Offshore News Digest for Week of May 15, 2006

GLOBAL LIVING & BUSINESS

SECOND-HOME BUYERS HEAD FOR THE BORDER

Buying a second home is increasingly a matter of adopting a second country. About 4.1 million Americans reside in other countries, according to the Association of Americans Resident Overseas, with about 1 million living in Mexico and 688,000 living in Canada. If all of these residents living abroad were placed in one U.S. state, it would be the 25th most populous state in the country, the association reported. The statistics do not include travelers who are visiting briefly and who do not secure visas, and also do not include members of the U.S. military.

“What we’ve noticed over the past five years – the trend is definitely accelerating. Americans are buying second homes in droves internationally,” said Jeff Hornberger, international market development manager for the National Association of Realtors trade group. Latin American countries, and particularly those in Mexico, Central America, and the Caribbean, are hot destinations for U.S. buyers, Hornberger said. There is more political and economic stability in the region than in years past, the dollar goes a long way, global travel to these destinations is quick and affordable, and baby boomers are looking for more than just homes on golf courses in typical U.S. retirement markets, he added. Also, in countries such as Panama and Nicaragua that are seeking to lure foreign buyers. “They are really rolling out the red carpet for Americans in terms of tax incentives.”

The International Consortium of Real Estate Associations, a group that includes participation from the National Association of Realtors, boasts “over 3 million properties around the world” at its Web site, WorldProperties.com. Hornberger said that the interest in international real estate is skyrocketing, although it is difficult to statistically track the actual number of U.S. residents who own property abroad. He has seen a growing interest in international real estate conferences and events. During a trip to Panama last month to discuss real estate opportunities in that nation, there were about 140 U.S. real estate agents who participated. “The first year 30 came, the second year 60 came. A lot of Realtors have themselves bought property. … The amount of construction happening in Panama – there are a lot of new developments going up. The boom is happening right now. There are so many construction cranes right now that it’s amazing. It’s just a country that’s very comfortable for U.S. [residents]. The U.S. dollar is their currency.” While Europe has also been a popular destination for U.S. residents to purchase property, the dollar has been weak against the euro for several years and air travel tends to be more costly and lengthy to European destinations.

Real estate practices can vary dramatically from country to country, Hornberger said, and ICREA has worked to provide information to consumers and agents alike about the peculiarities of home sales in many countries. In addition to its participation in the international real estate group, the National Association of Realtors offers a certification program for Realtors who work with international properties, called Certified International Property Specialist. There are about 1,500 Realtors who hold this certification. Tom Kelly, a real estate author and columnist who co-authored Cashing in on a Second Home in Mexico, said Panama is definitely a hot international real estate market. “Costa Rica continues to be hot but it’s kind of been found. Mexico is jumping up and down.” Belize, Panama and the Yucatan Peninsula region are becoming very popular, he said.

WANTED: BRAIN CAPITAL FOR CHILEAN ECONOMIC GROWTH AND DEVELOPMENT!

While we would love to tell you about the many local activities in Chile, the feel of the air, the aesthetically pleasing and sublimely fragrant flowering trees and plants, how much we enjoy living it up “Chile Style” (because summer in the southern hemisphere does feel different), we are instead going to spend some time writing about the emergence of Chile into the World Market. Since we did our fair share of traveling and researching the world before we decided that Chile would be our new home perhaps you will find some useful information in our humble thoughts and writings.

It is no secret that Chile is poised for tremendous growth and there are opportunities galore for anyone with the brains and background necessary to take this thriving, economically healthy country to the next level in world economic affairs. The fact that there are corporations around the world who have brought with them an influx of wealth into Chile is also apparent. But what is a bit of a secret is that Chile is like a young adult looking out at its worldwide “audience” from behind the curtains on a stage. Much like a teenager soon to experience college graduation, Chile has its entire future ahead of it. The country is the Class Valedictorian, the student voted Most Likely to Succeed and the pupil with the Highest Grade point Average all rolled up into one sweet package.

Not the seasoned veteran in world economics and lacking some street smarts, Chile nevertheless has all the bases covered. Textbook and hands-on education are two different animals and the USA has been raising the bar of technology and innovation for many, many years. During this time, Chile has been watching the world and the USA in particular, as it has quietly been growing and gaining in stature. Chile has been an apt student and has learned the lessons well. We think the world is in for a very big surprise.

Try to appreciate what has taken place in this South American country in the last 20 years. Few, if any countries can boast the type of accomplishment and advancement that Chile has achieved in such a relatively short period of time. As we look around the world, we view Chile as a country that has not only paid its dues but it has also formed a solid base that can sustain an avalanche of its own economic growth and prosperity. We really cannot see this type of preparation for future growth in any other country on Earth. If one comes to Chile with the desire of building a nice retirement home for oneself, on a beautiful parcel overlooking the ocean, a river or a lake and perhaps have a golf course nearby, that is one thing and it is a very viable plan for a good number of reasons.

On an entirely different level, if those same people have families who need to work and who need opportunity, people who either own or represent corporations or have expertise working for a progressive northern operation, they have a whole different reason to relocate to Chile. Corporate planners should begin educating themselves regarding the opportunities possible if they invest and export their technology and systems to Chile. Chilean corporations are looking for firms to invest in their companies, not for the money but for the knowledge and vision these firms can provide There are opportunities all over the world but few are as ripe for planting a seed and actually seeing it grow and bear fruit, as is possible, at this very moment, in Chile.

Chile is #1 in index ranking Latin countries’ business envirmonments.

As Oscar Arias assumes the presidency of Costa Rica, he can rejoice over some good news. His country is the third-best place to do business in Latin America, according to the Latin Business Index produced by Latin Business Chronicle. And Bolivia, which has provoked concern among foreign investors for its recent gas nationzalition, is the 2nd-worst place to do business, the index shows.

Logically, the best places for business should be the largest markets, offering the largest number of opportunities. However, the index shows that when other key factors are included, the ranking changes somewhat. Countries that do better include only two of the top seven economies, Chile and Mexico, as well as smaller economies like Costa Rica, Uruguay, Panama and the Dominican Republic. Countries that do worse include five of the top seven economies. Brazil, the largest economy in Latin America, only comes in at a 6th place on the ranking. Similarly, Argentina, the 3rd-largest, comes in at 5th place and Venezuela, which ranks 4th in GDP size, comes in at 7th place on the index. And Colombia and Peru, which are the 5th-largest and 7th-largest economies, only come in at 9th and 12th place on the index.

The Latin Business Index, the first and most extensive of its kind, looks at five key factors in 19 countries in Latin America - (1) macro environment (GDP growth, GDP per capita, inflation), (2) globalization and competitiveness (globalization, tariffs, education and health), (3) business environment (corporate tax rates, access to capital, ease of doing business, including starting and closing a business), (4) technology level (PC, internet, wireless and fixed telephony penetration), and (5) political environment (political and economic freedom, political stability, business policies, degree of transparency).

While size does matter in terms of business opportunities, the overall economic, social and political environment is also important. While growth of a country’s GDP is a strong indicator of a business climate, a similarly strong inflation is a negative counterpoint, hurting the purchasing powers of consumers, making it difficult for companies to plan ahead and dampening the credit availability from banks. If there is a huge market, but no legal recourse for disputes, that clearly is a negative. If there are laws favorable to business, but no enforcement, that is also a negative. If there are low tax rates, but rampant corruption (which can be seen as an informal tax), that is also a disadvantage. Even with a favorable legal and economic climate, an increasingly globalized economy requires a certain technological level. Finally, the political environment is fundamental. Witness, Bolivia and Ecuador, which have both seen presidents come and go frequently, creating significant uncertainty among both local and foreign investors and paralyzing key reforms.

