the company may itself petition for its winding up but then limits the authority of the company to do so:
“Where expressly provided for in the articles of association of a company the directors of a company incorporated after the commencement of this Law have the authority to present a winding up petition on its behalf without the sanction of a resolution passed at a general meeting.”

The directors of a company are its agents and derive their powers from the governing documents of the company, from the company acting in general meeting or from statute. In that context, section 94(2) is really a tautology: directors have power to do something only if they have express power to do it.

This was the conventional common law position: the ordinary powers of the directors are to carry on and manage the business of the company on behalf of the person who brought the company into existence; it is anathema to that appointment that the directors would have the power to terminate the business without the consultation of the shareholders . The leading English case on the topic was Re Emmadart Ltd., which was approved by Justice Anthony Smellie (now Chief Justice Smellie) as applicable in the Cayman Islands in 1998 .

The introduction of s94(2)

Sub-section 94(2) was introduced by the Companies (Amendment) Law 2007, which brought in changes recommended by the Law Reform Commission (LRC) between 2002 and 2006. The specific rationale for the amendment of this section can be seen in the bill introducing that law:
“The rating agencies normally require that special purpose vehicles have at least one independent director. Historically, this requirement has not applied to Caymanian companies because their directors had no power to present a winding up petition.

The ability to exclude this power in the articles will prevent Caymanian companies being put at a competitive disadvantage in the capital markets business. In order to avoid any adverse effect upon existing transactions, this amendment will only apply to companies incorporated after the commencement of the new law.”

The bill therefore entrenched the common law requirement that directors have express power delegated to them from the shareholder to seek to bring the company to an end.

Gavel and block sitting on money on a table.

Confusion in Cayman

It is inevitable that restructurings give rise to conflicts of interests between creditors and shareholders. In Cayman, the only formal means of imposing corporate rescue of a distressed and insolvent company is a scheme of arrangement. Schemes are an expensive and time-consuming process that do not, without additional steps, protect the company from potentially destructive creditor action. As such, the practice has developed for a scheme to be implemented in conjunction with the appointment of provisional liquidators. This enables the company to take advantage of the statutory moratorium on claims, so allowing the provisional liquidators and the company’s principal creditors to assemble the restructuring proposal.

It was in this context that section 94(2) came to be considered for the first time. China Milk was an investment holding company with shares listed on the Singapore Stock Exchange that raised finance through zero coupon convertible bonds. China Milk was insolvent and needed to restructure its debt. Its directors presented a winding up petition without the support of shareholders, to appoint provisional liquidators and pursue a restructuring. By a quirk of fate, the judge assigned to the proceedings was one of the authors of the reports recommending change .

The application was supported by the bondholders, and not opposed by the shareholders. Justice Jones construed section 94(2) within the context of the bill as a whole, but went further into recommendations that had been but not implemented in the bill, and held that :

1) directors of insolvent companies were allowed to present a petition whether or not authorized by the shareholders;
2) The directors of solvent companies incorporated from 2009 onwards (the date of commencement of 94(2)) could present a petition if authorized by the articles (or by shareholder resolution); and
3) The directors of solvent companies incorporated before 2009 could only present a petition to wind up the company if authorized by shareholder resolution.

The judgment was a pragmatic outcome that allowed the restructuring to proceed, but it was criticized for giving directors a discretion that was not apparent in the legislation.

The First Report of the LRC of April 2006 supports Justice Jones’s rationale that there should be a distinction between the liquidation of solvent and insolvent companies (“In practice this is the critical distinction” ). However, the LRC focused on the distinction only once in liquidation, and codified the “current best practice” of a voluntary liquidator of an insolvent liquidation applying for court supervision. Crucially, the 2007 Bill did not implement any distinction pre-liquidation – applying only the broad rule that directors could only petition if authorized. The ruling had consequences in practice, and empowered directors to take into account creditors’ interests at the appropriate time.

