Tax Scams & Banking in Russia

Karl FitzgeraldInternationalLeave a Comment

INSITE: Bulletin of the Land Policy Council
Editor: Fred Harrison, April 1996, Vol 2 (3)

Kill the Tax Scams and Create Jobs

IT’ S ENOUGH to make Marx turn in his grave! His arch champion, the Soviet Union, capitulated to the capitalists in 1991 just as the market economies crashed into their most severe crisis since the 1930s.

Government ministers from the seven richest nations on earth burdened with 24m jobless people, double the number since the spirit of Thatcher/Reagan was unleashed in 1979 – met in Lille on April 2 to agonise about what to do. Global unemployment is running at 700m people, according to the International Labour Organisation, but governments are bereft of ideas about what to do to liberate the labour market.

Governments face a double whammy a shrinking tax base and an increasing pool of aging people who need welfare support.

There is no mystery about the problem: the structure of taxation means that employers not only have to carry the cost of employing workers, they also have to carry the cost of public services. Non-wage labour costs represent an enormous proportion of total labour costs. This means that many people who would otherwise be able to provide goods or services to customers with a competitive profit to employers are excluded from the workforce because Wages+Taxes > Revenue, given the resistance to price rises.

There is no mystery about the solution: President Clinton’s chief economic adviser, Prof. Joseph Stiglitz, knows that the optimal fiscal policy – the one that does not distort the economy- is one in which the rent of land and natural resources is treated as the fiscal base. This policy, far from destroying jobs, would positively create them. It’s the market approach to full employment: a partnership between the private and public sectors which reduces prices to their costs of production and therefore expands the demand for workers.

So why are governments not transforming their fiscal philosophy? In his INSITE essay (see page 2) Wall Street analyst Dr. Michael Hudson explains that the financial institutions, operating in a tradition that accords primacy to the interests of the real estate sector, will not allow governments to think about such a reform. Russia is currently suffering the brunt of the threats. The IMF has just advanced a $9bn loan to Boris Yeltsin on the condition that their idea of what constitutes “the market” is adopted. This has forced the Russian president to sign an illegal decree which privatises the rent of land. That rental income, when tied into loans linked to land as collateral, will flow out of Russia and thereby tilt the tax system further against the workers.

RUSSIA is learning that global markets emancipate the corporate giants from the clutches of the tax authorities. Britain, for example, is chasing £100bn in unpaid taxes, penalties and interest – and is adapting anti-money laundering laws to try and snare the funds that ought to be flowing into the public coffers. A conference on money laundering in Lisbon this month will be reminded that multinationals use creative accounting techniques – such as reporting profits in low-tax territories to side-step their fiscal obligations.

Because the multi-nationals dodge their tax liabilities, the fiscal burden falls mainly on employees. And governments suffer because they have to plug the deficits (the 15 European Union countries have a total budget deficit of 296bn pounds) by borrowing. That borrowing then disrupts the economy by forcing entrepreneurs (who need to borrow to start new businesses) to pay higher rates of interest than would otherwise be necessary.

Russia, like other nations that do not regulate the flow of capital, has to learn that there is one way only to snare the full taxable surplus of the wealth creators without disrupting the economy: drawing its public revenue from the publicly-created rent of land. That policy would also stop the drain of public revenue into private pockets: you cannot conceal prime commercial sites near the Kremlin in a bank in Switzerland!

Rent-privatisation will ruin the chance to create a fair and efficient economy in Russia, says Michael Hudson. The West should learn the balance-of-payments lessons behind the hijacking of land and resource rents.

[DR Michael Hudson is a Wall Street analyst and a leading balance-of-payments theorist. His Super Imperialism: The Economic Strategy of American Empire, was published by Holt Rinehart & Winston, New York, 1972. 1t revealed how the US uses the World Bank and IMF against European and Third World countries.]

