Revista nº 174. Financial crisis and tax avoidance and tax evasión

Good afternoon, firstly, let me say that it is a pleasure to be here and that I thank the organization for inviting me to this conference.

The general title of my speech is “tax avoidance, tax evasion in the financial crisis”. Curiously we have to begin with the concept, that in my opinion should have been clear but which was not, that most commentators thought that financial crisis has nothing to do with tax avoidance and tax evasion. Only a few believe in the contrary, i.e. that financial crisis, tax avoidance and tax evasion are inseparable and that you cannot understand the situation of the breakdown of the financial meltdown without knowing what happened with tax issues.

My first remark: financial activity considers the tax motivation as a way to generate financial accountants” earnings. Second: tax departments of corporations became profit making units, rather than tax management units– as it should be. Third: tax rules were converted into a source of financial earnings.

The invasion of financial activity in the tax field is complete. I am unable to think in a separate analysis of financial crisis and tax avoidance and tax evasion because tax avoidance and tax evasion were another future of any financial activity. That means that the meeting point of both activities was tax minimization for financial maximization of earnings and then this is the beginning of this speech.

The origins of the financial crisis are well known. In the nineties, the first experiences of Lehman Brothers, Long Time Capital Investment and Enron were the school of financial malfeasance. Everything we know today about financial crisis was invented by Enron in the late 90″s. The procedures, the mechanism, the elements are the same. The only difference is that we believed that the ENRON experience was a specific experience and that was not true: the ENRON experience has been disseminated, it has been spread all over the economic system and financial system.

Which were the elements of this school of financial malfeasance? First: the structure of financial transactions, which means the selloff of loan”s exposure (mortgages, credit cards, bad titles, student”s loan) to a special purpose vehicle (SPV) – which is an empty entity of balance sheet normally located in a tax haven. The bankruptcy remoteness of the SPV was the agent of the sponsor, the bank, the insurance company, the hedge fund, to build all kind of financial transaction”s structure; the dominant form of this kind of transactions was the securitization, which means the issuance of over-the-counter derivatives with the blessing of the credit rating agencies.

In the first stage the underlying activity of derivatives was a real loan, it was an effective loan; at the end there was no real loan, no effective loan: it was invented on the paper as well as the concepts of collateral to the obligation and of credit default swap, which means betting at the same time in favour and against the investors. The most valuable case in this field is the Abacus case from the fraud of Goldman Sachs, one of the last frauds discovered: Goldman Sachs betting against its investors in the praxis of securitization of mortgage loans that were in default. Then, these were the elements of the Enron school, of the malfeasance financial school which grew to the present of the so called GSIFI, Global Systematically Significant Financial Institutions, no more than 20 (institutions) which control all the world finance. The GSIFI is a group of commercial banks, hedge funds and insurance companies. They avoided the regulatory arbitrage in their own country and shifted the risks in an opaque way to low taxation jurisdictions; they looked for short term cashflow and for long term investment with unlimited leverage; then it came the breakdown. The false idea of self correction of the markets and the so called permissiveness of the States ignoring the red flags, the global risks and the interconnectedness between institutions, investors and States, brought the failure of the system.

At this point you can ask yourself what is the correlation to tax avoidance and tax evasion? The answer is very simple: taxes were a co-operator of financial activity; without abusive tax planning, without tax shelter, without permanent differences in booked tax it would have been impossible for financial activity to obtain super profits, super earnings and super royalties during this era. So we are obliged to consider tax issues as inseparable from the financial crisis, this is not only an opinion: the reaction we have seen after the G20 is the recognition that financial and money abuses have also to do with tax evasion, tax avoidance and money laundering. Firstly, with the abusive tax design to skim, reduce, avoid, and evade taxes; secondly, through permanent difference in book taxes, which created the so called tax shelters: the creation of artificial losses through differences between book taxes. Thirdly, offshore industries which offer legal advice, banking and financial advice, opaque and secret advice, in offshore financial centres, tax havens and in other jurisdictions that are not necessarily tax havens. In addition, taxes are to be considered as a source for extirpating the legal risk of eliminating income taxes from certain kind of businesses, namely financial and multinational corporations. It was a kind of tax short-selling: the idea was to buy tax advantages and sell tax disadvantages: the application of the financial concept of arbitrage in the legal world. The system failure was due to a lack of understanding of the global risk, but the idea of market”s failure we have to think about is that of (negative) externality – e.g. of social costs imposed on others: unemployment, bankruptcy etc. These externalities have to be internalized, in some way, by those that provoke the damages.