That pragmatic approach was reversed by Justice Ingrid Mangatal four years later , reverting to a literal interpretation that restricted directors’ ability to present a petition in any circumstances if not expressly authorized in the articles or by shareholder resolution. In that case, the restructuring was opposed by the shareholders who succeeded in striking out the petition as an abuse of process brought without authority.

Although China Shanshui was undoubtedly a technically correct decision, the result was that directors of troubled companies without shareholder support were (and still are) often left in the invidious situation of choosing between being forced to remain in office for a hopelessly insolvent company or resigning and letting the company eventually be struck off without proper realization and distribution amongst the remaining assets . This can arise when shareholders are:

1. Disinterested: there is no prospect of a return to them and so no incentive to participate further;
2. Dysfunctional: parent companies in their own foreign insolvency process unable to take decisions;
3. Disparate: widely held small shareholdings; or
4. Dishonest: where the appointment of a liquidator may enable a liquidator to investigate the actions of the parent that a board could not do.

In each of these situations, it may be in the creditors’ interests to bring the company to an end or secure the appointment of provisional liquidators to promote a restructuring, but the creditors themselves may be unable to present a petition through contractual arrangements or other prohibitive factors.

The restriction appears to have been driven by a commercial concern regarding one specific use of corporate vehicles but had wider consequences to all insolvent companies.

Insolvency fail-safe

The legislature should reconsider the imposition of an insolvency fail-safe: permitting the board of an insolvent company to present a petition for its winding up . Providing for an express ability for directors to petition on the insolvency of the company will better accord to their fiduciary duties. A director’s duty is clearly owed to the company but as the solvency of the company shifts, the directors must begin to take into account the best interests of the creditors; the receding tide of solvency reveals the interests of the creditors that the directors must navigate.

The LRC recognized this in their report, suggesting a codification of directors’ duties in future revisions, and separately that there should be a distinction between solvent and insolvent liquidations but section 94(2) is anathema to this – permitting the shareholder to fetter the directors’ fiduciary duties in the shareholders’ own selfish interest beyond the point at which the shareholder no longer has a fiduciary duty.

Providing an insolvency fail-safe would not mean bestowing on boards of directors an indiscriminate power to bring the company to an end:

1) Active shareholders could simply take steps to change the constitution of the board;
2) The board would need to establish their standing to petition – they would need to satisfy the court that the company was indeed insolvent;
3) A board would be acting in breach of duty if they did not objectively and subjectively hold the view that the course of action that they were following was in the company’s best interests; and
4) Any winding up would still be at the discretion of the court – and shareholders or creditors have standing to appear at the hearing of the petition.

Given those protections, the inclusion of an insolvency fail-safe may actually improve corporate governance and shareholder responsiveness. There seems little harm in confirming that a director must act independently (as may be required in some contexts for ratings), but much detriment by removing their ability to do so at a time of crisis for the company.

Such an insolvency fail-safe would also be in line with much of the rest of the common law world:

  • In England and Wales, the legislature overturned Emmadart in 1986 by legislating for directors (not just the company acting by the board) to have standing to petition for the winding up of the company ;
  • In Bermuda, the courts have held that in the absence of requirement for express shareholder approval, given the civil and criminal consequences for directors of insolvent trading, the directors could present a petition if the interest of the creditors dictated that a winding up petition should be filed, the wishes of the shareholders at that point being irrelevant ;
  • In Jersey, the directors of a company, upon showing that it is insolvent on a cash flow test, but with realizable assets, may have the court declare the company “en désastre” ;
  • In Guernsey, any director is entitled to make an application that the company be wound up, although the exercise of this power will be influenced by the directors’ fiduciary duties ;
  • In the Isle of Man, the directors do not have express power to present a petition in their own name, but the courts have held that, where the “interests of justice” requires it, they are at liberty to make law where there are indications that the English common law are superseded by statute and so, although untested, may in the appropriate case, be persuaded to accept that the directors have power to present a petition on behalf of the company ;
  • In BVI, the company has authority to present a petition, but there is no express provision that the directors may only do so if authorized by the shareholders. It is therefore unclear how the BVI courts will deal with an unauthorized petition, but the absence of a clear restriction leaves the matter more open to judicial discretion.

