Tax Justice is the best friend free markets have

October 27th, 2010

I am fascinated by the recent attack on my work and that of John Christensen and the Tax Justice Network by Cayman Finance.

The Cayman Finance logo

It is not new of course, many tax havens / secrecy jurisdictions have made such attacks before. And no doubt they will do is again. But in making such a tax they show their real colours: they show that they are the real enemies of free and fair markets, and we are their strongest supporters. Why else would they be so annoyed?

If you believe in free markets you believe in tax justice

Let me be clear about what I am saying . If you believe that markets can or should continue to deliver well-being then you can’t believe in the continued existence of tax haven abuse. And you have to side with those of us who oppose tax havens. I say that because that is the only sustainable free market position there is.

Let me put it another way: if you really believe in free markets you have to be on the side of the Tax Justice Network. If you aren’t on their side then you’re opposing the operation of effective markets. That’s it – in a nutshell.

Now I am aware that there will be those who will reject this argument , especially on the right of the political spectrum. But if they do they show themselves for what they are – as supporters of privilege, not as supporters of markets.

Secrecy is the enemy of free markets

Let me explain. Markets, if they are to allocate resources as effectively as possible according to economic theory need three things to exist. The first is information. Unless those who participate in markets know what is happening in that market; unless they know the prices that others are offering; unless they know what their competitors are doing in other words they do not have the information they need to compete to greatest effect. And if they do not compete effectively they misallocate resources, or they misprice. In either case they undermine the market’s ability to deliver product at low cost, which is a precondition of it maximising well-being. This failure will be exacerbated by some market participants failing for lack of that information, which they here then imposes an additional cost on society as they will not have failed for reason of their own making: they will have failed because they did not have the information they needed to compete on a level playing field.

Tax havens go out of their way to hide information from view. It is not for nothing we call them secrecy jurisdictions, which we define as places that intentionally create regulation for the primary benefit and use of those not resident in their geographical domain that is designed to undermine the legislation or regulation of another jurisdiction and that do in addition create a deliberate, legally backed veil of secrecy that ensures that those from outside the jurisdiction making use of its regulation cannot be identified to be doing so.

By doing this tax havens/ secrecy jurisdictions seek to undermine markets. In the process they provide favour for some at considerable cost to others. So, for example, they favour large companies who find it much easier to access such locations, and they favour companies with greater resources who can overcome the barriers to entry that effective operation from a secrecy jurisdiction demands and they favour older companies as a result over new market entrants. Those new entrants will almost invariably have greater need for information than their larger competitors because their capital base will be smaller in proportion to their activity. Their larger competitors will, however, have the advantage of supplying asymmetric information to the market. As a consequence those larger competitors will exploit the vulnerability of newer, smaller market entrants, exacerbating their weaknesses, and will do so not because they have inherent competitive advantage but because they can and do create a market distortion in their favour by operating, at least in part, through tax havens.

The cost of this behaviour is significant. Smaller, newer companies, have greatest likelihood of delivering innovation, new jobs and in many cases well being for society. They are less likely to do so as a consequence of the operations of larger companies based in tax havens. This means market effectiveness is undermined . Worse, it means tax havens/secrecy jurisdictions support monopolies: monopolies that exploit asymmetry of information to exclude competition, to charge excessive prices and which as a result extort for their own benefit from those who should be protected from such abuse.

Free markets require effective states

But that’s only the first thing tax havens / secrecy jurisdictions do to undermine the effective operation of markets. All markets require regulation. Without the rule of law to uphold private property rights there could be no markets. Without regulation to ensure a level playing field there would be no markets, for that regulation ensures that those who supply honestly are protected individually and collectively from those who do not. And only government has been capable, since time immemorial, of providing that regulation. And only government, of course, can ultimately regulate money. So there has to be an effective state to ensure that effective markets exist: effective markets cannot exist without such states. And yet tax havens / secrecy jurisdictions set out to undermine the effectiveness of states by denying them tax revenues. So tax havens are responsible for directly attacking another of the key underpinnings of effective markets by seeking to destroy the revenue streams that governments need to ensure that regulation that markets need is in place.

