Sanctuaries from big government: how tax havens help preserve economic freedom

Governments are extending their tentacles into more and more aspects of people’s lives. They are undermining long traditions of banking privacy with international data sharing agreements. Lawyers and accountants are increasingly forced to reveal details of clients’ activities to public officials. And perhaps most worrying of all, states are engaged in the mass surveillance of their citizens, monitoring all manner of activity from e-mails and phone calls to financial transactions.

The emergence of such ‘Big Brother’ policies should come as no surprise. It is a predictable symptom of the long-term expansion of the state. During the 19th century, government spending accounted for under 10% of GDP in most Western countries. Today that figure is typically in the 40-60% range. In practice this means that politicians and officials decide how to spend roughly half of national income!

Furthermore, much of the remaining private sector is under strict state control. Although they may be nominally privately owned, many business activities are severely constrained by regulation. Indeed in many cases, the regulatory framework is so restrictive that firms are effectively under political direction. A prime example is the energy sector in the EU and many US states. Power companies are not allowed to produce electricity using the cheapest fuels. They are forced to invest in expensive offshore wind and nuclear generation.

Pervasive intervention has a heavy economic cost. Highly taxed and heavily regulated Western economies are declining rapidly relative to emerging economies. On some measures, China is expected to overtake the US as the world’s largest economy sometime this year. In Europe, Russia is close to surpassing Germany, although this may depend on current political difficulties being resolved. By contrast, both the US and EU are plagued by high living costs and stagnating wages.

Government debt has exploded as growth has declined and expenditure has risen. And official debt figures are just the tip of the iceberg. They don’t include enormous off-balance-sheet liabilities such as state pension commitments. Moreover, rapidly ageing populations will put further upward pressure on health and pensions spending. One recent estimate suggested the UK’s real national debt is about £5 trillion rather than the official total of £1.5 trillion. The US and other European countries have equally dire public finances.

Politics is part of the problem. As government spending has expanded, more and more groups have become dependent on hand-outs. This presents a major problem for politicians. For example, a government that cut state pensions might struggle to get re-elected, particularly when a high proportion of active voters are over 60.

Similarly, as regulation has become more onerous, firms have become increasingly reliant on red tape, whether as a source of business or to shut out competition. A high proportion of the West’s most talented people are now employed creating, enforcing or complying with government bureaucracy. Any deregulation programme is likely to generate strong opposition from the special interests profiting from state controls.

A combination of big government, poor economic performance and high debt means that states are now desperate for tax revenue. And given the strength of various interest groups, politicians find it easier to penalise entrepreneurs and wealth creators than risk offending the various client groups that depend on public spending.

But targeting the most productive members of society tends to be counterproductive. High tax rates deter entrepreneurship and innovation, lowering long-term economic growth and actually reducing revenues in the long term.

The most creative, talented and hardworking people might also decide to desert a country hamstrung by big government. They might relocate to places where they are allowed to keep a larger proportion of the wealth they create. Innovators will move to jurisdictions where their commercial ideas can be realised and not suppressed by red tape and bureaucracy.

Such a brain drain can send heavily regulated, high-tax countries into a spiral of decline. The top few per cent of earners make a disproportionate contribution to government budgets. For example, in the UK the top 1% contribute 28% of income tax revenues.

Entrepreneurship also has many wider economic benefits, such as creating a business friendly culture that stimulates further creativity and attracts investment from abroad. There is also a political aspect, since wealth creators will tend to support political parties that favour a light-touch approach to both tax and regulation.

By driving the gifted away, governments risk haemorrhaging tax revenues and bolstering anti-commerce attitudes in culture and politics. These trends further exacerbate a country’s long-term problems and risk driving even more talent away.

Something like this seems to be happening in France at the moment. Punitive tax rates on business people, combined with a moribund economy constrained by layers of bureaucracy, are encouraging entrepreneurs and high-skilled workers to relocate to countries such as the UK.