It is inconsistent with the fiduciary duties of the board of a Cayman company to be constrained from taking steps that are likely to significantly benefit the company’s creditors. Other safeguards exist to protect the interests of shareholders from over-zealous director action. The introduction of an insolvency fail-safe to permit directors to petition in appropriate circumstances would prevent insolvent zombie entities from being perpetuated and allow for a more efficient resolution than requiring directors to abandon ship. The issue cannot be resolved by more judge-made law but should be reconsidered by the legislature.

OECD’s tax initiatives thwart US policy goals

A back-lit sign with the OECD logo on it.

International tax bureaucrats at the Organization of Economic Cooperation and Development (OECD) and elsewhere have waged a decades-long campaign to promote a one-size-fits-all approach to tax policy. They unambiguously favor larger and more intrusive government at the expense of individual economic freedom and privacy. President Donald Trump’s willingness to shake up international status quo opens the door for the U.S. to oppose all OECD-led efforts unless they are aimed at reducing the size and scope of government.

Once hailed for its efforts to liberalize the global economy, the OECD has been hijacked by pro-tax bureaucrats who use the OECD platform to advocate for higher and more intrusive forms of taxation. The OECD’s Centre for Tax Policy and Administration, in particular, has most recently focused on a multi-year initiative to promote its “Base Erosion and Profit Shifting” (BEPS) project, which is little more than the international tax regulators’ most recent attempt to increase taxes on multinational businesses – many of them American-based.

The BEPS project aims to centralize and harmonize global tax rules with the goal of increasing effective tax rates on international firms by restricting their ability to do tax planning. The project was born out of a renewed concern among some tax collectors that imperfect and at times mismatched international tax systems might allow some corporate profits to go untaxed.

The sometimes porous tax systems around the world, however, have fostered international pressures that act as a restraint on ever-higher taxes on business. If one country’s tax rates are too high, a company can more easily protect its shareholders and customers by finding another country with lower tax rates or more favorable tax rules. Decades of research and the recent reduction of the U.S. corporate tax rate show that competitive pressures among countries’ tax policies and procedures have served as a stimulus for economic growth and global investment. The benefits of these competitive pressures, however, are undermined by efforts (such as BEPS) to crack down on tax planning.

New taxes: The bitter fruit of the BEPS project

Although the world is not in danger of full implementation of the OECD’s BEPS project anytime soon, the real-time impact of BEPS has actually been worse than if it had been fully implemented. The OECD’s work serves as thought leadership; it gives cover to tax administrators around the world to propose and implement new, overly intrusive, and extraterritorial “fixes” to the supposed problem of tax planning that is more often than not legal.

One prominent outgrowth of the BEPS project is an interim digital-transactions tax proposed by the European Commission. Aimed at the same perceived problem as the BEPS project, the new digital tax would be a 3 percent levy on revenues from online advertising, sale of user data, and facilitated user interactions. The proposal is nothing more than a poorly disguised attempt to extract additional revenue from large U.S. firms, notwithstanding the negligible presence they may have in any given country.

Lacking global buy-in on a BEPS strategy, the European Commission is proposing a go-it-alone strategy. The new digital tax, however, is given legitimacy by and builds upon the work completed through the BEPS project.

More intrusive reporting

During the Obama Administration, the United States declined to sign the Multilateral Convention that would have implemented the BEPS project in the U.S., but the Treasury Department did promulgate regulations to comply with new Country-by-Country (CbC) reporting, a recommendation of the BEPS project.

