Monday, December 07, 2009

Tax avoidance as a civic good

Sarita handed me several file folders full of old papers she thought I could get rid of.

She was right that I could get rid of most of the papers. But one caught my eye. It was a newsletter from March of 2000. The lead article was titled "Tax Avoidance Pays Off" and it is by James Dale Davidson.

"One of the more cloying conceits of the 'Goo-Goos,' the good government crowd, is that tax-avoidance defrauds other taxpayers and harms the economy. Don't believe it," he writes.


Before I go any further, let me note the difference between tax avoidance and tax evasion. The first is legal. The second is not.

As Wikipedia notes,
Tax avoidance is the legal utilization of the tax regime to one's own advantage, to reduce the amount of tax that is payable by means that are within the law. By contrast, tax evasion is the general term for efforts to not pay taxes by illegal means. The term tax mitigation is a synonym for tax avoidance. Its original use was by tax advisors as an alternative to the pejorative term tax avoidance. Latterly the term has also been used in the tax regulations of some jurisdictions to distinguish tax avoidance foreseen by the legislators from tax avoidance which exploits loopholes in the law.
But back to Davidson's article.

He wrote his article immediately following Team New Zealand's 5-0 win in 2000 over Italy's Prada to retain the oldest grand prize in sport--the America's Cup.

Davidson first tells the story of the America's Cup, and then a little about how Team New Zealand came to own the technology that gave them the winning edge. I'll skip the story of the America's Cup. Let me tell you about Team New Zealand.
Italy's Prada entry, Luna Rosa, funded by fashion tycoon Patrizio Bertilli, to the tune of a reported $120 million, proved to be faster than the yachts entered by all five American syndicates, as well as those from Japan, Australia and elsewhere. But while Prada was the champion among the challengers, it could not take even one race from Team New Zealand.

The puzzle is that a small economy like New Zealand['s] . . . was able to achieve breakthroughs in fluid dynamics and the computer modelling of wind propulsion sufficient to create a super-yacht speedier than any produced in much wealthier and larger economies.
How was New Zealand able to do this? Ultimately, said Davidson, it had to do with a tax avoidance scheme.
A merchant banking firm, Fay, Richwhite had found a brilliant way to satisfy New Zealand tax liabilities at a 90% discount to the taxpayers.

As a result of this scheme, the partners of Fay, Richwhite became very rich.
And it was with these riches that Sir Michael Fay, principal of Fay, Richwhite, engineered New Zealand's rise to prominence in international yacht racing.



But what about all the other New Zealand taxpayers who were forced to pay far higher tax rates? And (this really chapped my hide): How and why could Davidson make the fantastic claim--as he did several times in the article--that Fay's decision to invest in an ultra-expensive yacht racer was some kind of "high value" use for the money he had earned and been able to keep because he was paying relatively low taxes?

Indeed, how could Davidson claim--as he did--that the New Zealand media were foolish and wrong to suggest that Fay and his cohorts had done something dishonorable--or, at least, less honorable--than their compatriots who had failed to use the loophole? Why and how could Davidson suggest it was inappropriate for the media to tell New Zealanders "that they were victims of a terrible outrage [and that t]hey had been 'defrauded' of billions in tax revenue by wealthy corporations"? And why did Davidson suggest that, "[w]hen courts determined that the tax avoidance formula at issue was perfectly legal, New Zealand's parliament [acted against New Zealanders' best interests when it] promptly enacted legislation to close the 'loopholes'"?

Listen to his logic:
As welfare states mature, an ever-larger share of government expenditures around the world is devoted to simple income transfers, which are just about the lowest order possible use of money.

Let me illustrate. One of the more high value uses of money in the 20th century was when Misters Hewlett and Packard started their company with a total investment of less than $400 during the waning years of the Great Depression. In time, that $400 grew to be tens of billions. Clearly, they deployed their money in a way that created a lot of value.

As a counter-example, suppose the U.S. government in the late 1930s had succeeded in taxing away Hewlett and Packard's founding stake, and had used it instead to fund roughly $400 of soup kitchens for the unemployed. The public would have cheered. But the money would have been consumed in short order and little or nothing of value would have been created. Subsidizing the lowest orders of human endeavor generally results in the minimum possible value creation.
He continues:
Tax rates are set at the margin. The greater the degree of compliance, the higher rates can be. If tax avoidance is widespread, governments must lower tax rates in order to raise additional revenues, the so-called Laffer Curve, in action. In that sense, taxpayers who successfully avoid taxes are not forcing others to pay higher burdens in their stead. Rather they are performing a public service in placing downward pressure on tax rates for everyone.

The strongest confirmation of this is provided by the outraged responses of governments to successful tax avoidance. If it were really true that lower tax payments from you simply meant that your neighbors had to pay more, governments should logically be indifferent to tax avoidance. By their arguments they would get the money anyway.

In fact, they treat tax avoidance as a mortal threat.

Note in this respect the ominous efforts by the OECD, prodded by the Clinton Administration to destroy off-shore tax havens. The destruction of tax havens would make tax avoidance more difficult thus facilitating still higher taxes in the world's high tax countries.
Counter-intuitive, but I think Davidson has convinced me: Long live the creative souls who find and utilize every loophole in the tax law!

Oh. And one last comment.

I said it really chapped my hide to have Davidson suggest that entering a yacht in the America's Cup could, somehow, be a "high value proposition." With what I have quoted so far, I'm sure we can see that tax avoidance, per se, offers some strange but very real potential economic benefits to broader society. Kind of.

But how can Davidson suggest, as he does, that the America's Cup investment, per se, was a high value investment?

Listen to his conclusion.
How do I know that the America's Cup has been a high value proposition for New Zealand? The mayor of Auckland and the New Zealand Herald have kindly provided public calculations of the hundreds of millions in benefits accruing to New Zealand as the result of the America's Cup. As Alan Bond said of his four challenges for the America's Cup, it draws a good crowd. "Successful men come to the America's Cup to be with other successful men."

By the same token, it is not solely an elitist activity. No one who was in Auckland on March 2 could doubt the genuine enthusiasm and delight that hundreds of thousands of ordinary New Zealanders experienced from Team New Zealand's victory in what might be considered an anachronistic, rich man's sport.

It probably would never have happened if Sir Michael Fay had not succeeded in mastering the arts of tax avoidance sufficiently to accumulate such great wealth that he could he write the big checks necessary to fund an America's Cup yacht challenge.

The long and short of it is that Michael Fay and his associates can create more value deploying money for their own amusement than governments can with the most sober of intentions. Note that Fay, Richwhite also played a leading role in privatizing Telecom New Zealand and New Zealand Rail, in each case creating a staggering increment to value in the worth of those enterprises.

Counter-intuitive all the way through.
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