Faced with these problems, sensible governments would introduce economic reforms. They would cut taxes and lift the burden of regulation. Indeed, reducing tax rates tends to produce more revenue for the government in the medium term, because it improves work incentives and encourages business activity.

Reform therefore has the potential to convert a spiral of decline into a virtuous circle. Lower taxes and less red tape boost the economy, improve government finances and lower public debt. Countries then become more attractive to entrepreneurs and investors. Instead of repelling wealth creators, reforming jurisdictions attract them.

Most governments have not followed this path, however. The struggling economies of the Eurozone are a case in point. Countries such as Greece, Spain and Portugal are experiencing a full blown depression of a similar magnitude to the US in the 1930s but have so far refused to change course. In fact their ill-conceived policies have exacerbated an already severe slump. Steep tax increases have been the main focus of their attempts to address the debt crisis, choking off business activity and making a bad situation worse.

A similar attitude has been evident in the bureaucracies of the European Union. Despite the depth of the depression caused by the failed Euro experiment in southern Europe and Ireland, the EU has continued piling on more and more burdensome rules. These countries desperately needed a radical programme of deregulation to cut the costs of doing business, but instead Brussels has made it even more expensive to raise finance, employ workers, buy energy, dispose of waste, and so on.

Recent EU policies augur very badly for the future. If the worst economic crisis since the aftermath of World War 2 doesn’t stimulate reform, then what hope is there under more normal conditions?

There are several reasons for the counterproductive policies of national governments and the European Commission. Obviously any programme of tax cuts and deregulation would negatively affect groups that depend on big government for their livelihoods. The bureaucrats in national and European agencies comprise one of the largest such groups themselves. But these special interests can be overcome, as shown by examples of reform elsewhere. Indeed, it can be possible to bring senior officials onboard by giving them key roles in streamlining their own organisations. Measures such as recruitment freezes can dramatically shrink bureaucracies without placing undue pressure on existing staff.

Big-government ideologies are arguably a more challenging obstacle to change. The political culture in many countries and within the European institutions is anti free enterprise and views large-scale state intervention as the best solution to social and economic problems. Despite the rapid relative decline experienced by big-state jurisdictions in the West, and the striking success of small-state competitors such as Hong Kong, these attitudes seem to be firmly entrenched.

In this context, recent attacks on economic freedom are unsurprising. Rather than rolling back the state to foster entrepreneurship and wealth creation, administrations in both the US and the EU have moved towards further centralisation and top-down control.

The focus is on preventing countries from competing with one another by harmonising tax rates and regulations. This is gradually making it harder and harder for entrepreneurs to escape big-government controls. Increasing centralisation also makes it difficult for all but the largest corporations to influence policy decisions. Whereas local governments are relatively accessible to smaller businesses, elite transnational organisations are remote, and their decision-making processes opaque.

The centralisation agenda is likely to have dire consequences for the economy. Supranational bodies are detached from the localised and place-specific knowledge that is needed to adjust policy to suit changing circumstances. Harmonisation also destroys the diversity that is so essential to economic development.

When different jurisdictions are free to try out different policies, the successful ones can be copied and the failed ones discarded. This process was vital in bringing prosperity to the West. Lots of small political units competed with one another and successful policy experiments in one area were rapidly adopted by others. This kind of evolution is not possible in large political blocks governed by top-down bureaucracies.

The trend towards centralisation makes tax havens more important than ever. As more countries become harmonised by bodies like the EU, tax havens are among the last bastions of economic freedom.

While they exist there is still a deterrent to those predatory politicians wishing to impose punitive tax rates or draconian regulations that discriminate against entrepreneurs and investors. Tax havens give wealth creators alternative options when policies move in the wrong direction or, in more severe cases, where various forms of confiscation are threatened.

In this way, enclaves of freedoms perform a highly valuable service for the populations of countries afflicted with big government. More capital is retained by the people who produce wealth rather than captured by those who squander it to buy votes and bolster their own power.

