IN THE run-up to the Lok Sabha elections,. the Bharatiya Janata Party (BJP) has raised the issue of illegal wealth in Swiss banks and other tax havens—astutely combining its economic and national security planks. It has also alleged that the Congress-led United Progressive Alliance (UPA) government is not very keen to get these funds back—insinuating corruption as the reason.
Unfortunately, both partisan and non-partisan reactions have focused on the quantum of money, not the fundamental incentives involved. Yet for money to reach the privacy-protecting banks of a country deemed to be a tax haven, it must first leave the originating country. Therefore the first responsibility of preventing illegal transfer of funds lies with the latter, not least because the transfer to be prevented has been deemed illegal there.
So if the originating country cannot trace the black money in its own backyard, then it must simplify tax laws and adopt electoral reforms to tackle the root of the problem. For example, if consumption taxes like Value Added Tax (VAT) or Goods and Services Tax (GST) are emphasised more than complicated direct taxes, a big loophole can be plugged. Concerns about the progressivity of taxes—the idea that those with higher incomes must pay a higher percentage of their income as tax—can be tackled by direct transfers to the poor. Also, trade policy needs reform: to stop under- and over-invoicing of trade overall tariffs must be reduced. Similarly, unrealistic caps on election expenditures by individual candidates should be scrapped because they encourage crony capitalism and corruption.
Also while the global economic crisis has converted financial privacy from a sacrosanct value to a sacrilegious one overnight, in many circumstances, the desire to keep financial affairs hidden from the authorities is still a reasonable one for many reasons. Avoiding over-taxation by a predatory state like pre-liberalisation India, or saving for a rainy day in an hyper-inflationary country like Zimbabwe, or to protect human rights lest a dictator’s witch-hunt result in the seizure of domestic accounts.
Moreover, we must be careful of a slippery slope if we go about restricting the financial sovereignty of small countries—if today a cartel of influential nations can somehow force them to discard privacy laws, then can not the very same cartel of governments also force these small countries to “harmonise” taxes and adopt certain minimum tax rates? In fact this is the real undercurrent to the issue as far as the Germans, the French and the American Democrats are concerned. Faced with demographic contraction and ballooning welfare states, and unable to allow free immigration because of political considerations, Western leftists want to somehow prevent their rich citizens and corporations from leaving for the greener shares of lower taxes, instead of controlling their own expenditures.
After all, many technocrats in the European Union and the United Nations have said so openly—and the latest financial crisis has at least strengthened the superficial pull of the argument that fiscal policies must be internationally co-ordinated.
But international tax competition is a very healthy phenomenon, and tax harmonisation very dangerous. Tax competition forces countries to make the spending of federal governments more efficient. It is the efficiency of spending that is important, not quantity—therefore “race-to-bottom” descriptions of tax competition are wrong. If global taxes are constrained, then the Indian state will also be forced to become more efficient to continue to attract investment—and this will be a boon for its millions of poor citizens, if not for its status quo loving political elite.
Now undoubtedly, financial privacy and tax competition are technically two different issues. Tax havens could theoretically dump privacy and still stand at the vanguard of international tax competition—but will future populist urges for big spending in originating countries not conveniently demolish this nuance, once a punish-the-haven precedent has been set? Also, if sanctions and tariffs are allowed to be slapped against Switzerland because of this issue, would not “green” sanctions and tariffs against countries like India also gain legitimacy in the future?
Then how does one get past the impasse? The real distinction then should be on kind of money coming in to these havens. There are two potential reasons to secretly expatriate money—the money in question is “dirty money” (connected with crime and terrorism) or the money is legitimately earned—but where the earner wants to evade taxes. These two reasons should not get conflated if we are to maintain financial sovereignty and yet at the same time confront the very real threat of global liquidity at the disposal of terrorists.
This is a workable distinction. Financing terrorists anywhere in the world is a serious crime in most countries. On the other hand, not paying taxes in another country is not necessarily a crime in many countries. This principle of “dual criminality” therefore outlines a basic framework for a negotiated settlement between the “tax havens” and (say) other G-20 nations. Moreover, the potential infiltration of terrorists into the tax havens is highly unlikely—according to Chris Edwards and Daniel Mitchell, authors of Global Tax Revolution “[t]here are no longer any ‘non-cooperative’ jurisdictions, including any tax havens, on the blacklist of the Financial Action Task Force—an international agency that monitors the fight against dirty money.”
Moreover, getting any money back quickly—if at all—is well nigh impossible. The money is in different havens, it has been moved around and probably consumed. At least some individual-specific documentation of suspicion would have to be provided. A lot of the money in these havens is legitimate, like Mauritius-routed foreign institutional investment, and even if the havens all collectively somehow buckle who is to say that the black money from an Indian point of view would now not be with some hawala dealer in Dubai instead of in the secretive-but-still-largely-safe-from-terrorists Swiss accounts? Unintended consequences are, well, unintended and they can be very ugly indeed.
In any case, the biggest tax haven in the world happens to be the United States of America. No information collection takes place nor does taxation of interest or capital gains income of nonresident aliens take place there. Many other countries have differential tax and privacy policies—for their locals and for foreigners—even those which ostensibly follow “territorial taxation”. The difference between ‘tax havens’ and other relatively low-tax and high-privacy countries (like the United States) is often just the amount of power they wield.
India should be on the side of fiscal sovereignty, lower taxes and tariffs, and legalisation and transparency of money in politics. If it goes beyond proximate factors and gets these basic facets of governance right, it will not only stop wealth from leaving—but also create a lot more right at home.
Harsh Gupta is a resident commentator on The Indian National Interest and blogs at Swaraj ?(swaraj.nationalinterest.in)
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