Europe's Phony War on Tax Evasion

The American liberal’s image of a compassionate society — of a Western European country generously funding entitlements by leveling incomes — is, and always has been, a myth.  France, Germany, Italy, and Denmark may have steeply progressive tax rates; but that does not mean wealthy citizens are complying or even that their governments are that serious about collecting.

What Europe does have is a remarkably convoluted and interrelated system for tolerating tax evasion, which give the appearance of progressivity — and does indeed inhibit poor and middle class entrepreneurs — but which leaves big corporations and old money largely unscathed.

In 2008, Germany’s exchequer estimated its annual income tax shortfall at $30 billion; Britain put its own at $40 billion.  Attilio Befera, head of the Italian tax authority, has estimated that his countrymen evaded $7.6 billion in the first half of 2009.

Affluent Europeans have always been able to take advantage of tax loopholes in cross-border jurisdictions, from secretive banking practices in Switzerland, Luxembourg, and Liechtenstein to Monaco’s convenient lack of an income tax on residents.  A banker in Milan admitted last August to the Financial Times that Italians alone have €600 billion ($840 billion) stashed away outside their home country.
In recent years, European governments have made a public show of attempting to tax undeclared income in secret accounts, especially after a rogue Liechtenstein bank employee sold an embarrassingly long list of German clients to their home country’s tax authority in early 2008.  In June of 2009, the 19 member states of the Paris-based Organization Cooperation and Development (OECD) signed an agreement aimed at tapping the estimated $6.7 trillion in the tax havens world-wide to fund stimulus programs in their own troubled economies.

But like past tax treaties, the rhetoric in this OECD agreement exceeded the severity of its provisions.  Manuel Ammann, director of the University of St. Gallen’s Institute of Banking and Finance in Switzerland, notes that bank secrecy laws have been suspended only when a specific individual is being investigated for tax evasion and “such concrete cases don’t occur all that often.”  In spite of follow up tax amnesty strategies by Germany, France, and Italy, the expected flow of undeclared income back to home countries has failed to materialize.

Even when the governments of European tax havens make what appear to be significant concessions to pressure from other countries, insiders know that local courts will find a way to protect bank depositors.  Just this January, a Swiss court barred the federal government in Bern from complying with an agreement to provide the United States I.R.S. with the records of 4,450 Americans suspected of hiding unreported income at UBS.

The very focus on bank secrecy obscures the many other ways that European countries allow the very wealthy to evade taxes, especially those willing to operate within a corporate shell.

Businesses that establish a token presence in the Netherlands, for example, pay little tax on the interest, royalties, dividends, and capital gains accruing to that subsidiary.  The Amsterdam-based SOMO Centre for Research on Multinational Corporations estimates that 20,000 “mailbox companies” have a branch in the Netherlands, even though they conduct little commerce there.

Lax real estate laws provide the Continent’s affluent with another convenient way to evade compliance.  In Spain, home sales are certified by a notary who is expected to leave the room, while the buyer hands the seller a supplemental cash sum not included in the “official” closing price.

Indeed, the closer one looks at Europe’s famously progressive tax rates, the more cosmetic they appear.  Common practices include channeling interest and dividend income through non-profit organizations where they accrue tax-exempt, concentrating income on business subsidiaries that license trademarks from the parent (thus reducing taxable profits), distributing partnership income with fake invoices, and taking salaries in the form of interest-free loans that never have to be repaid, so-called “loan and forget” arrangements.  According to a 2006 documentary on the BBC, many of England’s richest executives get around taxes by taking their year-end bonuses in hard assets, such as gold and even animal furs. 

A 2007 study on “Tax Evasion, Black (Market) Activities, and Deterrence in Germany,” conducted by researchers at the universities of Heidelberg, Cologne, and Linz, found no relationship between the severity of legislated penalties for tax evasion and compliance, suggesting that violators had little fear of the German government’s real commitment to enforcement.

“In this new, more globalized world, where you can go on the Internet and open a secret offshore bank account in eight minutes,” explains Grace Perez-Navarro, deputy director of the OECD’s tax unit, hiding income is easier “and more difficult for tax authorities to follow the financial trail.”  A wealthy individual can set up a trust in Liechtenstein that owns a company registered in the Netherlands that in turn has a bank account in Ireland or the Cayman Islands.

European governments do offer their citizens more entitlements than currently available in the United States; but they are not funded by “soaking the rich.”

Some of the money comes from skimping on defense, knowing that the Continent is protected by America’s armed forces.  On a per capita basis, U.S. taxpayers spend twice as much on military expenditures as their European counterparts.

Similarly, the cost of product development in retailing, electronics, and many other areas is significantly reduced by licensing already successful inventions from American (and increasingly Asian) companies.  When it comes to expensive medical technology, says Glen Witman, associate professor of economics at California State University, the United States covers most of the basic research “while other nations take a relatively free ride.”

In the end, Europe’s generous social entitlements depend primarily on national sales taxes and other regressive levies on middle class workers, which sadly limit their ability to purchase alternative services when public education, universal health care, and other government programs prove unsatisfactory.  This is a major reason why European families have fewer children than their American counterparts and have less disposable income to donate to charity.

American liberals have always tried to sell voters on expanding government programs by arguing that only the affluent will have to pay the bill.  But the real “European model” suggests that lawmakers either tolerate back-door incentives for wealthy investors to stay home and grow the local economy or watch helplessly as financial assets migrate offshore.

Either way, it is the middle class that pays for its own entitlements — with federal, state, and local governments taking a hefty cut for administration.