Monthly Archives: February 2008

The Chancellor hasn’t had much luck since he took command of the good ship Britannia. Some of the back luck was of his own making and the criticism of his (in)actions has been partly deserved. As Martin Wolf has pointed out, even when he has done the right thing, he has at times done it for the wrong reasons and clumsily. The taxation of non-doms is an example. The Tories came up with the clever populist wheeze of taxing non-doms and using the (overestimated) proceeds to pare back death duties. The immediate ‘me-too’ reaction of the Labour government lead to the hasty introduction of a two-part proposal.

Non-doms would remain exempt from UK income tax on foreign earnings not remitted to the UK for seven years. After seven years, they would either pay a yearly £30,000 fee per capita to retain their non-dom status, or pay UK income tax on their worldwide earnings, regardless of whether they are remitted or not – like the poor doms have had to do all along. There would also be some tightening up on the legal definition of repatriation of earnings, to close some glaring loopholes.

A second, rather fuzzy part of the proposal involved (or appeared to involve) greater reporting obligations for non-doms on assets held in foreign trusts. Many of these foreign trusts are off-shore vehicles located in tax havens.

The explosion of indignation that greeted this proposal was deafening and largely bereft of logic other than the financial self-interest of those non-doms who would be adversely affected by the proposal. The fact that the UK government’s introduction of the non-dom proposal was motivated by a knee-jerk opportunistic response to an opposition initiative, and that the details of the proposal were hastily cobbled together and ill thought out, ought not to obscure the fact that the proposal makes moral and economic sense. It is fair and just that those who are resident in this country be taxed on their worldwide income; they are the beneficiaries of the public goods and services financed through this country’s tax system. The very existence of the resident but non-dom category is an outrageous sop to a small number of highly vocal and well-connected rich folk and their lobbyists. The unequal treatment of equals introduced by the creation of the non-dom (resident but non-domiciled for the purpose of income tax and inheritance tax) category undermines respect for the law among the tax paying public at large.

Anne Sibert and I have just written a blog for Vox, the economic policy blog of the London-based Centre for Economic Policy Research, criticising the (mostly) dangerous or (occasionally) just plain silly protectionism of Barack Obama. The link is here .

Today the National Bank of Hungary (the country’s central bank) abandoned the currency’s ERM-style trading band (15 percentage points fluctuation margins in either direction from a central parity of 282.36 forints to the euro). At the end of the trading day, the market rate was 263,57; the abandonment of the band was from the ‘strong’ side of the band. It was meant to give the forint greater scope for appreciation than would have been possible with the band in place (the band would have ‘capped’ the forint at 240 to the euro).

The NBH was right to can the band. An exchange rate target zone or exchange rate band is the worst exchange rate regime designed by man or dog. It combines the major weaknesses of any fixed or managed exchange rate regime – lack of flexibility combined with, ultimately, lack of commitment – with those of a market-determined exchange rate regime – the exposure of producers, consumers and portfolio holders to large and sudden swings in the nominal and real exchange rate, often caused by nothing more fundamental than one of the many manifestations of foreign exchange market psychosis.

For reasons understood only by the authors of the Treaty of Maastricht (and quite possibly not even by them), membership of the ERM for a period of 2 years preceding the examination date for full (stage 3) membership in the EMU, is a prerequisite for becoming a member of the Euroclub. So for countries willing to join and with some hope of meeting all the other criteria as well (inflation, interest rate, public debt, public deficit, central bank independence, good table manners etc.) entering the ERM makes instrumental sense. The 2-year ERM purgatory remains at best, an exercise in futility and an investment without any prospect of a positive return; at worst it exposes a candidate Euroclubber to unnecessary risk of financial and macroeconomic instability.

Clearly, the Hungarian authorities have given up on joining the eurozone for the time being. Quite wisely too. They have serious economic problems on their hands; not meeting the criteria for eurozone membership is the least of these. Growth is the lowest of any CEE country (1.3% for real GDP in 2007; maybe around 1.5 in 2008 – with a global economy that is slowing down and an effective real exchange rate that may be appreciating in the short term). Inflation is high, starting off January 2008 at 7.1% (on a year earlier). Private sector unit labour costs rose by 8.0 percent in 2007. It will have to be a lot less than that if domestically generated inflation is going to be anywhere near the Bank’s target.

After a 49-year rule, Fidel Castro has decided to give up the presidency of Cuba, although he will continue to lurk in the background exercising influence as and when his failing health permits, through his position as first secretary of the ruling Communist Party. The most likely successor as president is his younger brother Raúl Castro, essentially Fidel without the charisma and without the beard. He represents perhaps a minor improvement in administrative competence, but no change in anything of substance.