It is precisely for this reason that those who support strong, effective and fully functioning markets must also support tax compliance. Tax compliance is seeking to pay the right amount of tax (but no more) in the right place at the right time where right means that the economic substance of the transactions undertaken coincides with the place and form in which they are reported for taxation purposes. Tax compliance is utterly inconsistent with the use of tax havens / secrecy jurisdictions because, as I note below, there is no economic substance to what takes place in those locations. Tax havens/secrecy jurisdictions promote tax avoidance at best and tax evasion at worst. The Tax Justice Network promotes tax compliance because that promotes a level playing field and it ensures that the resources that are needed for the effective operation of markets are available to the governments who deliver the marketplace to all participants who want to engage in commercial activity on the basis of equal access – a fundamental requirement of fair competition. All those who believe in free markets should, therefore, be supporting the Tax Justice Network position.

“Make believe” undermines markets

And then there’s the last issue I’ll mention in a short article – which is the fact that secrecy jurisdictions deliberately seek to undermine good governance , reduce accountability and in the process encourage irresponsibility. This is not just because of the asymmetrical information they provide, or the assault on tax revenues that they facilitate: it is something much more invidious than that. Tax havens / secrecy jurisdictions undermine these things because of the fiction that they create.

The reality is that almost nothing ever really happens in the so-called offshore world of the tax haven/secrecy jurisdiction. These places do not create wealth. They do not undertake trades. Physical goods and services do not pass through them and are not supplied from them. These places are mere booking agencies where entries are recorded in the ledger of a company that is little more than a tiny piece of computer hard disk and a brass plaque on the wall. Anyone who believes that the substance of the transactions recorded in these places is real has to suspend their disbelief: the claim to any such reality is very obviously false. If nothing is really taking place in a tax haven/secrecy jurisdiction then to believe the claim that there is either requires the claimant to be a liar or it requires that they suppress their critical faculties for the appraisal of the substance of transactions. It so happens that I’m not claiming that most who advocate such belief (for I stress, this is a belief system, not a reality) are liars. I am instead suggesting that they are not in possession of their critical faculties.

This loss of critical faculty is however a cause for fundamental concern. Once you have suspended your disbelief on such a scale then your ability to appraise the realities with which you are faced is seriously impaired. At that point the prospect that the person who can suspend their disbelief to this extent can also be responsible for good governance, ethical conduct, transparent accountability or the proper stewardship of assets is remote in the extreme. I simply do not believe that the world of ‘make-believe’ that the use of tax havens / secrecy jurisdictions requires is compatible simultaneously with the appropriate mindset required for sound financial management when complying with the standards of probity that society expects of those to whom it entrusts its assets. In that case tax havens/secrecy jurisdictions undermine the essential quality of trust that must exist if capital markets are to function properly. As such, tax havens/secrecy jurisdictions do not facilitate the smooth flow of capital, they fundamentally undermine the availability of capital and the prospect that it will flow appropriately.

Again, the conclusion is clear. The position that the Tax Justice Network and hold on tax havens / secrecy jurisdictions is the only tenable position that a person who believes in free markets can support. We make clear that nothing happens in these places for the glaringly obvious reason that this is the truth. Anything else is a pretence. And that pretence cannot underpin effective markets, it does instead undermine them.

Tax havens don’t support free markets – they support oppression

In that case why do so many, who claim to believe in free markets support the use of tax havens? As I noted at the outset, there is only one explanation. These people are not telling the truth when they claim they believe in free markets. They do instead believe in the maintenance of privilege. They do that to sustain their monopolies. They do that to sustain their exploitation of ordinary people in developing countries. They do that to avoid their obligations to societies around the world. But this exploitation is utterly inconsistent with the potential for the creation of well-being that free markets have to offer in partnership with well funded, effective states.

It may be a surprising conclusion for some, but the Tax Justice Network may be one of the strongest supporters of the benefits of free markets that there is. And so am I. And I challenge anyone to disagree.

Originally published on the Tax Research UK blog.

Written by Richard Murphy

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