One of the (many) ways by which rich, sophisticated taxpayers who are also ultra-greedy have managed to avoid paying their fair share of taxes is to move money offshore through trusts and "companies" set up in various no-tax/lo-tax, hi-sun jurisdictions like the Cayman Islands, British Virgin Islands, Cook Islands, Singapore, etc. I suppose for many years this scheme served multiple objectives--it stashed the cash beyond the reach of the US government, it provided a nice place to visit the cash, and it had the cachet of belonging to the exclusive jet set behind it.
That's becoming less so as the US continues to pursue tax cheats with unreported offshore accounts. The dam started bursting with the revelation of the way Swiss bankers groveled at their American clients' feet, from smuggling diamonds into the country in toothpaste tubes to secreting gold in deep, hidden vaults to setting up sham companies in the Phillipines or other countries. Over the last half decade, more people have participated in voluntary disclosure and more have been identified for more serious penalty programs (including criminal prosecution). Each voluntary disclosure included full information about those who facilitated the offshoring--bankers' names, other involved lawyers, accountants, and bankers, other entities. That groundswell of information facilitated identification of even more tax cheats, and those identifications yielded a new trove of relational data--those who had assisted them. That finally seemed to begin to put some teeth into enforcement efforts and some gnashing of teeth into the lives of the otherwise obliviously happy tax evaders.
But various commentators (including my colleague at Wayne Law, Professor Michael McIntyre) have been concerned that the offshore gambit can't be cleaned up until countries begin more automatic sharing of the tax information they have without requiring the requesting country to have already identified the accountholder well enough to ask for information specifically about that person. If they can ask specifically, of course, it means they have already been found, which makes for a catch-22 that has made pursuing secret bank account holders an overly arduous task.
That makes the IRS's announcement today of a new coordinated effort among the U.S., U.K, and Australia heartening news. They have agreed to share information about trusts and companies holding assets in tax havens like the British Virgin Islands, the Cayman Islands, and Singapore. See IRS news release IR-2013-48 (May 9, 2013). With the cache of information each country has gleaned from the recent efforts, coordination will allow them all to benefit from each one's effort. That should accelerate the effort to catch the tax cheats.
Obama's budget isn't even released yet and he's already caving to the "let's make the rich richer and forget the rest" crowd. That crowd that claims that we need a capital gains preference so the rich can gather all that extra money to purportedly create jobs. The crowd, that is, that fails to acknowledge that the rich tend to take all that extra money to Singapore, the Bahamas, or the Cayman Islands or hide it away in some Swiss bank, none of which does any good for our economy compared to what the government investing that money in infrastructure projects would do. See, e.g., David Leigh, Leaks reveal secrets of the rich who hide cash offshore, The Guardian (Apr. 3, 2013); The corporatist crowd that refuses to admit the empirical evidence that says government investment is as important as private investment in creating jobs. It is the government that makes the market go round. And government money--our money--spent for schools, bridges, safer communities provides jobs and improves lives. Without that government investment, there is no market, just barter.
President Obama seems to have forgotten that he was elected. as a Democrat, over the Republican candidate. Obama has no business proposing cuts to Social Security benefits as part of a purported deficit reduction package. Social Security is not a deficit driver: it is a social insurance program earned by those who receive it by payments over lifetimes of hard work. It is the only stable retirement income most have. The average Social Security beneficiary receives just short of $14,000 a year from Social Security--that's just 125% of the poverty line, which of course is defined so low as to guarantee that anyone living at or below that line is indeed in abject poverty and unable to move out of it.
The Republican Party has argued for cuts to Social Security benefits for decades, using whatever crisis of the momen they can engender to argue that we can't afford the system in place. They've invented the perjorative term "entitlement" to imply that those who rely on social insurance because of disabilities or old age are just 'freeloaders' who are mooching off others. Not so, since Social Security is an earned benefit program like insurance: workers pay premiums throughout their working life, and then once they reach retirement age they may draw benefits.
There are a number of reasons for the amount of debt that the US government has--most of them related to the four-decade-long drive by the Republican Party to protect the wealthy and the corporations they own from much of a tax burden and to allow the accumulation of immense wealth by a few at the top of the income distribution. Outsize military expenditures driven by Bush's preemptive wars undertaken at the same time that the Bush Administration pushed through tax cuts that favored the rich are of course a big problem. The Bush tax cuts threw us from surplus to deficit and we haven't gotten beyond them yet. The almost complete capture of the financial regulatory agencies by Wall Street, and the resulting financial crisis driven by casino capitalism spiked with the heady bubbles of derivative inflation is of course another part of the problem, and we haven't gotten beyond that yet, as Big Banks still exercise far too much power over their own regulation, proven by the LIBOR scandal that demonstrated their ability to manipulate the purportedly objective market rate to suit their profit machines.
But Social Security is not one of those drivers of the debt. And the debt is not so outsize that it merits sacrificing the most vulnerable amongst us to mollify the wealthy who merely want to avoid paying their fair share of the revenues needed to get rail service up to snuff, bridges safe, and public schools owned by the public again.
The average Social Security benefit is just under $14,000: the use of chained CPI will result in a loss to the average recipient of "$4,631 in Social Security benefits by age 75, $13,910 by age 85; and $28,004 by age 95" (from release by Social Security Works, based on “Inflation Indexation in Major Federal Benefit Programs: Impact of the Chained CPI,” Alison Shelton, AARP Public Policy Institute, March 2013.).
Obama has no business facilitating the gluttony of the rich. He should drop the proposal to use “chained CPI” that will result in a cut benefits for Social Security recipients.
