Avoiding Tax and Panama

The big story at the moment surrounds Panama, which many folk may know best from Prison Break rather than its financial sector. A truly massive leak of confidential files from a law firm (terabytes, not just gigabytes…) is causing embarrassment and more for many leading global figures. UK Prime Minister David Cameron is fending off questions about his family’s involvement with the law firm via his father, while the Icelandic Prime Minister was more deeply embroiled and has already bitten the bullet. Links to Vladimir Putin do not appear to have caused quite so much shock and consternation

What exactly is going on, and why does it matter from a macroeconomic perspective? It must matter, since it pertains to billions of dollars. Economies have billions of dollars (or pounds, or euros) moving around within them, and hence that billions ended up in Panama rather than the places that the people mentioned above are located is of interest.

Towards the end of term we covered the Balance of Payments, which is the financial account of a country – what financial flows go in and out of a country. Clearly, it seems, considerable flows went out of the UK, Iceland, and Russia to Panama, and for what? Money is moved from one place to another usually for some purpose – for example an investment, or to pay for imported goods. The claim, however, is that much of these financial flows were “offshore” – moving of money primarily for the purpose of avoiding paying taxes.

In the case of Ian Cameron, the PM’s dad, their company Blairmore Holdings was based in Panama, it would seem, to avoid paying as much tax as would be paid in the UK. However, as the leaks appear to make clear, major decisions about the firm were still made in the UK (based on documented meetings of board members revealed in the leaks) – which apparently is the test of where a company is “located”. What this makes clear is the difficulty of regulation – definitions have to be made for things that are easy to think about, but harder to pin down the detail of – what is the definition of where a company is located? And once a definition is made in a country’s law, it will provoke those in that country to consider ways in which that law can be avoided. As a result, it’s likely that those involved will claim nothing illegal was done, regardless of the wider moral implications about doing right and wrong.

Economic activity, you’ll learn more as you study further in microeconomic topics, tends to need some level of regulation. However, that regulation need not be a panacea, and need not lead to unintended consequences. The rise of offshore tax havens came primarily in response to higher tax rates in major Western economies, particularly in the 1970s, and of course regulation is something that many in favour of the UK leaving the EU cite as a reason to leave. A very thoughtful friend of mine has noted the link between these two – the UK remains a place for lots of finance taking place onshore, and is so at least in part because of its position within the single market (single market = more customers = more revenues). If that attraction was lost, the UK may need to consider other ways to retain its position, which may include more favourable tax and regulatory arrangements for finance – yet financial markets are precisely the markets where the clamour for “more regulation” has been greatest since the financial crisis.

As with anything in macroeconomics, it’s complicated, but it’s well worth studying!

Tax Credits?

Today’s headline news is not tax credits, but they’ve been dominating the news of late. The government plans to cut tax credits, which many see as unfair.

Tax credits are essentially in-work benefits, paid to people working but earning below a certain threshold (£14k). The motivation for them is to reduce the disincentive to take work that many on benefits face: by taking a job, many can find themselves worse off than they would be if they remained on benefits and out of work – the poverty trap.

One criticism of tax credits is that they amount to a subsidy to for firms unwilling to pay a sufficiently live-able wage to workers, and as a result sustain a low pay culture. This criticism assumes all firms do this out of choice rather than because it is all they can afford to pay. This analysis from the Institute of Economic Affairs makes the same point. It’s possibly a little simplistic in that it assumes all firms are price takers and have no bargaining power, which is probably unrealistic in at least some cases (and probably most likely in low pay cases).

The main reason the government is pushing through cuts to tax credits is that they need to satisfy the fiscal charter they introduced recently, and many other parts of the benefits bill are protected (such as pensions). The political criticism of the move derives from the fact that, pre-election, David Cameron said that he wouldn’t cut tax credits in one of the live TV debates.

On purely economic grounds, a government policy that reduces the poverty trap (or at least shifts it to in-work decisions about how many hours to take), ought to be a good thing – and should be on political grounds too, given that strivers (those in work) are to be encouraged, and shirkers (those out of work) are the ones to be penalised. This raises deeper questions about what function a welfare state serves (insurance mechanism?) if we are to analyse it properly, which we won’t.

But either way, given the fiscal charter the government has a lot of cutting to do, which is going to be very unpopular…