Why Paul Krugman is Wrong About
24 March 2013 | Philip Ammerman
Journalists and politicians keep making fundamental errors about the Cypriot tax system which are so glaring and so obvious, you would think they know better.
Paul Krugman joined their ranks with his March 21st opinion piece “Treasure Island Trauma” in the New York Times. In it, he states:
Why are Cypriot banks so big? Because the country is a tax haven where corporations and wealthy foreigners stash their money. Officially, 37 percent of the deposits in Cypriot banks come from nonresidents; the true number, once you take into account wealthy expatriates and people who are only nominally resident in Cyprus, is surely much higher. Basically, Cyprus is a place where people, especially but not only Russians, hide their wealth from both the taxmen and the regulators. Whatever gloss you put on it, it’s basically about money-laundering.
And the truth is that much of the wealth never moved at all; it just became invisible. On paper, for example, Cyprus became a huge investor in Russia — much bigger than Germany, whose economy is hundreds of times larger. In reality, of course, this was just “roundtripping” by Russians using the island as a tax shelter.
This statement is wrong for the simple fact that Cyprus tax residents are taxed at higher rate than non-residents:
Cyprus tax residents, i.e. those residing in Cyprus more than 183 days per year, are liable for tax on worldwide income
Non-Cyprus tax residents are taxed on Cyprus source income only.
In both cases, the basic corporate income tax rate is 10% on profits. However, Cypriot resident companies are also liable for a defence tax and other levies, which takes the effective tax rate to approximately 16.5%.
Moreover, individuals resident in Cyprus are taxed on incomes and dividends. The income tax features a standard tax bracket which starts at 20% income tax for incomes over EUR 19,501; 25% on incomes over EUR 28,001, and so on.
For these reasons, there is absolutely no incentive to be a “nominal resident” of Cyprus. The correct structure for tax efficiency is to be the non-resident owner of a Cypriot company. Particularly if the difference between the base Cyprus rate (10%) and the base rate of the country of operations (e.g. Russia, 20%) are high.
Moreover, the attractions of Cyprus to international companies are actually far greater:
There is little chance of government expropriation or criminal activity in Cyprus on the scale see in Russia (ironically, the European Union expropriation of bank deposits probably qualifies)
There is a simple, stable English law tax and legal code, with business documentation and legal proceedings in English
Cyprus remains an excellent base for structuring deals within the European Union and the Middle East
Costs of living and doing business in Cyprus are far lower than those in Moscow, St. Petersburg, London, Paris and many other countries. Mr. Krugman should compare the difficulty of getting from Sheremtyevo Airport in Moscow to the Moscow City Centre, with an arrival at Larnaca Airport and a transfer to Limassol: he might find it instructive.
The individual residents of Cyprus that Krugman sneers at are hardly “wealthy expatriates”: they include over 30,000 British retirees who moved to Cyprus to enjoy a cheaper retirement in the sun, and over 40,000 Russians who have emigrated legally, and who are for the most part quite firmly in the middle class.
Besides being wrong on basic facts, it is regrettable to see that Krugman apparently does not understand the definition of money-laundering. The World Bank defines money-laundering as:
Money laundering is, however, a fundamentally simple concept. It is the process by which proceeds from a criminal activity are disguised to conceal their illicit origins. Basically, money laundering involves the proceeds of criminally derived property rather than the property itself.
The large majority of depositors and “round-trippers” in Cyprus are legitimate companies that include some of the biggest names in business: Gazprom, Itera, Columbia Ship Management, FXPro, and many others (whom I will not name here), who use the entirely legal transfer-pricing and holding company structures in Cyprus for their activities.
There are similar tax structures in place in “onshore” jurisdictions such as the UK, Ireland, The Netherlands, Switzerland, Austria, Luxembourg, Malta, Delaware, Hong Kong, Singapore, and others. Most of the un-named “villains” Krugman rails against use these other tax havens as well; the amounts of both round-tripping and deposits are usually far higher than in Cyprus.
Krugman makes the basic mistake that German policy-makers have made: he assumes that every Cypriot company and resident is a money-launderer, and that Cyprus is a tax haven. Besides being incredibly unfair to the hundreds of thousands of tax-paying companies and residents of Cyprus, most of whom are struggling with the fall-out of the financial crisis, neither Krugman nor Germany establish the correct solution:
Is the solution to destroy Cyprus, allowing other “tax havens” to operate?
Is the solution to destroy the legitimate savers and companies in Cyprus, ostensibly in the name of better bank regulation or a better business model?
I would have expected a Nobel Prize Laureate in Economics to get his facts straight while slandering an entire country on this scale. And I would have expected the New York Times to employ the services of a fact-checker and editor.
In both cases, it appears that I am mistaken.
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