Jul 07 2011

Tax Havens – Adam Smith would be spinning in his grave

Posted by: Nick Shaxson in: Thoughts

Professor Ed Kleinbard of the University of Southern California, a leading US tax professor, has an interesting presentation looking at the concept of ‘stateless income’ – that is, income that multinationals stash overseas, typically in tax havens. There’s currently a huge, turbulent debate going on in the U.S. about this – a bunch of heavily resourced lobbyists led by Apple want the Obama administration to let them whoosh a trillion dollars or so of this back home, and the forces of justice, reason and honesty are trying hard to stop them. (For more on that, see Nicole Tichon’s piece here.)

Anway, Kleinbard makes a point that I and my colleagues at the Tax Justice Network have made many times:

Stateless income privileges multinational firms over domestic ones by offering the former the prospect of capturing “tax rents” – low-risk inframarginal returns derived by moving income from high-tax foreign countries to low-tax ones.”

Indeed. It is incontrovertible what he says – this is a vast, harmful distortion at the heart of global capitalism.

Focus here on the word ‘rents,’ which is a particular term used by economists to denote unearned income, windfall income, ‘the income of the man who loves to reap where he did not sow,’ for instance. Income from rising land values is a case in point: it’s nothing to do with the hard work or brilliance of the rentier landowner, and everything to do with a free lunch.

Now let’s turn to what Adam Smith had to say about taxing rents. He called them

“the species of revenue which can best bear to have a peculiar tax imposed upon them.”

In other words tax rents – and at high rates.

He was talking about land, which was the primary source of rent in his day, but the principle can be extrapolated to all forms of rentier income. Today, economists of all stripes accept that it is efficient and just to tax rents at very high rates. This can be done without causing any market distortions.

If you’re getting a free lunch from doing something, taxes aren’t going to stop you doing it – you’ll still have your free lunch, even if you have to cancel the order for the 1969 Dom Pérignon.

Back to Kleinbard. Tax havens are providing multinationals with this particular form of rent, which he calls tax rents. They make bigger profits – not by producing better or cheaper goods or services – but by shuffling around bits of paper. A free lunch.

And here’s the real rub – these tax rents are accumulating offshore and cannot be taxed! The tax havens are creating these rents – then actively stopping anyone from taxing them. That’s the whole point.

We have always argued that tax havens, or secrecy jurisdictions, foster distortion after distortion. The more you look at it, the more obvious it becomes. They wreck competitive markets.

Adam Smith and legions of economists in his wake would be, at least for the defunct ones, spinning in their graves.

For more on rentiers – and how important they are – see Paul Krugman’s recent piece on the subject.

“everything we’re seeing makes sense if you think of the right as representing the interests of rentiers.”

3 comments so far

Demetrius 7th July, 2011 4.17 pm

Over at TJN I commented that perhaps “rent” is too polite a word. My suggestion is “extraction” in this context.

kim bjorkland 7th July, 2011 6.31 pm

Nick –

Firstly, Adam Smith died in 1790. Did DIY exist in 1790? Was there an entrepreneurial middle class that bought houses, renovated them, then rented them out as a way to supplement their retirement income? Clearly no.

Secondly, have you tried the activities in point #1 above? I can assure you that being a landlord is not an easy task, and the income doesn’t come ‘for free’. It takes lots of work and money these days to identify a property, prepare it for rent, advertise, find renters, etc. It’s not as easy as sign up and collect rent without doing any work. It’s not a ‘free lunch’.

Collectively point 1 and point 2 above should put to bed your and Adam Smith’s diatribe about the lack of ‘skill’ or workmanship required to generate rental income.

Thirdly, what do you call the interest income that you generate from your bank account? Is this indeed not EASIER to generate than rental income? You literally have to do NOTHING to generate this. And if generating rental income is naughty by your thesis, then paint everybody who deposits money into a bank account with the naughty brush (ie. every last one of us).

Fourthly, ‘shuffling bits of paper around’ – this romantic fetish that you and the leftists have about manufacturing = value seemed to shine through in your book as well (specifically the parts that you repeated that Keynes felt that workmanship and innovation and trades were real engines of the economy, and that capital and bankers were not). To this point allow me to ask you – isn’t the way you make a living essentially shifting pieces of paper around? Writing words on a piece of paper? Generating profit form ideas instead of a real trade or utilitarian value?

Doesn’t google just make money from virtual bits and bytes?

Isn’t the sale of copyrights and intellectual property rights – be they in the music, television, software, or video games industry nothing more than pushing pieces of paper around? Isn’t the procurement of a business license, a permit to hold a protest, a permit to put Dr. before your name or Ph.D. after your name also nothing more than just shuffling pieces of paper around?

The truth is, in the marketplace of Adam Smith’s 1790’s, there was little value appropriated to intangible goods or services. But in the marketplace of 2010, a considerable portion of our economy is represented by intangible goods. There isn’t anything evil or duplicitous about that. It’s just evolution and innovation. The so called Tax-Havens that are ‘generating rent’ as you claim, have identified that there’s market value to govern their sovereign jurisdictions in a way that doesn’t necessitate bankrupting military spending (how many cayman island soldiers were in Libya last week?), or nanny state big brothering (how many CCTV cameras exist in Malta?).

In Conclusion, where do we stand?

1. Rentiers and generating rent is not evil, is not easy, is not a free lunch, and is not unethical.

2. All of us are ‘Rentiers’ if we put our money in a bank account.

3. The market has evolved since 1790 to allocate value to intangible goods like location, copyright, and taxation is just one of those ‘intangible’ goods.

Adam Smith and Keynes would both be rolling in their graves if they knew that we were communicating instantly ten’s of thousands of km’s apart. Don’t let old dead men influence how the market and innovation will evolve.

Nick Shaxson 7th July, 2011 5.03 am

Kim, thanks for your long and considered response. The economic theory of rents has a long and venerable tradition in the field of economics: I’m not just making this up. There is plenty of literature out there worth reading – take a look at the Land Value Tax people’s work. There’s nothing ‘naughty’ about earning rents – the point in the economics literature is simply that because rents are, effectively, a free lunch, you can tax them at high rates and you won’t stop the activity. There’s no economic loss from it. Of course the world was different in Adam Smith’s day – of course it was – and of course it is a leap of faith to guess what he would have thought. The best we can do is see what he said about his world, and then apply the general principles. And that’s what’s been done here, no more. It’s a perfectly valid exercise. And as for your last para, remember Keynes’ memorable phrase, which is more than appropriate: “Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist.”

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