Country-by-country reporting is a new international system to implement the centralization and automatic exchange of country-specific taxpayer information with sovereign country tax jurisdictions all over the world. The treasure-trove of confidential taxpayer information on multinational businesses provided by the United States has furnished to potentially unfriendly, but revenue-hungry, states the information necessary to raise taxes unilaterally on American companies.

Concerns in the United States over the potential for abuse of this new, granular source of confidential information is so great that American defense contractor firms were recently awarded an exemption by Treasury from the full reporting requirement. The rest of the private sector, though, is still vulnerable to the threat that their trade secrets and proprietary business structures could be used for purposes other than tax compliance.

In its fervent pursuit of the elimination of tax planning, the OECD may also be inadvertently opening the door to global double taxation. The information included in the CbC reports could serve as grounds for a country to implement new taxes, along the lines of the digital transactions tax. Ironically, curbing double taxation was one of the OECD’s most important and beneficial early international tax contributions.

Even more intrusive than the CbC rules is the OECD’s new Protocol amending the Multilateral Convention on Mutual Administrative Assistance in Tax Matters. The Protocol is one element of a new and complicated international tax information-sharing regime devised by the OECD. It would mandate that the U.S. Internal Revenue Service automatically share bulk taxpayer information with governments worldwide, many of which (e.g. China, Russia and Nigeria) are corrupt or hostile to the U.S. and other Western countries.

Fortunately, as in the case of the full BEPS treaty, the U.S. has not fully implemented the Protocol. Automatic bulk exchanges of sensitive taxpayer information with other countries will largely end financial privacy and would lead to increased identity theft, industrial espionage, and political suppression of opposing views. Tax administrators claim that the information is secured and only available to vetted parties, but the IRS is largely unable to secure their own domestic electronic systems, let alone vet and monitor those of every other country that is party to the Protocol.

Together with other reporting requirements such as the CbC, the already-voluminous compliance costs imposed on financial institutions would only increase under the Protocol.

What can be done

President Donald Trump should continue to shake up the international status quo as he did at the recent G-7 meeting in Canada, where he declined to sign a joint Communiqué with the other country’s leaders. Admittedly, the clash at the G-7 over the shape of future trade relations among G-7 and EU nations is troubling. When it comes to tax policy, however, the president was well-advised to continue his disruptive tactics and oppose the G-7 Communiqué’s support of “international efforts to deliver fair, progressive, effective and efficient tax systems.”

Such international efforts may seem innocuous, but they are quite the opposite. The G-7, like the OECD and other international bureaucracies, promotes initiatives that systematically undermine both institutional diversity and national tax systems that promote privacy and economic freedom. Organizations such as the G-7 and OECD often wax eloquent on the virtues of freedom, democracy, and the rule of law – all valuable and worthy goals – but then quickly pivot to policies that are directly at odds with these universal goals. The actual policy work coming out of the OECD promotes the implementation of international standards and efforts to address base erosion and profit shifting.

To date, fortunately, the U.S. has largely resisted the constant push by the OECD to increase worldwide tax revenue. However, the American taxpayer continues to foot the bill for a large portion of the OECD research. Although it is only one of 34 member states, the U.S. provides more than 20 percent of the OECD’s budget. As the largest funder of its research, the U.S. should direct the OECD to turn its focus towards a more diverse set of policy goals such as ways to streamline and shrink the size of government and lower taxes.

By its aggressive, persistent, and lop-sided pro-taxation advocacy, global bureaucracies such as the OECD have demonstrated beyond the shadow of a doubt that they have disconnected themselves from the original goals of that organization, which was established to execute the Marshall Plan after World War II.

These rogue international bureaucracies have been emboldened by a few member states to pursue a high-tax European centric agenda that continually undermines U.S. policy objectives. Past U.S. administrations have been either complicit in the pro-tax research agendas or reluctant to disrupt the existing state of affairs. The European Commission’s digital tax and the expanded information sharing are vivid examples of these anti-American policies that are funded to a significant degree by U.S. taxpayers.

