The Panama Papers Show What Happens When the Wealthy Play By Different Rules

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By Eric Harris Bernstein |

Unless you live under a rock (and perhaps even if you do), by now you have heard a good deal about the Panama Papers, the 2.6-terabyte news leak orchestrated by nearly 400 journalists, currently being hailed as one of the largest document leaks in history. The documents detail the operations and clients of Mossack Fonseca, a Panamanian firm that specializes in creating shell companies for the purpose of shielding money from taxation.

The breadth of the leak is staggering: Mossack Fonseca’s clients (those who have benefited from their specialized skills in tax avoidance and some more nefarious accounting activities) comprise 12 current and former world leaders, including sitting Ukrainian President Petro Poroshenko and current Icelandic Prime Minister Sigmunder Gunnlaugsson, as well as friends of Syrian dictator Bashar al-Assad and a total of 33 individuals blacklisted by the U.S. for their ties to Mexican drug lords, terrorist organizations, and other unsavory groups. Just to name a few.

The number of criminals conducting business through Mossack Fonseca is outrageous, and these individuals should be prosecuted, but law-breakers exist in any political climate. The real outrage when it comes to tax sheltering is that most of what Mossack Fonseca does is completely legal. The leaks remind us yet again that, regardless of nationality, political leaning, or other distinctions, wealthy elites as a class simply play by different rules than the rest of us.

As the Roosevelt Institute has pointed out in Rewriting the Rules and Rewriting the Tax Code, the United States has codified a system of taxation that rewards large corporations and wealthy individuals for sheltering their profits abroad in order to avoid taxes. Mossack Fonseca is just an opportunistic firm that happens to specialize in making these complex arrangements a reality.

In a recent interview, Mossack CEO Ramon Fonseca compared his company’s role in financial misconduct to a car manufacturer’s role in a bank robbery, suggesting that blaming Mossack for money laundering or tax avoidance would be like blaming Ford when a Taurus was used as a getaway car. And while it seems there is ample evidence that Fonseca is lying, and that his firm did indeed profit from the provision of illegal services (working with robbers to design the perfect getaway car, to keep the metaphor going), in a broader sense, he makes a good point: If we create a system in which rules and regulations don’t apply to the super-rich, how angry can we be when some of the super-rich abuse that power?

After all, take a mostly legal multitrillion-dollar tax avoidance machine benefiting only the richest of the rich, subtract some law-breakers, and what do you get? A completely legal multitrillion-dollar tax avoidance machine benefiting only the richest of the rich.

Of course, we have a word for people who break laws—“criminals”—but what is the word for people who make bad things legal? Somehow “enabler” doesn’t sound strong enough. Maybe we should just call them “legislators.”

For decades, elected officials in the United States stood by as more and more multinational corporations elected to pay lawyers instead of taxes. (And they may have done more than stand by: There is speculation that as-yet unnamed U.S. politicians will soon join the ranks of those Russian, Chinese, and numerous Gulf officials already implicated.)

When reforms were recommended, they often centered on gimmicky features of the tax code, addressing one symptom of the problem (inversion, profit-shiftingtransfer-pricing, zzz) rather than the broader cause, which is that the tax code allows a single firm, say Google, to masquerade as multiple firms housed in various tax havens instead of one firm quite clearly housed in the United States.

Some policymakers even took pity, suggesting that we lower corporate taxes so that these victimized firms wouldn’t have to go through so much trouble to avoid paying their fair share.

And while rewarding tax dodging with tax cuts seems ridiculous, these would-be rate-slashers have a point; the tax code should be simpler. But there’s a better solution: Firms should be taxed based on who they are and where they operate in reality, not on what it says on arbitrary pieces of paper crafted by firms like Mossack Fonseca.

A system called formulary apportionment (catchy, I know), already employed in the United States to divide corporate tax burdens between states, would end these practices once and for all, putting Mossack Fonseca and its competitors out of business. The plan is detailed in this recent paper by Reed College Professor Kimberly Clausing, and in forthcoming work by the Roosevelt Institute. Essentially, it calls for companies to be taxed based on the location of their sales, employees, and capital assets rather than the address of their LLCs and various affiliates. By taxing based on this formula, the administrative maneuvers facilitated by the Mossack Fonsecas of the world are rendered meaningless.

For those interested in fairness and equity in the global economy, the Panama Papers have come at an opportune time. Prior to the release, public outcry over Pfizer Pharmaceutical’s planned inversion resulted in new, stricter IRS rules on multinational tax avoidance procedures in November, and again on Monday. The Panama leaks should reinforce this outrage and further illustrate just how widespread and severe multinational tax avoidance has become. They also confirm what many suspect: that the significant privileges of the wealthy extend to the corrupt and dangerous.

If policymakers capitalize on this rare moment of international outrage, it could spell doom for tax dodging. But new IRS regulations on inversions, and whatever prosecution or resignations follow from the revelations contained in the Panama Papers, will not stem the tide of international tax arbitrage unless the solution addresses the problem at its core. To do this, policymakers must propose a system that sees and treats corporations as what they are and not what they purport to be.

First, though, those policymakers may have to explain their own involvement.

Eric Harris Bernstein is a Program Manager at the Roosevelt Institute. Follow him on Twitter @erichbernstein.