The Weakening of Nations: How Tax Work-Arounds Undermine Our Society

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Loopholes, poor regulations, and off-shore havens allow corporations and the very wealthy to draw on the benefits of a strong nation-state without fully paying back in, eroding a system that's less tested than we might think.

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The Ugland House of Grand Cayman Island houses the office of the Cayman's largest law firm, Maples and Calder, and is the registered office of some 18,000 companies / Reuters

Millions of dollars of Mitt Romney's personal wealth have been recently tied to bank accounts in the Cayman Islands, a Caribbean UK territory with decent SCUBA diving and spectacular don't-ask-don't-tell banking regulations. The Romney campaign protests, weakly yet amusingly, that "the accounts provide no tax advantage to American investors like Romney" but are there purely for the convenience of foreign investors who might wish to invest in Bain Capital without the "entanglements" of the United States tax system. Either way, a portion of Romney's considerable wealth is parked where it isn't subject to the same taxation that the average citizen experiences.

Romney's situation is actually quite typical for a man in his societal position. He has enough money to make himself attractive to a variety of financial odd-duck "nations" around the world who would be more than pleased to "host" his wealth in exchange for the occasional transaction fee, without pestering him about financing their schools, healthcare, roads, war, or any of the annoying trappings of civilization. The question remains -- is that moral? Isn't Mitt Romney a citizen of a particularly large nation-state already? Does he not owe that nation-state taxes, given that he is such prominent citizen that he may actually be elected president of the place? What is going on here?

It seems that the concept of the nation-state itself is becoming a very pliant one for certain actors in society, be they corporations or the very wealthy. The fact is, nations only function because the majority of its citizens believe that their responsibilities to that nation are fixed and immutable, on everything from taxes to dying in war. If we don't make very clear distinctions as to who owes whom what in this world, the relative stability we've come to enjoy in the international system may give way to illegitimacy and, ultimately, chaos.

THE RECIPE FOR A NATION

It's impossible to talk about the ethics of offshore banking without bring up a much broader issue, one that is perhaps overdue for a revisit -- what is a nation and what does it mean? The average person takes the concept of a "nation" and assumes that it is concrete. In fact, today's system of states today is scarcely two or three centuries old. Sure, the United States and many other nations are technically older than that, but in reality what existed before was much more fluid and chaotic -- minor kingdoms, duchies, fiefdoms, and principalities, usually squabbling, sometimes cooperating, and only barely organized by ethnicity or language. Historically, states have very rarely agreed upon common currencies. Your identity was instead tied to a locality, scarcely a few hundred miles in any direction, and you probably thought the next kingdom over was the worst place on earth.

Born theoretically with the Treaty of Westphalia in 1648, but not truly coalescing in most places until the 19th or even 20th centuries, the modern concept of the nation-state is a larger entity united under a flag -- a very early, pre-Adobe Illustrator attempt at branding. Local dialects were stomped out to make way for a single, standard language. National creation myths were taught in order to give all citizens a similar set of assumptions about who they are, where they come from, and where they are going. All this, plus agreed-upon borders, make up what we now consider an inhabitable "country."

In the 21st Century, every place on Earth is divided into these nation-state things, even where they probably don't quite fit, such as African countries with hundreds of ethnicities and dozens of languages. Regardless of their imperfection, they are the unit of analysis. But that's changing.

ON RIGHTS AND OBLIGATIONS

Throughout the world, we are at a crisis point as to defining the rights and obligations of the members of a nation-state.

From individuals, it is clear: you owe taxes from your income and your purchases; you must obey the laws; if necessary, you must go to war; you can elect political officials so that these obligations are tailored more to your liking. The nation-state pledges in turn to give you access to recourse of grievances and to limit the application of violence and harassment to you from official actors. You get rights and responsibilities.

There is, of course, another inhabitant of a nation-state: the corporation. Though originally created specifically as entities that were not supposed to receive the benefits of citizenship, in exchange for which they received the ability to walk away from debts, corporations are getting an improving deal as they move through society as actors, gaining the privileges of individuals while taking on fewer of the obligations associated with being located in a single place.

Let us take, as an example, Citibank, the second largest financial institution in the United States. Consider the fact that Citibank received billions in bailout cash. Though publicly traded to anyone, this behemoth enjoys an explicit guarantee from the U.S. government to keep existing no matter what business strategy it might employ. After all, they are an American institution, and it is in the best interest of Americans to make sure that it keeps existing, no matter what it might cost in terms of tax money. So when the company got up to its eyeballs in worthless derivatives, the U.S. Federal Reserve Bank sprang into action to make the company whole. Even without the bailouts, Citibank benefits tremendously from the American government, the physical and legal security it provides, all of which is expensive.

