LRB on Tax Avoidance and how the 01% are destroying our economy

Didn’t they notice?
David Runciman
London Review of Books, 14 April 2011
See also accompanying article, "Out of Sight" by Richard Murphy

Books under Review

T

reasure Islands: Tax Havens and the Men who Stole the World by Nicholas Shaxson
Bodley Head, 329 pp, £14.99, January 2011, ISBN 978 1 84792 110 9
Buy
Winner-Take-All Politics: How Washington Made the Rich Richer – and Turned Its Back on the Middle Class by Jacob Hacker and Paul Pierson
Simon and Schuster, 368 pp, £11.50, March 2011, ISBN 978 1 4165 8870 2

How to sum up Saif al-Islam Gaddafi, that emblematic figure of our times, with his doctorate from the LSE (‘The Role of Civil Society in the Democratisation of Global Governance Institutions’), his charitable foundations, his extensive property portfolio, his playboy lifestyle, his motley collection of friends (Peter Mandelson, Nat Rothschild, Prince Andrew), his ready access to Libya’s sovereign wealth fund, and his recently professed willingness to eliminate the enemies of his father’s regime one bullet at a time? He’s a hypocrite, of course, but that hardly does him justice (who isn’t?). He is also, on some accounts, a victim: his unfortunate mentor at the LSE, David Held, has described the predicament the ostensibly reform-minded Saif found himself in after his father’s people had revolted as ‘the stuff of Shakespeare’, but that surely is letting everyone concerned off far too lightly. He may just be a smooth-talking thug, and many online observers have noted that he seems to model himself on the smooth-talking thug and would-be businessman Stringer Bell from The Wire. But the word that best captures Saif Gaddafi comes from Nicholas Shaxson’s blistering account of the role that tax havens play in international finance. Shaxson doesn’t discuss the Gaddafis themselves, but he does paint a picture of the world in which the young Gaddafi, until very recently, felt right at home. This is the world of ‘offshore’. Shaxson doesn’t limit the term to its technical meaning, as a simple description of the particular jurisdictions that enable people to eliminate their tax bills. He applies it to people as well as places, and to a way of life along with a state of mind. Seen like this, it turns out to be a very useful word. Saif Gaddafi is just an offshore guy, living in an offshore world.

The essence of offshore is the need to keep up a solid appearance of respectability, while allowing money in and out with as little fuss as possible. Tax avoidance (unlike tax evasion) is not a clandestine activity, and tax havens don’t exist just to enable people to squirrel their money away from the authorities. The money needs to be accessible, and it needs to be liquid. For that reason, people prefer tax havens where they can conduct their business relatively openly, and the most successful offshore jurisdictions are the ones that ask no questions but also tell no lies. Shaxson’s memorable phrase for this is ‘theatre of probity’. The Swiss have always been the masters, with their formal manners and careful paperwork. But it turns out that the other champions of this way of doing business are the British. Shaxson’s book explains how and why London became the centre of what he calls a ‘spider’s web’ of offshore activities (and in the process such a comfortable home for the likes of Saif Gaddafi). It is because offshore is the offshoot of an empire in decline. It perfectly suited a country with the appearance of grandeur and traditionally high standards, but underneath it all a reek of desperation and the pressing need for more cash.

As Shaxson shows, many of the world’s most successful tax havens are former or current British imperial outposts. These include Hong Kong, the Channel Islands and remaining overseas territories like the Cayman Islands. What such places offer are limited or non-existent tax regimes, extremely lax regulation, weak local politics, but plenty of the trappings of respectability and democratic accountability. Depositors are happiest putting their money in locations that have the feel of a major jurisdiction like Britain without actually being subject to British rules and regulations (or British tax rates). The Caymans, or Jersey, make full use of their British connections to reassure people that their money is safe (the Cayman national anthem is still ‘God Save the Queen’), but when anyone complains to the authorities back in London that these places are being used by criminals and dictators to launder their assets, they are told that it is no longer Britain’s role to tell its dependencies how to run their own affairs. It was a function Hong Kong fulfilled before its handover to China in 1997: it could be presented to the outside world as somewhere with British values but without its unfortunate tendency to raise either taxes or regulatory standards in response to political pressure. Strikingly, it plays the same role for China today. After 1997 China preserved Hong Kong as a ‘special administrative zone’ autonomous of the mainland in all matters except foreign relations and defence. As Shaxson puts it, ‘The resemblance with the ambiguous Britain-Jersey link, or the Britain-Cayman arrangement, is no coincidence. Chinese elites want their own offshore centre, complete with political control and judicial separation.’ So offshore suits empires on the rise as well.

