Article on Moving Money: International Financial Flows, Taxes, and Money Laundering (1/17/14)

I just became aware of a recent article by Richard Gordon and Andrew P. Morriss titled Moving Money: International Financial Flows, Taxes, and Money Laundering, 37 Hastings Int'l & Comp. L. Rev. 1 (2014).  The article is available through paid services such as LEXIS-NEXIS.  See here.  A draft of the article is available on Professor Gordon's SSRN page, here.  Here is his SSRN abstract for the article.

Moving Money: International Financial Flows, Taxes, & Money Laundering
Abstract:  

Allegations by political leaders and others that offshore financial centers enable multinational enterprise to avoid paying a “fair” amount of tax — and that they enable wealthy individuals to evade paying any tax, much of it on ill gotten gains — are once again garnering headlines and inspiring government action. One of the most prominent commentators on these topics, The Tax Justice Network, has recently claimed that thanks to the services of tax havens $21-$32 trillion of wealth of questionable origin remains hidden and untaxed, and that such abuse must be stopped through greater regulation. In this paper we argue that such claims rest on poor data and analysis, and on mistakes about how financial transactions, international taxation, and anti-money laundering rules actually work. We further argue that demands for more regulation without considering cost and effectiveness rely on a belief that international financial transactions are assumed illegitimate unless tightly controlled, rather than primarily reflecting the normal, legitimate workings of an efficient market.

It is not a light read, but an enlightening one.  At the risk of misfocusing the analysis in the article and not giving the entire context, I thought I would offer some excerpts that might whet the appetite of readers to read the whole article (footnotes omitted and bold face supplied by JAT):

Most recently, the Tax Justice Network caught public attention by arguing that, "[a] significant fraction of global private financial wealth ... has been invested virtually tax-free through the world's still-expanding black hole of more than 80 "offshore' secrecy jurisdictions" though they also ranked the United States in the top five in terms of financial secrecy. Similarly, the popular press often portrays "offshore" transactions as sources of criminal activity. 

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These arguments rest on a profound misunderstanding of how financial transactions occur. We argue below that much of this "tax justice" literature is driven by its incorrect assumptions about money, business, finance, and government. The assumptions are disguised by often overheated rhetoric and pseudoscientific, or completely unscientific calculations. Like a three card monte dealer rapidly shifting cards on a box while distracting his victims with rapid chatter, some proponents of "tax justice" divert debates over tax policy, global finance, and international business away from the economic underpinnings of financial transactions and the fundamental substantive policy differences that should be the focus of discussion. Although they seek to persuade policymakers that adopting their proposed policies will not limit the beneficial aspects of the existing financial system, what they are advocating is a fundamental reordering of global finance in ways that we contend would reduce social welfare. 

* * * * 

We believe that much current commentary (and actual public policy) is hewing too close to the "illegitimate without strict control" end. We refer to this as the "control first" view. "Control first" advocates often begin by neglecting the benefits of free markets, and then overstate the benefits of control while ignoring the costs of those controls. 

We, on the other hand, believe that one should begin with the view that voluntary transactions among people and firms that wish to trade and invest with one another is a positive good, and therefore that keeping transactions costs of "moving" money from one place to another is also a positive good. We also believe that some public controls are needed to prevent the costs of abuse, and that any controls must be judged by their costs to market efficiency and their real, demonstrated benefits. At no time should policy makers assume that controls have no costs, or that because controls are well intentioned they have good results. Because we believe in including both benefits and costs of free markets, market abuse, and controls of market abuse, we call this the "Efficient Enterprises" view. To be clear, we are not anti-regulation; we are against inefficient and wasteful regulation. 

Those of us that hold this view believe that we should start by looking at the benefits of international markets in goods and services, which cannot take place without the international movement of money. For example, the Peterson Institute for International Economics calculates that Americans alone benefitted from trade liberalization by nearly $ 1.4 trillion in 2012. It is not just rich countries that benefit. By the 1970s, "economic growth in the open world market economy had been so great that few governments are now in strong enough control over their civil societies to be able to deny them the chance to participate in this wealth-creating system." In 1998, the head of the World Trade Organization (WTO) cited the growth in trade as a cause of the doubling of income in ten developing countries with a combined population of 1.5 billion and overall annual growth in the world economy of 1.9% per year since World War II, a historically high figure. This was the dominant vision in international private law until the 1990s and underlies how international financial institutions were constructed. 

On the other hand, "Control First" begins by seeing the "movement" of money as a problem unless subject to control. Control can only be implemented if information on the money has been reported to governments (or occasionally quasi-governmental organizations), which will then be able to use the information to prevent transactions that represent the proceeds of crime, including the evasion (and, increasingly, the legal avoidance) of taxes. In this vision, transfers of money, international finance, and globalization are seen first as the means by which the powerful exploit others, depriving the victims of their livelihoods and resources. For example, the Tax Justice Network argues in its widely cited report The Price of Offshore Revisited that $ 21 trillion to $ 32 trillion in "financial" wealth in 2010 was "hidden" in OFCs and so is "virtually tax free." Similarly, analyst Raymond Baker contended in the early 2000s that $ 1 trillion in "dirty money" crosses borders annually, and that there was $ 5 trillion in accumulated hidden assets (as of the early 2000s). Proponents of the Control First framework argue that the most important impact of financial openness is to allow the looting of developing country economies by a coalition of local elites, multinational businesses, and multinational financial institutions.  

