Democracies around the world face two serious threats: a crisis of legitimacy and increasingly aggressive authoritarian regimes. What links these threats and makes them much more dangerous is the harmful impact of secret money transfers, especially those that pass through offshore tax havens and jurisdictions with excessive financial secrecy. Limiting such tax havens and demanding greater transparency in cross-border financial flows should be a top policy priority for all G7 countries in 2024.
The internal threat to democracy is the erosion of legitimacy. Over the past half century, in industrial economies such as the US and Europe, new technologies, growing cross-border capital flows, and lower trade barriers have raised average labor productivity and generated economic growth, but the benefits of this growth have not been widely distributed. Inequality has risen sharply in these countries since the mid-1970s, and millions of people now feel left behind.
Support for democracy is undermined by the belief that the economic game is "fixed" and that people who already have power and privilege benefit the most - sometimes at the expense of others. Although this belief may be exaggerated, it is consistent with the reality of tax evasion.
Tax havens allow rich people not only to grow their wealth essentially without paying taxes, but also to wield economic and political power away from prying eyes and without any accountability. One list of tax havens includes, in the top ten, both small Caribbean states and venerable countries such as the British Overseas Territories (British Virgin Islands, Bermuda and Cayman Islands), the Netherlands, Switzerland, Luxembourg, Singapore and the United Arab Emirates.
The United States and Great Britain are also included. Their financial secrecy rules allow huge amounts of foreign (and illegal) money to be hidden (the US tops this index of financial secrecy).
A multi-billion dollar industry has emerged, employing some of the world's best lawyers, accountants and consultants, focused on helping the rich and unscrupulous. Tax havens are particularly useful for people who have illicit wealth acquired through bribery, theft and other forms of corruption. The ability to conceal the identity of the participants in any financial transaction is key to successful management.
This form of financial engineering corrupts democracy. Worse, it exacerbates the other major threat we face: the rise of authoritarian regimes.
Secret offshore money makes it easier to support candidates, manipulate public opinion and convince people to vote for dictators. The secret money of Russian oligarchs has long been the basis of the country's economy and political system. President Vladimir Putin's close ties to dark money sources are well documented.
The fact that non-transparent transactions have allowed the Chinese government to build a huge global empire of influence has been underestimated. We are only now beginning to realize how much low-income countries, especially in Africa, owe to various Chinese-backed entities. In addition, the Chinese Communist Party has reportedly "invested billions of dollars" in a global disinformation system around the world. This includes efforts aimed at the recent (and likely future) US elections.
It has also become painfully clear that large amounts of money from Iran are flowing to groups such as Hamas in Gaza, Hezbollah in Lebanon and the Houthis in Yemen, who are now firing missiles at merchant ships in the Red Sea. Almost all Iranian financing goes through dubious channels, including (according to US authorities) structures in Turkey and Yemen.
Closing these channels will not be easy, but the most effective way to combat secret money - and its financing of authoritarian regimes, crime and terrorism - will be to dismantle the dozens of tax havens that exist around the world. This would strengthen tax collection in democratic countries and reduce the resources available to authoritarian regimes.
Ironically, some of these tax havens are at risk from climate change and need international help to combat possible sea level rise and more destructive storms. And if these island states and other jurisdictions want to participate in fair and reasonable adjustment mechanisms (such as climate finance or debt relief) partially financed by the G7, they will have to comply with increased transparency requirements.
One of the key elements should be the expansion of the "know your client" rule to all these jurisdictions, accompanied by appropriate criminal sanctions. It is especially necessary to fully disclose to the G7 tax authorities who owns which property and who pays whom and what.
Unfortunately, some forms of tax avoidance remain legal solely because of the lobbying power of super-rich and powerful consultants and accountants, who will undoubtedly argue that productive jobs will move elsewhere if the loopholes are closed. This should be countered by a simple principle that should be the same for all G7 countries: business profits are taxed in proportion to the place of sale.
If, for example, you move your headquarters (or ownership of your intellectual property) to another country, you still have to pay US tax on your activities in that country. The G7 agreement on a global minimum corporate tax was a step in the right direction, but much remains to be done.
In the age of artificial intelligence, we can expect many rich people to become significantly richer. It is also assumed that they will also use artificial intelligence tools to avoid tax more effectively. This will be easy to do within the current international agreements. However, AI can also help detect tax evasion as well as unusual cash flows that are often illegal.
Here's a challenge for the tech barons who keep talking about the use of artificial intelligence for welfare: support the rapid introduction of new AI-based tools to combat tax evasion and tax havens.
S. Johnson is a professor at the MIT Sloan School of Management, faculty director of MIT's Shaping the Future of Work initiative, and co-chair of the CFA Institute's Systemic Risk Council; he was the chief economist at the IMF;
D. Acemoglu is a professor of economics at the MIT Institute
Copyright: Project Syndicate, 2024. (translation: NR)
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