If there is one country that embodies the ideal business climate, it is Chile. The country managed to top all but one of the five main categories. The high score is partly due to free-market reforms implemented in the 1970s and 1980s, but also the return to a vibrant democracy in 1990. Chile is only one of three countries in Latin America with perfect scores in political rights and civil liberties, according to Freedom House. Mexico, the 2nd-largest economy in Latin America, came in second on the index, thanks to a strong macro environment (including highest GDP per capita), and a relatively strong political environment. Brazil did not fare too well on the index when compared to its position as Latin America’s top economy.

Costa Rica, Latin America’s 11th-largest economy, came in at a surprising 3rd place on the index. High scores in globalization & competitiveness and technology level (both second-best) as well as a relatively high score on political environment, more than offset lower scores on macro environment and business environment. Uruguay, Latin America’s 11th-largest economy, also did well and captured the 4th place on the index – helped by a high score in political environment (2nd-best in Latin America), technology level (3rd-best) and macro environment (5th-best). Argentina and Venezuela did surprisingly well despite hostile policies against private enterprise. The result is due to the fact that both countries have a high GDP per capita and have seen strong economic growth the past two years as well as further growth expected this year. Venezuela’s high rank also comes despite having the least-free economy in Latin America – less free than even Cuba! – according to surveys from the Heritage Foundations and the Cato Institutute.

While the gas nationalization in Bolivia affected the country’s score in terms of political outlook and business policies of the government, it came on top of a wide range of negative factors that propelled the country to the 2nd-last position in the index. And the poorest country in South America is expected to worsen the business climate further over the next 12 months, thanks to increasing anti-market policies by president Evo Morales, who assumed office in January. Haiti comes in last on the index as well as on each of the five subcategories. Colombia has also been hard hit by internal violence, yet the country managed to capture a ninth place. The low rank for Haiti also contrasts with neighboring Dominican Republic, which came in 10th place on the index.

I-Been-Hosed

Out here in the real world we refer to the fruits of our labor as “earnings”. But up on Capitol Hill, politicians recognize these same fruits as “taxable gains”. We believe we deserve our earnings, by virtue of the fact that we worked hard to produce them. But the politicians believe that they deserve our earnings, by virtue of the fact that they have already spent them. So whenever somebody earns a whole bunch of money, all at once, politicians like Hillary Clinton begin to imagine that they deserve an even larger share of our earnings than usual. And so do politicians like Hugo Chavez, Evo Morales and Alfredo Palacio – the respective presidents of Venezuela, Bolivia and Ecuador.

In the name of “equity” and “fairness” the aforementioned politicians – along with a number of other politicians around the globe – are conducting a kind of economic terrorism against the oil and resource companies that operate within their borders. This emerging wave of econo-terrorism is not a good thing. The terrorists’ preferred tactics include tearing up existing contracts, imposing massive “windfall” taxes, or simply expropriating property and production facilities. Oil and mineral exploration is already challenging and costly, without the added threat of crippling, afte–the-fact taxation.

Already, the horror stories are proliferating, from Venezuela to Bolivia to Russia … to Mongolia. On Monday, the shares of Ivanhoe Mines (a.k.a. “I-been-hosed”) tumbled about 30% on reports that the Mongolian government will impose a whopping 68% “windfall tax” on mining companies. Ivanhoe has invested about $370 million in a copper and gold project within the country, but has not yet begun production. Earlier this month, the shares of Apex Silver (SIL), which operates a large silver project in Bolivia, plummeted 25% when President Evo Morales nationalized Bolivia’s oil industry. Morales took his cue from Venezuelan President, Hugo Chavez, who one month earlier, forced foreign oil companies to cede majority ownership of their projects to the Venezuelan national oil company and to accept higher taxes … or to abandon their projects and leave.

Chavez’s tactics may be different in degree from that of Senators Clinton and Levin, but it is hardly different in kind. It may not matter to today’s populist politicians that their actions will impede future efforts to develop the world’s natural resources. But it may matter very much to resource investors. The nearby charts (here and here) present a glimpse of what may lie in store. Commodity prices are up, while resource stocks are down.

Andean foriegn direct investment report.

Venezuela posted the strongest increase in foreign direct investment (FDI) in Latin America last year, measured in both percentage and value terms, according to the UN Economic Commission for Latin America and the Caribbean (ECLAC). The country, which has followed a hostile policy towards foreign companies the past year, posted total FDI of $2.9 billion last year – an increase of 94.8% and $1.4 billion, ECLAC reported. Measured in percentage terms, Bolivia was the biggest loser, although Brazil posted the strongest decline in value terms. All in all, FDI in Latin America grew by a mere 1% to $61.6 billion, ECLAC says. Mexico, the region’s top recipient the past five years, posted a decline of 2.4% to $17.8 billion. However, both Mexico and Brazil are expected to see strong growth this year and reach the highest FDI levels since 2001, according to forecasts from Bear Stearns.

Venezuela’s three Andean neighbors Colombia, Ecuador and Peru also noted strong growth last year. FDI increased by 25.3% in Colombia to $3.9 billion, while Ecuador FDI grow by 31.9% to $1.5 billion and Peru posted a 38.7% increase to $2.5 billion. Bolivia, the 5th country in the Andean Pact, noted the worst dramatic decrease from $63 million in 2004 to an net outflow of $279 million, ECLAC says.

The six Latin American members of the Central American American Free Trade Agreement (CAFTA) saw strong differences between them. Nicaragua posted the strongest increase in percentage terms, growing 24.3% to $230 million, while the Dominican Republic saw the strongest growth in value terms (up $141 million). Guatemala noted a respectable increase of 8.4% to $168 million. El Salvador, however, saw relatively weak growth of 2.4% to $477 million, while FDI fell in Costa Rica by 1.3% to $609 million. Honduras managed to see an even worse decline – 35.1% to $190 million … the worst percentage decline in Latin America after Bolivia. The four members of the South American Common Market (Mercosur) also saw substantial differences from country to country. Argentina posted an impressive 9.1% increase to $4.7 billion, while Brazil posted a 16.4% decline to $15.2 billion. FDI in Uruguay increased by 3.9% to $323 million, and remained the same in Paraguay at $70 million. Chile and Panama, the only two other countries that are not full members of any regional trade group, both saw small increases in FDI last year, at $7.2 billion and $1.0 billion.

GUIDE TO OPENING A BUSINESS IN SOUTH AFRICA’S GOLDEN CITY: JOHANNESBURG

Why would anyone want to open a business in a country where people get killed for less than $5? There are many good reasons. South Africa may be the country with the highest crime and AIDS rate in the world, but it offers several incentives that cannot be overlooked. Apart from the economic benefits, it is a vibrant, sunny and beautiful country with friendly people, cultural diversity and tolerance, a rich wildlife, and endless opportunities.

The South African government aims for a 6% annual economic growth and has implemented several incentive measures to curb the high unemployment rate. The main goals of the incentives are to promote export, spatial improvement, industrial growth, enterprise development, and decrease unemployment. The incentives are geared toward foreigners who want to invest or open a business in South Africa. Certain zones have been identified as prime priority, and Johannesburg as part of the Gauteng province, is one of them.

The agro-processing, motor industry, banking chemicals, food and beverages, information services, computer technology, tourism, telecommunications, property and mining are all segments that show positive growth. The industry includes preparation processes with regard to maize, sugar, fruit, malt, and meat. South Africa is an international player with regard to food and beverage processing and self sufficient in food production. It is one of the main exporters of food and agricultural related products to countries in Africa. It has the fifth fastest growing information technology and communications industry in the world. The tourism industry topped $10 billion in 2003. Eco-tourism is seen as a viable alternative to normal farming practices and provides thousands of jobs to poor communities situated next to game reserves.

SLOVENIA IN ON TRACK TO JOIN EURO ZONE, WHILE LITHUANIA’S APPLICATION IS REJECTED

The European Commission turned down Lithuania’s application to join the Euro next year but approved Slovenia – now likely to become the first new user of the common currency since it was launched in 2002. Lithuania’s high inflation scuppered its bid to adopt the Euro, EU Economic and Monetary Affairs Commissioner Joaquin Almunia said in a statement. “Lithuania meets all the convergence criteria except the one on inflation,” he said. The commission said the average inflation rate in Lithuania during the 12 months to March 2006 was 2.7%, just above a 2.6% guideline.

