Lessons from the “Panama Papers”

The unveiling of the contents of millions of documents from a legal firm based in Panama has revealed a degree of corruption, money laundering, tax evasion, and tax avoidance beyond most people’s expectations.

It also provides some interesting links for the economics syllabus:

  1. There is significant asymmetry of information in financial markets. In an article, Thomas Piketty (the author of the book on growing income and wealth inequality published last year) writes that “There is still a complete lack of transparency as far as private assets held in tax havens are concerned”. As in the run-up to the 2008 financial crisis, this is a cause of market failure because financial regulators and central banks do not know how much “money” there is in the financial system, who owns it, and how secure (safe) financial assets are.  According to Piketty, there could be another global financial crisis due to this lack of knowledge.
  2. The use of “tax havens” allows multinationals (MNCs) to avoid  paying almost any tax on profits in Europe.  They can do this by the technique of “transfer pricing” through their subsidiaries in Luxembourg and Ireland.  It is legal, but disclosure rules (plus new rules in the UK’s most recent budget) mean that governments can perhaps claim back at least some of the tax. But this is much more difficult when the tax haven is on a Caribbean island.
  3. Governments attempt to redistribute income through progressive income taxes. If the marginal tax rates are very high for very high income individuals, some people will try to avoid (legally) and/or evade (illegally) paying the tax by setting up complicated trusts or pretend companies employing, perhaps, a Panamanian law firm. While this is often legal, it does ultimately mean that the progressivity of the tax is lessened, that governments lose potential tax revenue, and that there is a waste of resources (opportunity cost) spent on accountants and lawyers who work out the complex avoidance schemes. Thus there is an argument for making taxes less progressive and, in particular, providing fewer “exemptions” which can be exploited as loop-holes.
  4. Different economies have very, very different tax rates and systems. Could there be an international tax on income and wealth (perhaps applied by the IMF or the UN or the World Bank) which applies the same set of rates to all economies?
  5. Free global financial markets  allow individuals, often including the ruling elite and even the government in a country, to take financial assets, change them into another currency, and send them overseas. This is not only an outflow on the financial sector of the BOP, which will tend to depreciate the exchange rate,  but also removes a significant portion of the economy’s wealth and income (a leakage) which could have been reinvested to increase future GDP.
  6. Corruption  (illegal behaviour that allows powerful people to gain financial benefits)  is also made much easier, because the funds obtained can be transferred secretly to other countries.           

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