Inflation: the hidden tax

PUBLICATIONS / Newsletters / 2012 / Newsletter December
Inflation: the hidden tax

I am not really a fan of the board game Monopoly, mostly because it reinforces popular conceptions as to what is wrong with capitalism: that assets are over time accumulated into the hands of fewer and fewer people and prices are nature-bound to increase all the time.
In any case when my kids insisted on me playing the game with them, and I finally conceded, I took it as an opportunity to teach them about inflation.
When you play a game of monopoly, the amount of money in the game is slowly increasing due to the “salary” you get when a player gets passed “start”. The way we tend to play it is that when a player doesn’t have the funds any longer to pay the rent, he has to sell his property, piece by piece. When a player doesn’t have any properties left to sell in order to pay the rent he is out.
More and more money enters the game as it progresses. Since the rent prices are fixed, the only prices that are freely fluctuating are the prices paid for buying the houses from one of the others. While as 5 Dirhams might sound like a lot in the beginning of the game, after 45 minutes of playing and 2% more money entering the game every round, 50 Dirhams suddenly doesn’t feel like a whole lot to pay to outbid another player to acquire a property.
Why, I ask them, are the prices higher in the end of the game? Is it because we all got more “evil” as the game proceeds, hence entering into price gouging, or is it maybe that since there is more money in circulation you would have to bid more to outbid the others?
Initially, getting your hands on more paper bills makes you feel richer until you realise that you need to pay more to get the same. Clearly the prosperity created by the new money is an illusion.
Unfortunately, the creation of new money is the essential ingredient in the policies of most governments in getting the economy back on track to the path of growth and prosperity. The reasoning being that if only we would spend more we’d get back on track.
The alleged main problem is that we just don’t have sufficient confidence in the future. If we’d only spend more there would be demand for products, businesses wouldn’t fail, we’d all have jobs and we’d be back to the good old halcyon days.
The only problem is that in a sane world you would only be able to spend more when you first earn more or are able to find a willing lender. In the actual world, however, governments can print money at will by having their central bank buy government bonds or other assets and in the process induce savers to spend their money by eroding the value of their saved funds.
The role then of government is to trick us into feeling confident on the one hand and on the other to make it unattractive to hold on to savings, in order to stimulate us to spend. So the control of the money supply is considered an essential tool of governments in economic policy making.
Inflation. What does it mean?
Originally the definition of “inflation” was an increase in the amount of money in circulation (the monetary base). The common meaning assigned to it currently is “general price increases”.
This change in meaning is very convenient for governments bent on increasing the monetary base through their central banks, since it divorces cause from effect. In the old meaning inflation caused price increases over time. By using the term “inflation” as a substitute for “price increases” it diverts attention from the real cause: the fact that there is more money to go around.
And it diverts attention from the culprit: the central banks. Instead the new definition shifts the focus to the resulting “price increases”; so as long as there are no price increase there is no inflation, even though the seeds for price increases might have already long ago been sown.
By diverting from the real cause and obfuscating who is behind the price increases, it leaves convenient leeway in assigning scapegoats for deteriorating standards of living caused by slow inflation and for the destruction that run-away inflation causes when it gets out of hand. After all who is responsible for price increases? Well the shop owners, the big corporations, and the speculators of course.
Inflation is in reality just a tax on society as a whole, although, granted, a windfall for some. So how does inflation work? It doesn’t increase the price level at once across the economy. It depends where the newly printed money is spent first. The spenders who first get the fresh money are richer. Because the new money has not trickled down through the rest of the economy the first spenders get to buy goods against old, not yet inflated, prices. They are indeed richer.
On the other hand, the ones last in line to receive the new money will see their buying prices rise before their incomes have risen. They are poorer. Hence, inflation redistributes money from the latest receivers to the first receivers.
So who are the ones first in line for the new money: government and its employees itself, the industries with government contracts, and second in line the businesses serving them. It is no coincidence that in the US real estate prices have plummeted across the country except in Washington DC.
And the ones last in line: those on fixed incomes, mom and pop stores not politically connected in a remote area far away from the capital city.
The other thing that inflation does is that it erodes the value of savings and debt: it favours debtors over creditors. If this sounds abstract, consider the following. If you have saved a million euros when you are sixty five years old and you want to live off the interest without consuming your capital a 1% real interest rate will give you 10000 euros before tax to live off. With a real interest rate of 6% it would have been 60000 euros. It is the difference between abject poverty and a reasonably comfortable life.
Had the government not created new money any new investments would have had to be financed from existing savings, investors would have had to bid the interest rate up. Inflation has the nice side-effect for governments that it makes pensioners and would be pensioners dependent on the state and that it erodes the value of the debts the governments incur.
Most governments, in particular Western governments, are now so much in debt that they are beyond the point of no return: inflation is the only way out. Morgan Stanley for instance reported recently that there is “no historical precedent” for an economy that exceeds a 250% debt-to-GDP ratio without experiencing some sort of financial crisis or high inflation.
Total debt (public and private) in the US is 300%+ of GDP. This year’s US budget deficit will be about $1.2 trillion. During Obama’s first four years in office public debt has increased from $10 trillion to $16 trillion.
The only theoretical alternatives governments have besides inflating away debt are to drastically cut government spending and increased direct taxation. In democracies drastic spending cuts are not going to be politically feasible for the simple fact that anyone that proposes these will have a hard time being elected, to say the least.
Increased levels of direct taxation are always popular though as long as it is only on the rich, i.e. anyone better off than oneself. The disadvantage of direct taxation is however that it is easier for people to figure out what they are left with when they are working. And if that is only 40 cents on the euro then some might be tempted to take it easy instead of doing their share to keep the economy going, or maybe even move abroad as Gérard Depardieu did.
Who is responsible?
The disadvantage of direct taxation it is all too obvious that it is the government that is responsible. Inflation on the other hand is a form of taxation that is not widely understood. Yes, in case of a Monopoly game most will find it easy enough to see what is going on but in real life what is going on is easily obfuscated by talk of central bankers that I believe really very few, if any, people understand, yet it leaves the feeling that they probably know what they are talking about since they look like intelligent people.
Inflation in real life works insidiously. It is just that after few years you realise you have to work harder to maintain the same standard of living, or that that you have to save an impossible amount in order to live off a private pension. Or maybe the sudden realisation that in 1990 a cup of coffee in the Netherlands cost the equivalent of 10 euro cents and now 1.50 euro, or that in the 1970’s one breadwinner could in most Western households easily maintain the household while now both partners have to work impossible hours to just get by.
The amount of newly printed money since 2008 so far has not caused significant price increases because the new money has been offset to some extent by human nature that is inherently conservative: in times of uncertainty you save more money to be able to deal with these uncertainties, you don’t spend more money.
Governments around the world seem to think that “human nature” gets it all wrong and try to induce their populations into spending by making it extremely unattractive to save. It is precisely this conservative nature which ensures that the increased amount of money in circulation is not immediately reflected in increased prices.
The problem happens when the confidence returns. When all important “confidence” of the consumer returns, when most people think all is hunky dory again, then that pent up money is going to be released into the system. And at that point we can expect to see hyper inflation and as a result substantially eroded living standards for most people.
As always, governments are ready to help us finger point the villains. In the 1930’s it were those gouging prices and those “hoarding gold”. Now it is the tax avoiders, the offshore financial services industry, the bankers, and probably a few others. After the next crisis hits, who knows? Although it will probably include all of the above.
It takes on truly ludicrous forms, with Starbucks being accused by politicians and mainstream newspapers in the UK of engaging in the practise of “transfer pricing”. For the record “transfer pricing” is a practice that tax authorities impose on companies to ensure that prices between related parties are set at an arms-length basis.
No matter, mass hysteria in the UK leads to consumers boycotting Starbucks and its management having to declare that they are looking into paying more tax in the UK. What you can do to protect yourself? Do something good this Christmas: make a plan to vote with your feet in 2013.
Buy hard assets such as gold that the government cannot inflate away. Make sure you keep it in a safe place. If possible move your business, assets, or your life to places where you get to keep what is yours, away from frivolous lawsuits, asset forfeiture, with a limited government interested in encouraging wealth accumulation by respecting private property and letting you keep what is yours. The UAE and Panama I would suggest are good candidates.
Finally, to stay within the Christmas spirit, if you want to do something good for others then put some of the money you have saved by implementing the above strategies into a local volunteer initiative to help out a specific unfortunate individual, such as Richard Holland who was hit by a car while cycling, is now in coma and whose insurance coverage will soon be maxed out: http://backonyourbike.com/
Merry Christmas and a Happy New Year.
Adriaan Struijk, Chairman Freemont Group