Banking on Rent

MOST debt in the modem economy is mortgage debt. This is because the land, natural resources and other real estate is by far the largest asset. In the US, for example, land accounts for about 40% of assets, homes and office buildings for another 20%. Creditors are eager to lend money against such collateral, because it is the most valuable asset.

The principle of mortgage lending is simple: A banker can lend money up to the point where interest and amortization absorb the entire net rental income (or its equivalent value to owner-occupants). This transformation of rent into interest has occurred in every major industrial economy, from America to Japan.

As the land becomes mortgaged, bankers convert the rental revenue generated by farms and forests, mines and oil wells, office buildings and residential housing into interest and amortization payments. As the home market for such credit is exhausted, lenders remit their earnings abroad to continue the process wherever incomes or asset values remain unpledged to creditors.

The transfer of earnings abroad will gain momentum as foreign banks and financial institutions establish subsidiaries. In a country like Russia the “foreigner” is simply a Russian operating out of his offshore bank account. Inasmuch as financial capital knows no country, it tends to flow to wherever in the world interest rates are highest and free income remains unpledged for debt – today into Russia tomorrow out of it.

THE remission of interest and amortization on loans puts downward balance-of-payments pressure on the rouble. And as its international value falls, the main victim will be Russian workers. This is because prices for most economic inputs – fuels and other raw materials, paper and wood, capital goods and interest rates – are uniform internationally, and are set in US dollars. The most important domestic variable to be devalued is the price of labour. Regardless of what labor unions may win, wage gains and public income supports are offset by the currency’s decline. This explains why IMF “austerity plans” involve devaluation as a basic anti-labour strategy.

As the rouble falls. domestic output is siphoned away from the home market as the export market (priced in foreign currency) becomes more profitable. Consumers must pay more for imports, as well as for domestic goods whose prices are raised to the higher levels of imported goods.

As land becomes a commercial asset and an object of financial speculation, the tendency is for it to pass into the hands of absentee buyers and creditors, especially for the most valuable sites. As economic conditions deteriorate, distress sales and emergency borrowings increase. Many Russians living on low wages will be tempted to use their land as collateral for loans to balance their income and expenditure.

This has never been a stable situation for any economy. Adding interest charges to a family’s already tight living expenses makes it even harder for them to survive. Inevitably, much of the land sold to absentee owners. The moral is that privatizing the land gives its present occupants the freedom to lose their tenure righs. If they seem to gain in the short run, it is ultimately to benefit the absentee owner or creditor. And because Russia’s savings has been all but wiped out, today’s major source of credit and purchasing power is abroad.

THE indebting and forfeiture of land has been occurring for four thousand years. What is new in Russia today is the foreign-exchange effect. As land is loaded down with debt, its revenue is remitted abroad. (The IMF bans capital controls.) This capital outflow by Russian banks and lenders represents the hidden depth charge in Russia’s privatization plan. It is the major Western objective in Russia. It is this objective that shapes IMF and World Bank advice to Mr Yeltsin. Privatization thus does not mean ultimate Russian ownership and enjoyment of the revenue produced by its land and raw materials. It means turning over this revenue to repay debts to foreign creditors.

The mature industrial nations have a problem. They have an expanding mountain of savings which keeps growing. Much of this saving ought to be plowed into investment that produces more goods and services, creates jobs and improves the quality of life. Instead, the banking and financial system rolls over each year’s interest income and amortization (and capital gains) into more new lending. This expands the economy’s burden of debt-claims at compound interest rates.

Industrial profits likewise are diverted into the bond and stock markets as it becomes more profitable to extract interest than to invest directly to make the economy grow. In colloquial American terms, Wall Street “downsizes” Main Street: workers are sacked, capital equipment is not upgraded, and the public infrastructure is left to decay: roads and bridges, air and rail transport, the education and health systems. And the worse matters get, the less incentive there is to make new direct investment. The stock market may rise, and bond prices also as interest rates fall. But this is simply because savings are not going into building or modernizing new factories or undertaking more research and development. More savings are plowed into lending at interest, even as the economy’s ability to pay this interest is being hollowed out by its deflationary debt burden.