David Cay Johnston, former NY Times reporter and now Syracuse professor, writes about the thing that most journalists don't bother to (or are told not to) write about--the way that Big Business successfully lobbies legislators and regulatory agencies to write the rules to favor Big Business, at the expense of ordinary Americans, all under the false claim that they are pushing de-regulation for the good of competition and ordinary consumers. Johnston, Missing the Story, American Journalism Review (March 2013).
Johnston describes a number of ways that state legislatures, Congress and state and federal regulatory agencies have made life easy-street for Big Business at the cost of ordinary consumers. He notes it is often discussed as "deregulation" but that "is a misnomer because, literally, no such thing exists in commerce....Everything in business is regulated in some fashion, and has been since long before the first nearly full set of laws we have.... [Thus, d]eregulation typically means reregulation under new rules that favor business interests." Id.
Businesses claim that the 'deregulation' they seek is just another step towards their ideal of "free markets" to help competitiveness. Not so, Johnston replies. The regulatory climate that results is almost always one that creates "moats" making competition much harder for small businesses and allowing duopolies or monopolies to arise that can set prices as high as they wish. And often the captured regulatory agencies allow the most absurd subsidies imaginable.
The Bush Treasury did that in spades. One example is the changes the pro-business Treasury under Paulsen made in the regulations under section 368 governing corporate reorganizations, in which the Bush Treasury (many officials of whom are still part of the Obama Treasury) promulgated rules that provide, for the first time, the possibility of a loss recognition by shareholders in the nonrecognition reorg exchange. Settled law at the time said no such loss could be recognized. And the Bush Treasury also did it in setting up (through regulations) yet another tax subsidy of Big Oil (as an add-on to an already ridiculous subsidy enacted by Congress when it allowed Big Oil to operate as limited partnerships). Here's how Johnston describes this.
The simple story is that Congress in 1986 exempted monopoly pipelines from the corporate income tax if they organized themselves as Master Limited partnerships. The George W. Bush administration then let these pipelines include the nonexistent tax in the rates they charge.
The cost of this fake tax is both tiny and huge.
The pipelines raise prices to cover the cost of the tax, which in turn means they have to raise prices even more to cover the taxes on the extra earnings, known as "grossing up." A 42 percent tax on profits, grossed up, means a pipeline gets to earn its profit plus 75 percent for taxes. These higher costs are then built into prices people pay for gasoline and natural gas to heat homes. Paying this fake tax costs each American less than three cents per day, about $10 per year, I calculate. That is the tiny part. The huge part is that collecting just a penny a day from everyone in America adds up to $1.1 billion in a year — or $3.3 billion at three cents per day per American. Id. (emphasis added).
Note, folks. That's an unnecessary $3.3 billion subsidy provided to already-profitable businesses that comes entirely at the cost of ordinary Americans. It is a subsidy put into law entirely through Big-Busienss-friendly tax administrators in ways that most Americans do not see it--or, if they see it, they believe it is a "real" tax cost of the businesses rather than just another theft subsidy.
This is another aspect of the problem of the way the media treats any discussion of "free markets." The fundamentalist approach to free markets (that I have sometimes labeled "free marketarianism" or "friedmania") claims to believe that deregulation helps people by increasing competition and opening up markets. In fact, it is usually the opposite. Deregulation helps Big Business by decreasing competition and allowing the development of powerful oligarchs and powerful monopolies or near-monopolies. Brute capitalism, that is, allows those who hold capital to hold power, and those who hold power act against the interests of ordinary people in order to consolidate their power. Another blog addressed this well:
A free market requires that everybody plays nice and follows the rules. Guess what. There’s always someone who will do whatever evil they think is required to make money. Once you realize that, you know there can be no such thing as the free market.
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That’s one of the primary reasons that uncontrolled capitalism has been such a gross failure since the Reagan/Thatcher “revolution”, leaving us with record inequality and damaged democracy, and bringing the world economy to the brink of total collapse that simply evaporated trillions of dollars. Random Notes from the Exasperation File, Class War In America.
I have often noted that the media treat the daily ups and downs of the stock market as though it is an accurate reflection of the entire economy. It is not. When the stock market is up, it is likely that one or another segment of Big Business is doing well or exceptionally well. That means the affluent--those in the top 30% who own most of the financial assets of this country, including Big Business's CEOs and board members, are doing well. So as the stock market has resurged after the 2007 financial crisis brought on by the excess of Big Financial Businesses, the wealthy who run and own those Big Businesses are doing mighty well indeed.
This is corporatism at its worst--the takeover of the economy and all of its institutions by a corporate mindset that favors the wealthy and the managers/owners of Big Business over ordinary people, leaving ordinary people's views unheard. It often is associated with class warfare, wherein the rich ensure that their money buys laws and regulations written by, for, and of the rich. Corporations pay less in taxes and ordinary workers pay more--either in direct taxes or in the indirect tax of wage and benefit loss that is a tax subsidy for the wealthy.
Those at the bottom of the economic distribution are of course the ones most hurt by the decline and by the class warfare policies of the rich. They are most likely still doing poorly or just barely getting by, mostly because those big profits at Big Business are taken at their expense--through constantly rising prices not reflected in increased quality or costs of production, or through increasingly unfair worker wages and benefits that have been cut in order to increase the rents to the owners/managers. And usually with the assistance of legislators and regulators.