“Hey Starbucks. PAY YOUR TAX”
Just days before Christmas the newest Starbucks Twitter campaign is being hijacked by UK tax protests. UK consumers massively boycott the ever so tasteful Christmas Starbucks specials and turn to different coffee chains. But why exactly? What has Starbucks done to drive its loyal coffee drinking customers mad?
The world leading restaurant and café chain (globally second largest after McDonald’s) simply used all possible legal methods to optimize its tax situation. It engaged in tax avoidance.
There are no suggestions nor evidence that Starbucks has broken any laws. As the matter of fact, the group’s overall tax rate – including deferred taxes – was 31 percent in 2011, much higher than the 18.5 percent average rate that large U.S. corporations paid in recent years.
It is just that thanks to clever corporate structuring, on overseas income, Starbucks paid an average tax rate of 13 percent, one of the lowest in the consumer goods sector. And this is the water on the mill of the UK member of parliament Michael Meacher (Labour Party) who is known for his campaigns against tax avoidance. Meacher claims that Starbucks’ practice “is certainly profoundly against the interests of the countries where they operate and is extremely unfair … they are trying to play the taxman, game him. It is disgraceful.”
Let us repeat some facts about Starbucks. The company based in Seattle has a market capitalization of $40 billion. It has been present in UK since 1998 and there are 735 in total now. The total sales reaches $4.8 billion and tax paid in UK is 8.6 million pounds.
So what is really going on?
Starbucks, like other multinationals in consumer goods business (Google, Microsoft, Amazon, McDonald’s) makes its overseas operations pay a royalty fee of six percent of total sales for the use of its intellectual property such as its brand and business processes. These taxable income reducing fees are paid to Amsterdam-based Starbucks Coffee EMEA BV, the company’s European headquarters.
The UK tax authority allows companies to deduct intellectual property fees if firms can show the charges were made at “arm’s length” – that is, if companies can show they would have agreed on the terms even if they were not connected. Starbucks declared to comply with this principle.
The corporation then makes a perfectly legal choice to pay some of the revenues to Switzerland where royalty income can be taxed at a rate of two percent – rather than repatriate it directly to the United states against the maximum of 39 percent.
Furthermore, Starbucks buys its coffee beans for the European units through its Swiss import company. Before shipping e.g. to UK, the beans are being roasted in another Dutch company and that is why the Swiss and Dutch tax authorities require part of the profits to remain in both countries. Again, when doing so, Starbucks fully complies with the international transfer pricing rules. A recent UK customs enquiry (2009 and 2010) concluded that as well.
The company is also being heavily criticized in the UK for not disclosing the detailed information on profits of the bean trading and roasting. But both in Switzerland and in The Netherlands, Starbucks files its accounts according to the local legislation and why would a leading world company make itself vulnerable by disclosing to its competitors more than necessary by law?
The third topic of criticism targets the inter-company loans, yet another legal way of optimizing the tax burden by shifting profits within the corporation. Such loans can bring a double tax benefit to multinationals: the borrower can set any interest paid against taxable income, and the creditor can be based in a place that doesn’t tax interest.
Can you blame a corporation for making use of the legal ways of structuring its business in order to generate a profit?
According to Troy Alstead, Starbucks’ CFO, the company strictly follows international accounting rules and pays the appropriate level of tax in all the countries where it operates. Starbuck’s spokeswoman expressed that in the best possible statement: “We seek to be good taxpayers and to pay our fair share of taxes … We don’t write this tax code; we are obligated to comply with it. And we do.”


