Perhaps these trends sprang from the uneven recovery experienced since the 2008 global recession, the populist mood and rhetoric that has dominated the 2016 presidential race thus far, shifts in our national demographics, or some secret sauce combination of these and other factors. Whatever the causes, the effects are being felt in the real world, and if these trends continue, we can expect to see significant and lasting social and economic impacts. We will explore these trends in more detail over the next few blog posts, beginning with….
Trend # 1 - Tax Evasion and Corruption
While most Americans were scrambling to prepare their annual tax returns by the April deadline, global headlines were dominated by a different pair of tax related stories. It isn’t often that tax matters make front page news - editors certainly know only a small minority of readers would seek out that content - so what made these two stories different?
The first story revolves around how the $150 billion merger-acquisition of Allergan, a US run pharmaceutical company with its tax domicile in Ireland and best known as the maker of Botox, by Pfizer, the largest pharmaceutical company tax domiciled in the US, fell apart because the US Treasury Department decided to further crack down on a dubious but technically legal practice known as tax inversion.
At its core, tax inversion involves reincorporating in a lower tax country by acquiring an address in a lower tax country. That coveted address is most often acquired by purchasing a local company, but other methods are also available. More than 50 US companies have inverted since 1982. Burger King famously did so in 2014 by purchasing the much smaller Canadian firm Tim Horton’s. As an added twist, Tim Horton’s was originally a US company that inverted to Canada back in 2009….the mind is boggled.
For years, Congress and government agencies have been trying to close the tax code loopholes that have allowed inversions to flourish. For the Treasury Department, the proposed Pfizer deal was the proverbial straw that broke the camel’s back. Not only was Pfizer the largest firm to attempt inversion, but the pace of inversion has been sharply increasing since 2012, with more than 20 US firms completing the reincorporation process overseas. By imposing new calculations and limits on inversion participation and shareholder ownership thresholds, the Treasury Department essentially erased the bulk of the tax benefits Pfizer was anticipating, thereby killing the deal with Allergan and likely giving other US firms serious doubts about any current or future inversion plans.
For more about the history of inversion and reincorporation over the last decade, click on this Bloomberg link: http://www.bloombergview.com/quicktake/tax-inversion
For more about the Treasury Department moves that killed the Pfizer Allergan deal, click on this Wall Street Journal link: http://www.wsj.com/articles/pfizer-walks-away-from-allergan-deal-1459939739
Despite its tax-dense theme, this story resonated with the public because closing loopholes to force companies to pay their fair share of taxes is something the majority of Americans can agree on. We may disagree about how or even if taxes should be levied, but exploiting a loophole - let’s call it “tax avoidance” - even if technically legal, violates our fundamental sense of fair play.
In contrast, our second headlining tax story lacks even the thinnest veneer of legality. Last month, the leak of millions of documents from the Panamanian law firm Mossack Fonseca shed some rare sunlight on the murky world of offshore companies and tax havens. Collectively known as the “Panama Papers”, the documents detail numerous schemes in which the law firm set up anonymous shell companies on behalf of real owners hiding behind hired “nominees”. Investigators describe these shell companies as “getaway cars” for tax dodgers, money launderers, and corrupt officials looking to stash their ill-gotten gains.
While this type of tax evasion is nothing new, the documents have raised global awareness about the sheer scale and reach of this type of activity and the associated direct and indirect costs. By some estimates, tax evasion (as opposed to the technically legal tax avoidance activity previously discussed) costs governments across the globe $200 billion annually. Crunching the numbers another way, experts have estimated that 8% of the world’s total wealth is not part of any legitimate economic system. Governments make up the shortfall through spending cuts, borrowing, or taxing law abiding citizens more heavily.
The corruption is not evenly distributed across the globe and, as you might suspect, countries that can least afford it are hit the hardest. 22% of the total wealth of Latin America is off the grid, 30% of Africa’s, 52% of Russia’s, and a whopping 57% of the Gulf States’. Unfortunately, these parts of the world are known for corruption and instability and lack strong local institutions willing and able to take action. On the flip side, politicians in both the UK and Iceland have been implicated by the Panama Papers and the public response has been swift and harsh. Indeed, Iceland’s prime minister stepped down after large groups of protestors demanded his resignation.
Will the Panama Papers scandal galvanize responsible governments and other institutions to work together to start shutting down this corrupt underground financial “system”? The US Department of Justice and similar agencies in France, Germany, Australia, New Zealand, Sweden, Brazil and the Netherlands have promised to investigate and pursue wrongdoing affecting their respective jurisdictions, but without sustained global commitment and cooperation, it is difficult to see how systemic change can take hold.
One hopeful sign is the international anti-corruption summit scheduled to take place on May 12th in London. Hosted by UK’s Prime Minister David Cameron, its self-stated goal is to bring together world leaders to agree on a package of practical steps to expose corruption so there is nowhere to hide, punish the perpetrators and support those affected by corruption, and drive out the culture of corruption wherever it exists. Let’s hope the current Panama Papers backdrop gives summit participants an extra push in the right direction.
In our next post, we will explore recent trends in the relationship between labor and business.