Take a friend of mine, who was laid off from an auto parts manufacturer for almost three years and has been struggling to make a full-time living at it since he was reinstated--at a much lower salary then before the crash (conveniently for the company but not so good for the workers). He bought a new truck about a year before the financial crash. The payments were supposed to be around 250 a month. In the first months of the layoff he couldn't find any substitute work, and he fell behind in payments on the truck (his family depends on him as the sole breadwinner; his family has almost no assets and no liquid assets; he depends on the truck to allow him to take odd jobs when his job at the factory is on hiatus--often landscaping, mowing, etc.). The interest rate on the loan went up to 32% almost immediately. That would once have been treated as illegal usury. Not now, since "deregulation" has allowed financial firms to rip off their customers coming and going for their own profits. Now his payments are around $400 a month and he owes as much on the truck as he did several years ago in spite of all the payments he has worked hard to make since then. This Thursday he missed the payment again, after keeping up for most of the year. He missed it because his company began selectively laying off workers for a week or 3 days at a time during the winter, and he didn't work for about ten days of the month before the payment was due. On Wednesday he talked to his adviser at the financial firm that gave him the loan. It was a new "adviser". They replaced a more understanding one with one who was considerably harsher. The adviser told him on Wednesday that he would give him til Friday to make the next payment. On Thursday, however, he sent a repo man who took the truck. Friday my friend got a paycheck and could have made the payment (as he'd told the adviser on Wednesday). Instead, when he went to make the payment thinking he could get the truck back that day, the financial firm advised him that he now had to pay off the truck in full--as well as a bunch of additional charges due to the repossession. What would that be, he asked? He assumed he owed about $3500, in his calculations the amount still due on the original loan. Oh, no, the finance guy told him. You will have to pay $4975 on Monday, and that amount will increase by $25 a day for every day you do not pay. It's that much because of all the late fees we added on the bill. Oh, and we are charging you $400 for repo-ing the vehicle on Thursday (even though we had promised we would not do so).....
Again, deregulation of financial institutions has made these rent-seeking add-on charges customary for anyone in the lower part of the income distribution. Big Business sells it as competitive services for the underprivileged but it is really deregulated excess profits for the financial firms for acting like modern equivalents of plantation owners with a captive workforce unable to ever build up financial assets and always dependent on the firms' calculations as to what they owe or are owed.
How is my friend (who happens to be an African American) supposed to ever advance beyond the near-serfdom in which he currently exists? Lucky for him, we are willing to offer him a personal loan at market-rate interest so that he can finally pay off his overseer and begin to dig himself out of the hole that our deregulated, GOP-ideology-driven state puts most Detroit low-income residents in. Mass transit hardly operating and not permitted to expand as it should to permit low-income residents to commute easily to work in the region. White suburbs that cannot be annexed into the city, so continue their oblivious lives exploiting Detroit's assets while pitying the poor black residents that just can't seem to do anything right. Businesses that charge white folks in the suburbs less than black folks in the city. Insurance companies that rip off their Detroit clients. And on and on.
This is all happening in a world where white folks with money set all the rules and now, in Michigan, have made it very hard for any union to form and exert some worker-power on behalf of the employees. Michigan's new, so-called "right-to-work" law that the religiously right-wing Republican party of Michigan passed with no input at all from the people and with misinformation galore--all of the newspaper coverage talked about workers being "forced" to join a union unless you have "right-to-work" and how "right-to-work" would free them not to have to pay for the union and encourage more economic growth and more jobs. None of the newspaper articles or the legislators reported the fact that right-to-work states tend to have lower wages for their workers, less good jobs, and poorer economies. Of course, the information was wrong to start with--no one was forced to join a union without right-to-work laws--they were merely required to pay some amount (less than union dues) for the services that the union provides. Now, they can demand the same services and pay nothing. No Republican business would provide services on that basis, but Republican legislators serving their oligarchic base ensure that no true freedom exists for anybody without money.
Michigan, of course, has also just taken over the City of Detroit, with Gov. Snyder's appointment of an emergency manager. This is as undemocratic as it gets, given the state vote rejecting the last EM law and the fact that the EM will have dictatorial power to ignore the Mayor, the City Council and all other elected officials. Snyder is a right-wing tool, in office backed by a majority-GOP legislature that reflects the racism of most of the "upstate" part of Michigan and blames Detroit's problems on its predominately black residents. The legislature passed right-to-work to retaliate against unions for trying to get protection for workers' rights in the constitution. Apparently, the GOP thinks the constitution should only protect the wealthy, as it does by prescribing a flat tax, ensuring that the wealthy in Michigan get to choose what they support but are hardly taxed at all by the State. The rabid right in this state forget that what condemned Detroit was the "white flight" to the suburbs and Michigan's foolish state constitution which does not allow Detroit to take the suburbs into the city. So Royal Oak's mayor a few years ago could refuse to fund metropolitan buses because he didn't want Detroit's black population able to cross the border into Royal Oak and pollute the city by taking jobs there. And the wealthy residents of the 90% white suburbs of 80% black Detroit come into the city for its amenities--opera, plays, sports, museums--and its work, but take their pay out of the city to maintain their schools and shops and amenities while complaining about how awful Detroit is. We Detroit residents are very worried that the GOP's takeover of the Democratically elected city government will result in the rape of the city's assets--Belle Isle is a jewel in Detroit's crown that the state covets; Detroit's water system is another asset that the state--and the white suburbs--covet and want to control. The EM will be pressured by Snyder and the rest of the upstate Detroit haters to take over those assets and make Detroit pay for being a center of unionism and Democratic voters.