Dubai Multi Commodities Centre (DMCC) golden coin: the Krugerrand of the Middle East
Out of the estimated 2,500,000 million ATM machines worldwide, only 16 can be used to disburse gold. Seven of them are located in the United Arab Emirates.
With the global crisis progressing, the world tends to look back to traditional valuables like gold and other precious metals. Historically, gold coins as legal tender have been successfully used all over the world – the recent example is of course the immensely popular South African Krugerrand but also e.g. the American Gold Eagle or Australian Gold Nugget.
That is why, after successful launch of the first UAE bullion coin, the Dubai Multi Commodities Centre Authority (DMCC) entered into discussions with the UAE Central Bank to designate the coin as the first gold bullion legal tender in the Middle East.
These bullion coins were launched in August this year by DMCC. They were designed to commemorate the numerous accomplishments and visions of the UAE leaders: The first edition carries a portrait of His Highness Sheikh Khalifa bin Zayed Al Nahyan, the UAE president, on one side and the Burj Khalifa, with its 828 meters the world’s tallest tower on the reverse. The second edition has been launched earlier this month. It features a portrait of the Dubai ruler His Highness Sheikh Mohammed bin Rashid Al Maktoum and Palm Jumeirah, the world’s largest man-made island, on the reverse.
Minted by the Swiss refinery, Argor-Heraeus, the 24 karat coins are accredited by the DMCC’s Dubai Good Delivery (DGD) standard and available in four denominations weighing 1 oz, ½ oz, ¼ oz and 1/10 oz.
Whether the UAE gold coin will become the legal tender in the Middle East or not, it is an interesting investment opportunity for the ones who believe in the growing value of precious metals.


Deferral of payment of exit charge when leaving the Netherlands
In December the Dutch Parliament approved a law allowing for deferral of the exit tax levied on companies when transferring fiscal residence to another EEA member state. The exit tax is and will continue to be levied in the Netherlands on unrealised (and therefore yet untaxed) gains at the time of emigration. Examples are unrealised gains on currencies and goodwill. The new law establishes that the tax will be due, with accrued interest, when the gain is realised. Alternatively the company can pay the tax immediately or pay off the tax with accrued interest on a 10 year instalment plan, the advantage being that this will avoid the necessity to continue filing Dutch tax returns in the mean time. Finally the company will have to provide guarantees for the payment of the exit tax.
The change in law was necessitated because of a ruling of the European Court of Justice (ECJ) in 2011. It ruled in the case “National Grid Indus” which concerned a company that moved its residence from the Netherlands to the UK. It was taxed on its unrealised currency gains at the time of emigration. The company argued that this was a violation of the principle of freedom of establishment that is applicable within the EU, since making a similar move within the Netherlands would not have triggered such a tax.
However the ECJ did ratify that the exit tax on unrealised gains as such is justified, since eventually these gains would have been taxed had the company stayed in the Netherlands. It declared only the insistence on immediate payment not to be consistent with the freedom of establishment.

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