Lithuanian officials reacted angrily, saying the rules had been applied too strictly. Almunia said he had asked Lithuania to postpone its application to join the Euro but Vilnius had insisted on moving ahead. He said he expected Lithuania’s inflation to rise to 3.5% on average this year. Natural gas prices rose by around 40% in January after the expiration of a long-term agreement with a major gas exporter. EU officials have insisted they are just sticking to the rules designed to keep the economies of the 12-nation Euro area stable. However, EU governments bent the rules in 2001 to allow Italy, Belgium and Greece to sign up for the Euro even though their public debt was well above the legal limits.

Slovenia, however, is on track become the first new member to join the 12-nation common currency if EU finance ministers approve its bid – as is likely – on July 11. The country of 2 million, one of the most prosperous in southeast Europe, has an inflation rate below 3% and economic growth at about 4%. Almunia warned that Slovenia now had to speed up crucial practical preparations to ensure a smooth changeover, including efforts to prevent unjustified price hikes. Hoping and expecting a positive decision from the EU, Slovenia earlier this year started marking prices of goods and services in both Slovene tolar and Euro. The Central Bank also plans to distribute calculators to all households in the fall, to make it easier to Slovenes to calculate a price in Euro once it’s fully introduced.

The EC is due next October to assess nine other countries’ prospects of joining the Euro, Almunia said. Malta, Cyprus, Estonia and Latvia have set a 2008 target but Latvia may choose to delay this deadline to tackle its inflation – the highest in the EU. Slovakia wants to join in 2009, followed by Czech Republic and Hungary – if it manages to lower its massive public debt. Poland has not set a target date. Almunia said Sweden’s chances of joining the Euro would be examined even though it, Britain and Denmark chose stay out of the common currency for political reasons. He said Sweden did not have an opt-out clause and was obliged to prepare itself for Euro membership.

ISLE OF MAN SCOOPS PRESTIGIOUS OFFSHORE AWARD AGAIN

The Isle of Man has been selected as the “best international financial services center” for the the 6th consecutive year by International Investment magazine, a leading UK offshore publication. “This prestigious award recognises the Isle of Man’s strength as a leading jurisdiction of choice,” stated Alan Bell, the Isle of Man Treasury Minister. According to the Manx government, the International Investment Fund & Product Awards are viewed as the most high-profile and prestigious awards ceremony for the offshore world. They took place in London on May 10th, and were attended by more than 300 leading financial services providers. “The Island is maintaining a competitive edge by pursuing the economic, social and fiscal strategies that have stood us in good stead over the last five years. We are also delighted that the financial services industry has been recognised by the awards to Isle of Man-based companies,” Mr. Bell added.

Isle of Man-based companies won nine awards out of a total 14 award categories in this year’s awards, and in four awards a further five local companies were highly commended. The strength of the Isle of Man as a leading finance center has also been recognised by Financial Times publication, The Banker, when it was named European Winner of its Financial Centers of the Future 2005 in November 2005.

AIR OF “FIN DE REGIME” HANGS OVER EUROPE

As the late British parliamentarian Enoch Powell famously noted, all political careers end in failure. Powell’s grim maxim haunted Europe last week. In Britain, PM Tony Blair’s days are numbered as calls intensify for him to set a resignation date. The Labour Party seethes with rumors about Blair being unseated by the same kind of brutal putsch that kicked out Margaret Thatcher. Britons are fed up over Iraq and Blair’s closeness to U.S. President George Bush. Italy is a political zombie. Former PM Silvio Berlusconi, ousted in a razor-thin vote, has been forced to go back to simply owning Italy, rather than leading it. But he and his allies are straining to thwart the new centre-left coalition of Romano Prodi by promoting political paralysis.

Germany’s new PM, Angela Merkel, has dedicated herself to doing nothing – apart from making nice to Washington – after promising to reform and revive her stagnant nation. In glittering springtime Paris, the government is torn by open political civil war and barely able to conduct normal business. President Jacques Chirac, still ailing from what his spokesmen delicately described as “a medical mishap”, remains unwell. Only 20% of the French still back him. Chirac has one more year in office and is unlikely to run again. With Chirac offstage, his two would-be successors, Prime Minister Dominique de Villepin and Interior Minister Nicolas Sarkozy, are waging an embarrassing, increasingly ugly public battle. Now, De Villepin is enmeshed in a vicious scandal that threatens his political demise. The left’s amiable leader, Francois Holland, is boring and bereft of ideas.

Europe’s old political order is on its last legs, but there is nothing new to replace it.

TAXES

TAX BLOW FOR U.S. EXPATS

Americans living in Bermuda will see their tax costs rise dramatically as a result of tax legislation U.S. president George W. Bush is expected to sign this week. The election year tax measure aims to cut U.S. taxes by $70 billion over the next decade by extending low tax rates on dividends and most capital gains until 2010 and preventing 15 million households from being hit by the alternative minimum tax (AMT). However the 4.1 million Americans – excluding military personnel and foreign service officers – living outside the U.S. will bear a portion of those cuts via complicated tax rules which will result in them paying $2.1 billion more in taxes over the next decade.

Currently, U.S. expatriates are exempted from paying U.S.US taxes on the first $80,000 of foreign earned income. The new legislation would increase the exemption by $2,400 to $82,400 as of tax year 2006. However, U.S. citizens will see the tax exemption on foreign housing expenses significantly reduced. Currently, American expatriates can deduct virtually all of their housing expenses which is a benefit that has helped attract Americans to live in high priced locations such as Bermuda. The new rules however cap the housing deduction at $11,536 although Treasury has the ability to adjust the housing deduction when countries have abnormally high costs of living relative to the U.S.

Expatriates will also be subject to higher tax brackets so a single taxpayer or married filing jointly taxpayers who maximize the combined foreign earned income exclusion and housing deduction – approximately $94,000 – would see additional tax costs of $20,806 and $16,811 respectively, said PricewaterhouseCoopers Bermuda tax advisor Rick Irvine. Republican Senator Charles Grassley, chairman of the Senate Finance Committee, who was a key player in an unsuccessful bid to eliminate the foreign income and housing deduction for expatriates in 2003, helped move the last minute modifications to the 2006 tax legislation through Congress.

In 2003, U.S. business groups successfully lobbied against the plan to eliminate the deductions on the grounds it would make it prohibitively expensive to promote American products and ideas. This time around however the provision related to US workers abroad was added late last week with no warning and therefore little time for opposition.

AUSTRALIAN TAX OFFICE GETS MORE MONEY TO POLICE WEALTHY TAXPAYERS

Commonwealth Treasurer Peter Costello has announced that the ATO will be furnished with additional resources in order to maintain tax compliance by high wealth individuals and their associated entities. The ATO will be recieving A$82 million in extra funding over the next four years to police wealthy individuals and implement measures that are expected to raise an additional A$615 million in tax revenues.

The number of Australia’s high wealth individuals has tripled since the government established the HNWI Taskforce in 1997. The extra funding will allow the ATO’s High Wealth Individuals Taskforce to cover this increase in the number of high wealth individuals and enable the ATO to improve the timely identification of tax compliance risks. The ATO will undertake additional audit activity for all identified high risk cases, including closely-held private company groups. Since it was established, the Taskforce has collected A$1.3 billion from audits of high wealth individuals. Indications are that this activity has also improved “voluntary compliance” by this sector.

UK OFFICE OF NATIONAL STATISTICS REPORTS DRAMATIC RISE IN VAT FRAUD

Official data from the UK government’s statistical office has suggested that carousel fraud levels are far worse than previously thought, skewing the country’s trade figures, and potentially throwing Chancellor Gordon Brown’s precariously-poised budget forecasts into a tailspin. According to the ONS, some £5.5 billion of the UK’s £59.5 billion exports in the first quarter of 2006 can be written off because of carousel fraud. This is up sharply from the same period last year, when the ONS estimated that £1.1 billion of exports were affected by the fraud.