Restraints are placed on those leaders tempted to drag their countries into a spiral of decline. The high likelihood of the brightest and best transferring their assets and activities elsewhere deters even the most reckless politicians, particularly given the implications for tax revenues.

The economic importance of tax havens is therefore out of all proportion to their often small geographical size. They are sanctuaries from big government and safety valves for a world increasingly suffocated by the dead hand of centralisation. This is why tax havens must resist bullying tactics from the US and EU and seek to retain their long-held traditions of respect for private property and financial privacy. They might also consider extending their role as safe havens by providing asylum for entrepreneurs facing persecution for violating increasingly complex and incomprehensible regulations.

By sticking to their guns, tax havens can become a source of inspiration for the opponents of big government in the West. As Europe and North America are harmonised into stagnation, these islands of prosperity will point the way to successful reform.

An earlier version of this article was published in the July/August 2014 edition of Offshore Investment.

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Why the new snooping law threatens individual freedom

Those people who hoped the coalition government would roll back the surveillance state must be deeply disappointed. Although the new snooping law is being sold as a replacement for existing rules, the reality may be rather more worrying.

According to NO2ID:

“The Government’s Data Retention and Investigatory Powers Bill (DRIP) is much more than a replacement for existing regulations…It gives future Home Secretaries sweeping new powers to order telephone and internet companies to keep almost any sort of information about their users.”

Guy Herbert, General Secretary of NO2ID adds:

“This is a classic database state scheme for mass surveillance that can be indefinitely modified once it is on the statute book. A DRIP can easily become a torrent.”

While the government’s rhetoric has focused on the threat from terrorists and paedophiles, it is important to remember that there are many good reasons why people behaving ethically would not want to be monitored by the authorities.

For example, a whistleblower might be working to expose government wrongdoing, such as corruption among officials or lies told to foster support for a particular policy. Information obtained through surveillance could potentially be used to hamper such activities or to deter people from speaking out.

There could also be negative implications for financial privacy and for the dissemination of unpopular political views by ‘dissidents’ (the latter in the context of the UK’s restrictions on free speech on certain issues). The danger of a ‘ratchet effect’, perhaps in the context of some emergency or the election of a government with more authoritarian instincts, should not be dismissed.

The railways are a classic example of a politically distorted market

In September 2012 I was invited to discuss rail policy with the Transport Select Committee. The session can be viewed here (@39 min). Some excerpts from the (uncorrected) transcript are provided below:

Chair: Do you support the Government’s overall strategy in HLOS [the government’s rail plan]? Have they got the right priorities?

Dr Wellings: I would say no. The Government has not dealt with the fundamental problem that the rail industry is hugely distorted by subsidies and other distortions such as the planning system. Basically, the central planners in the DfT are groping about in the dark. They don’t have an idea of genuine levels of demand or genuine prices because we also have price controls. Before embarking on these absolutely huge investments at taxpayers’ expense, they ought to get the fundamentals right and remove these distortions and, in particular, the subsidy regime.

Chair: What would you like to see change?

Dr Wellings: I would like to see the subsidies phased out and a change in the planning laws that force developers into corridors around railway stations, for example. There needs to be a change in the tax regime as well so that there is a level playing field with other transport modes.

Mr Leech: Dr Wellings, you argue that there is no economic case for the improvements because of the cost to the taxpayer. You suggest that taxpayers are already paying about £5 billion a year in subsidy. As far as you are concerned, that is an unacceptable level of subsidy. What would be an acceptable level of subsidy?

Dr Wellings: Zero. I would like to see it phased out over a period of, say, 10 years to zero.

Mr Leech: What impact do you think that would have on fare prices on trains and the number of passengers who could afford to use them?

Dr Wellings: It would vary. I don’t think it would have much impact on, say, the London commuter market, which I think is probably fundamentally economically viable, particularly if we also liberalise the planning system so that rail companies could make money from property development as they do in Japan. At the other extreme, you have railways in places like rural Wales that are very poorly used. I think they should definitely close down. There is no economic case whatsoever to keep them going and there is also no social case.