The essence of double entry book-keeping is that one person’s saving is another’s debt. Financial claims on wealth tend to grow more rapidly than the means of production, or the incomes of labour or industrial capital. “Paper wealth” thus overtakes “real” wealth.

Marx called this phenomenon the “self-expanding power of capital”. He made fun of this term, for obviously debt (finance capital) cannot continue indefinitely to grow more rapidly than the ability to pay interest. Marx therefore considered the financial system to be composed increasingly of “fictitious capital”, that is, of debt-claims in excess of the economy’s abillty to pay the stipulated interest.

Marx was an optimist in believing that finance capital would become subordinated to industrial capital. He thought that creditors would use their interest to finance the industrial system’s productive powers. But this is not what occurred. Emperors of finance conquered captains of industry. The process culminated in the 1980s, when financial raiders took over industrial companies using high-interest “junk bonds” as their weapon in corporate takeovers.

Like taxes, interest charges become elements of intemational pricing. They are not returns to the factors of production, they add to the economy’s overall cost structure. This is what worried American trade strategists in the closing days of World War II, when they decided to exclude Russia from the World Bank and the stillborn International Trade Organization. (See Ch. of Super Imperialism: The Economic Strategy of the American Empire). The fear was that socialist economies were free of a major cost that burdened the finance-capitalist economies. Capital invested in socialist enterprises did not have to pay interest. Nor did it have to bear the cost of market real estate rental. In the West, interest costs are factored into the cost of capital used up in producing output (including exports). Tax charges likewise must be defrayed out of sales proceeds. This increases the cost of exports for highly indebted economies, as compared to economies with lower interest rates and taxes (such as Hong Kong). American officials actually worried that Russia might have an economic advantage in this kind of market competition between socialist and capitalist countries.

Of course, the Soviet economy had a cost burden of its own: bureaucratic inefficiency. The question was, which kind of overhead would prove to be more costly in the end: finance-capitalism, or bureaucratic collectivism?

Russia’s economy can now obtain the best of both worlds: avoiding statist inefficiencies by using market reference-points. while minimizing, the debt and rental burden by promoting user-occupancy of the land rather than absentee ownership. Will Russia follow Hong Kong’s example by financing its public spending out of the rental income of land rather than labour and industrial capital? These are the issues which will determine the outcome of competition between Russia and the mature industrial nations.

The central issue is the kind of banking system Russia will have. Will it follow the German long-term investment-banking model? Or, will Russia retrogress and adopt the much less successful Anglo-American merchant-banking model which focuses mainly on real estate, lending money against whatever collateral is easiest to foreclose on? A passive banker lends on real estate and bills due for output already sold. An active banking system lends to create the productive assets that generate the interest to repay the loan.

Collateral-based banking ends up lending money mainly against the land and natural resources. (About 70 percent of U.S. bank lending takes the form of real-estate mortgage lending.) This does not bring new productive assets into being; it merely loads down the wealth creators with more debt, diverting more of a shrinking income stream into interest and amortization payments.

This means that land rent is collected by the banking system rather than by society. It is more efficient to create a banking system that finances new direct investment, instead of merely foreclosing on existing property, financing absentee ownership and speculation, and creating the kind of fiscal crisis that is now plaguing the Western economies which are being de-industrialized.

The industrial economies are in a debt crisis, above all a real-estate crisis since their financial bubbles broke in 1989. In modernizing Russia’s economy, I hope that they aim at getting the best of both worlds. But I fear that the Yeltsin/World Bank plan will burden Russia with the worst of both worlds: bureaucratic corruption stemming from the privatization of land and mineral assets, and a banking system that burdens the Russian economy with a growing debt rather than financing its industrial and agricultural modernization.

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