The Michigan passage of the so-called "right-to-work" law and the renewal of the emergency manager law AFTER it was defeated by the people in Novemberare perfect illustrations of the contempt that the current Republican party shows for ordinary people when it is in power in a state. And it also illustrates well the capture of legislators and agencies by oligarchs, monopolies and duopolies. This is, as Johnston notes, a sad state of affairs that will only get worse unless the press reinvigorates itself to inform rather than kiss Big Business's ass.
The New York Times today reiterated what many Americans lament--Big Banks went uncharged for serving as the main engine of the Great Recession that cost ordinary Americans jobs, homes and futures. See Andrew Ross Sorkin, Big Banks Go Wrong, but Pay a Little Price, New York Times, at B1 (March 12, 2013).
Big Banks (and especially their managers), however, made out like bandits through the socialisation of losses and privatisation of gains. The aftermath of the crisis provided lower cost of funds from the perceived government TBTF subsidy. Big Bank managers made big bucks leading their institutions into disaster and "staying on" after the disaster because their "expertise" was essential. The stock market, but not ordinary Americans' pocketbooks or paychecks, has recovered from the recession, forging a return of lucrative M&A activity and, of course, the management of wealthy people's assets. No Big Bank has faced criminal indictment for "the damage caused to the economy and millions of Americans" by their sloppy mortgage financing, sloppy foreclosure procedures, and casino capitalism "bets" with credit default swaps and other derivatives.
The reason--the lesson from Enron and Arthur Andersen, where thousands of lower-level employees who had no control over corporate actions lost their jobs when the firms collapsed after wrongdoing and charges. Any Big Corp can be TBTF. "[S]imply charging a company with a crime reaises the possibility of putting the firm out of business." Id. at B5. Collateral damage is therefore a major hurdle to bringing a criminal case against a corporation.
The takeaway, according to the Times article, is that "prosecutors should focus on the individuals responsible for the misconduct" rather than indict corporations, which can result in "condemnation of one person [many employees] for the actions of another [boards and managers or 'rogue' employees]" (quoting, in the latter case, Elizabeth Ainslie's paper on indicting corporatrions).
While protecting employees of rogue firms (where management and directors have pursued aggrandisement of their own status and riches at the cost of society's well-being) is important, it is not clear that the takeway outlined above is a complete answer. Several additional components should be addressed, by a combination of Congressional and state legislative action and regulating agencies. And actions to limit the size of corporations would have another advantage--acting as a deterrent to their power in dictating the well-being of ordinary employees, and thus helping to deflect the growth of corporatism in our society.
First, boards that make irresponsible judgements that allow CEOs and managers to engage in reckless bets with their companies should be able to be held personally responsible more easily, without corporate protection for the ultimate costs.
Second, anti-trust needs to be expanded to limit the interwoven boards and contractual relationships that permit a few TBTF institutions in an industry to dominate the market and set the "Wall Street Rule" for what is acceptable behavior. ULtimately we need forced split-up of TBTF institutions, through anti-trust or new means, as necessary.
Third (and most relevant for this blog, of course), tax policies encouraging corporate consolidation should be strictly limited. The section 368 reorganization provisions should be tightened to require a much higher percentage of continued shareholder interest: the current requirement for a tax free reorg of only 40% (under an example in the reorg regulations) should be tighted to at least 70%. The opportunities for loss recognition in reorgs provided by the Bush Treasury under regulations should be eliminated. Spins of parts of mega corporations to existing shareholders should remain tax-free, but spins that amount to initial steps in acquisitions should be more limited.
Will Congress (or state legislators) take any of these actions? It is highly dubious. The left is too often too cowardly to act and mostly funded by wealthy interests. Most on the right--disproportionately represented in Congress because of gerrymandering in the House and the disproportionate Senator-to-population ratios in the Senate--dogmatically favor market fundamentalism no matter the evil it causes when it comes to advantages for business to make more profits, even if it comes at the expense of ordinary people through market power to defeat unions, defeat reasonable pay requests, etc. (Of course, when it comes to exploiting government , the right tends to favor government subsidies--look at Wisconsin's recent move to remove pesky environmental regulations protecting wetlands to support a mine owner, in the purported interest in supporting job creation, even when the mine is likely to cause long-term environmental damage and potentially devastating water pollution and destruction of wetlands.)
It seems that billionaires think they are entitled to it all and think they should be able to run their speculative games without paying much of anything at all in taxes to the government they depend on. And none of this is good for the economy or good for the taxpayers not in "the 1%".
Case in point--John Paulson, the notorious hedge fund manager who got a CDO built to his desires with a bunch of iffy subprime mortgages and then took the short side of the bet, making a fortune off the bet against subprimes in the mortgage crashes underlying the 2007-8 Great Recession. See, e.g., Zuckerman, Trader Made Billions on Subprime, Wall St. J. (Jan. 15, 2008).
What has Paulson done? He established a new "reinsurance company" in Bermuda in April, that turned around in June and put the money invested in it back into Paulson's hedge funds in New York, as a portfolio of insurance "reserves" to be held to pay off insurance risks that go bad. The result is tax deferment for Paulson and other executives of his hedge fund along with recharacterization of ordinary compensation income as preferentially taxed capital gains.
For a discussion of the hedge fund reinsurer gambit, see , e.g., any of the following. The story at Bloomberg has reinvigorated media attention to this issue.
