At a cost of €1 trillion to EU states, tax evasion is undoubtedly an area in need of attention. With government finances in deficit across the world, part of the gap could be plugged by preventing tax revenues from going unpaid. Well-known companies and individuals have been accused of tax evasion (and avoidance), but part of the problem is the existence of countries that make such activities possible.
Tax havens not only offer favourable tax rates, but also have in place regulations that prevent the effective exchange of information. That is, they are able to keep the identity and income information of depositors a private affair and are not required to share that information with other governments. This means that other tax authorities are unable to demand the tax revenue from income earned, when it is held in some of these countries. This can deprive the government’s coffers of substantial amounts of money.
In 2000, the OECD produced a report naming so-called ‘uncooperative tax havens’, including Monaco, Andorra, Liechtenstein and Liberia. Since then, all nations on this list have pledged their cooperation and been removed and in a recent step, Andorra has announced a proposal to implement its first ever income tax. This move is partly in response to pressures from EU governments to tackle tax evasion. Furthermore, talks between the finance ministers of tax havens, such as Switzerland and Liechtenstein have been agreed with the aim of improving the flow of bank account information and thus combating tax evasion. The Council of the European Union said:
The decision represents an important step in the EU’s efforts to clamp down on tax evasion and tax fraud”
Countries, such as Switzerland (a non-EU member) are likely to find requests for information difficult to ignore, if they want to have access to EU financial markets. However, any concessions on information provision will come at a significant cost for a country that has long regarded its banking secrecy as an ‘honourable policy.
Reforming policy on tax havens is essential, not only to help tackle tax evasion and thus government deficits, but also to generate investment into countries that don’t offer such favourable tax rates. Investors naturally want to invest in those countries with low tax rates and as such, could it be that countries like the UK suffer from a loss of investment and that the only way to encourage it is to offer similarly low tax rates? International agreement is certainly needed to tackle the worldwide issue of tax evasion and at the moment, it seems as though pressure is building on secretive countries. The following articles consider this controversial issue.
Clock ticks on Swiss banking secrecy BBC News, Imogen Foulkes (21/5/13)
Andorra bows to EU pressure to introduce income tax The Telegraph, Fiona Govan (2/6/13)
Andorra to introduce income tax for first time BBC News (2/6/13)
Andorra to introduce income tax for the first time Economy Watch (3/6/13)
Swiss have no choice but to bow to US ultimatum – Ackermann Reuters, Katharina Bart> (3/6/13)
Austria out front as EU zeroes in on tax evasion The Budapest Times (29/5/13)
EU to start talks with non-EU countries on tax evasion BBC News (14/5/13)
Questions
- What is tax evasion?
- Using game theory, explain why an international agreement on tax evasion might be needed?
- When an income tax is imposed in Andorra, what will be the impact on government revenues?
- How might the labour supply incentive change once an income tax is imposed?
- How do tax havens affect investment in other countries?
- Is there an argument that countries such as the UK should cut its tax rates to encourage investment?
Imagine if none of the clubs in the English Premier League (EPL) or English Football League (EFL) had junior or youth teams. Instead envisage a situation where all of the talented young footballers in the country go to college or university to develop their skills. Then once a year there is a big televised event where each of the clubs in the EPL and EFL take it in turns to choose which young college/university players they would like to recruit.
Strange as it sounds to football fans in Europe this is exactly what happens in American Football in the USA. It is called the NFL draft and this year’s event took place over three days between 25th and 27th April at Radio City Music Hall in New York. There was greater interest in Britain than usual in this year’s event because of the involvement of 24 year old Menelik Watson who was born and raised in Manchester. Although originally a basketball player, coaches spotted his potential to play American football in the NFL and two years ago he obtained a place at Florida State University.
The NFL draft has seven rounds. Each of the 32 teams has the right to choose one player in each round. An important design issue for any draft system is how to determine the running order in which the teams make their choices. Obviously all 32 teams would like to get the first chance at recruiting the most talented of all the college players. The NFL’s solution to this allocation problem is an interesting one. The team with the worst playing record from the previous season gets the first choice in each round. In the 2012-13 season this happened to be the Kansas City Chiefs who played 16 games and only won 2 of them. The second choice in each round goes to the team with the 2nd worst playing record from the previous season and so on. The final choice in each round goes to the previous year’s Super Bowl champions who in the 2012–13 were the Baltimore Ravens. Another interesting characteristic of the system is the ability of teams to trade draft choices. For example in 2013 the Oakland Raiders traded their choice in the first round (which was the 3rd choice overall) with the Miami Dolphins for their choices in both the first and second round (12th and 42nd choice overall).
