Hidden Wealth and Government Incentives

Marshall Steinbaum has a very useful overview of a major problem that we don’t talk about enough–the hidden and therefore untaxed wealth of corporations.

But if the economics is so clearly against tax havens and the policy solutions are straightforward, then how did we get to where we are? The answer is not that a few villainous, self-serving countries act as parasites on the world economy by offering rich people a way out of their responsibilities. Unfortunately the situation isn’t that straightforward.

In fact, U.S. policymakers tacitly encourage the proliferation of tax havens and the chicanery that enables rich people and corporations to stash their money beyond the reach of the Internal Revenue Service (with a few notable exceptions, including the Foreign Account Tax Compliance Act of 2010). Even now, Congress is debating a “Repatriation Holiday,” which would allow companies who strategically book large profits at overseas subsidiaries to avoid corporate taxes by returning their cash stockpiles to their U.S. shareholders. Even talking about such a policy furthers such tax avoidance, since it signals to companies that they won’t have to pay up if they hold out long enough.

Speaking of Luxembourg, Zucman writes, “Starting in the 1970s, the government initiated an unheard-of enterprise: the sale to multinationals throughout the world of the right to decide their own rate of taxation, regulatory constraints, and legal obligations for themselves.” In other words, companies get to choose their own tax rates by strategic use of low-tax jurisdictions to earn profits and conduct some of their operations, and wealthy individuals do as well. That is not a privilege available to ordinary citizens. But the trend has been mimicked everywhere, directly by authorities in havens and indirectly by those in productive economies who tolerate them.

Moving beyond tax havens in particular, the ideological justification for low and falling rates of taxation on capital is the Chamley-Judd Theorem, which “proves” that the optimal tax rate on capital is zero in the long run. According to the theorem, anything more destroys the incentive to save and thus the productive capacity of the economy. That is why, the same thinking goes, even workers who don’t own any capital should prefer zero taxes on capital. Whatever its theoretical merit–and recent research suggests it doesn’t have much–the intellectual influence of the theorem has been strong. In the United States, as in most countries, the individual tax rate on capital is below the income tax rate precisely in order to incentivize people to save, and recent proposals involve eliminating capital taxes altogether for that reason.

Why is the Chamley-Judd result relevant to international tax havens? Unfortunately for the rich, public sentiment is not always as enlightened as mathematical economics, especially in the voting booth, and the possibility exists that a dangerous capital-taxing radical might sweep to power. That “threat” can be neutralized if the wealthy avail themselves of tax havens. All of this is part of the larger trend among policymakers to be too credulous about formal “optimal policy” results in theoretical economics.

Basically, it’s sheer greed and the only way to stop that is for the government to crack down and take the money. But it doesn’t do that. Instead, it provides incentives to keep doing it through proposing the repatriation holiday. Criminalizing the behavior and arresting and prosecuting the tax frauds who do this would be a lot more effective. As we see over and over, carrots do not work for the rich. Like with Volkswagen executives taking advantage of industry self-regulation to cheat the pollution standards, being nice to corporations leads to terrible policy outcomes because they are going to cheat the system any way possible. And with the chances of being caught relatively low and the government accommodating to corporate interests in most cases, the wealthy will continue with this sort of behavior.