Barile notes that these hedge funds are using reinsurance premiums and investing in a very aggressive way, compared to traditional reinsurers". This aggressive position produces a downside if there are low investment returns, especially if there are catastrophes for which they have to pay claims when their investment strategies have produced losses. He says that "it remains to be seen" whether hedge-fund reinsurers are in it for the long haul, since they have a shorter time frame on making greater returns on their money.
Looking at this as a global concern, Baker ultimately suggests that the Basle Capital Accord rules should be extended to hedge fund reinsurer operations, "Another area in which the BIS should take a leadership position," he says, "is the role in which reinsurance firms play in hedge fund operations. The tax implications of hedge funds using reinsurance firms in their funds for tax advantages points to the need for more government regulation of this activity."
He describes the basic problem as follows: "wealthy individuals invest in private placement offerings of offshore reinsurance companies. These companies, many headquartered in Bermuda, buy insurance policies written by name-brand insurers...and "may then invest its stock issue returns in a hedge fund. ...[That reinsurer] pays no taxes on the trading profits until it sells the fund shares and then the reinsurer is taxed at a lower capital gains tax. The tax savings are passed on to the individual investor.
He goes on to say that "The problem ... is that insurers are exempt from registering as investment companies....These reinsurers do not have to make annual distribution of profits as mutual funds do and they are not taxed by the Internal Revenue Service as investment vehicles. ...In short, the activity ... is a method for wealthy investors to reduce their tax burden as a result of a tax loophole. Since these insurance companies are mixing insurance business with investment business, they need more supervision.
This is especially true when hedge funds are involved. "[H]edge funds work with reinsurers to reduce tax liabilities for their wealthy clients. ...U.S. hedge fund managers and investors form a tax-advantaged reinsurance company offshore in...Bermuda, which has no corporate income tax. The Bermuda-based reinsurer sends investment assets to the hedge fund to invest. Investors return to the United States with shares of the reinsurer and pay no taxes until the company goes public. At that time, investors [and managers] sell their shares in the reinsurer company and are taxed at a lower capital gains rate.
These schemes are worrisome from both tax and insurer regulatory perspectives. "Aside from the tax loophole problem, the real issue in these cases is the added underwriting risk incurred in the process. ... [Hedge funds acting as reinsurance companies] have insufficient insurance expertise.... Much of this activity has stemmed from financial engineering and deal making of the 1990s. ... [W]ithout the bailout of LTCM [Long-term Capital Management hedge fund] by national bank regulatory authorities, many banks and reinsurers might have collapsed as well."
So why do it and how does the hedge fund reinsurer gambit work? Remember that these hedge fund execs get a ridiculous amount in compensation in the form of a "fee" (usually 2% of assets under management) and a "carry" (usually 20% of the profits). (The fee and carry are often represented as 2 and 20, but can be much higher for some firms with status, rising to as much as 5 and 50.) Without more, hedge fund managers don't get as much benefit from the claimed treatment of a "profits" partner as private equity fund managers do. Though the managers claim classification as "profits" partners whose taxation is based on their share of the partnership's gains and ordinary income and not as payments of (ordinary) compensation, hedges mainly yield ordinary income so don't act directly as "converter" entities. Private equity fund managers also claim they are "profits" partners whose income should not be classed as compensation but as pass-through shares of the partnership items: in their case, most of the private equity fund's gains will be deferred anyway (for several years at least until the partnership sells the leveraged company) and they claim those deferred gains should be characterized as pass-throughs characterized by the partnership rather than being characterized as ordinary compensation income to them.
So for hedge fund managers, gaining deferment (of what is clearly in substance their compensation as managers) can achieve minimal current tax. If the money is cycled through an offshore corporation that pays no taxes, that's even better because it gets preferential rates as well. The deferrment is achieved by waiting to sell the stock, and the sale of the stock is reported as a capital gain. Thus what is really current compensation income is recharacterized, through the reinsurer "conduit" scam, as a deferred capital gain. So hedge fund and private equity managers ultimately both claim to get the best of all possible worlds--their wages from work are not currently taxed as wages at ordinary income rates, they pay no payroll taxes on their compensation, and their compensation is deferred and taxed at preferential capital gains rates.
This is so obviously unfair to the vast majority of ordinary taxpayers who pay taxes on their compensation income even before the end of the tax year through the withholding mechanism that Congress should step in with legislation. It seems hard to justify a "profits" interest in a partnership at all: it has been created by the "Wall Street Rule" that gains credence because big-money people claim it is correct. As usual, tax administration eventually mostly went along with it (Rev. Proc. 93-27) and a few court cases (Diamond, Hale) mostly treat the notion of a profits partner who pays no taxes on his compensation as reasonable. Congress could easily legislate away the profits interest and define partner in a partnership for tax purposes as someone who has made a genuine at-risk equity contribution of cash or property to the partnership. There really should be no such thing as a services partner with a "profits" interest who hasn't contributed up front for a capital interest. And all compensation shares to what are currently treated as profits partners could be treated as ordinary income --i.e., compensation currently subject to the income tax and to payroll (Social Security/Medicare) taxation.
This use of reinsurers by hedge funds is itself a tax dodge that has been around a decade or so. In 2007, the Senate Finance Committee held a hearing on Offshore Tax Issues: Reinsurance and Hedge Funds (S. Hrg. 110-875, Sept. 26, 2007) (179 pages). In his introduction, Baucus described insurance tax avoidance schemes as follows:
Insurance companies make a living by doing two things: they assess premiums based on the prediction of the likelihood of events against which they insure—that is called underwriting—and they also make money by investing the premiums that they collect until they have to pay out claims. If they are good at those two jobs, they make a profit.