Carousel fraud, also known as missing trader intra-community fraud (MTIC), involves the importation of goods (typically high value small electronic goods such as mobile phones and computer components) free of value-added tax. The goods are then sold on by companies with the 17.5% VAT added, following which the firms disappear, having pocketed the difference. In many cases, the goods are passed along a long chain of traders, making the fraud hard to detect and the perpetrators difficult to apprehend. Originally, most carousel chains only involved EU member states. More recently, there has been an increase in carousel chains that include non-EU countries, for example, Dubai and Switzerland.

The findings have huge implications for the Chancellor’s budget calculations, due to the amount of VAT receipts foregone by the Treasury. It has been estimated by the government that it lost up to £1.9 billion in VAT revenues in 2003/4 because of carousel fraud, but the ONS figures suggest that the problem is now much more pervasive, and some analysts believe the annual revenue loss could now stand at £10 billion. However, the ONS qualified its estimates by warning that carousel fraud was difficult to quantify and hard to measure reliably.

EC seeks to modernize VAT treatment of financial services.

The EC announced last week that it intends to submit a legislative proposal by the end of 2006 for modernizing the current legislation for VAT on financial services and insurance. It has launched a public online consultation, and will work closely with the European Banking Federation in this process. The main objectives of a modernization would be to reduce the administrative costs for administrations and traders, to remove potential or actual competitive distortions between suppliers across different Member States, and to create more clarity and security for Member States and traders.

Current VAT legislation (adopted in 1977) exempts financial services and insurances. This creates “hidden VAT” charges in supplies from financial and insurance services providers to other businesses. They cannot deduct input VAT on services or goods (e.g., computers) supplied to them because the services they supply themselves, are exempt. Their charges to customers therefore reflect this VAT cost and, as it cannot be recovered by business customers, the charge cascades through the system, increasing the cost of the goods and services supplied.

IRS AUDITS CREDIT COUNSELING FIRMS, REVOKES TAX EXEMPT STATUS IN MANY CASES

The IRS earlier this week released a report on tax-exempt credit counseling agencies, and announced further steps to ensure that these organizations comply with the law. Over the past two years, the IRS has audited 63 credit counseling agencies, representing more than half of the revenue in the industry. To date, the audits of 41 organizations, representing more than 40% of the revenue in the industry, have been completed. All of the completed audits have resulted in revocation, proposed revocation or other termination of tax-exempt status.

Each year many Americans turn to credit counseling organizations for financial education, advice and assistance. Furthermore, under the Bankruptcy Reform Act of 2005, anyone who files for bankruptcy must first visit one of these agencies. “Over a period of years, tax-exempt credit counseling became a big business dominated by bad actors,” explained IRS Commissioner Mark W. Everson. “Our examinations substantiated that these organizations have not been operating for the public good and don’t deserve tax-exempt status. They have poisoned an entire sector of the charitable community.”

The revocations result from these organizations failing to provide the level of public benefit required to qualify for tax exemption. Many of these agencies offered little or no counseling or education and appeared to be primarily motivated by profit. In many instances, these agencies also served the private interests of related for-profit businesses, officers and directors.

MAKE-BELIEVE, DECEIT ARE BEHIND LATEST TAX-CUT

When Senator Jeff Bingaman stopped to get a cup of coffee on Capitol Hill on the morning of May 11, he greeted a woman he knew, who replied, “Good Morning. Another beautiful day in the land of make believe.” Later that day, as the Senate debated the latest tax cut bill, the New Mexico Democrat observed, “I thought that sounds right.” Indeed.

The official title of the bill, which President George W. Bush proudly signed into law this week, is “The Tax Increase Prevention and Reconciliation Act of 2005.” It cuts taxes by roughly $70 billion over the next 10 years. Nevertheless, Republican Senator Charles Grassley of Iowa, chairman of the Senate Finance Committee, argued the legislation really only extends some parts of the tax code that have expired or would later. “So I don’t want anybody to come over and say we are cutting taxes,” Grassley said. The new legislation is really a stop-gap measure that settles nothing for the longer term. Still, it reduces taxes significantly, and that is a tax cut except in the land of make believe.

The bill’s principal provisions involve tax rates on income from dividends and capital gains and the income thresholds at which taxpayers are subject to the alternative minimum tax (AMT). In another bit of make believe, the rates were set to expire in the first place because neither Bush nor a majority of the members of Congress was willing to own up to the amount of lost revenue if they were made permanent. That type of deceit is still embedded in the new legislation for the same reason. The income thresholds for the AMT have never been adjusted for inflation, so a provision originally intended only to make sure very high income taxpayers did not escape income taxes altogether is now hitting upper-middle-income households. In 2003, the thresholds were lifted for that year and the next and later for 2005 as well. Now, they have been extended for one more year, 2006, with an estimated revenue loss of $31 billion.

Low tax rates of 15% on stock dividends and capital gains – and no tax at all in 2008 for taxpayers in the 10% and 15% brackets – were to expire at the end of 2008. Nevertheless, Bush and Republican congressional leaders pushed through a two-year extension, to 2010, at a 10-year revenue loss of $51 billion. Presumably, there will be another bill next year to prevent the AMT from affecting millions of additional middle-income taxpayers. And now all the other major tax cuts passed since Bush became president in 2001 will expire at the end of 2010, two years after he has left the White House.

That is going to make fiscal policy a key issue for the presidential candidates of both parties. Are any of them going to tell the truth about the terrible fiscal bind the country is in?

ASSET PROTECTION / LEGAL STRUCTURES

PLATO, FRANKENSTEIN AND OFFSHORE ESTATE PLANNING

When it comes to estate planning – especially offshore estate planning – there are things you should do, things you should not do, and there are downright stupid things no one should ever do. Plato said that nothing in the affairs of men is worthy of great anxiety. Perhaps not, but flawed estate planning can cause a great deal of worry and frustration for your heirs. One of the fundamental mistakes I have come across in the offshore financial services industry is the failure of those with assets held offshore to adequately deal with succession before the (usually) unexpected event of death occurs. It does not matter in what offshore jurisdiction those assets are controlled, the potential dangers, delays and, often, distress remain.

If a will exists, control of the deceased’s offshore assets passes to his executor. If there is no special foreign will covering the offshore assets, however, there will be a delay before the domestic will is recognized by the foreign court that has jurisdiction over the assets. Meanwhile, management of those assets might be affected while transfer of control to the executor takes place. Intestacy – dying with no legal will – is the worst-case scenario. Even before representation by an executor is approved, one has to be found. Often, there will be a delay while family members decide who to appoint, especially if rivalries exist or some members live in different countries. As an executor, I have looked across my desk and seen the disappointed faces of those who, except for the prevailing intestacy laws, would-and should-have received some benefit.

Failing to have your offshore estate in proper order when you die leaves a debt unpaid to your heirs. In so many instances, a simple trust will suffice – and I mean “simple”. I have found in my career that too often people are offered complex solutions to their offshore affairs when a very direct path can be traveled. If, for example, all a person is concerned about on his death is that the assets of his offshore company will be enjoyed by his heirs, then why should a deed of more than two pages be required? Skilled draftsmen can be concise and you just have to choose professionals of the right caliber.

Now, let me hammer home my point. Mr. O (an associate of the late Red Adair, famous for putting out oil fires) ran a very successful business, which provided specialized equipment to international oil companies worldwide. The administration and accounting for the worldwide lease agreements and supporting services were all managed offshore and the company through which the operations flowed was owned by an offshore trust. The important point here is that the success of the entire offshore structure hinged on the validity of the trust underpinning it. If the trust was void, the entire edifice would crumble and any tax advantages would be lost. The resulting financial conflagration on Mr. O’s death would have been impossible for even Red Adair to tackle.