What is the rationale for having a draft system? It was first introduced in February 1936 and many commentators have argued that it has been a key factor which has helped to maintain competitive balance in sport. The man behind the idea, Bert Bell of the Philadelphia Eagles, argued that without this type of system the sport would be dominated by the 4 richest teams. He stated that:
Every year, the rich get richer and the poor get poorer. Four teams control the championship. Because they are successful, they keep attracting the best college players in the open market, which makes them more successful.
Some evidence for the success of the scheme is that in the last 15 years the Super Bowl has been won by 10 different teams. However in 1934, just before the scheme was proposed, there was another major issue for team owners. The Brooklyn Dodgers and the Philadelphia Eagles had become involved in a bidding war for a very talented young player called Stan Kostka. Brooklyn won the battle but had to pay him a salary of $5,000 – the same amount that was paid to the star player in the league. Some people have argued that the real purpose of the draft scheme was to limit the pay of young players by effectively reducing any competitive bidding for their services. Once drafted, a player is expected to join the team who selected him. There may be some protracted negotiations over his final salary and bonuses but the only option open to him if an agreement breaks down is to re-enter the draft the following year. This effectively gives the teams monopsony power which may enable them to restrict players pay to below that of their marginal revenue product. For example although Andrew Luck, the first choice draft pick in 2012, reportedly earns just over $20million from his 4 year contract with the Indianapolis Colts some commentators have argued that his true market value is over $100 million.
The good news for Menelik Watson was that he was finally drafted by the Oakland Raiders and was the 42nd overall player chosen in the draft process. This is the highest choice ever made by a team in the NFL for a player born and brought up in Britain. The final outcome for the league as a whole can be seen on the NFL website.
NFL Draft 2013: Your essential comprehensive guide BBC Sport Simon Clancy (25/4/13)
NFL Draft 2013: Menelik Watson goes to Oakland Raiders BBC Sport, (26/4/13)
NFL Draft makes Menelik Watson Oakland Raiders’ second British player The Guardian, Paulo Bandini (27/4/13)
NFL Draft: Manchester’s Menelik Watson looking to start with Oakland Raiders right away Sky Sport, Paul Higham (28/4/13)
Manchester’s Watson lands dream NFL job after being drafted by the Oakland Raiders Daily Mail, Matthew Sherry (27/4/13)
Abolish the NFL Draft Sports on Earth, Patrick Hruby (25/4/13) .
Questions
- Explain why the marginal revenue product for sports stars is so much higher than it is for people in most other jobs.
- Draw a diagram to illustrate how the wage rate for players would be determined if the labour market was perfectly competitive.
- Assuming that the marginal revenue product for sports stars was in fact lower than that of most people in other jobs, draw a diagram to illustrate why they would still tend to be paid so much more.
- What is monopsony? Explain how the draft system could give the teams in the NFL monopsony power.
- Draw a diagram to illustrate the impact of monopsony on wages and employment in the labour market for NFL players.
- Can you think of any perverse incentives that the draft system could create for the performance of teams towards the end of the regular season.
The most common demands for trade unions are for higher wages and better working conditions. However, pensions have become an increasingly important issue that many public-sector workers in particular have raised concerns over. While actions by trade unions have been less frequent and public in recent months, the Public and Commercial Services Union (PCS) has voted to strike.
The labour market works like any other market – there is a demand for and supply of labour. The intersection of the demand and supply of labour give the equilibrium wage rate and equilibrium number of workers. Trade unions may aim to push up the wage rate above this equilibrium and the impact on the number of workers employed will depend on the type of labour market. If we have a competitive labour market, then the increase in wage will create an excess supply of labour: that is, unemployment. This is often a choice a trade union has to make. However, if the market is a monopsony, then it is possible for a trade union to force up wages and yet there may not be any fall in the number of workers employed.
Pay is just one of the issues being raised by the PCS. Public-sector pay was frozen for two years for those earning above £21,000. According to the Cabinet Office, this was necessary to ‘protect jobs in the public sector and support high quality public services.’ A 5% pay rise has been requested to counter an alleged 7% fall in earnings since 2008. 61% of those who voted in the ballot were in favour of strike action. Other concerns include job losses and pensions.