Customers buy insurance from insurance companies to guard against the risk of fire, disaster, or some other calamity. In exchange for paying premiums, the customers shift some of their risk to the insurance companies. Insurance companies also buy insurance. Property and casualty insurance companies pay premiums to reinsurance companies in exchange for shifting some of their risk to the reinsurance company. Sometimes the reinsurance company is also the parent company of the property and casualty insurance company. In that case, the property and casualty insurance company shifts risk to their parent reinsurance company at something less than an arm’s length transaction.
Here is where the tax avoidance comes in. Some parent insurance companies set their headquarters in low-tax jurisdictions, like Bermuda. Subsidiary property and casualty insurance companies shift risk to the Bermuda parent. Because of Bermuda’s low tax burden, the Bermuda parent can get a greater after-tax return on their investment activities. As a result, subsidiary property and casualty insurance companies can charge lower premiums for their insurance. They get a competitive advantage over insurance companies doing business in jurisdictions that tax investments.
The second setting that we will examine today involves hedge funds. Foundations and other nonprofits are some of the largest investors in the world. The law requires a nonprofit investor that invests directly in hedge fund partnerships to pay the unrealized business income tax, otherwise known as UBIT. The policy behind the law is that tax-exempt entities should not be able to have an unfair advantage over taxpaying entities doing the same thing. To avoid UBIT, nonprofit investors sometimes invest in hedge funds through offshore entities incorporated in lowor no-tax jurisdictions, such as the Cayman Islands or Bermuda. These offshore entities are called blockers.
The third setting we will examine today is the compensation of hedge fund managers. Hedge fund managers receive fees from offshore blocker corporations used by nonprofits and foreign investors.Some hedge fund managers elect to defer their income, and deferring income means you pay taxes later, which is the same as a significanttax savings.
The IRS has already noted that offshore arrangements using reinsurers for hedge fund managers may be shams that are subject to challenge on audit. See Notice 2003-34 (indicating that "Treasury and the Internal Revenue Service have become aware of arrangements, described below, that are being used by taxpayers to defer recognition of ordinary income or to characterize ordinary income as a capital gain. The arrangements involve an investment in a purported insurance company that is organized offshore which invests in hedge funds or investments in which hedge funds typically invest.") Although the notice says that these purported insurers may be challenged as not insurers because they are not using their capital and efforts "primarily in earning income from the issuance of insurance", and although it states that such arrangements will be subject to close scrutiny that could result in the application of the PFIC rules (leading to current taxation), it has apparently not bothered to challenge any of the big hedge funds' reinsurer companies.
Again, why would they be subject to challenge? On the basis that they are not real reinsurers, since the low amount of reinsurance that many provide is the less risky part of the business and provides a buffer to the very high reserves that they retain, sometimes invested solely in a single promoter's hedge funds. And if they are not insurers, they are at the least "passive foreign investment companies" (PFICs) on which shareholders are subject to current taxation on profits. (Or perhaps the IRS might go further and recharacterize the arrangement as a sham , causing the hedge fund executive to have current ordinary compensation income.) In other words, there is good cause to think that for many of these, the tax haven corporation is acting as an offshore tax-avoidance pocketbook for the hedge fund executive, and not really as an insurer.
By the way, if you think these hedge fund managers who are making multi-millions and billions from managing other people's assets and hardly paying any U.S. taxes on those huge compensation payments are incredibly smart people who add to the economy's well-being and therefore merit that kind of out-sized pay or because of the returns they bring to people that then invest them in needed projects in the good ole US of A, you need to rethink that. Hedge funds typically pay out very poor returns, when all the expenses and profits to managers are taken into account.
Roughly speaking, if the typical fund manager worked for free, and if the investment firms didn’t charge, these masters of the universe would still have underperformed a balanced index since 2003, by roughly 2.5 per cent per year. Andrew Hallam, Think you're smarter than a hedge fund manager?, The Globe and Mail (Feb. 19, 2013) (emphasis added).
Elizabeth Warren started out her questioning of big bank regulators by noting that actual trials, where guilty parties are paraded before juries, information about their wrongdoing is spread over front pages, and everybody is aware that bad guys get punished for their bad deeds has an effect on whether the wrongdoing is committed in the first place. In the case of the big Wall Street banks, however, she notes that they made out like bandits during the speculative orgy that caused the financial system crisis, and yet not a one has paid by being taken to trial in this expressive way.
"Tell me," she says to a group of bank regulators called before her Senate committee, "about the last few times you've taken the biggest financial institutions on Wall Street to trial. Anybody?"
The FCC representative, Tom Curry, notes that ordinarily they are just trying to move things along and correct deficiencies. Warren interrupts and notes--"yes, and you set a price for that... that's effectively a settlement. What I'm asking is ... when did you last take a financial institution, a Wall Street Bank, to trial? " Curry "We've had a fair number of consent orders. We don't have to bring them to trial." Warren "I understand that you say you don't "have" to but my question is when is the last time that you did?" (No further responsive answer).
The same kind of interchange--can you identify when you last took Wall Street Banks to trial --was similarly nonresponded to by Elisse Walter. Nobody else even offered to comment. Certainly nobody offered a single date for "last time a Wall Street bank was taken to trial."
Warren closed with a comment that made clear that she thought that a very different standard was being applied to Wall Street than is applied to ordinary citizens that commit even minor infractions. She noted that there are District Attorneys every day squeezing ordinary citizens on rather small matters and taking them to trial explicitly to set an example, but "For Wall Street banks, 'too big to fail' has become 'too big to try [take to trial]'. That just seems wrong to me."