I was asked to review the trust deed and I found that it had a fatal flaw. Fortunately, the situation could be salvaged but what had happened in this case has an all-too-familiar ring. The trust deed had been prepared by amateurs who had done with scissors and paste (we are talking 25 years ago) what today, using a computer, would be called “a copy and paste job”. Parts of several precedents had been combined to create the deed. What had originally been intended to be a Liechtenstein trust had become, through their doctoring, a Frankenstein trust. The lesson here is that, whether the trust deed is two or, as in the case of Mr. O, nearly 30 pages long, it needs to be right.

GASOLINE AT 10 CENTS A GALLON AND FALLING

Does gasoline at 10 cents a gallon and falling sound impossible in today’s world? Well, if you think it is impossible, you are wrong. Because that is where gasoline actually is, and it looks like it is going even lower. Of course, it is not 10 cents a gallon in today’s paper money. But it is 10 cents a gallon in the Constitutional money of the United States, which is gold coin and bullion. Gold is now at $700 per ounce, and rising. To the right is a picture of a $20 U.S. gold coin known as a Double Eagle. If you look carefully, at the bottom of the coin, you can actually see where it says “Twenty Dollars”.

This coin contains approximately one ounce of actual gold, which means that at today’s market price of gold, it is worth $700. And this means that one gold dollar is worth $35 of today’s paper dollars. And that means that one gold dime is worth $3.50 in today’s paper money. This last, of course, is roughly what a gallon of gasoline costs in today’s paper money. Which means that a gallon of gasoline costs just 10 gold cents.

The key point here is that our money is getting cheaper and that is why prices are rising. Do not be surprised if in the future, gasoline is a lot more expensive in paper money than it is today and, at the same time, cheaper than it is today in our Constitutional gold money. Look for $5 per gallon gasoline in paper and seven cents per gallon gasoline in gold. That is a real possibility.

JUST WHAT IS A “TAX HAVEN”? KOREA TRIES TO NAB THOSE ESCAPING THE TAX NET

There are places widely called “offshore tax havens”, such as the British Virgin Islands and the Cayman Islands, where certain taxes are imposed at low rates or not at all to attract foreign companies or individuals. Now, some label Belgium a “tax haven” when they complain that Lone Star Funds is conducting the sale of Korea Exchange Bank through its Belgian unit in order to avoid taxes here. They say that the tax haven list, which will be made by the Finance Ministry next month, should also include the Netherlands, paying attention to the fact that a Dutch unit of the French retailer Carrefour has an 80% stake in Carrefour Korea, whose sale to Korea’s Eland was agreed at the end of last month.

But it is difficult to find Belgium or the Netherlands on globally adopted tax haven lists made by the OECD and well-known business magazines such as Forbes. In fact, the corporate income tax rates in Belgium and the Netherlands are 33.99% and 31.5% respectively, much higher than Koreaqfs rates of 13 to 25%. Under the bilateral double taxation treaties between Korea and those countries, if Lone Star or Carrefour does not pay tax on their capital gains here, it will have to pay tax in Belgium or the Netherlands. Then why are Korea’s tax authorities concerned about “tax avoidance”" by Lone Star and Carrefour? And why has Lone Star chosen Belgium, with a higher corporate tax, and not Korea as the country to which it will pay tax on more than 4 trillion won ($4.4 billion) of profits from the sale of Korea Exchange Bank? The U.S. private equity fund said that the profit was not taxable in Korea because the sale is being conducted by LSF-KEB Holdings, a unit that the fund set up in Belgium as a holding company for the Korean lender.

Here is an answer. Capital gains realized by a company based in Belgium on shares in a domestic or foreign company are fully exempt from corporate income tax, according to the Belgian Ministry of the Economy. The Netherlands also exempt companies from capital gains tax and there are several more such countries, including Hong Kong and Singapore, according to the American Council for Capital Formation. “Although the Netherlands has a sophisticated tax system with high tax rates, some aspects of its fiscal system are extremely attractive,” Lowtax.net, a tax saving information agency, said on its Web site. “Attractive fiscal incentives are further enhanced by a complex network of double taxation treaties, few of which contain any anti-avoidance provisions.” And Belgium is a similar case, said the online information provider, which itself is based in a tax haven, the British Virgin Islands.

As more and more multinational companies are making use of differences in tax benefits between countries and loopholes in tax treaties, tax authorities of some countries are making moves to counter the practice. Japan and the UK kept Labuan, where offshore companies are exempt from income tax on their offshore activities, as an exception from their bilateral double taxation treaties with Malaysia. Seoul has also asked Malaysia to remove Labuan from the benefits of the double-tax arrangement between the countries but Kuala Lumpur has not yet responded to the substance of that request. The Korean government is also making other moves. But any changes will take time, and will probably not apply to the cases Koreans now rail at. The tax authorities are likely to focus their efforts on proving that those foreign investors’ business activities related to the profits Seoul wants to tax are actually based in Korea.

U.S. COMPANIES CAN CONSIDER LABUAN IOFC FOR ASIAN VENTURES

Companies from the U.S. can consider the Labuan International Offshore Financial Centre for their international ventures to tap the Asia Pacific market, International Trade and Industry Minister Datuk Seri Rafidah Aziz said. She said the IOFC offered a wide range of offshore financial products and services such as banking, fund management, insurance, investment holding, trust business, Islamic finance and investment banking. She cited the business-oriented legislative framework, tax incentives, strategic location in the Asia Pacific region, competitive operating costs, pool of professionals and good infrastructure as among the IOFC attractions.

Besides providing a competitive and cost-effective investment environment in Malaysia, the government is committed towards upholding intellectual property rights protection and has implemented several measures, Rafidah said. Among them are increasing the number of prosecution officers to 40 in 2004 compared to 20 in 2001, and the number of enforcement officers to 2,175 in 2006 from 1,430 in 2005, and upgrading of forensic laboratories to detect infringed copies. She said the country also established a dedicated Intellectual Property Rights Court recently. “Malaysia is also the frontrunner in providing the whole spectrum of Islamic financing products, which American companies can tap on,” she told 308 participants of the “Business Opportunities in Malaysia” seminar held here in conjunction with trade and investment mission led by her.

The 49-member mission aimed to inform the U.S. business communities about trade and investment opportunities, update them on Malaysia’s economic situation and woo investors, mainly to explore joint ventures and technical tie-ups. Irvine, California, marked the last leg of an 8-day mission that started on May 3 and similar seminars were held earlier in Toronto, Canada, and San Francisco, U.S. Malaysia, Rafidah pointed out, is also as an important hub for shared services, data centres, back office operations and call centers. Multinational companies which have set up such operations include Dell (call center), BMW and Hong Kong Bank (data centers), and Standard Chartered Bank, DHL, Shell and Citibank (back office operations), she said. AT Kearney’s Global Services Location Index ranked Malaysia for two consecutive years in 2004 and 2005 as the third most attractive business location for business process outsourcing, behind India and China. Hence, U.S. companies are encouraged to use Malaysia as their springboard to the bigger Asean market, she added.

MIDDLE EAST FRAUD WARNING

The Middle East will be an easy hunting ground for fraudsters until the region’s financial security measures match those of other countries, a leading expert told a conference in Bahrain. Sriram Natarajan, head of risk management for American Express in the Middle East and North Africa, warned that the lack of data available to banks on the area’s large expat population and the introduction of more effective credit card security in countries such as the UK had made parts of the GCC highly enticing to criminals.

Identity fraud is now a $54 billion enterprise and new technology designed to protect credit cards is in use in several European countries. But Natarajan told Bahrain Tribune, “The fraudsters are not going to go out of business. They will come here and to the other countries of the region. Somewhere like Dubai is so open because holders of so many passports can just walk straight through.” He detailed a raft of potential dangers for both financial institutions and the general public in the Gulf – from scheming individuals who default on loans to the vulnerability of the old style of credit cards in the region to fraud. “Skipping out on loans is a major menace. It’s pretty insidious. In Dubai when some people know they will be leaving the country they actually go shopping for loans. We have a clever section of the population who understand that banks are keen to lend and they take advantage of that.”