The other thing most of these places have in common is that they are islands. Islands make good tax havens, and not simply because they can cut themselves off from the demands of mainland politics. It is also because they are often tight-knit communities, in which everyone knows what’s going on but no one wants to speak out for fear of ostracism. These ‘goldfish bowls’, as Shaxson calls them, suit the offshore mindset, because they are seemingly transparent: you can see all the way through – it’s just that when you look there’s nothing there. Jersey is the template: a nice, genteel place, with a strong sense of civic responsibility and plenty of opportunities for public participation, including elections to all manner of public offices (senators, deputies, parish constables), but weak political parties, staggered ‘general’ elections, and never a meaningful change of government. ‘If you don’t like it, you can leave’ is the basic refrain of Jersey politics. Dissent is not obviously suppressed, as it might be under a dictatorship (which is why dictatorships make bad tax havens: you never know when the whole thing is going to blow up). Instead, dissent is simply allowed to wither away. The same thing happens on the Cayman Islands, with its tiny population (around 55,000), its elected legislature and its governor-general appointed from London, who takes all the difficult decisions but allows the locals to have their say. As one former governor-general put it, ‘I think we are in the world of semantics here. The more Caymanians we can put in positions of power, the better; they will act as lightning conductors for political dissent.’

This is the web, but where is the spider? At the heart of Shaxson’s story lies the City of London, itself a kind of island within the British state. Again, the rise of the City as the favourite place for foreigners to park their money, no matter who they were or where it came from, is related to imperial decline. After the Second World War, sterling still financed much of global trade, but the British economy was no longer able to sustain the value of the pound against the dollar. In the aftermath of Suez, which caused a run on the pound, the government attempted to impose curbs on the overseas lending of London’s merchant banks. The response of the banks, with the connivance of the Bank of England, was to shift their international lending into dollars. The result was the creation of the so-called ‘Eurodollar market’ – which was effectively an offshore haven. Because the trade was happening in dollars, the British saw no need to tax or regulate it; because it was happening in London, the Americans had no means to tax or regulate it. Among the first people to spot the advantages of this new system were the Soviets, who wanted a secure place outside the US to hold their dollars so that the Americans could not seize them if relations between the countries deteriorated. They were soon followed by the Americans themselves – that is, American banks and wealthy individuals – who saw the London market as somewhere to do business free from the grasping hand of the US authorities. The money started to pile in.

The Bank of England was happy: London was once again a lynchpin of international finance. The American authorities, unsurprisingly, were not so happy: they feared a balance of payments crisis. But when in 1963 President Kennedy tried to stem currency outflows by taxing the interest on foreign securities, in an effort to reduce the incentive to export dollars to more lucrative overseas markets, it had the opposite effect, and produced what Shaxson calls ‘a stampede for the unregulated London offshore market, free of tax and regulations’. US policy-makers were now in a dilemma. They could try to face down the threat of offshore, either with higher domestic interest rates, or with tighter controls on currency outflows and a tougher regulatory regime requiring US banks to share information about their overseas activities. Or they could copy London by creating an offshore world of their own closer to home: in other words, if you can’t beat them, join them. The second was the path of least resistance – among other things it was a useful way of reinforcing the dollar’s position as the global reserve currency – and over time it was the one they took. Slowly in the later 1960s and 1970s, and then much more rapidly in the 1980s and 1990s, America deregulated its financial controls and allowed money to move in and out with fewer if any questions asked, in the hope that more of it would stick to the sides.

