Irrational tax and regulatory systems

The financial district in St. Peter Port, Guernsey
The financial district in St. Peter Port, Guernsey, Channel Islands (source: dpa)

The so-called Paradise Papers appeared last week in the media. They contained information leaked from offices in Bermuda and Singapore, showing activities of mainly large corporations and well-to-do individuals in so-called “offshore centers.” It was acknowledged that most of the activities described are perfectly legal.

Nevertheless, readers of these reports were misled to assume that these activities were shady and unethical, intended to avoid taxes and hide corruption. Full transparency is being demanded in total ignorance of basic values, such as the right to financial privacy, the presumption of innocence, respect for the law and the importance of business confidentiality. Business confidentiality is an essential ingredient for effective competition and free markets.

The controversy also begs the real question. Why do people use “offshore centers” in the first place?

We do not want to deny that any system can be misused. However, the anti-money-laundering procedures now in place in most “offshore centers” are much stricter than in most other countries. Illegal transactions tend to avoid those jurisdictions.

Self-inflicted

So why go offshore? The reasons are many, but they mostly lie in the regulatory structure of the countries where these individuals or companies live or operate.

It starts with something that the World Bank calls “the ease of doing business.” In many places, including most industrialized countries, setting up companies has become very cumbersome. Regulatory and tax systems are byzantine in their complexity. In many cases, the need to preserve the confidentiality of business know-how is not guaranteed. Tax planning has become close to impossible, as the desperate greed of governments to cover public overspending produces ever more erratic changes to tax codes and highly arbitrary procedures in their application.

Last week, France delivered a very clear example of damaging tax legislation. This is the sort of practice that drives companies to seek offshore solutions. The duty of every responsible business is to act in a way that guarantees its long-term survival within the law. This can only be achieved through sustainable profitability. Financial management and planning in view of future investments is a crucial fiduciary responsibility. Such planning requires confidentiality and a secure legal environment, including in tax matters.

Arbitrary measures critically damage the ability of large companies to invest


In his election campaign, French President Emmanuel Macron promised to reduce the French budget deficit in 2018 to less than 3 percent of gross domestic product – a eurozone requirement – by a combination of lower public spending and faster economic growth. But public spending was not sufficiently reduced. Spurring economic growth is also difficult, due to overregulation and the large public debt. Further spending cuts would only worsen the president’s already high unpopularity.

The French government tried to plug the budget gap with a totally illogical measure – a special tax on dividends. Quite justifiably, this measure was declared illegal by France’s Constitutional Court. In response, politicians opened their fiscal bag of tricks and came up with an even more toxic proposal. The French National Assembly decided to increase the corporate tax rate for companies with sales exceeding 1 billion euros by 15 percent, and for those with sales exceeding 3 billion euros by 30 percent (to a rate of 43.3 percent)!

Wrong response

These arbitrary measures will critically damage the ability of large French companies to invest. In the long term, such policies are economically unsustainable and undermine any trust in legal security or planning. They are a perfect explanation of why companies – to fulfill their duties – use shelters.

Even so, Pierre Moscovici, the European Union’s Commissioner for Economic and Financial Affairs, Taxation and Customs, reacted to the “Paradise Papers” by decrying the damaging effects of “offshore centers.” He proposed that the EU set up a blacklist of tax havens, followed if necessary by sanctions. This will only make a bad situation worse.

To all the problems mentioned above, there is a very simple remedy. It would be enough to create a leaner, more efficient regulatory framework, get rid of excessive bureaucracy, introduce a tax system that is logical, transparent and not overcomplicated, and the costs of government would be dramatically reduced. Complex fiscal and regulatory structures would become unnecessary. This would greatly help the economy and ease the strain on public finances.

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