Mr Leech: On the basis that there is a subsidy taking people out of cars and reducing carbon emissions, in your studies what impact would there be on carbon emissions and on the cost to congestion as far as the economy is concerned? Have you done any of that work?

Dr Wellings: It is a myth about carbon emissions. If you closed the entire rail network down overnight, the impact on carbon emissions would be barely measurable. There are two reasons for that. One is that it is quite a small share of overall transport use. The second reason, of course, is that we are talking about a different market from cars. A high proportion of journeys are into central London, for example. These would probably hypothetically go on to coaches and buses, which are more efficient than trains. It would actually be barely measurable.

There is also the effect of subsidising people to move further and further away from where they work through cheaper train fares. You end up, for example, with long-distance commuters through the season ticket system. Although the rail journey might be relatively efficient from an environmental perspective, in terms of the whole lifestyle they probably emit more than if they lived in inner London or close to work.

Steve Baker: Dr Wellings, in your article for City AM in July you were highly critical of the Government. You said that “cynical political calculation seems to be the driving force of policy”. You talked about the railways as a classic example of a politically distorted market. You have also said, without reading the whole article, that many of the projects are motivated by politics rather than economics. Could you give us some examples of where these things can be seen?

Dr Wellings: Yes. The most telling example from the recent plans was the plan to electrify the branch lines in south Wales. Of course the Welsh railways already have perhaps the highest operating subsidies per passenger mile in the whole network. We already have a false market, a rigged market, and yet we are going to invest good money after bad in this already hugely subsidised market. It seemed that the Government was allocating new schemes across the country to pay off various special interests. Few of them made any economic sense. For example, if you wanted a fast train up to Sheffield, it can already be done by the East Coast Main Line in an hour and three quarters. There just isn’t the demand for that kind of service. The idea to spend this money electrifying the Midland Mainline to make some very tiny time savings didn’t make any business sense to me.

Of course the worst example of all is High Speed 2, which has a very low benefit-cost ratio. We saw road schemes being cancelled in the Comprehensive Spending Review that had a benefit-cost ratio over three times High Speed 2. There is no economic logic at all behind current transport policies.

Chair: We are on rail today, though.

Steve Baker: I would follow it up by asking this question. Isn’t it true that all Government investment decisions, including right across transport, are influenced by politics to some degree?

Dr Wellings: What we have is basically a thinly veiled version of Soviet-style central planning here. It is hugely centralised with the DfT and politicians making the big decisions. This is in a morass of economic distortions from price controls, subsidies and distortionary tax treatments as well. These people just can’t make sensible investment decisions because, first, it is hugely politicised, and, secondly, because we don’t have genuine prices or genuine levels of demand.

Tour de France road closures could be avoided

The Tour de France comes to Britain this weekend, starting in Yorkshire then moving down to Cambridge and London.

Cycling fans will enjoy the spectacle, but the race will also cause considerable disruption and inconvenience to travellers and residents. Some people could almost be trapped in their homes by the road closures (for example, those with mobility problems who rely on cars and buses).

For large numbers who do not enjoy cycle racing there will be significant costs but few if any benefits. Yet, it seems that no compensation will be paid to those negatively affected.

To add insult to injury, taxpayers are being forced to spend millions hosting the race. And worse still, the BBC and the cycling lobby are already exploiting it to promote ill-conceived and economically damaging transport policies.

Such sporting events are telling examples of the state throwing its weight around and disregarding the costs imposed on individuals and businesses. As long as governments control the roads, politicians and officials will continue to impose their transport diktats on the wider population.

By contrast, roads under voluntary ownership would face strong incentives not to allow such disruption. On commercially operated roads, closures could mean fewer customers and less revenue. The interests of users and owners would be closely aligned and there would be a clear trade-off against potential revenues from any special event.

On local roads controlled by residents and businesses, small communities could decide for themselves whether to allow organisers to use their infrastructure, subject to pre-existing contractual rules on denial of access.