Corporate Taxes and Investor Frauds – Updates

This week there are a number of stories that relate to recent posts on Brucenomics.

Corporate taxes

My latest post Corporate Taxes: No More Simplistic Solutions!” talked about President Obama’s proposal to raise the tax on dividends. My opinion is that raising the tax on capital gains make more sense. This week a special feature article in the Financial Times, “Tax treatment of private equity: Questions over a quirk” delves into the issue of taxes paid, or rather not paid, by hedge fund managers.

Hedge fund managers have been given a  special deduction for a type of income called carried interest. This is interest that is required to be carried on their books over a multi-year period before it is disbursed and taxed. Hedge funds must carry profits until they reach a minimum level. As a result, the government seems to feel that fund managers can count the gains made each year (until they meet the minimum) as short-term capital gains income. Carried interest enables hedge fund managers to pay the equivalent of a low 15% rate on their huge long-term investments. As a result, many managers of hedge funds have become millionaires and billionaires over the past decade.

Obviously, in an election year where the incumbent President is likely to be running against a hedge fund billionaire, it isn’t surprising that Mr. Obama is floating the idea of removing the tax deduction on carried interest. But carried interest is not just a US concern. Denmark switched to using the personal income tax rate on carried interest years ago. The reasoning for taxing carried income as personal income is that other kinds of “performance bonuses” are taxed as personal income, not capital gains. The UK, on the other hand, just raised its capital gains tax rate from 18% to 28%. Germany too is thinking of removing its tax exemption for 60% of carried interest earned there.

A major issue is the fact that tax exemptions exist to encourage constructive use of money, for example investments in new businesses. However, hedge funds have been charging clients very high fees, yet as a whole paying out on average zero  to their investors over the past year. Meanwhile, hedge fund managers (the active partners in the hedge funds) only risk 2-3% of their money and can take a 20% return out of profits.

Also, in regard to corporate taxes it should be noted that the corporate tax return rate in the US has fallen to its lowest level in a decade, dropping from 35.4 to 31.9 percent over the past year. The reason is that corporations are paying lower taxes abroad, e.g., 26% in London. This has resulted in higher earnings reports for companies doing business abroad. For a proposal about how to tax overseas earnings more constructively, please see my post on Corporate taxes.

A Tobin Tax for the US

Last summer I posted an article in favor of a Tobin tax in the US. A Tobin tax is a miniscule tax on investment transactions. This year we have a bill for Congress calling for a Tobin Tax in the US. The bill, created by Tom Harkin (Senator) and Peter DeFazio (Representative) would produce $350 billion in revenue from a tiny tax of .03% for buying and selling of investments. The expected effect of a Tobin tax is to curtail the activities of financial speculators.

For example, a problem with high-speed trading is that traders are placing multiple orders on exchanges such as NASDAQ which they then instantly cancel. Their purpose in doing this is to confuse their competitors about what prices they are paying for buying or selling financial investments. However, the SEC is concerned that the flurry of rapid-quote-canceling at ultra-high speeds will clog up investment exchanges and disrupt financial markets. A Tobin Tax might be an adjunct or in some cases even be an alternative to regulation to stop bogus trading.

For more reasons why we need a Tobin Tax, please see my article, “Bring Back The Tobin Tax”

The Libor Fraud Investigation

The Libor Fraud may be the first shot across the bow in a global battle against financial crime. In “The First Global Crisis — Coming Soon?  ” I wrote about how investment bankers in countries around the world have been accused of manipulating the Libor and other indexes used to set interest rates for loans among big banks in the world.

On March 7th the Financial Times reported that “Bankers embark on rethink for Libor rate-setting.” Currently a number of bankers around the world send daily estimates to a committee of bankers who set these rates. Insane as such a fox guarding the hen house seems, it seems even crazier when a government bond trader is quoted as saying, “If you want a figure for term interbank rates you have to use the Libor survey because there are no or very few trades.”

It may apply to only a few trades, but the Libor is used for setting interest-rate swaps and other derivatives. These trades aren’t small trades! And perhaps even more relevant to most of us, the Libor rate is what is used by bankers to set the interest rates on our credit cards and home mortgages. According to Canadian regulators, a bank turned over evidence to them showing several conspirators “were able to move yen Libor rates” to benefit themselves.

Moral of this story: like it or not, financial markets do need regulation! Read on for what kind of regulation we need.

The Big Cons Who Didn’t Get Away

An amazing and depressing story this week was the conviction on 13 out of 14 counts of fraud, conspiracy, and obstructing an SEC investigation, of Sir Allan Stanford Texas billionaire for the second largest fraud in US history. As I wrote in February of this year, “Fraud is NOT GOOD for Us! (a response)“. The outlook isn’t very good for Sir Allan’s 20,000 victims. While Stanford will spend “decades” in jail for a multi-country investor fraud involving over 7 billion dollars, the headline on Yahoo finance last week read, “Investors: Stanford verdict won’t restore losses”.

Prosecutors in the US, UK, Switzerland and Canada are seeking $300 million Stanford has in bank accounts around the world. The court-appointed receiver for this case has eked out another $80 million from sales of Stanford’s houses and yachts. However, the receiver has to fight in court with SIPC, the Securities Investment Protection Corporation. SIPC argues that money was held in overseas banks and Stanford’s customers aren’t eligible for the up to $500,000 that SIPC pays for broker fraud. And to add injury to injury, US taxpayers are footing Stanford’s legal bills!

The SEC is being criticized for “concluding as far back 1997” that Stanford’s business was fraudulent yet the SEC did not bring criminal charges until 2009. (See report of Stanford conviction in the Financial Times, March 7th). Investors hoping for a payout can take a lesson from the Madoff case. The court-appointed receiver for Madoff’s moneys has recovered more than $9 billion, partly by suing some victims to pay others, but only $325 million total has been paid to victims. So far most of the Madoff money is “tied up in legal appeals.”(Financial Times, “Judge sets cap on Mets owners’ Madoff payout” 3/16/12)

Clearly we need better regulatory reform in the US. We need regulators to nip ponzi schemes and financial frauds in the bud, long before they bring massive disaster to hundreds of people around the globe. We need to hire financial experts, not attorneys, to run the SEC. The savings and loan crisis of  the 1980s and the conviction of Charles Keating for the S&L fraud in 1992 clearly shows that no matter what political party is in charge, financial fraud is an area we’ve made almost no progress in combating over the past 30 years!

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