I”m optimist. I think the G20 forum is acting in the right way: regulation against irregularities, transparency against opacity, integrity against corruption. The G20 reacted against market abuses, financial abuses and also against tax evasion and money laundering and the traffic of capital. The G20 carved the soft law, why? Because there was an important passage in terms of international principles at the time: first we have the so called transnational legal proxies, which means interaction, interpretation and internalization of international principles through local rules: for example the principle of abuse of law in Italy came from the concept of abuse of law elaborated by the European Court of Justice. The new stage is not a transnational legal proxies, it is the creation of common law international principles. This means that there are international common law principles that shape expectations of complying with binding rules, there are red lights warning for the route for every State: this is the novelty. In all G20 speeches we heard the phrase: “international agreed standards”, which means “international common law principle”, which in turn means the application of international law principle to local law in a straightforward way. This has been the best innovation promised by the G20 up to now. What does this mean? Firstly, the principle of harmful tax competition has been assumed by the G20 with the special meaning of exchange of information (no bank secret, clear distinction between cooperative and non cooperative States). Under this principle tax avoidance, evasion, money laundering are linked in a way not so different from other crimes. Secondly, the principle of antierosion of tax base – this is a radical change, since each State has the right to protect its tax base. An Italian economist, Vito Tanzi, talked about fiscal termites which serve to erode tax base. Now this principle is assumed by the G20. What does it mean? Regulation of transfer pricing, earnings, stripping, of abusive tax planning, of corporate tax base by debt financing, of tax deferral not only on CFC but also in economic activity. All these changes are under the umbrella of antierosion of tax base principle. Few years ago we had a notion about this complex antierosion tax base, I suggest a synonym which is not mine, Prof. E. Kleinbard wrote a beautiful essay called ” State less Income”. ” State less Income” is an attribute generated by financial activity and multinational activity whose aim is to move the taxable base to low tax jurisdictions from high tax jurisdictions – e.g. to locate tax base in a way that does not bear taxes but captures tax rents. This means, in our economic systems, that there are agents which have the particularity of not being subject to taxation: through tax avoidance, tax evasion, they have the possibility to no taxation in any place of the world. So the content of “State less income” principle is the same as the antierosion principle. If there are agents which have income not subject to taxation, this means that we have States with taxes but with no significant taxpayers.

So, two principles and one new idea.

You know that taxation is omitted from the general agenda of globalization, why? We talked about externality and one way to internalize them is by taxation itself; however, from the work of G20 and of EU Commission it seems that this omission is going to be removed. In fact, they introduced a new expression, they invented the concept of “systemic levy”. But, what does it mean “systemic levy”? Banks, multinational corporations, financial activities and derivatives assets should be taxed in a specific manner (e.g. the Tobin Tax): tax with names applicable to specific taxpayers. This means, firstly, “one single tax for a single organization”, because there is only one ability to pay.

Pugliese,a well known Pavia scholar, suggested many years ago the creation of an international fiscal bank related to the international settlements payments of Basel; the creation of an international tax court and the formula apportionment or the common consolidated tax base in the euroepean language. This is the idea, it was utopic during the “20 e “30 but now it seems prophetic. We need this answer for globalization, we need to invest in the structure of international tax law and in its enforcement.

Prof.Dr.Tulio Rosembuj

Catedrático de Derecho Financiero y Tributario

de la Universidad de Barcelona