Once this process began, it also unleashed a new wave of competition between individual American states to offer the most hospitable, least intrusive regulatory environment for outside companies to work in. Leading the way was little Delaware, which had always tried to compensate for its lack of size by being open for any business. Since the 1980s more and more corporations have moved to Delaware to take advantage of the state’s extreme laissez-faire attitude to the rights of shareholders and employees against company managements. If you took your business to Delaware (and this was often just a question of establishing a shell office and filling in some forms), it would be much harder for anyone to prove anything against you, because the Delaware courts did not think that much of what you did was any of their concern. Again, other states faced a choice: they could try to isolate Delaware by tightening up their own standards or they could try to compete for a share of the spoils. Enough of them decided to compete to start a race to the bottom. Offshore had moved onshore.


When officials from Delaware toured the globe in the late 1980s advertising their services (and hoping, among other things, to provide a haven for all the hot money that was expected to flow out of Hong Kong in the run-up to the handover to China), they did so under the slogan ‘Delaware can protect you from politics.’ Shaxson defines a tax haven as ‘a place that seeks to attract business by offering politically stable facilities to help people or entities get around the rules, laws and regulations of jurisdictions elsewhere’. But this is the crux: where is the politics? Why aren’t these moves more politically unstable, or at least politically contentious? In the case of Delaware, as with other goldfish bowl communities, size probably tells (for a long time Delaware politics was shaped by the influence of the Du Pont family, whose vast chemical operations dominated the local economy). What, though, about Washington, where the shift to an offshore mindset at the national level might be expected to run up against some serious political opposition? What happened to the representatives of all those people who don’t have lots of money to move around, who can’t relocate even if they wanted to, and who have an interest in a fair, open and broadly progressive tax system? Didn’t they notice what was going on?

This is the question that Jacob Hacker and Paul Pierson tackle in Winner-Take-All Politics. They don’t spend much time talking about offshore, but the story they tell has striking parallels with the one laid out by Shaxson. One of the ways you can identify an offshore environment, according to Shaxson, is that local politics gets captured by financial services. In that sense, Washington has gone offshore: its politics has been captured by the interests of a narrow group of very wealthy individuals, many of whom work in finance. For Hacker and Pierson this, more than anything else, explains why the rich have got so much richer over the last 30 years or so. And by the rich they don’t mean simply the generally wealthy; they mean the super-rich. The real beneficiaries of the explosion in income for top earners since the 1970s has been not the top 1 per cent but the top 0.1 per cent of the general population. Since 1974, the share of national income of the top 0.1 per cent of Americans has grown from 2.7 to 12.3 per cent of the total, a truly mind-boggling level of redistribution from the have-nots to the haves. Who are these people? As Hacker and Pierson note, they are ‘not, for the most part, superstars and celebrities in the arts, entertainment and sports. Nor are they rentiers, living off their accumulated wealth, as was true in the early part of the last century. A substantial majority are company executives and managers, and a growing share of these are financial company executives and managers.’

Hacker and Pierson believe that politics is responsible for this. It happened because law-makers and public officials allowed it to happen, not because international markets, or globalisation, or differentials in education or life-chances made it inevitable. It was a choice, driven by the pressure of lobbyists and other organisations to create an environment much more hospitable to the needs of the very rich. It was even so a particular kind of politics and a particular kind of choice. It wasn’t a conspiracy, because it happened in the open. But nor was it an explicit political movement, characterised by rallies, speeches and electoral triumphs. It relied in large part on what Hacker and Pierson call a process of drift: ‘systematic, prolonged failures of government to respond to the shifting realities of a dynamic economy’. More often than not the politicians were persuaded to do nothing, to let up on enforcement, to look the other way, as money moved around the globe and up to the very top of the financial chain. This chimes with what Shaxson says about the way the offshore system was allowed to develop over the last four decades. Here too there was no real conspiracy, because there was no real need. Instead, it happened because ‘nobody was paying attention.’

