I’ve been warning of it for years, and we now have fresh evidence; the wealthy industrialised countries’ desperate search for more tax revenues is causing actual problems that risk seriously damaging the global economy.
Many European and American governments’ spending makes drunken sailors look restrained, but rather than looking at their own behaviour they are blaming their deficits on their citizens’ unwillingness to pay even more tax.
Offshore tax evasion is one culprit often blamed for deficits, even though real tax evasion, hiding income that really is taxable, is very rare. HMRC estimates that it loses only a tiny 0.8% of tax revenues through tax evasion, and only a small part of that is from offshore evasion (most tax evasion is local, such as small businesses not reporting cash-in-hand income).
But a ‘clampdown on tax havens’ is seen by politicians as a convenient way of distracting attention from their failure to balance their budgets, promising that the latest schemes will bring in the lost billions and solve their financial problems.
The tax authorities’ current favoured tool is automatic exchange of information, whereby banks and other financial institutions around the world are forced to report their clients’ income, not just to the banks’ home tax authorities but, directly or indirectly, to their clients’ home country tax collectors, wherever they may be around the world.
The USA was an early adopter of this, with its 2010 Foreign Accounts Tax Compliance Act (FATCA), which imposed onerous reporting requirements on banks around the world. In response, some banks stopped providing accounts to US nationals, because of the burden of compliance and risk of penalties for making mistakes in their unpaid work for the taxman, but the reach of the US economy meant that many had to comply.
FATCA, backed up by the long arm of Uncle Sam, spawned several related schemes, and now the OECD (the Organisation for Economic Co-operation and Development, which is helping its member governments collect more taxes whilst preserving its own tax-free status in Paris) has its own “Common Reporting Standard” to demand information from financial bodies.
So a massive information collection and reporting exercise has been created to pursue proportionately tiny amounts of tax, but as financial services businesses start to implement it we are seeing alarming evidence of the costs and risks that it is causing, costs that have to be passed on to the customer and that risk de-railing global growth.
Worse, by making international business more difficult, there is a danger of wider costs to the world economy and for society.
The latest evidence comes from compliance firm Sovos and financial researchers Aberdeen Group, who have produced an analysis of financial institutions which shows that financial services providers are struggling with the requirements of FATCA and similar measures.
The Sovos report found that less than half, only 44%, of FATCA returns are accurate, showing that the financial service sector is finding it difficult to comply with the demands made on it.
And although the systems are still new, the regulators are clearly not giving any leeway while the industry gets to grips with the requirements; the Sovos report found that firms subject to FATCA reported that they were paying an astonishing 6% of their turnover in fines, not for deliberately hiding information but for accidental mistakes in their reporting.
And note, that’s not 6% of profit; it’s 6% of turnover. That’s going to wipe out a large chunk of the profits of any finance business.
Not surprisingly one of the reasons why finance businesses are finding this difficult is that governments just cannot make a decision and stick to it; 21% of finance businesses surveyed for the Sovos report said that “frequently changing regulatory standards” were a top challenge.
But the bigger issue is more fundamental; the Sovos report found that 26% of finance businesses see “reporting across multiple jurisdictions” as being a major problem.
And that problem is fundamental to FATCA and similar processes; large financial services providers have operations in different countries, possibly with different languages, and customers in different countries. They are having to capture and collate information from all around the world, put it into various required formats and submit it to different tax authorities around the world, quite possibly for countries where they do not even operate. And all of this is in addition, and generally different, to their domestic reporting requirements.
Computer systems, according to the Sovos report, are struggling to reconcile client information from multiple sources (only 45% success), to cleanse data of errors (as low as 32% success) and create reports with the correct formats and required encryption (as low as 25%) without expensive manual intervention.
Of course the procedures are still relatively new; as they bed in (if governments can ever resist tinkering for long enough to allow that), systems will be put in place to reduce costs and improve compliance, reducing fines. Apparently Sovos, the authors of the report, have systems to do just that. But the fundamental problem remains; the ever-increasing demands for more, and more complex, information from tax authorities is increasing the costs of providing financial services. Those increased costs are going to be passed on to customers, both individuals and businesses.
It is difficult to justify that these complex, expensive processes are even needed. The old days when money could be confidently hidden away in a “tax haven” have long gone. Finance centres, including offshore ones, have operated for years on the basis of “information on demand”, whereby financial institutions, law firms and other intermediaries answer legitimate questions from tax authorities and other government bodies in other countries. Those systems have now bedded in and are working well.
This was supported by the recent leaks of confidential information (Panama, Liechtenstein, Luxembourg and so on), which have not actually disclosed much tax evasion; by and large the supposedly “hidden” money has either been declared to the tax authorities or is legitimately not taxable.
It is therefore doubtful whether much extra tax will be collected from automatic information exchange; it looks more like the usual government desire to be seen to be doing something rather than actually doing something useful.
But the costs of compliance are huge, and because these reporting requirements are increasingly about international investors, the cost of doing cross-border financial business is going to rise disproportionately. Worse, it is likely that some financial services providers will pull out of some jurisdictions, or stop serving customers from some countries, because the compliance costs of reporting on them to the various tax authorities will just be more trouble than it’s worth.
That is a serious problem for the world economy. Global financial integration, making it easier to move money to trade and invest around the world, has played a major role in the growth in world trade and reduction in world poverty in recent decades. Reducing financial integration, by making it more costly for financial services providers to operate in, or serve customers from, various countries, risks stalling this growth.
Nor is this just a “first world” problem; when businesses pull out of countries, they pull out of the least profitable first, and that means that less developed countries are going to find it increasingly difficult to access world financial markets because banks will decide they just aren’t worth the costs and risks of dealing with the compliance regulations.
IMF research estimated that a 10% reduction in global financial integration would reduce annual GDP growth by 0.3 percentage points. That may not sound like much, but it would have pretty much wiped out all economic growth in the EU for the last eight years.
Governments’ misguided attempts to prevent the relatively tiny problem of offshore tax evasion risks causing horrifying damage to the world economy. Is it really worth that, just to demonise a minor problem of offshore tax evasion which is already far more myth than reality?