BUSH CREATES TASK FORCE TO FIGHT “HORROR” OF IDENTITY THEFT

Identity theft, in which a person’s personal and financial information is stolen and his or her identity is assumed by another, affected some 3.6 million U.S. households – or about 3% of the total in the U.S. – over a 6-month period in 2004, according to a U.S. Justice Department report. The estimated loss in those six months was about $3.2 billion, or an average of $1,290 per household, U.S. officials said. Bush said the panel has been created to “not only put those people who commit identity fraud in jail, but to help the victims of identity fraud.”

He also called attention to new U.S. laws cracking down on convicted identity thieves, imposing stiffer fines and prison terms. “I signed laws enhancing penalties. Now what we’re going to do is make sure that the 13 governmental agencies involved with identity theft have a well-coordinated strategy to help the victims and to put those who commit the theft behind bars,” the president said.

KPMG STILL IN PURSUIT OF MISSING CANADIAN HEDGE FUND DIAMONDS

KPMG says it has asked a Hong Kong judge to force Yu Jieying, sister-in-law of Boaz Manor, founder of bankrupt Canadian hedge fund Portus, to reveal the whereabouts of the $8.8 million worth of diamonds bought with investors’ money. It is known that Manor bought the diamonds in June 2004, with cash from a Bermuda bank. The gems, including one of 22-carats, were picked up from a shop on four visits by Yu Jieying, and passed on to private banker Yitzhak Toiv. Yu says that she acted on instructions from Manor’s wife, Wendy Yu, and had no idea what was in the packages. Manor himself has told Israeli questioners that Toiv still has the diamonds, but Toiv says he returned the gems to Yu.

Meanwhile, back in Canada, Boaz Manor and co-founder Michael Mendelson have been charged by the Ontario Securities Commission with failing to act in good faith with clients. Mendelson was also charged with unregistered trading and issuing securities without filing a prospectus. The maximum penalties are C$5 million and five years in jail. Earlier, Commission had successfully browbeaten 55 investment and mutual fund dealers into agreeing to repay investors all fees received from the failed hedge fund, totaling C$12 million.

But KPMG is not yet offering a time-horizon for payouts of the bulk of Portus’s assets. The firm says that C$662.15 million and about US$37.2 million have been found and secured in 130 Portus bank and investment accounts in Canada, the Turks and Caicos and the Cayman Islands, out of more than C$800 million that was collected by Portus. The majority of Portus assets remain tied up in notes issued by France’s Société Générale which were purchased for C$529 million, and mature between 2008 and 2011.

Fugitive hedge fund manager arrested.

Fugitive money manager Kirk Wright, missing for nearly three months after his Marietta, Georgia-based hedge fund caved in, was arrested at a Miami area hotel. Now that the CEO of International Management Associates has been found, authorities hope to find the bulk of missing funds belonging to about 500 mostly well-heeled investors. A small portion of the estimated $184 million from IMA accounts has been traced, and many angry clients have filed lawsuits against Wright and the company.

He is scheduled to be brought before a U.S. magistrate in Miami, then returned to Atlanta to face federal charges of mail fraud. Those charges represent the tip of the legal iceberg. The SEC has sued on five counts of fraud connected to the fund’s operation. And several investors have sued, the first group consisting primarily of former and current pro football players who typify the income strata that hedge funds attract. IMA, registered in 17 states, began to unravel when the NFL-connected investors sued in Fulton County Superior Court in February, claiming they were unable to withdraw funds from their accounts. A judge froze IMA’s assets and locked down company offices.

A court-appointed receiver has seized a few million dollars in assets, much of it personal property from the high-living Wright, who fancies expensive cars, has owned multiple residences and entertained guests in a Georgia Dome suite. He fled his Marietta home in late February and was AWOL until several leads from around the country pointed law enforcement to the Miami area hotel. Wright is suspected of fabricating financial statements provided to his clients, diverting the money either into bad investments or for personal use. His client list is top-heavy with athletes, active or retired. It includes ex-Denver Broncos star Terrell Davis and one-time teammate Steve Atwater, along with NBA standout Antawn Jamison and Georgia Tech alumnus Willie Clay. Wright, who is black, is believed to have relocated in the Atlanta area six years ago to tap into the growing class of affluent African-Americans here. His roster of investors includes black doctors and other professionals, though it includes many white clients as well.

PRIVACY

THE SPIES WHO SHAG US

I know you are shocked – SHOCKED! – that George Bush is listening in on all your phone calls. Without a warrant. That is nothing. And it is not news. But this is: The snooping into your phone bill is just the snout of the pig of a strange, lucrative link-up between the Administration’s Homeland Security spy network and private companies operating beyond the reach of the laws meant to protect us from our government. You can call it the privatization of the FBI – though it is better described as the creation of a private KGB.

The leader in the field of what is called “data mining”, is a company, formed in 1997, called, “ChoicePoint, Inc,” which has sucked up over $1 billion in national security contracts. Worried about Dick Cheney listening in Sunday on your call to Mom? That ain’t nothing. You should be more concerned that they are linking this info to your medical records, your bill purchases and your entire personal profile including, not incidentally, your voting registration. Five years ago, I discovered that ChoicePoint had already gathered 16 billion data files on Americans – and I know they have expanded their ops at an explosive rate.

They are paid to keep an eye on you – because the FBI cannot. For the government to collect this stuff is against the law unless you are suspected of a crime. (The law in question is the Constitution.) But ChoicePoint can collect if for “commercial” purchases – and under the Bush Administration’s suspect reading of the Patriot Act – our domestic spying apparatchiks can then BUY the info from ChoicePoint.

Who ARE these guys selling George Bush a piece of you? ChoicePoint’s board has more Republicans than a Palm Beach country club. It was funded, and its board stocked, by such Republican sugar daddies as billionaires Bernie Marcus and Ken Langone – even after Langone was charged by the SEC with abuse of inside information. I first ran across these guys in 2000 in Florida when our Guardian/BBC team discovered the list of 94,000 “felons” that Katherine Harris had ordered removed from Florida’s voter rolls before the election. Virtually every voter purged was innocent of any crime except, in most cases, Voting While Black. Who came up with this electoral hit list that gave Bush the White House? ChoicePoint, Inc. And worse, they KNEW the racially-tainted list of felons was bogus. And when we caught them, they lied about it. While they have since apologized to the NAACP, ChoicePoint’s ethnic cleansing of voter rolls has been amply assuaged by the man the company elected.

And now ChoicePoint and George Bush want your blood. Forget your phone bill. ChoicePoint, a sickened executive of the company told us in confidence, “hope[s] to build a database of DNA samples from every person in the United States … linked to all the other information held by CP [ChoicePoint]” from medical to voting records. And ChoicePoint lied about that too. The company publicly denied they gave DNA to the Feds – but then told our investigator, pretending to seek work, that ChoicePoint was “the number one” provider of DNA info to the FBI. “And that scares the hell out of me,” said the executive (who has since left the company), because ChoicePoint gets it WRONG so often. We are not contracting out our Homeland Security to James Bond here. It is more like Austin Powers, Inc. Besides the 97% error rate in finding Florida “felons”, Illinois State Police fired the company after discovering ChoicePoint had produced test “results” on rape case evidence … that did not exist. And ChoicePoint just got hit with the largest fine in Federal Trade Commission history for letting identity thieves purchase 145,000 credit card records.

But how can they get Americans to give up our personal files, our phone logs, our DNA and our rights? Easy. Fear sells better than sex – and they want you to be afraid. Consider a story about a weird new law passed by the state of Georgia to fight illegal immigration. Every single employer and government agency will be required to match citizen or worker data against national databases to affirm citizenship. It will not stop illegal border crossing, but hey, someone is going to make big bucks on selling data. And guess what local boy owns the data mine? ChoicePoint, of Alpharetta, Georgia.

That is the Fear Industry for you. You are not safer from terrorists or criminals or “felon” voters. But the national wallet is several billion dollars lighter and the Bill of Rights is a couple amendments shorter. And that is their program. They get the data mine – and we get the shaft.