You go, Elizabeth. Without using the words "class warfare", she has made absolutely crystal clear the class warfare problem that exists in our country today, where Wall Street institutions and their chiefs and chief owners get all kinds of protections while the little guy is shaken down for peanuts. As a commenter on the site already noted, if only there were 99 more like her in the Senate.....
Jack Lew, former budget director under Clinton and Obama and former Obama chief of staff, answered questions at Senate Finance today in his bid to succeed Tim Geithner as Treasury Secretary. See, e.g., Rubin & Klimasinska, Lew Says He Didn't Know Money-Losing Investment Was in Caymans, Bloomberg.com (Feb. 13, 2013) and other related articles linked below.
When he was first nominated, I noted that I found his candidacy somewhat worrisome. While there are a number of considerations that suggest a decently competent person, there are also some suggestions of a person who has lived in the "Wall Street" flow too long and thus falls into line with the typical Wall Street/mainstream economics thinking--thinking which ultimately supports policies that will continue to slide towards oligarchy.
The hearing focused on several interesting aspects of Lew's career and investment choices.
1) Investing in the Caymans. Lew made an investment of 50 to 100 thousand in a Citigroup fund based in theCaymans while he was at Citigroup, and claimed that he didn't know it was an offshore investment. He got out of it when he went into government and lost money on it.
ME: There we have it--like most rich people, he just didn't care enough to consider closely whehter his investment was in a tax haven country and certainly didn't ponder the negatives .
2) Compensation at Citigroup. Lew got a "bonus" of $940,000 in January 2009 when Citigroup was receiving federal bailout funds. He defended it as being paid in the same way other private-sector employees in similar jobs were paid.
ME: But there was a ridiculous racheting up of financial sector compensation during the years when the big banks were feeding at the trough of easy mortgage securitization money and derivative speculation. Shouldn't someone that we hire as the head of Treasury have been more aware of that speculative binge? Or shouldn't that person be at least somewhat ashamed now that such an exorbitant "bonus" (10 times what most Americans receive in annual pay) should have been funded, in essential part, by taxpayer bailouts of his institution?
Now, Orrin Hatch (GOP-Utah) tried to make a big deal out of Lew overseeing the Financial Stability Oversight Council in administering the Volcker Rule limiting proprietary trading, saying that "it could lead to an awkward situation in which, in your role as chair of the FSOC, you would effectively be saying to financial firms: 'Do as I say, not as I did.' " Hatch claimed that this issue "bear[s] directly on your qualifications." I'm not so sure that is such a big worry since I think it is advantageous if Treasury has some understanding of how big banks trade, but it is just one more piece of Lew's overall nature of being well-attuned to Wall Street (and not so well-attuned to Main Street).
3) Corporate taxes. Lew suggested in the hearing that Republicans and Democrats could "work together" so that changes in the international tax scheme could lead to lighter burdens on some foreign income of US multinationals. The Bloomberg report notes that he supported a global minimum tax, but indicated that could be nominally territorial, with limits on offshoring income to tax haven countries.
4) Earned benefit programs. Lew is one of those Democrats who is more right of center than the party's base. He still mentions the need for "entitlement" program changes as well as additional revenue increases as a part of "balanced" deficit reduction.
ME: This is one of the most disturbing aspects of the Lew nomination. He is pushing the GOP agenda of deficit reduction and "entitlement" reform when instead he should be staunchly defending the New Deal against the oligarchs who want to shrink government, diminish the safety net, end any support for innovative environmental and energy progrms, yet continue to reap benefits from the long-term government subsidies for Big Oil.....We should not tamper with Social Security--and there is no deficit reason for doing so.
A Taxing Matter has reported frequently on the scandals of offshore banks aiding and abetting US taxpayers in avoiding tax due on income from their capital held overseas. The opening of the UBS case cracked open a vast network of mostly wealthy US taxpayers who had held money overseas and avoided tax. With the exposure of the bank's role in assisting tax avoidance, and the requirement that taxpayers "come clean" about the particular bankers and banks that assisted them, the government began to create a web of information leading to tax evaders, even those who thought they had moved Swiss accounts to Liechtenstein banks to avoid capture. That web has already led to the demise of one of the oldest Swiss banks--Wegelin. See Robert Wood, FATCA Cliff: Tax Evasion Guilty Plea and Death for Oldest Swiss Bank, Forbes.com (Jan 3. 2013); Swiss Bank's Demise: Glass Half Empty or Half Full?, Jan 9, 2013.
The IRS offered a number of voluntary disclosure programs with slightly escalating penalties but, importantly, no criminal prosecution, for people who would come forward before their names/accounts turned up in the ongoing chase after tax avoiders. (There is considerable suspicion that one of the reasons Mitt Romney refused to release the usual number of tax returns is that he may well have been a participant in that voluntary disclosure program.)
For those who don't come forward soon enough and are caught by the IRS, the statutory penalties and potential for criminal punishment are very real. The statute in effect allows the government to collect amounts that could well exceed the amount left in the account, and criminal punishment for filing falsified tax returns can well mean jail time.