In the absence of a new research agenda and tax policy focus, the U.S. delegation to the OECD should continue to shake up the international landscape. It should announce that the United States will block any new U.S. voluntary contributions that could be used to fund OECD tax work. The Trump Administration’s Department of Treasury should also take the necessary steps to rescind the country-by-country regulations and remove the U.S. as a signatory to the Protocol.

To follow up on the momentum from the enactment of historic and positive tax reform in 2017, the U.S. should also continue to lean into the strategy of making businesses want to grow and produce in America. The new, lower corporate tax rate and other business reforms, such as “expensing,” have combined to make the U.S. one of the most attractive new investment locations in the world.

The U.S. could lead the international community by repealing domestic examples of intrusive and burdensome international tax laws. Congress could start by repealing the Foreign Account Tax Compliance Act (FATCA), which was signed into law in 2010 and is intended to make it harder for Americans to keep money overseas and out of the reach of the IRS. The law requires that foreign financial institutions to identify and report to the United States Government most types of transactions for all American clients, a requirement that creates an intrusive and burdensome system that likely does not actually raise any net revenue.

The OECD’s base erosion project and the overreaching goals of globally harmonized tax policy would be a step backwards for America, reducing the attractiveness of the U.S. to investors. Rather than attracting commerce with business-friendly policies, OECD policy solutions such as BEPS create new barriers, making it more difficult for businesses and incentivizing them to leave the U.S. and do business elsewhere.

President Trump must continue to make it clear to the world that America does not support the OECD’s or international tax bureaucracy’s goal of raising business taxes. The outgrowths from decades of the OECD’s international tax work have only served to protect and give cover to high tax European welfare states. The U.S. must send a strong message in support of less intrusive governments that protect individual economic freedom and privacy.

Adam N. Michel is Policy Analyst in the Thomas A. Roe Institute for Economic Policy Studies, at The Heritage Foundation. James M. Roberts is Research Fellow for Economic Freedom and Growth in the Center for International Trade and Economics, of the Shelby and Cullom Davis Institute for National Security and Foreign Policy, at The Heritage Foundation.

Predictability of Atlantic hurricanes

NHC Official Track Error Trend Atlantic Basin

The 2017 Atlantic hurricane season was remarkable, including five landfalls of Category 5 storms in the Caribbean Basin, and three Category 4 strikes on the U.S. coastline. The 2017 landfalls cost hundreds of lives and record-breaking economic losses, exceeding $250 billion. These losses are sober reminders of hurricane vulnerability and the importance of hurricane prediction for public safety and the management of insurance and other economic risks.

Hurricane forecasts have continued to improve in recent years, but they are not yet as good as they could be. Continued advances in weather and climate computer models used to make forecasts, and improved observations from satellites and aircraft are driving these improvements. Also, essential to progress are advances in understanding of weather and climate dynamics.

Short-term track and wind intensity forecasts

The National Hurricane Center (NHC) provides five-day forecasts of hurricane tracks and wind intensity that guide emergency management. Technological improvements from higher resolution weather forecast models and improved satellite observations are helping improve hurricane forecasts. The figure below shows the improvement over several decades in the NHC’s forecasted location of storms, referred to as “track error.” See figure 1

Graph showing NHC official track error trend Atlantic Basin

An average track error at 48 hours of about 50 nautical miles is impressive in a meteorological context. However, a track uncertainty of just 50 nautical miles for Hurricane Irma’s predicted Florida landfall in 2017 meant the difference between a costly Miami landfall or a relatively benign Everglades landfall. As seen in the figure above, we are approaching a track forecast accuracy limit for one to two days, arising from the inherent unpredictability of weather. Over the past decade, the greatest improvements have been in the three to five-day track forecasts.

