Monday, August 18, 2008

Are investment banks bad taxpayers?

An editorial piece in the Financial Times starts with this sentence:

"The penny has dropped in London and New York that banks are not reliable sources of tax revenues. Losses from the credit crisis means that some investment banks may not pay taxes, as Michael Bloomberg, mayor of New York, gloomily phrases it, “for years”."

The reason is that companies can, under accounting rules, "carry forward" losses into future years so as to offset their tax bills for those years. In this case, Merrill Lynch is in the headlines (the picture is of the Merrill Lynch bull on Wall Street) . The American bank booked $29 billion of losses from its involvement in trading fancy collateralised debt obligations (CDOs) to its London subsidiary for accounting purposes, even though many of the deals were done in New York (be sure to read to the end of this blog; TJN's Richard Murphy offers an interesting perspective.)The FT continues:

"As a result, London and the UK can forget Merrill paying any tax on its local profits for a very long time. Merrill Lynch International has accumulated tax losses that it will be able to carry forward indefinitely."


The investment bank has become, as the FT says, the institutional equivalent of a “non-dom”, one of the lucky global elites who can escape most of their taxes by becoming "domiciled" in the UK - the result of a morally repugnant strategy by the British authorities to lure wealthy people to the country.

There is more good stuff in the FT editorial.

"For Merrill and for the UK, this is an unintended consequence of the low rate of corporate taxation. The UK corporation tax rate of 28 per cent meant it made sense for Merrill to book the deals in London rather than the US, where the federal rate is 35 per cent and state taxes add a few percentage points. Low taxation has now become zero taxation, which will further add to the incentive for Merrill to do (or to book) business in London. . . . After a period in disgrace with their shareholders and changing their senior executives, investment banks will be able to get on with business. But the hangover from the credit crisis will affect cities for years to come. They will have to find other sources of revenue to make up for the absence of taxes from financial institutions."

It's astonishing, isn't it? It reminds us of a recent comment by the FT's chief economics commentator, Martin Wolf:

"I may like many bankers, but I rather dislike banks. I recognise their necessity, but fear their irresponsibility. Worse, they are irresponsible partly because they know they are necessary. No industry has a comparable talent for privatising gains and socialising losses. Participants in no other industry get as self-righteously angry when public officials – particularly, central bankers – fail to come at once to their rescue when they get into (well-deserved) trouble."

The FT continues:

"Investment banking is not dead but it is in a cyclical downturn. It has occupied an outsized role in western economies in the past decade and is now shrinking. This cyclicality, and its tendency to make losses every few years, make it an unreliable financial partner. Let the taxman beware."

Mervyn King, governor of the Bank of England, adds important context to this sad British story:

"I do think it is rather unattractive that so many young people, when contemplating careers, look at the compensation packages available in the City and think that these dominate almost any other type of career. It’s not a very attractive situation that such a high proportion of our talented young people naturally look at the City and think it is the only place to work in. It shouldn’t be. It should be one of the places, but not the only one."

A recent article about Denmark in the authoritative U.S. publication Foreign Affairs, examining Denmark's remarkable economic and political success (and very high taxes) highlighed one aspect of its economic model, which was:

"fairly equal wages among different sectors, so that a shift from manufacturing to service-sector work does not typically entail a pay cut . . . Danish respondents reported that they had changed employers an average of six times, the highest figure in the European Union. One in three Danes changes jobs every year. And with employers free to deploy workers as they wish and all Danes eligible for generous social benefits, there is no inferior “temp” industry, because there is no need for one. As precarious short-term contract employment has grown in most other countries, the number of Danes in temporary contracts has decreased since the mid-1980s. Where most other OECD nations have a knot of middleaged people stuck in long-term unemployment, in Denmark, the vast majority of the unemployed return to work within six months, and the number of long-term unemployed is vanishingly small."

Now Britain is different, of course, but there's a lesson here: the country has become massively dominated by financial services, which have crowded out other sectors and badly (and very harmfully) distorted Britain's employment market and its overall business environment. And that's not to mention the economic lobbying and political capture of British politics by the financial services industry. It's high time to rebalance the British economy - and significantly so.

Ruth Sunderland writing yesterday in The Observer (in an article that also quotes TJN's Richard Murphy) tends to agree:

"The UK has courted Big Capital - and big capitalists - by offering tax concessions, without asking whether it is necessary or desirable to excuse them from contributing to our social wellbeing. But there are better ways of selling Brand Britain to wealthy firms and individuals than tax bribery. To name just some: the English language, an advantageous time zone for business, our top universities, our legal system and secure property rights, and the cluster of expertise and skills that have grown to service financial firms. Over the past decade our economy has become unbalanced. Politicians have lionised the City and allowed themselves to be influenced and even cowed by it. Manufacturing has shrunk, with more than a million jobs lost since Labour won office."


It's not only a British problem. Kenneth Rogoff, former chief economist of the IMF, weighs in with this:

"Is it not now clear that the main macroeconomic challenges facing the world today are an excess demand for commodities and an excess supply of financial services? (italics added.)"


Back to Merrill Lynch, however, and a last word from our Richard Murphy, who, as far as we are aware, is the only commentator actually to look deeply into Merrill Lynch's UK accounts and highlight the real technical issues involved in the latest story. Richard, in fact, offers a ray of hope for the beleaguered British taxpayer:

"It takes very little change in what you do for loss carry forwards to be disallowed. For example, a company who made losses on making medical equipment using rubber who then switched to using plastic was deemed to have started a new trade and was denied loss carried forward. . . What’s the chance (Merrill Lynch International) will ever use all these losses in that case given the simple volatility of the volume and type of this trade? Very little if there’s anything like a good tax inspector on the case in my opinion. Which is pretty good news, I think."

We hope he's right. The bankers' lobbyists and tax tricksters will certainly try to make sure he isn't. And note this comment underneath Richard's blog:

"What presumably follows is whether the preservation (or otherwise) of the tax losses then becomes a bargaining tool in the UK, with MLI using any threat of their denial as a reason to reduce their UK activities (with the usual arguments about loss of UK investment, jobs, spending etc.)"

And we also need to ask the question: it's hard enough for (relatively) well-funded and experienced tax inspectors in countries like the UK to get wily multinationals to pay their fair share of taxes. How easy is it for poorly resourced, political vulnerable, and often inexperienced tax authorities in developing countries to fight these kinds of battles?

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