Even during the late sixties-early seventies, when almost every western male is his late teens or early twenties sported a poster of Che and/or Fidel on his wall, that particular cultural bacillus passed me by. I was fortunate that my father took the time to explain to me that this duo stood for a repressive, totalitarian regime. My father spent his entire life fighting totalitarian regimes at home and abroad. This started in earnest when he was 18 and the Nazis rolled into the Netherlands, but like much of his vintage of European and American democratic socialists, his political education began with the Spanish civil war. After World War II he was, as a Dutch trade union official for the Metal Workers, then as Secretary General first of the European Trade Union Confederation and later of the International Confederation of Free Trade Unions, involved in resistance to communist dictators in central and eastern Europe and in China, fascist dictators in Spain and Portugal, fascist Colonels in Greece, military dictatorships throughout South America and in Indonesia, white racist regimes in Rhodesia and South Africa, black dictatorships throughout Sub-Saharan Africa, repressive regimes in North Africa, the Middle East and elsewhere in Asia.

Around 1000 rather affluent Germans are not sleeping too well since former Deutsche Post AG Chief Executive Officer Klaus Zumwinkel was arrested by the German tax authorities on February 14. The information leading to his arrest came from a DVD containing a list of alleged German tax evaders, purchased for around € 5 million by the German BND intelligence service to pay a former employee of LGT, Liechtenstein’s biggest bank. It was money well spent.

Tax havens are to those engaged in tax evasion what fences are to thieves. Tax evasion is a crime. It’s not harmless cleverness and fun; it’s theft from the community you live in. Those who engage in it, and those who facilitate it, are criminals. It is time that the more determined, if not yet sufficiently aggressive, attitude and actions of the civilised world towards money laundering is extended to tax evasion through off-shore tax havens and the corrupt states/entities that live off this trade.

What follows is a much expanded version of an OpEd piece of mine, Did Gordon Brown have a choice over Northern Rock? in the Daily Telegraph of Tuesday, 19 February 2008.


There’s been a bit of a cock-up on the economic management front. Northern Rock’s nationalisation is the latest Act in a 12-Act tragicomedy that has landed that bank in the company of Railtrack. Let’s recall the main facts. Northern Rock, a medium-sized UK mortgage bank (assets around £110 bn), had been pursuing a very aggressive policy of expanding its market share. In the first six months of 2007, Northern Rock had grabbed 40 percent of the increase in gross UK mortgage lending and 20 percent of the net. A full 75 percent of its funding did not come from deposits but from short-term borrowing in the wholesale markets, mainly through the issuance of asset-backed securities. When the US subprime crisis erupted in August, the UK and international wholesale markets seized up and froze. Unable to roll over its maturing debt, Northern Rock went to the Bank of England for financial support. With the agreement of the FSA and the Treasury, the Bank of England created the Liquidity Support Facility through which it has now lent about £25bn to Northern Rock, secured against Northern Rock’s assets – mostly prime mortgages. The exact terms on which these funds were made available, or the methods for valuing the collateral, have never been disclosed, but are likely to involve a subsidy from the tax payer.

No sooner had the lending facility to Northern Rock be announced, or the depositors started a run on the bank. To halt this the government not only guaranteed all retail deposits but also, quite unnecessarily, the wholesale deposits and most of the unsecured debt, other than subordinated debt and other hybrid capital instruments, the bank’s debt to its own securitisation vehicle, Granite. Covered bonds (a type of collateralised bonds) were also excluded. For this guarantee, Northern Rock pays the government an unknown fee, which once again is likely to involve a government subsidy. The total exposure of the government to Northern Rock is now of the order of £60bn.

I never believed there was much of a chance that a private party or consortium would be able to take over Northern Rock, pay off the tax payer reasonably promptly and make money. Not surprisingly, Olivant threw in the towel before the deadline for bids on February 4, 2008. Branson’s Virgin Group’s bid would have picked the tax payers’ pockets too blatantly.[1]The bid by Northern Rock’s own management was a seriously underfunded no-hoper. Both remaining bids required continued large-scale and probably long-term government financial support.

Columbine, Virginia Tech and now Northern Illinois University. In most of the US any adult can, with less effort than it takes to rent a car, get hold of enough firearms to wage a small war. It is therefore not surprising that, with mind-numbing regularity, some mentally unhinged individual walks into a lecture theatre, shopping mall, office or school and uses the firepower contained in his arsenal to kill or maim large numbers of fellow citizens. In the ghettos, gangbangers who feel they have been ‘disrespected’ fire their automatics and semi-automatics in the general direction of the alleged disrespect, killing and wounding targets and bystanders indiscriminately.

In addition to these headline-grabbing mass-murders, there are the regular, everyday gun-related deaths: some 14,000 routine killings were committed in 2005 with guns as well as some 16,000 suicides by firearm and 650 fatal accidents (2004 figures). Admittedly, many of these deaths, especially the suicides, would have happened anyway, but there is no doubt that rampant gun ownership in the US costs many lives: it’s just so much easier to kill someone with a gun than to knife or club them to death.