HOW THE NSA DOES “SOCIAL NETWORK ANALYSIS”

Last week, USA Today reported that the NSA has been collecting the phone records of millions of Americans. The agency is apparently using “data mining” techniques to scour these records for connections between terrorists. According to an intelligence official interviewed, the NSA is analyzing this data using “social network analysis”. Social network analysis is a technique to map and study the relationships between people or groups. The basic concept of the social network is familiar to anyone who has used Friendster or played Six Degrees of Kevin Bacon. Social network analysis formalizes this parlor game, using details about the network to interpret the role of each person or group.

In a basic analysis, people are seen as “nodes” and the relationships between them are “links”. By studying the links – in the case of the NSA program, telephone calls – it is possible to determine the importance (or “centrality”) of each node. There are several ways to determine which members of a network are important. The most straightforward technique is to figure out a member’s “degree”, or the number of direct connections he has to other members of the network. With groups that are decentralized and complex, like terrorist cells, other measures of centrality are important as well. Network analysts also study the “betweenness” and the “closeness” of members. A member with relatively few direct connections could still be important because he serves as a connector between two large groups. A member might also be important because his links, direct and indirect, put him closest to all other members of the group (i.e., he has to go through fewer intermediaries to reach other members than anyone else).

Network analyst Valdis Krebs set out to prove after 9-11 that networks could help uncover terrorist cells. Working from publicly available information, Krebs showed that all 19 hijackers were within two connections of the al-Qaida members the CIA knew about in early 2000. Krebs’ network map also showed that Mohamed Atta was a central figure. It is not clear whether such analysis could have been performed in advance, when researchers would not have been certain which links were significant connections to another terrorist and which were casual connections to an acquaintance.

There are two schools of thought on whether large data sets like the NSA’s database of phone records help or hinder network analysis. One group argues that adding lots of innocuous data (the phone calls of ordinary Americans) will cloud the picture, and that it is better to construct a network by looking only at calls made to and from known terrorists. Another group maintains that large data sets are useful in establishing a “baseline” of normal behavior. Social network analysis has been used in many areas besides terrorist surveillance. Google’s PageRank system is based on network theory and the concept of “centrality”.

ZFONE’S KEY ENCRYPTION PROTOCOL IMPLEMENTS LESSONS LEARNED FROM PGP

Zfone is PGP creator Phil Zimmermann’s latest brainchild, a small desktop application that encrypts VoIP softphone conversations using strong encryption and peer-to-peer communication. Zimmermann released the first public beta in March. While I am intrigued by the concept, getting the application to work is another story. Zfone runs as a standalone app, outside of your VoIP client. To use it, you must use a Session Initiation Protocol (SIP) softphone that allows you to specify the port settings in accordance with Zfone’s documentation. Zfone encrypts the Real-time Transport Protocol (RTP) stream (which carries the audio packets), not the SIP channel that does call setup and teardown.

Neither party in a call needs a persistent “key” as is used in the PGP email security model, and there is no public key infrastructure. Instead, when Zfone clients connect, they perform a Diffie-Hellman key exchange, creating a “shared secret”. The shared secret is then used to establish a secure channel over which communication takes places. The parties can verbally check a short verification code computed by Zfone. If they both see the same code, then the call has not been intercepted. When the call is terminated, the keys are destroyed. Zimmermann has submitted a draft proposal to the Internet Engineering Task Force (IETF) for ZRTP, and cites Zfone as a reference implementation.

With ZTRP, there is no worrying about forgetting your pass phrase, keeping your private key safe from compromise, or the hassles of creating, distributing, and signing a new key. Reliance on a PKI is the millstone tied around the neck of PGP. Users find it both arduous and (at times) confusing. Is it any wonder that after more than a decade of free implementations, patents passing into the public domain, and relaxed U.S. export laws, almost all email is still transmitted in the clear? The Zfone app demonstrates that it is possible to add a secure layer to VoIP without requiring any additional support from hardware vendors, SIP providers, or network operators. It is great to see that ZTRPt will be usable even with closed-source softphones such as Gizmo.

And since ZRTP is designed to stay out of the way if either party to the call lacks support for it, providing support for it does not corral users into an encrypted-only ghetto, able to talk only to each other. Zimmermann may be in the process of turning Zfone into a commercial product – perhaps targeting hardware manufacturers instead of individual desktop users. Even if he does so, and pulls all free versions of the app, by proposing ZRTP as an IETF standard he is opening the door for free software developers to secure VoIP communication while it is still in its infancy. If we wait too long to do so, as with email, before we know it it will be too late.

BRITISH LEGISLATION TO ENFORCE ENCRYPTION KEY DISCLOSURE

The British government is preparing to give its police the authority to force organizations and individuals to disclose encryption keys, a move that has outraged some security and civil-rights experts. The legislation that gives the police such authority is contained within Part 3 of the Regulation of Investigatory Powers Act. The RIP Act, also known as RIPA, was introduced in 2000, but the government has held back from bringing Part 3 into effect. Now, more than five years after the original act was passed, the Home Office is seeking to exercise the powers within Part 3.

Some security experts are concerned that the plan could criminalize innocent people and drive businesses out of the U.K. But the Home Office, which has just launched a consultation process, says the legislation contained in Part 3 is needed to combat an increased use of encryption by criminals, pedophiles and terrorists. “The use of encryption is … proliferating,” Liam Byrne, Home Office minister of police and security, told Parliament last week. “Encryption products are more widely available and are integrated as security features in standard operating systems, so the government has concluded that it is now right to implement the provisions of Part 3 of RIPA … which is not (currently) in force.” Part 3 of the RIP Act gives the police powers to order the disclosure of encryption keys or force suspects to decrypt encrypted data. Anyone who refuses to hand over a key to the police would face up to two years of imprisonment. Under current antiterrorism legislation, terrorist suspects now face up to five years for withholding keys.

If Part 3 is passed, financial institutions could be compelled to give up the encryption master keys they use for banking transactions, security experts have warned. “The controversy here (lies in) seizing keys, not in forcing people to decrypt. The power to seize encryption keys is spooking big business,” said Cambridge University security expert Richard Clayton. “The notion that international bankers would be wary of bringing master keys into [the UK] if they could be seized as part of legitimate police operations, or by a corrupt chief constable, has quite a lot of traction,” Clayton added. “With the appropriate paperwork, keys can be seized. If you’re an international banker, you’ll plunk your headquarters in Zurich.”

Opponents of the RIP Act have argued that the police could struggle to enforce Part 3, as people can argue that they do not possess the key to unlock encrypted data in their possession. Clayton backed up this point. “The police can say, ‘We think he’s a terrorist’ or ‘We think he’s trading in kiddie porn’, and the suspect can say, ‘No, they’re love letters; sorry, I’ve lost the key.’ How much evidence do you need (to convict)? If you can’t decrypt (the data), then by definition, you don’t know what it is.”

THE ETERNAL VALUE OF PRIVACY

The most common retort against privacy advocates – by those in favor of ID checks, cameras, databases, data mining and other wholesale surveillance measures – is the line, “If you are not doing anything wrong, what do you have to hide?” Some clever answers include (1) “If I am not doing anything wrong, then you have no cause to watch me.” (2) Because the government gets to define what is wrong, and they keep changing the definition. And (3) Because you might do something wrong with my information. My problem with quips like these – as right as they are – is that they accept the premise that privacy is about hiding a wrong. It is not. Privacy is an inherent human right, and a requirement for maintaining the human condition with dignity and respect.

Two proverbs say it best: Quis custodiet custodes ipsos? (“Who watches the watchers?”) and “Absolute power corrupts absolutely.” Cardinal Richelieu understood the value of surveillance when he famously said, “If one would give me six lines written by the hand of the most honest man, I would find something in them to have him hanged.” Watch someone long enough, and you will find something to arrest – or just blackmail – with. Privacy is important because without it, surveillance information will be abused – to peep, to sell to marketers and to spy on political enemies … whoever they happen to be at the time. Privacy protects us from abuses by those in power, even if we are doing nothing wrong at the time of surveillance.

