The Hidden Wealth of Europe

von Marco David Schmandt 

Recently, with the publication of Capital in the twenty-first century (2014), research on economic inequality experienced long not seen prominence within public debate, most notably, enabling a discourse about the distribution of wealth. Gabriel Zucman (2015) sheds light on a highly-related phenomenon – the problem of tax evasion in tax havens – with importance particularly for European countries. However, the most promising potential solutions lie on international level cooperation. The European Union thus may play a major role, advancing progress in the fight against tax evasion.

Severe Losses from Tax Evasion

According to the new and unique estimates provided by Zucman, 8% of worldwide financial wealth is held in tax havens, reducing worldwide tax revenues (investment income taxation, inheritance taxation, wealth taxation), relying on conservative estimates, by roughly $200 billion every year. The phenomenon has particularly importance for Europe. In 2013 Europeans held roughly 10% of their entire financial wealth in tax havens (thereof 2/3 in Switzerland), creating losses in tax revenues of $78 billion.
On one hand, tax havens are used by the wealthy to avoid income, inheritance and wealth taxation which is generally illegal. Corporations avoid taxes legally, using tax loopholes. The former phenomenon is particularly related to countries as Switzerland, Luxembourg and Liechtenstein (in Europe), the latter is primarily related to Ireland and the Netherlands (and has high importance especially for the United States where tax evasion by multinational corporations amounts $130 billion every year).

Tax Evasion in Europe

The mother of all tax havens, Switzerland, emerged shortly after the First World War when European countries started to raise taxes on income and wealth (Figure). In the absence of automatic information exchange procedures, banking secrecy provided the possibility to hide wealth (and income generated by this wealth) easily. Today’s offshore wealth amounts $7.6 trillion (8% of global wealth) of which $2.3 trillion (roughly a third) is held in Switzerland. The money that officially lies on Swiss bank accounts, however, does not stay in Switzerland (which would anyway have severe impact on the Swiss currency), but is invested in other tax havens, primarily in Luxembourg, where taxes on investment income are virtually zero. It is this combination, banking secrecy that hides the true owners of wealth, and zero investment income taxation provided by some countries that allows for the previously described scope of contemporary tax evasion.
The losses of tax evasion are primarily carried out by the great economies – France, Germany and Italy in Europe. The losses do not only occur due to the evasion itself, but also due to attempts to reduce the very incentives to avoid taxes. Taxation of investment income has been lowered in all european economies; Italy for instance nowadays essentially taxes solely real estate. The actual losses (due to these reductions in tax rates – which can be seen as a reaction to the scope of tax evasion) are thereby much higher than the beforehand introduced estimates suggest.

Zucman EZG Graph Kopie

Tax Evasion and just Societies

The extent of tax evasion nowadays leads to a reduction of tax burdens thereby reducing actual tax rates for the very part of societies that already evades taxes. Only a small part of the population essentially – the richest households (1% richest or even the 0.1% richest households) – evades taxes. However, this can be of high importance not only for tax revenues but also for society’s justice, since the very end of wealth distributions usually holds substantial parts of the entire wealth and income of societies. This very end of the wealth distribution, hence the richest households, nowadays face lesser effective tax rates than the middle part of the society.

Are Solutions Available?

Despite the proclamations of several institutions and countries that the century of tax evasion would be past, little change occurred in the last years. The fatalists are on the rise, declaring the combat against tax evasion to be lost. Fortunately, tax evasion is no natural emerging law and phenomenon, but located in the social realm. There are potential solutions. According to Zucman, automatic information exchange between countries is essential. International information on global wealth holders do exist, but are controlled by private companies. This situation must and can be changed, as recent attempts like the Foreign Account Tax Compliance Act (FATCA) in the United States, establishing automatic information exchange, forcing tax havens to give up their secrecy laws, show. The experience of the past century, however, suggests that tax havens will improbably stop providing the services of „wealth management“ if they are not forced to do so. Happily, simple economic insight advices to threaten tax havens with costs equally high as the profits gained by the provision of their services. Since tax havens are essentially small (Switzerland is the largest), the threat of an introduction of tariffs by greater economies (e.g. by France, Germany and Italy in the case of Switzerland) can be a way to force them to give up on their globally harmful services.

Towards a more just European Union

The European Union might play a major role, starting to put pressure on tax havens, not least because it should have high incentives to do so since it is the main loser of these practices. However, it needs to start with its own antisocial member states as Luxembourg or Ireland, and partners like Switzerland. These countries entirely depend on the integrated European markets, indeed, destroying the basis of a democratic and socially just region and Union.

Source: Zucman, Gabriel (2015). The Hidden Wealth of Nations. The University of Chicago Press: Chicago.

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