Of the fourteen years I lived in New Haven, Connecticut, seven were spent on East Pearl street in Fair Haven, which was but a couple of blocks from one of the combat zones. At night I would have gun fire as background noise when going to sleep. A gun store opened at the end of my street, but was zoned out of existence again when its clientele began to look as dangerous as its contents. The American love affair with the gun is either a social disease – indeed a form of collective mental illness – or a manifestation of massive institutional failure – an example of Mancur Olson’s nefarious logic of collective action at work.

If ever a bank was sufficiently systemically insignificant and small enough to fail by any metric except for the political embarrassment metric, it is surely IKB, the German small and medium enterprise lending bank that got itself exposed fatally to the US subprime crisis through a conduit (wholly owned off-balance sheet entity) devoted to speculative ventures involving instruments it did not understand.

Yet after two bail outs by its shareholders (which provided funds or guarantees for just over €6 bn), we now have the German Federal Government about to inject €1bn out of a third rescue attempt total of €1.5bn. The earlier rescue attempts were largely public sector bail outs in any case. The largest shareholder of IKB is KfW, a state-owned development bank which holds 38% of the shares of IKB. 

There has been a big hue and cry about Chancellor of the Exchequer Alistair Darling’s proposals for increasing the tax burden on those that are resident in the UK but not domiciled for tax purposes in the UK.

As the law stands today, the remittance basis of income taxation applies when an individual is resident in the UK but non-domiciled for income tax purposes. Tax domicile is a fuzzy concept. Even if you live most of the year in the UK, you could be considered domiciled in another country if you were born in that country and express the intention of being buried there. You can be non-domiciled for income tax purposes even if you live in the UK and have British nationality. Under the current law governing non-domicile status, certain non-UK income is excluded from UK income taxation if it has not been remitted to the UK. It’s a pretty strange part of the income tax code, but as it is a free option for those eligible, you would be mad not to sign up for it if you could. I certainly did when I returned to the UK in 1994, even though I had/have negligible non-UK income and remit to the UK what little there is.

The government proposes that from April 2008 on, when an individual has been resident in the UK in at least 7 out of the 9 tax years immediately preceding the relevant tax year, they will be subject to UK income tax on their worldwide income unless they pay a £30,000 annual charge. For me that makes it easy. As of April 2008, I shall no longer claim non-dom status. 

The £30,000 annual charge is per person, not per family unit, so a couple of Greek ship owners with three adult kids working in the business would have to pay £150,000 extra per year. If they own just a few small ships, this may well cause them to consider relocation to Athens.

In addition to the £30,000 annual charge, the proposed new legislation also closes a lot of loopholes that in the past made it possible to effectively remit income earned abroad to the UK without incurring income tax. For instance, it would make subject to UK income tax (even when they accrue to non-doms) income in kind and gifts remitted from abroad as well as capital gains on UK assets parked in non-resident (offshore) trusts. This appears to be the part that truly upsets non-doms with serious amounts of assets that are currently beyond the reach of the UK tax authorities.

In a recent contribution to the Financial Times (Insight: Time will judge the Fed’s rate moves), Richard Yamarone, chief economist at Argus Research Corp. in New York, argues that Fed inside information about an as yet unrevealed financial calamity may have been the reason for the recent sharp cuts in the Federal Funds target rate – 75 basis points on January 22 (the announcement was made out of normal hours and not on a day scheduled for a regular FOMC rate-setting meeting) and 50 basis points on January 30. His argument follows.

“This all said, we suspect that there is something more disconcerting looming in the financial markets encouraging this pace of rate cutting. Promoters of full employment and price stability do not forcefully cut rates on an inter-meeting basis in hope of staving off an economic recession that hasn’t convincingly surfaced in the data. Changes in monetary policy move with long and variable lags – upwards of twelve to eighteen months – so moving a week earlier is meaningless for economic reasons.

Quite possibly, a big bank or financial institution may be in dire straits or on the verge of failure. Somebody may have gone to the Fed and said, “We’ve got a critical disease and we’ve slept with the world, you guys better deal with it.” That’s a pretty reasonable explanation for the ensuing change in policy.

It’s too soon to say whether or not these were prudent or foolish moves. If in fact there is some calamity looming that only those around that 27-foot Honduran-mahogany table at the Federal Reserve are aware of, then this stimulus will be more than justified. It is indeed a priority to insure a proper functioning of the banking system.”

The argument does not make sense. Not because I believe that there is no big bank or other financial institution at risk of going under or even about to do so. While I don’t have any inside information on the matter, there may well be such tottering entities, either in the US or in Europe or both. It would be remarkable if the massive mispricing of risk of the past five years and the associated reckless borrowing, careless lending and imprudent investment were not to result in the demise (or bail-out) of some household-name internationally active bank or other financial institution.

Maverecon: Willem Buiter

Willem Buiter's blog ran until December 2009. This blog is no longer active but it remains open as an archive.

Professor of European Political Economy, London School of Economics and Political Science; former chief economist of the EBRD, former external member of the MPC; adviser to international organisations, governments, central banks and private financial institutions.

Willem Buiter's website