One of Hacker and Pierson’s complaints about the way we usually regard politics is that we miss what’s really going on by focusing on the show of elections and the competition between parties. This is the theatre of electoral politics, to set alongside the theatre of probity. Too often, they say, we reduce politics to the level of sport: ‘This is no doubt why politics as electoral spectacle is so appealing to the media: it’s exciting and it’s simple. Aficionados can memorise the stats of their favourite players or become experts on the great games of the past. Everyone, however, can enjoy the gripping spectacle of two highly motivated teams slugging it out.’

I have to plead guilty here. I have often wondered whether I am interested in politics because I am interested in sport, and sometimes I have felt vaguely guilty about this, suspecting it means I don’t actually understand what’s happening. Elections are seductive, and these days the build-up is so protracted that they can drown out the real business of politics: the way organised groups use pressure – money, lobbying, threats – to squeeze whichever politicians happen to be in power, in order to influence the shaping of policy. Elections also suggest false historical turning points. It is easy to assume that if the rich have been winning in recent decades, the process must have started with the election of the pro-big business, anti-big government Ronald Reagan in 1980 (and concomitantly, Margaret Thatcher in Britain in 1979). But Hacker and Pierson argue that the real turning point came in 1978, during the presidency of Jimmy Carter. This was the year the lobbyists and other organised groups who were pushing hard to relax the burden of tax and regulation on wealthy individuals and corporate interests discovered that no one was pushing back all that hard. Despite Democratic control of the White House and both Houses of Congress, 1978 saw the defeat of attempts to introduce progressive tax reform and to improve the legal position of trade unions. Instead, legislation was passed that reduced the tax burden on corporations and increased the burden on their employees (through a hike in the payroll tax, a regressive measure). All this happened because the politicians followed the path of least resistance – as elected politicians invariably do – and the better organised and better-funded resistance came from the representatives of big business, not organised labour.

What took place in the 1980s was therefore an extension of the Carter years, not a reversal of them. The process of deregulation and redistribution up the chain accelerated under Reagan, who was broadly sympathetic to these goals. Yet it happened not because he was sympathetic to them, but because his sympathies were allowed free rein in a political environment where the opposition was muted and the expected coalition of interests opposed to the changes never materialised. After all, as Hacker and Pierson point out, Richard Nixon, who might have been expected to share some of Reagan’s sympathies, had gone the other way in his actual policies a decade earlier, shoring up the legislative framework of the welfare state and maintaining a broadly progressive tax system. (Something similar happened in Britain under Edward Heath.) He acted like this because he felt he had little choice: the organised pressure ready to resist change appeared much too strong. It was only during the Carter years – and to some extent the Callaghan years in Britain – that this pressure turned out to be weaker than anyone thought. The politicians of the Reagan/ Thatcher revolution did what they did not because they were committed ideologues, determined to stick to their principles. They did it because they found they could get away with it.

So where did the resistance go? This is the real puzzle, and Hacker and Pierson take it seriously because they take democracy seriously, despite its unhealthy fixation on elections. Democracies are meant to favour the interests of the many over those of the few. As Hacker and Pierson put it, ‘Democracy may not be good at a lot of things. But one thing it is supposed to be good at is responding to problems that affect broad majorities.’ Did the majority not actually mind that they were losing out for the sake of the super-rich elite? In the American case, one common view is that the voters allowed it to happen because they minded more about other things: religion, culture, abortion, guns etc. The assumption is that many ordinary Americans have signed a kind of Faustian pact with the Republican Party, in which the rich get the money and the poor get support for the cultural values they care about. Hacker and Pierson reject this view, and not just because they don’t think the process they describe depends on there being a Republican in the White House: they see strong evidence that the American public do still want a fairer tax system and do still see it as the job of politicians to protect their interests against the interests of high finance. The problem is that the public simply don’t know what the politicians are up to. They are not properly informed about how the rules have been steadily changed to their disadvantage. ‘Americans are no less egalitarian when it comes to their vision of an ideal world,’ Hacker and Pierson write. ‘But they are much less accurate when it comes to their vision of the real world.’