The disagreement between these frameworks is partly philosophical. Regardless of the size of "undertaxed" money flows, who gets the money, or benefits of financial freedom, one might believe that taxing every dollar of wealth trumps any benefit. One might believe that a poorer but more equal world is preferable to a richer but less equal one, or, alternatively, that ensuring that investors are free to shift assets wherever they prefer is worth any reduction in tax revenues anywhere, or that eradicating absolute poverty trumps concerns over inequality. The Tax Justice Network, for example, rarely concedes that there is any benefit to the movement of money in the international financial system. As its name suggests, it is focused on applying its definition of "justice" to the tax system, largely to the exclusion of any benefits of financial freedom. However, the disagreement is also empirical - there are important disagreements about the facts: does making international financial flows cheaper help or hurt the global economy, particular economies, or particular individuals? 

The relative influence of these visions over future measures governing the international financial architecture in particular countries, in treaties among countries, and in multilateral governance structures will profoundly shape the future of the world economy. In part, the choice between them reflects a disagreement about the mix of different kinds of transactions in the world economy. For example, the more criminal transactions that occur, the greater is the justification to implement preventive measures. At the same time, however, Control First measures necessarily add transactions costs, which by definition will reduce legitimate, value-maximizing transactions, while perhaps blocking some criminal ones. How to balance the costs and benefits of such measures will depend in part on views about the relative importance of reducing crime, including fiscal crime, (as well as the effectiveness of these measures in actually reducing crime) and of increasing the volume of private, wealth-maximizing transactions. That, in turn, rests not only on disagreements within and across societies over the appropriate size and scope of governments, but also over the costs and effectiveness of different financial infrastructures. 

As the global financial crisis provided the opportunity for substantial changes in the world's financial infrastructure, understanding this clash of visions is important. In this Article, we make several contributions. In Part I, we contrast the Efficient Enterprises and Control First frameworks, examining their different assumptions about how the world economy functions. In Part II, we set out the financial "plumbing" through which money "moves" and show why this infrastructure is important and how it affects the two frameworks' policy prescriptions. In Part III, we analyze the evidence provided by the Tax Justice Network, among the primary proponents of the more extreme Control First framework measures, and show that it fails to support their claims. Part IV concludes by setting out some criteria for evaluating policy trade-offs in decisions about financial architectures.  

Tax Discussion (Later in the Article)

This is exactly what the G-7, the OECD, the United States, and the European Union have been advocating for some time, and the framework, which has recently been adopted as policy by the Group of 20. Previously larger, mostly onshore jurisdictions that depend on the income tax had pressed low or no income tax jurisdictions only to provide information on particular accounts when the taxing jurisdiction believed that one of its residents was committing tax evasion by receiving undeclared income in the low or no tax jurisdiction. Although no offshore center or other jurisdictions with low or no income tax would ever need to request such information from high tax jurisdictions, nearly all have signed tax information exchange agreements with onshore jurisdictions. Given the disparity in benefits, such agreements have been signed under pressure from onshore jurisdictions, organized in part through the OECD's two initiatives, the Harmful Tax Practices initiative and the Global Forum on Taxation, later renamed the Global Forum on Transparency and Exchange of Information, and the European Union's Code of Conduct Group on Harmful Tax Practices.  

However, realizing that this did not uncover tax evasion but only facilitated prosecution of otherwise identified instances of tax evasion, these high tax jurisdictions are now seeking to require that financial institutions in other jurisdictions routinely report to the high tax jurisdictions details of the financial transactions of the residents of high tax countries when these transactions occur outside the high tax countries. In other words, the high tax countries wish to treat the financial institutions of low or no tax countries as if they are under the jurisdiction of the high tax countries. For example, starting in January 2014, the European Union's Council Directive on Administrative Cooperation in the Field of Taxation will do this for members with respect to wages, director's fees, and income from life insurance products, pensions, and immovable property.  

Perhaps the most extensive (and intrusive) expansion of transnational reporting is the U.S. Foreign Account Tax Compliance Act (FATCA). FATCA requires foreign financial institutions to identify to the United States their U.S. account holders and to disclose their names and addresses, and the accounts' balances, receipts, and withdrawals. Failure to do so would result in the United States applying a gross withholding tax of 30 percent on all payments of gross income to those financial institutions. And, to uncover exactly who is a resident of the high tax country, foreign financial institutions will need to determine if U.S. residents are actually beneficial owners of arrangements with accounts in those countries. In spite of such burdensome and expensive requirements, many low or no tax offshore centers have reached agreements or are expected to reach agreements with the United States to avoid the sanctions, including the Cayman Islands, Guernsey, Jersey, The Isle of Man, Singapore, and Switzerland. European nations are creating their own "son-of-FATCA" laws to require similar efforts. 

In other words, high tax countries are forcing all jurisdictions, including those who do not have significant income taxation as a matter of policy, to serve as unpaid income tax law enforcement officers of the high tax countries, and even if the country does not report on the financial transactions of its own residents, typically because it has no income tax to enforce. An alternative, of course, would be for the high tax countries to provide their own tax authorities more resources, but this, of course, would cost them money. The high tax jurisdictions, not surprisingly, believe that it is better to require foreigners to provide them free tax administration services. This, even though the vast majority of tax cheating in high tax countries like the United States is done strictly domestically. Nevertheless, nearly all offshore and other low or no tax jurisdictions are complying. They have little choice, since their economies are dependent on access to the larger onshore economies.

 From the Conclusion:

As we have shown, the global financial network is a complex system that uses different jurisdictions for different purposes. Some of these purposes are legitimate, while some are not. The question facing policy makers around the world is how much reworking the system can tolerate before the benefits it yields are too eroded. Unfortunately, that debate turns in part on data that is impossible to obtain. The most recent effort by the Tax Justice Network falls so far short of any reasonable analysis that it cannot be considered seriously. 

As a result, the debate is being conducted based on world-views rather than realistic cost-benefit appraisals.