A recent analysis conducted by Climate Forecast Applications Network (CFAN) compared track errors from different global and regional weather forecast models, all of which are considered by the NHC in preparing its forecast. The European model, operated by the European Center for Medium Range Weather Forecasting (ECMWF) and supported by 22 European countries, consistently outperformed the U.S. models maintained by the National Oceanic and Atmospheric Administration (NOAA) for track forecasts beyond two days. At five days lead time, the ECMWF model had an average track error for the 2017 season of 120 nautical miles, compared to 148 nm for the official NHC forecasts.

Innovators in the private sector apply proprietary algorithms to improve upon the NOAA and ECMWF model forecasts. At CFAN, ECMWF forecasts are corrected for model biases based upon historical track errors. For 2017, CFAN’s bias corrected storm tracks resulted in five-day average track error of 114 nautical miles – 26 percent lower than the average track error for the official NHC forecast.

Forecasts beyond five days (120 hours) are becoming increasingly important to the insurance community, especially with the development of insurance-linked securities and catastrophe bonds. The superior global weather forecasts provided by the European model (ECMWF) produced Atlantic hurricane tracks for 2017 with an average track error of 200 nautical miles out to eight days in advance. The proprietary track calibrations and synthetic tracks produced by CFAN from the European model maintain an average track error of 200 nautical miles even beyond 10 days, for the longest-lived storms.

Forecasting of storm wind intensity (as measured by maximum sustained wind speed) is also of key importance. The NHC’s intensity forecasts are slowly improving – the NHC’s intensity forecast errors at time horizons of two to five days average from 10 to 20 knots (10 knots = 11.5 mph) over the past several years. The greatest challenge in short-term hurricane forecasting remains the prediction of rapid intensification, as occurred with Hurricane Harvey in August 2017, immediately before landfall. The NHC has invested considerable resources in the development of high-resolution regional models to improve prediction of hurricane intensity. The prediction of rapid intensification remains elusive, although there is considerable research underway on this topic.

Seasonal and longer-term forecasts

Advances have been made in forecasting the probability of track locations on weekly timescales out to a month in advance. Monthly forecasts based on global weather forecast models are provided by several private sector weather forecast providers. Beyond the timescale of about a month, however, global models show little skill in predicting hurricanes. Hence, most seasonal forecasting efforts, particularly beyond timescales of six months, focus on data-driven statistical methods that examine longer-term trends in the global atmosphere.

Sea surface temperatures in the Atlantic and the tropical Pacific are key predictors for seasonal forecasts of Atlantic hurricane activity. El Niño (warmer tropical Pacific sea surface temperatures) and La Niña (cooler tropical Pacific sea surface temperatures) patterns have a strong influence, with La Niña being associated with higher levels of Atlantic hurricane activity.

Atmospheric circulation patterns also have some long-term “memory” that is useful for seasonal forecasts. CFAN’s research has identified additional predictors of seasonal Atlantic hurricane activity through examination of global and regional interactions among circulations in the ocean and in the lower and upper atmosphere. The predictors are identified through data mining, interpreted in the context of climate dynamics analysis, and then subjected to statistical tests in historical forecasts.

While forecasts issued around June 1 for the coming season generally have skill that is better than climatology, different outcomes are suggested by late May/early June forecasts for the 2018 Atlantic hurricane season. Predictions range from low activity (CFAN and Tropical Storm Risk ) to average activity (Colorado State University ) to near or above normal activity (NOAA Climate Prediction Center ). While many of the late May/early June 2017 forecasts predicted an above normal season, none of the publicly reported forecasts predicted the extreme activity that was observed during the 2017 season.