Why is no one paying attention? Perhaps it’s the fault of the internet, which is making it increasingly hard for anyone to focus on anything for long. Yet it is striking that Hacker and Pierson’s argument is really a return to a much longer-standing critique of democracy, one that flourished during the 1920s and 1930s but was supplanted in the postwar period by expectations of rational behaviour on the part of voters. This traditional critique does not see the weakness of democracy as a matter of the voters wanting the wrong things, or not really knowing what they want. They know what they want but they don’t know how to get it. It’s because they don’t understand the world they live in that democracy isn’t working. People aren’t stupid, but when it comes to politics they are ignorant, lazy and easily satisfied with pat answers to difficult questions. Hacker and Pierson recognise that it has become bad manners to point this out even in serious political discourse. But it remains the truth. ‘Most citizens pay very little attention to politics, and it shows. To call their knowledge of even the most elementary facts about the political system shaky would be generous.’ The traditional solution to this problem was to supplement the ignorance of the voters with guidance from experts, who would reform the system in the voters’ best interests. The difficulty is that the more the experts take charge, the less incentive there is for the voters to inform themselves about what’s going on. This is what Hacker and Pierson call the catch-22 of democratic politics: in order to combat what’s taking place under the voters’ radar it’s necessary to continue the fight under the voters’ radar. The best hope is that eventually the public might wake up to what is going on and join in. But that will take time. As Hacker and Pierson admit, ‘Political reformers will need to mobilise for the long haul.’

Yet time may be one of the things that the reformers do not have on their side. As Shaxson points out in his account of the rise of the tax havens, one of the reasons for the drift towards deregulation is that politics has been too slow to resist it. This, again, is one of the traditional critiques of democracy: while decent-minded democrats are organising themselves to make the world a better place, the world has moved on. In a fast-moving financial environment, it is usually easier to assemble a coalition of interests in favour of relaxing the rules than one in favour of tightening them. Similarly, it’s easier not to enforce the rules you have than to enforce them: non-enforcement is the work of a moment – all you have to do is turn a blind eye – whereas enforcement is a slow and laborious process. Shaxson, like everyone else, is torn. On the one hand, he thinks the key to resisting the rise of offshore is a more transparent system, based on what he calls ‘automatic information exchange on a multilateral basis’. This is the equivalent of putting the experts in charge. On the other hand, he wants national governments to be more active, dynamic, responsive to the interests of their citizens. But a speeded-up national politics may go against the international co-ordination needed for a fully transparent system. If you reawaken democratic politics at the national level, it will by definition be harder to co-ordinate it at the international level. This is the catch-22 of globalisation.

Shaxson illustrates the problem at the end of his book, where he lists his proposals for changing the culture of offshore. One example he gives of how it can be done comes from the United States, where in 2001 Congress finally passed stronger anti-money laundering legislation and clamped down on the spread of offshore shell banks, which hide behind nominees and trustees so no one knows who their real owners are. But the date is important: these measures were included in the Patriot Act, and the reason they were passed was that national politics had been woken up by 9/11. Yet no one could argue that the ultimate consequences either of that act or the vitality of American politics in the aftermath of 9/11 was a better integrated, more transparent world. Another of Shaxson’s demands is that governments do more to keep money onshore. One of the drivers of the offshore world is what he calls the ‘tides of looted or tainted oil money [that] sluice into the offshore system, distorting the global economy in the process’. One radical solution is to get a country’s mineral windfalls out of the hands of a few super-wealthy individuals and into the hands of ordinary citizens, by redistributing the money directly to every inhabitant. This may sound unrealistic but such schemes have been implemented in a few places, including Alaska. However, Shaxson doesn’t see fit to tell us the name of the politician who spread the wealth there: it was Sarah Palin. So yes, dynamic, quick-thinking democratic politicians can make a difference, but no, it doesn’t follow that greater understanding between nations will be the result. These two brilliant books are right to suggest that politics is the answer. Still, politics is also, as always, part of the problem.