What tax havens do – 5 – they harm the operation of markets

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In a recent editorial the Financial Times said:

Every first-year economics student learns the conditions for an unregulated market, in theory, to function efficiently. The most important are full information, enforceable property rights and contracts, and the absence of “externalities” – effects of economic transactions on third parties.

When these conditions are absent, markets malfunction; the way they do so is one of the great topics of economic theory. It tells those who care to listen that when a market is too opaque, or when the effects of market transactions are too inter-dependent, the pursuit of self-interest can make everyone worse off, or unfairly land some with the losses caused by others, or – in extremis – make markets disappear altogether.

Anyone who believes that markets have a role in the economy (and I do) will find it difficult to argue with this. What it makes clear is that efficient markets are dependent upon the availability of information: the better the quality of the information and the more open the access to that information is then the better will be the efficiency of the allocation of resources by the market.

Tax haven activity is entirely dependent upon secrecy. That secrecy is an entirely deliberate and artificial market distortion. It is only available to some businesses and people and not others: a premium is placed upon access to this ability to hide one’s affairs.

One premium is imposed by cost: it is not cheap to set up offshore structures. As a result they are only available to larger businesses and wealthier individuals. As a result the wealth gap increases.

Another premium is imposed by age: those able to create structures before they are declared illegal are usually allowed to retain them after use by new market entrants is banned. This means older people, and most especially older companies have opportunities not available to new businesses that cannot legally access these centres. This has created a bias against new enterprise.

Thirdly, there is a premium imposed by legality. Some will choose to act illegally and take the risk of doing so. Others will not. If insufficient resource is allocated to tackling the illegality there will be a positive, and predictable return from that illegal behaviour which imposes a premium on those who choose to be law abiding.

Lastly there is a premium on those who work nationally: they cannot access offshore in a way those who work internationally can. They suffer as a result.

But in each and every case the answer is not to open the market to all: for a start that is not possible. Second, it would only make the problem worse: there would be even less data available to markets than now, and as the FT notes, the result might be no markets at all.

The answer is to create a level playing field. This is what efficient markets require. That means all should place their data on public record; all should have their data exchanged with their domestic tax authorities; all should provide it to those who need it to appraise the risk of trading with them if they are a limited liability entity.

Then we remove a market distortion. That market distortion does at present:

  • support monopoly power,
  • support the power of those already wealthy,
  • support the power of the large company over the small company, and
  • support the power of the existing market player over the new market entrant.

These all result in the misallocation of economic resources because

There is no benefit from this for society as a whole. Far from it. Wealth and resources are misallocated. Because of the secrecy implicit in offshore the cost of capital goes up (one reason why the bank bail out has been so expensive). Because of the activities of offshore agents a cost of tackling abuse is imposed on society at large.

None of these things need happen. Those who argue against tackling offshore argue for inefficient markets. Those who argue for tackling it argue for efficient markets where resources are as optimally allocated as possible, where risk is mitigated and capital has the lowest possible cost.  Getting rid of tax havens would help achieve that.

Then we’d have proper globalisation for the benefit of all, not globalisation to reinforce monopoly profit which is the tax haven inspired variety that we have now.