Mary Estelle Curran fell into that trap when she choose not to report the Swiss accounts her husband had established after he died, from 2001 through 2007, using foundations in Liechtenstein and Panama. By the time she tried to participate in the voluntary disclosure program, it was too late, because she was one of the Americans revealed by UBS in its deal to defer US prosecution. The taxes she evaded amounted to about $667,000, but the penalty under the law for this type of willful evasion is quite severe, allowing the government to take 50% of the highest account balance for each failure to report. Forbes notes that "[b]y 2007, the accounts totaled over $42 million. Her penalty? 50% of the highest balance: $21,666,929, and that’s not all. She has not yet been sentenced but faces a potential prison term up to six years." Florida Widow Guilty + $21M penalty for Inherited Swiss + Liechtenstein Accounts, Forbes.com (Jan. 8, 2013).
The moral of this tale--if you have money sequestered offshore on which you haven't filed the required FBAR reports or paid taxes, you'd better 'fess up before you get discovered in this continuing sweep. And next time, go on and pay your fair share. You really owe those taxes, you know.....
If you are a company that depends on IP for a lot of your revenue, you may be able to avoid considerable taxes by funnelling profits from subsidiaries in high-tax countries into a Bermuda shell company. Google avoided about $2 billion in worldwide income taxes in 2011 by shifting about 80% of its total pretax profits-- $9.8 billion -- into Bermuda. See Jesse Drucker, Google Royalties Sheltered in No-Tax Bermuda Soar to Nearly $10 Billion, Bloomberg.com (Dec. 10, 2012).
Meanwhile, the US decided not to take action against HSBC for its fraudulent behavior because it was considered so big that it could damage the financial system (again) to interfere with its continuing corporate existence. See Glenn Greenwald, HSBC, too big to jail, is the new poster child for US two-tiered justice system, guaradian.co.uk (Dec. 12, 2012) (noting that "one of the world's largest banks, HSBC, spent years committing serious crimes, involving money laundering for terrorists; 'facilitating money laundering by Mexican drug cartels'; and 'moving tainted money for Saudi banks tied to terrorist groups' " but US officials decided "not to prosecute HSBC for accepting the tainted money of rogue states and drug lorgds on Tuesday, insisting that a $1.9bn fine for a litany of offences was preferable to the 'collateral consequences' of taking the baqnk to court").
Maybe this kind of information will finally incense governments against corporate tax dodging. What we need are laws that refuse to recognize shell companies set up in tax-haven countries to siphon profits from the countries where they originate. What we need are fewer possibilities for companies to expand through tax-free mergers and acquisitions that allow them to get so big that they become immune to ruin when they commit major crimes.
The US and other countries like Germany have been pressing the Swiss on their bank secrecy, which allows U.S. and other foreign citizens to establish bank accounts without the knowledge of the home country and thus hide assets and income from home-country taxation. The US passed laws (called by the acronym "FATCA") that require foreign banks to actively report information on US accountholders. The hope is that every country will recognize the harm done to tax systems by banking secrecy and join in imposing similar information-reporting requirements.
The Swiss, meanwhile, have been trying to circumvent universal adoption of such laws. See, e.g., Nicholas Shaxson, A scheme designed to net trillions from tax haves is being scuppered, Guardian.com (Nov. 22, 2012). Britain, Luxemburg and Austria are cited as being in the forefront of the scuttling movement: Britain, for example, has entered into a "Rubrik Agreement" with the Swiss.
The Swiss thought they had a deal with Germany. This would be a bilateral deal in which the Swiss agree to an upfront payment in lieu of any back taxes on the accounts and then agree to act as tax collector for the foreign government on the accounts, thus maintaining secret the identity of the foreign taxpayers.
Such an agreement is problematic for two reasons: (i) it requires the foreign government to trust the Swiss banks to pay the right amount over in taxes and (ii) it undermines the drive to eliminate offshore banking secrecy as a cover for tax evasion.
Transparency in international banking and taxation matters would require that banks provide information on accounts held by foreigners to the foreigners' home jurisdictions, without any account-specific or accountholder-specific request required. The reason for a more transparent rule is that otherwise the home jurisdiction has to have information it does not have (who has an account at a Swiss bank) before it can ask for the information it needs to ferret out who has such an account and may be engaging in tax evasion. The biggest cracks in banking secrecy have thus come from whistleblowers and opportunists who sell account-holder information to purchasing jurisdictions.
Friday, the Germans rejected--for now at least--a German-Swiss deal supported by Chancellor Merkel that had been two years in the making. France is apparently also considering rethinking a similar deal.
The Swiss leverage was clearly stated by Swiss banking official Mario Tuor, who "noted that without a deal, the status quo would remain: German officials can seek specific information from the Swiss government on people suspected of tax evasion, or go back to buying data stolen from Swiss banks. 'With an agreement, every German taxpayer in Switzerland would be taxed,' Mr. Tuor said." German Lawmakers Reject Swiss Tax Deal
This is an oldie but goodie, one worth reminding you of (or calling to your attention for the first time).
[The] minimum wage, in constant dollars, has had its ups and downs since 1970 but the overall trend indicated by the straight black line is down. The numbers show that the American economy puts less value on the entry level worker than it did in 1970. Why is that? Are minimum wage workers less intelligent now than they were forty years ago? Are they lazier?
Representative Steve King (R-IA) on the floor of the House of Representatives last year:
"Labor is a commodity just like corn or beans or oil or gold, and the value of it needs to be determined by the competition, supply and demand in the workplace."
***
Samuel Gompers, cigar maker-turned-labor organizer and founder of the American Federation of Labor in the early 20th Century, had a different business ethic related to labor and said this: “You cannot weigh the human soul in the same scales with a piece of pork.”
Labor advocates actually managed to insert a statement affirming the status of human labor in the 1914 Clayton Antitrust Act: “The labor of a human being is not a commodity or article of commerce.”
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