One concern of the PCS will be the low turn-out. Only 28% of the union’s members voted in this ballot and this is likely to weaken the union’s bargaining position. The government has monopsony power in employing civil servants and this is one of the reasons why a powerful trade union is likely to emerge: it acts to reduce the power of the monopsonist employer. Negotiations will typically take place between the employer and the trade union and with such a low turn-out, the power is certainly with the government. However, with the threat of strike action to occur around the time of the Budget, this does present something of a concern for the government, especially with growth remaining weak and the loss of the AAA rating.
Two separate pay offers have been made to 1.6 million public-sector workers, but Unison has suggested that members of PCS should reject them. If headway is not made in negotiations between PCS and the government, then strike action could be just around the corner. The following articles consider this looming industrial action.
Articles
Questions
- Use a diagram to illustrate a competitive market for labour and show how a trade union will aim to push up the wage rate. Show why a trade-off exists between the higher wage and the number of workers employed.
- Illustrate a diagram showing a monopsony and explain why the MC curve exceeds the AC curve. Why is it possible for a trade union to force up wages without creating a decline in the equilibrium number of workers employed?
- What other actions, besides striking, are available for trade union members? What are the costs and benefits of each relative to striking?
- Which factors, besides a low turn-out in the ballot, will reduce the trade union’s negotiating power?
- Public-sector pay was frozen for two years. If the government accepted the trade union’s pay demands, what would be the impact on the budget deficit? Could the higher pay help boost economic growth by creating a multiplier effect?
As part of the Basel III round of banking regulations, representatives of the EU Parliament and member governments have agreed with the European Commission that bankers’ bonuses should be capped. The proposal is to cap them at 100% of annual salary, or 200% with the agreement of shareholders. The full Parliament will vote in May and then it will go to officials from the 27 Member States. Under a system of qualified majority voting, it is expected to be accepted, despite UK resistance.
The main arguments in favour of a cap are that it will reduce the focus of bankers on short-term gains and reduce the incentive to take excessive risks. It will also appease the anger of electorates throughout the EU over bankers getting huge bonuses, especially in the light of the recession, caused in major part by the excesses of bankers.
The main argument against is that it will drive talented top bankers to countries outside the EU. This is a particular worry of the UK government, fearful of the effect on the City of London. There is also the criticism that it will simply drive banks into increasing basic salaries of senior executives to compensate for lower bonuses.
But it is not just the EU considering curbing bankers’ pay. The Swiss have just voted in a referendum to give shareholders the right to veto salaries and bonuses of executives of major companies. Many of these companies are banks or other financial sector organisations.
So just what will be the effect on incentives, banks’ performance and the movement of top bankers to countries without such caps? The following videos and articles explore these issues. As you will see, the topic is highly controversial and politically charged.
Meanwhile, HSBC has revealed its 2012 results. It paid out $1.9bn in fines for money laundering and set aside a further $2.3bn for mis-selling financial products in the UK. But its underlying profits were up 18%. Bonuses were up too. The 16 top executives received an average of $4.9m each. The Chief Executive, Stuart Gulliver, received $14.1m in 2012, 33% up on 2011 (see final article below).
Webcasts and podcasts
EU moves to cap bankers bonuses Euronews on Yahoo News (1/3/13)
EU to Curb Bank Bonuses WSJ Live (28/2/13)
Inside Story – Curbing Europe’s bank bonuses AlJazeera on YouTube (1/3/13)
Will EU bonus cap ‘damage economy’? BBC Radio 4 Today Programme (28/2/13)
Swiss back curbs on executive pay in referendum BBC News (3/3/13)
Has the HSBC scandal impacted on business? BBC News, Jeremy Howell (4/3/13)
Articles
Bonuses: the essential guide The Guardian, Simon Bowers, Jill Treanor, Fiona Walsh, Julia Finch, Patrick Collinson and Ian Traynor (28/2/13)
Q&A: EU banker bonus cap plan BBC News (28/2/13)
Outcry, and a Little Cunning, From Euro Bankers The New York Times, Landon Thomas Jr. (28/2/13)
Bank bonuses may shrink – but watch as the salaries rise The Observer, Rob Taylor (3/3/13)
Don’t cap bank bonuses, scrap them The Guardian, Deborah Hargreaves (28/2/13)
Capping banker bonuses simply avoids facing real bank problems The Telegraph, Mats Persson (2/3/13)
Pro bonus The Economist, Schumpeter column (28/2/13)
‘The most deluded measure to come from Europe since fixing the price of groceries in the Roman Empire’: Boris Johnson attacks EU banker bonus cap Independent, Gavin Cordon , Geoff Meade (28/2/13)
EU agrees to cap bankers’ bonuses BBC News (28/2/13)
Viewpoints: EU banker bonus cap BBC News (28/2/13)
Voters crack down on corporate pay packages swissinfo.ch , Urs Geiser (3/3/13)
Swiss voters seen backing executive pay curbs Reuters, Emma Thomasson (3/3/13)
Swiss referendum backs executive pay curbs BBC News (3/3/13)
Voters in Swiss referendum back curbs on executives’ pay and bonuses The Guardian, Kim Willsher and Phillip Inman (3/3/13)
Swiss vote for corporate pay curbs Financial Times, James Shotter and Alex Barker (3/3/13)
HSBC pays $4.2bn for fines and mis-selling in 2012 BBC News (4/3/13)
Questions
- How does competition, or a lack of it, in the banking industry affect senior bankers’ remuneration?