At the longer forecast horizons, forecast skill is increasingly diminished. The greatest challenge in making seasonal forecasts in April and earlier is the springtime ‘predictability barrier’ for El Niño/La Niña, whereby random spring weather events in the tropical Pacific Ocean during spring can determine its longer seasonal evolution. Seasonal forecasts from the latest version of the European model show substantially improved forecast skill of El Niño and La Niña across the spring predictability barrier, which improves the prospects for seasonal hurricane forecasts issued in late March/early April. La Niña generally heralds an active hurricane season, whereas El Niño is generally associated with a weak hurricane season. However, the occurrence of El Niño or La Niña accounts for only about half of year-to-year variation in Atlantic hurricane activity. In particular, the extremely active years such as 2017, 2004 and 2005 were not characterized by much of a signal from La Niña.

The greatest challenge for seasonal predictions of hurricane activity is to forecast the possibility of an extremely active hurricane season such as observed during 2017, 2005, 2004 and 1995. CFAN’s seasonal forecast models capture the extremes in 1995 and 2017, but not 2004 and 2005. Improved understanding of the causes of the extreme activity during 2004 and 2005 is an active area of research.

The most important target of seasonal forecasts is the number of landfalling hurricanes and their likely locations. The number of U.S. landfalling hurricanes in one year has varied from 0 to 6 since 1920. The number of landfalling hurricanes is only moderately correlated with overall seasonal activity. It is notable the period of overall elevated hurricane activity from 1995 to 2014 overlapped with a historic 2006-2014 drought of major hurricane and Florida landfalls.

Several seasonal forecasters provide a prediction of landfalls. These forecasts may specify the number of U.S. and/or Caribbean landfalls, the probability of a U.S. landfall (tropical storm, hurricane, major hurricane). Few forecast providers attempt to predict location of the landfalls. New research conducted by CFAN scientists has uncovered strong relationships between U.S. landfall totals and spring atmospheric circulation over the Arctic, which tends to precede summer dynamical conditions in the western North Atlantic and the Gulf of Mexico.

Certain insurance contracts with hurricane exposure typically take effect January 1 of each year, and for this reason there has been a desire for Atlantic hurricane forecasts to be issued in December for the following season. Such contracts often are written for a period of a year or even longer time horizons. Because of the apparent lack of hurricane predictability on this time scale, in December Colorado State University provides a qualitative forecast discussion, rather than a forecast. CFAN research has identified some sources of hurricane predictability on timescales from 12 to 48 months. Research is underway to exploit this predictability into skillful annual and inter-annual predictions of Atlantic hurricane activity.

Five to 10-year outlooks

Some atmospheric modelers provide a five-year outlook of annual hurricane activity, focused on landfall frequency. A key element of such for such outlooks is the state of the Atlantic Multidecadal Oscillation (AMO). The AMO is an ocean circulation pattern and related Atlantic sea surface temperature that changes in 25 to 40-year periods with increased or suppressed hurricane activity.

The year 1995 marked the transition to the warm phase of the AMO, which has been an active period for Atlantic hurricanes. In the warm phase of the AMO, sea surface temperatures in the tropical Atlantic are anomalously warm compared to the rest of the global tropics. These conditions produce weaker vertical wind shear and a stronger West African monsoon system that are conducive to increased hurricane activity in the North Atlantic.

There has been a great deal of uncertainty about the ongoing status of the AMO, complicated by the overall global warming trend. According to the AMO index produced by NOAA, the current positive (warm) AMO phase has not yet ended. In contrast, an alternative AMO definition, the standardized Klotzbach and Gray AMO Index, indicates the AMO has generally been in a negative (cooler) phase since 2014 – and May 2018 had the lowest value since 2015.