What should we make of the fact that the company is owned 25 percent by investment holding companies from Abu Dhabi, Singapore, and Saudi Arabia, none of which governments aided in the bailouts? These foreign corporations get the guarantee of tax revenues that come from welders in Wilkes-Barre, Pennsylvania, film producers in Los Angeles, and school teachers in Manhattan, Kansas, who backstop the risk side of the investment should anything go wrong. But when times are good, the dividends are transferred out to Singapore, Riyadh, and Abu Dhabi.

General Electric has a particularly great deal regarding the nation-state. It avails itself of foreign tax havens when reporting its global income, but then actually prevails upon the U.S. federal government to give it tax credits, recently achieving the impressive feat of having the IRS give them money.

Even our good friends at Google, with their reassuring motto of "Don't Be Evil," find themselves relocating income at will and negotiating with the federal government for the proper times and amounts to recognize taxable returns from its global advertising revenue. You might find this a touch ironic given the fact that Google was established with capital provided by In-Q-Tel, the venture capital arm of the U.S. intelligence community. Quite reasonably, the U.S. government saw a benefit in having a world-beating provider of search algorithms, and put money toward assuring its existence. Curiously, now that said world-beating company is trading at $600 a share or more, its accountants are much more reticent to return the favor of keeping the government in business.

It should be noted that when individuals attempt to place income in foreign bank accounts for these same purposes, they are either arrested for tax evasion or subject to an audit (unless, it seems, they are Mitt Romney caught using offshore tax havens that happen to be perfectly legal). You are probably free of the legal concerns, at least, if you are an individual whose wealth is so significant that it can be arranged into trusts, corporations, funds, and other legal frameworks. In that case, while the benefit to the individual in question might be significant -- qualifying for 0 to 15 percent interest as opposed to 33 to 60 percent, depending on the countries involved -- the responsibility of that individual to pay for offramps and old folks homes is suddenly lifted.

And herein lies our modern predicament. There is a considerable amount of cognitive dissonance involved in all of the political, legal, and financial frameworks we have working in society. The nation-state -- which is still relatively new as far as history is concerned -- tells us as individuals in a very clear voice, "You belong to me, from birth to death. You have rights and responsibilities, and how you go about discharging them will guide whether you get honorific titles and a big house, or a prison cell." And the vast majority of the population of every country has bought into it.

Yet, at the same moment, we have corporations and individuals-rich-enough-to-be-corporations whose money is not fully expected to contribute to any of the projects of the nation-state: security, transportation, health, science. The nation-state whispers to them in a somewhat more tentative voice, "Well, we're willing to negotiate." And as to the rest of us, we're not sure to whom these institutions belong. The nation-state looks the other way as corporate money wends its way from Seychelles to Mauritius to Ireland while lobbyists negotiate special tax rates should the money finally arrive "home" -- but is quick to write checks for all the tax credits it promised. And even a man hoping to be president of a nation-state can look squarely in the camera and suggest to potential voters that he and his family got wealthy from business conducted in a certain place, but want to make sure their friends don't become "entangled" in the system of taxes that is responsible for maintaining the basic infrastructure that made it all possible in the first place.

This lack of clarity could challenge the legitimacy of the institutions we have taken pains to build over the last couple centuries, the ones that keep us comfortable and protected and civilized. The writer Nicole Foss in the blog Automatic Earth recently forecast the coming reduction in the "trust horizon," in which individuals believe less and less that these large institutions will support anything positive in their daily lives. All this turmoil from housing bubbles and derivatives and subprimes and currency swaps and Greece and Germany and austerity is eroding the trust we have in top-down institutions. This is particularly true because of the corporations who are first in line to use the nation-state as a wheelbarrow for its risk, and which exploit every rule to claim that technically the income belongs to no one, especially not the nation-state that made their very existence possible, and shouldn't be taxed.

It's also true when you see presidential candidates like Mitt Romney who offshore their own gains from Staples and Domino's and who, should he be elected in November, will be taxing people to pay for the awesome impact of Baby Boomers hitting Medicare, not to mention everything else in the American federal government. We are all unclear on what these nation-states mean, but as the balance between benefit and liability tips toward the latter, people will begin to walk away in ways big and small. This will include tax revolts, already quite common in more corruption-prone societies such as Pakistan or Greece or China, and general flouting of laws, if not revolutions. And as Egypt illustrates painfully today, just because you know something does not work does not mean that you know what to do next.

For those of you who benefit from this mythical being, the nation-state -- including me, you, Google, Mitt Romney, and the government of the Seychelles -- we need some clarity on what is expected from every actor in society, including corporations and the very rich. Enough clarity that you could reasonably explain the world tax system to a ten year-old. The alternative may unfortunately be to get sewing some new flag designs.

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Eric Garland, a futurist and strategic analyst, is the author of Future Inc: How Businesses Anticipate and Profit from What's Next and How to Predict the Future...and WIN!

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