- What incentives are created by the bonus structure as it is now? Do these incentives result in desirable outcomes?
- How would you redesign the bonus system so that the incentives resulted in beneficial outcomes?
- If bonuses are capped as proposed by the EU, how would you assess the balance of advantages and disadvantages? What additional information would you need to know to make such an assessment?
- How has the relationship between banks and central banks over the past few years created a moral hazard? How could such a moral hazard be eliminated?
When you look at the linked articles below, I’m sure many of you will be thinking that this is an odd choice for an economics blog! However, part of the economic relevance of ‘cyber-crime fighters’ relates to the relative skills of workers and the gap that exists between the most and least skilled workers in the UK.
Crime has always existed, but as technology has developed the types of crime committed have grown along with the complexity of them. For certain crimes, a very skilled individual is needed. With this emergence of technologically advanced crimes, those fighting crimes have also had to improve their skills and techniques. Thus crime-fighters have become more technologically advanced as well.
The problem is that the number of skilled workers able to deal with things like cyber crime has not kept pace with the demand for them and thus we have a skills gap. Usage of the Internet has continued to grow, creating more and more opportunities for cyber crime. However, the UK supply of IT and cyber-security professionals has not been able to keep pace. Therefore, we have a shortage of skilled labour in this area.
More investment into research and education is occurring, with the aim of addressing this shortage, but it is expected to take many years before supply catches up to demand. In particular, more investment is needed in the sciences and technology subjects at school to create the supply at university level. The NAO said that:
‘The current pipeline of graduates and practitioners are unable to meet demand.’
A second area of relevance to economics is the cost of cyber crime. The NAO estimated that the cost is somewhere between £18bn and £27bn per annum. However, on the other side, is there a case that crime actually benefits the macroeconomy by requiring government investment. As cyber crime has grown, so has the demand for cyber-crime fighters and this has created more jobs. With more jobs comes increased spending and the benefits of the multiplier. The following articles consider cyber crime and the impact it is having.
National Audit Office warns UK needs more skilled cyber crime fighters BBC News (12/2/13)
IT staff shortages raise cyber crime risk Sky News (12/2/13)
UK planning ‘Cyber Reserve’ defence force BBC News (3/12/12)
Britain vulnerable from cyber attacks for at least 20 years The Telegraph, Tom Whitehead (12/2/13)
Britain targeted by 120,000 every DAY with cost to country thought to total £27billion Mail Online, Jack Doyle (12/2/13)
Questions
- Illustrate the demand for and supply of labour curves in the market for cyber crime fighters. How is the equilibrium wage determined?
- If there is increased investment in education, how would this affect the shape and position of the MRP curve and what impact would this have on your diagram?
- If there is a shortage of cyber crime fighters, what does that suggest about the position of the two curves? Illustrate this situation and explain why it is a problem.
- Which factors would be considered by NAO in estimating the costs of cyber crime?
- Explain why crime can pay.
- How does the macroeconomy benefit from increased crime? Illustrate this on a diagram.
- Does your answer to question 5 above suggest anything about the effectiveness of using GDP as a measure of welfare?
- How is the multiplier effect relevant?
At a cost of €1 trillion to EU states, tax evasion is undoubtedly an area in need of attention. With government finances in deficit across the world, part of the gap could be plugged by preventing tax revenues from going unpaid. Well-known companies and individuals have been accused of tax evasion (and avoidance), but part of the problem is the existence of countries that make such activities possible.