The invisible wealth of the rich

July 04,2017

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In 2007, an engineer managed to extract confidential documents from the system of a bank. The data contained eye-popping details of 30,000 wealthy individuals around the world who had managed to funnel their wealth into secret offshore accounts.

They did this with the help of a large, thriving shadow industry that claimed special expertise at doing this work. Once those papers went public, they became known as the ‘Swiss leaks’. Last year’s Panama leaks are just an addition to this ongoing saga of the extent that the rich would go to shield their wealth from their governments. The list of infamy includes the world’s top five technology firms, such as Apple and Microsoft, who are hoarding 80 percent of their cash abroad just to defer paying taxes (the total cash holdings of these firms amount to approximately $700 billion).

Sensational revelations aside, the leaked documents provided an opportunity for researchers to examine other aspects. One such aspect is tax evasion – the primary motive for stashing wealth in offshore accounts. Researchers in Scandinavia and the US have tried to come up with estimates of the taxable amounts evaded through wealth offshoring.

Their initial estimates – stated in a recently published paper, titled ‘Tax Evasion and Inequality’ – suggest that tax evasion is far more prevalent than we had previously believed. The richest 0.01 percent of the globe may be hiding as much as a quarter of their wealth offshore and the quantum of evaded taxes may be as much as 10 percent of the world’s total GDP (approximately $80 trillion).

The bifurcation of the tax records by countries revealed even more astounding details. In Scandinavia, the tax evasion rates are one of the lowest in the world – standing at three percent. Yet, when the offshore wealth of the wealthiest in that region was taken into account, the estimates suggested that the percentage of their evasion is as high as 30 percent.

In addition to the evaded tax money, the research has another important implication in the form of inequality estimates and policymaking. The yawning wealth gap between the haves and have-nots is no secret and – in today’s perspective – has taken a new urgency. Policymakers, who are worried about the socio-economic implications of the increasing wealth gap, are trying to come up with strategies to reduce it. But the latest estimates suggest that the extent of inequality in wealth may be understated by a substantial margin. What this implies is that governments around the world have been working on estimates that have turned out to be incorrect. As a result, they will probably have to re-tailor their policies in accordance with the new numbers.

What I have discussed above are statistics supported by research and revelations. But perhaps the real quandary lies in coming up with a probable explanation for why rich people resort to such acts?

Theoretically, it doesn’t make much sense. Their wealth is enough to afford them a comfortable living and paying government-imposed taxes is only a minute fraction of their overall income. This holds true whether they are in Scandinavia – where the income taxes are one of the highest in the world – or in countries where income taxes are quiet low. If the top technology firms hoarding their wealth in offshore destinations were to pay their taxes, it would hardly amount to $50 billion of the $ 700 billion.

So what gives? There is no simple answer to this puzzle, but let me venture forth to propose a few. The most obvious reason is that most – if not all – of the wealth stashed in offshore accounts has been accumulated illegally (mostly from developing countries). This makes it easy to understand why people who have made money in this way would want to hide it. Tax havens like Panama, the Bahamas and the Virgin Islands provide them with an easy option.

In order to attract investments, they have tailored their laws to ensure a ‘no questions asked’ policy for the wealth that flows into their borders. This is a boon for people who stash their coffers with black money. Their life becomes easier when this wealth lands in places where it’s not only secure, but also difficult to trace or report.

But it’s not just ill-begotten wealth that lands in offshore accounts. The mega firms mentioned above make their money legally. However, their money’s flow in offshore accounts is largely the result of the tax policies in their respective countries. In places like Europe and the US, the tax on corporate profits is substantial to the extent that many firms and individuals look upon it as unfair. To avoid what seems unfair to them, they use the offshore accounts option. This is why there are persistent calls for overhauling tax codes within these countries.

A related reason is the lack of belief in welfare statism. In welfare states, such as those in Scandinavian countries, the revenues of the state come largely from those with higher incomes. Governments tax the rich more to run a welfare system that specifically covers the ones at the bottom tier.

In many instances, the system is akin to negative income taxation whereby the lower tiers are subsidised in terms of their income. However, there are individuals and organisations who do not believe in running a state on the basis redistribution. In order to avoid this predicament, rich people may pursue the option of offshoring their wealth.

Now comes the practical part: what can we do about this problem? How can governments and laws tackle this menace? From a policy perspective, the answer lies in arresting those developments that give rise to the illegal accumulation of wealth – which, in turn, gives rise to unequal distribution. A relevant example comes in the form of Russia’s billionaires, whose offshore accounts contain substantial wealth. In 2014, the Credit Suisse report on global wealth stated that Russia’s top 10 percent – in terms of wealth – held 85 percent of the country’s assets.

But these people were not always wealthy. Research traced the noteworthy turn in their fortunes to the disastrous privatisation of the 1990s in the aftermath of the Soviet Union’s dismemberment. As public assets were privatised in a dubious manner, these people acquired assets at throwaway prices owing to their political connections. Two decades down the line, the result is one of the most unequal societies in the world. The point here is not to discredit privatisation but to also question the process. If done correctly, this process can benefit many rather than a few.

Second, financial liberalisation has made it easier to move capital around the globe without maintaining checks and balances. This has become possible under the umbrella of globalisation, which has led to the easier flow of capital and services across borders. There are many positive aspects of this development. But this openness has also opened many illicit channels that are under legal cover. Shell companies, which were established to hide ill-begotten wealth, are a reflection of this fact. Therefore, governments need to revisit those aspects of financial globalisation that facilitate the movement of black money.

Third, governments need to lay special emphasis on implementing such domestic policies that discourage the accumulation, inflow and outflow of illegally accumulated wealth. Two prominent examples of this are the plethora of tax amnesty schemes and a specific provision of the investment act of 1992 in Pakistan. Persistent tax amnesty schemes over time to legalise illegal money have only served to further incentivise corruption and the accumulation of black money. Similarly, as per the investment act of 1992, the government departments, like the FBR, have been banned from asking about the source of incoming foreign exchange. These policies need to be done away with if governments are serious about tackling the accumulation of illegal wealth.

The flow of wealth to offshore destinations is largely driven by the illegal accumulation of wealth and, to a minor extent, by the dynamics of the taxation structures within countries. To stop this practice, reforms will have to be mainly driven by domestic policies and initiatives that not only ensure stringent checks on the accumulation of black money but also aim to simplify taxation policies.

The writer is a freelance contributor.




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