Map of Atlantic sea surface temperature for the month of June.
Figure 2

An intriguing development is underway in the Atlantic in 2018. The figure below shows sea surface temperature anomalies in the Atlantic for May. You see an arc of cold blue temperature anomalies extending from the equatorial Atlantic, up the coast of Africa and then in an east-west band just south of Greenland and Iceland. This pattern is referred to as the Atlantic ARC pattern. See figure 2

A time series of sea surface temperature anomalies in the ARC region since 1880, depicted below, shows that temperature changes occur in sharp shifts occurring in 1902, 1926, 1971, and 1995. On the bottom graph, the ARC temperatures show a precipitous drop over the past few months. Is this just a cool anomaly, similar to 2002? Or does this portend a shift to cool phase of the AMO? See figure 3

Figure 3. Top: ARC temperatures from 1880-2017. The black lines reflect the cold and warm regimes of the Atlantic Multidecadal Oscillation. Bottom: ARC temperatures from 1982 through June 2017.
Figure 3. Top: ARC temperatures from 1880-2017. The black lines reflect the cold and warm regimes of the Atlantic Multidecadal Oscillation. Bottom: ARC temperatures from 1982 through June 2017.

Based on past shifts, a forthcoming shift to the cool phase of the AMO is expected to have profound impacts:

  • diminished Atlantic hurricane activity
  • increased U.S. rainfall
  • decreased rainfall over India and the Sahel region of Africa
  • shift in north Atlantic fish stocks
  • acceleration of sea level rise on northeast U.S. coast.

The figures below depict how the AMO has a substantial impact on Atlantic hurricanes. The top figure shows the time series of the number of major hurricanes since 1920. The warm phases of the AMO are shaded in yellow. There are substantially higher numbers of major hurricanes during the periods shaded in yellow. A similar effect of the AMO is seen on the Accumulated Cyclone Energy (ACE). Seasonal ACE is a measure of the overall activity of a hurricane season that accounts for the number, strength and duration of all of tropical storms in the season. See figure 4

Figure 4. Observations of Atlantic hurricane activity since 1920. The warm phase of the Atlantic Multidecadal Oscillation is indicated by orange shading, with the cool phase indicated by purple shading. Top: Annual frequency of major hurricanes. Bottom: Annual frequency of Accumulated Cyclone Energy (ACE).
Figure 4. Observations of Atlantic hurricane activity since 1920. The warm phase of the Atlantic Multidecadal Oscillation is indicated by orange shading, with the cool phase indicated by purple shading. Top: Annual frequency of major hurricanes. Bottom: Annual frequency of Accumulated Cyclone Energy (ACE).

By contrast, the warm versus cool phase of the AMO has little impact on the frequency of U.S. landfalling hurricanes generally. However, the phase of the AMO has a substantial impact on Florida landfalls. During the previous cold phase, no season had more than one Florida landfall, while during the warm phase there have been multiple years with as many as three landfalls. A major hurricane striking Florida is more than twice as likely during the warm phase relative to the cool phase.

These variations in Florida landfalls associated with changes in the AMO have had a substantial impact on development in Florida. The spate of hurricanes starting in 1926 killed the economic boom that started in 1920. Florida’s population and development accelerated in the 1970’s, aided by a period of low hurricane activity.

New developments in decadal scale prediction are combining global climate model simulations with statistical models. Such predictions have shown improved skill relative to climatological and persistence forecasts on the decadal time scale.

2018 Atlantic hurricane season

The recent tropic Pacific Ocean La Niña event is now over; the tropical Pacific is trending to neutral with an El Niño watch underway. Sea surface temperatures in the subtropical Atlantic are presently the lowest that have been seen since 1982. For the 2018 Atlantic hurricane season, many forecasters who predicted a normal or active season previously are now lowering their forecasts, considering the trend towards El Niño and the cool temperatures observed in the tropical Atlantic.

Based on the overall expectations for low Atlantic hurricane activity in 2018, combined with forecasts of a U.S. landfall ranging from 50 to 100 percent, we can expect 2018 to be a year with smaller economic loss from landfalling hurricanes relative to the average.

Looking at longer time horizons, there is a potential game-changer in play – a possible shift to the cold phase of the Atlantic Multidecadal Oscillation that would herald multiple decades of suppressed Atlantic hurricane activity that would have a substantial impact on reduced landfalls, particularly in Florida.