We do nothing wrong when we make love or go to the bathroom. We are not deliberately hiding anything when we seek out private places for reflection or conversation. We keep private journals, sing in the privacy of the shower, and write letters to secret lovers and then burn them. Privacy is a basic human need. A future in which privacy would face constant assault was so alien to the framers of the Constitution that it never occurred to them to call out privacy as an explicit right. Privacy was inherent to the nobility of their being and their cause. Of course being watched in your own home was unreasonable. You ruled your own home. It is intrinsic to the concept of liberty.

For if we are observed in all matters, we are constantly under threat of correction, judgment, criticism, even plagiarism of our own uniqueness. How many of us have paused during conversation in the past 4½ years, suddenly aware that we might be eavesdropped on? Probably it was a phone conversation, although maybe it was an e-mail or instant-message exchange or a conversation in a public place. Maybe the topic was terrorism, or politics, or Islam. We stop suddenly, momentarily afraid that our words might be taken out of context, then we laugh at our paranoia and go on. But our demeanor has changed, and our words are subtly altered.

This is the loss of freedom we face when our privacy is taken from us. This is life in former East Germany, or life in Saddam Hussein’s Iraq. And it is our future as we allow an ever-intrusive eye into our personal, private lives. Too many wrongly characterize the debate as “security versus privacy”. The real choice is liberty versus control. Liberty requires security without intrusion, security plus privacy. Widespread police surveillance is the very definition of a police state. And that is why we should champion privacy even when we have nothing to hide.

LAW

NEWSPAPER REPORTS NSA COLLECTING PHONE RECORDS

Congressional Republicans and Democrats demanded answers from the Bush administration about a report that the government secretly collected records of ordinary Americans’ phone calls to build a database of every call made within the country. “It is our government, it’s not one party’s government. It’s America’s government. Those entrusted with great power have a duty to answer to Americans what they are doing,” said Sen. Patrick Leahy of Vermont, the ranking Democrat on the Senate Judiciary Committee.

AT&T, Verizon Communications, and BellSouth telephone companies began turning over records of tens of millions of their customers’ phone calls to the National Security Agency program shortly after September 11, 2001, said USA Today, citing anonymous sources it said had direct knowledge of the arrangement. The Republican chairman of the Senate Judiciary Committee, Sen. Arlen Specter of Pennsylvania, said he would call the phone companies to appear before the panel “to find out exactly what is going on.” The companies said that they are protecting customers’ privacy but have an obligation to assist law enforcement and government agencies in ensuring the nation’s security. The White House defended its overall eavesdropping program and said no domestic surveillance is conducted without court approval.

On Capitol Hill, several lawmakers expressed incredulity about the program, with some Republicans questioning the rationale and legal underpinning and several Democrats railing about the lack of congressional oversight. “I don’t know enough about the details except that I am willing to find out because I’m not sure why it would be necessary to keep and have that kind of information,” said House Majority Leader John Boehner, R-Ohio. Republican Sen. Lindsey Graham, R-S.C., told Fox News Channel, “The idea of collecting millions or thousands of phone numbers, how does that fit into following the enemy?”

The program does not involve listening to or taping the calls per se. Instead it documents who talks to whom in personal and business calls, whether local or long distance, by tracking which numbers are called. NSA is the same spy agency that conducts the controversial domestic eavesdropping program that has been acknowledged by President Bush. The president said last year that he authorized the NSA to listen, without warrants, to international phone calls involving Americans suspected of terrorist links.

Abolish both the Hayden nomination and NSA.

The nomination of Gen. Michael V. Hayden, the National Security Agency’s former director, to replace the disastrously incompetent Porter Goss as Director of the CIA, should be rejected on the grounds that Hayden subverted the U.S. Constitution. In addition, the public debate about the efficacy of the recent intelligence reorganization should lead to the abolishment of his former agency and the inclusion of its more legitimate functions into a slimmed down and more agile intelligence community.

In an effort to save the Hayden nomination, intelligence officers, through leaks to the press, are arguing that only Hayden’s heroic efforts against Vice President Dick Cheney’s juggernaut limited the warrantless NSA eavesdropping program to cases where a caller in the U.S. was calling abroad or receiving a call from there. They say the V.P. believed, under his expansive theory of executive power, that the president could eavesdrop on purely domestic calls as well in order to preserve national security. But Hayden should be held accountable for suggesting the expansion of NSA’s activities into warrantless spying in the first place.

What part of the Fourth Amendment to the Constitution does the general not understand? The amendment states: The right of the people to be secure in their persons, houses, papers, and effects, against unreasonable searches and seizures, shall not be violated, and no warrants shall issue, but upon probable cause, supported by oath or affirmation, and particularly describing the place to be searched, and the persons or things to be seized.

The amendment clearly intends that a warrant is needed for all searches – which includes modern-day eavesdropping and wiretapping – and specifically states that warrants should not even be issued unless government officials can attest that there is “probable cause” that a crime has been committed. The highest law of the land deems the right of U.S. citizens to be protected against the government’s potent police power to be so important that it creates no exemption for “national security”. The artificial distinction the Bush administration has made between the international and domestic calls of people in the United States is ludicrous and has no basis in law. Hayden was advocating subverting the Constitution to expand the activities of his agency.

Also, under Hayden’s watch at NSA, he approved a program to attempt to keep track of every phone call in the U.S., whether made within the boundaries of the country or involving a party abroad. The Bush administration maintains that this is not eavesdropping but merely keeping track of callers, recipients, and calling patterns so that they can be mined to uncover terrorist activities. Can Americans really believe the president’s claim that the creation of such an expensive database does not mean that the government is spying or will spy on the hundreds of millions of people whose calls are on file? The government has a long history of illegal and unconstitutional spying on individuals. Also, this argument resembles Bill Clinton’s claim that he smoked marijuana but didn’t inhale – verbal gymnastics do not reduce the illegality of the action. The program also seems to violate the portion of the Fourth Amendment requiring specific, rather than general, searches.

But scrapping Hayden’s nomination to be CIA director is not enough. Those in the intelligence community who believed that spying on people in the U.S. could discredit spy agencies were right in the case of NSA. The NSA has been so discredited by its warrantless spying and data mining that it is time to reorganize the agency out of existence.

ABC claims government traced its reporters’ calls.

ABC News claimed that phone calls made by its reporters and journalists at the New York Times and Washington Post are being traced by the federal government as part of an investigation into leaks of classified information. In a blog posting, the network said two of its reporters, Richard Esposito and Brian Ross, were told by an unnamed senior federal official that the government had obtained records of calls placed by the two men. The network said the probe may be focused on leaks about a CIA program to detain terrorism suspects at secret locations outside America, but could also involve the network’s reports on the spy agency’s use of missile-firing Predator drones in Pakistan. ABC did not assert that its reporters’ conversations were being listened in on, but solely that the government had obtained information on whom reporters were calling.

This time, it really is Orwellian.

Given George W. Bush’s history of outright lying, especially on national security matters, it may seem silly to dissect his words about the new disclosure that his administration has collected phone records of some 200 million Americans. But Bush made two parse-able points in reacting to USA Today’s story about the National Security Agency building a vast database of domestic phone calls. “We’re not mining or trolling through the personal lives of millions of innocent Americans,” Bush said, adding “the privacy of ordinary Americans is fiercely protected in all our activities.”

In his brief remarks, however, Bush did not define what he meant by “ordinary Americans” nor whether the data-mining might cover, say, thousands or even hundreds of thousands of people, just not “millions”. For instance, would a journalist covering national security be regarded as an “ordinary American”? What about a political opponent or an anti-war activist who has criticized administration policies in the Middle East? Such “unordinary” people might number in the tens of thousands, but perhaps not into the millions.

Also, is it not reasonable to suspect that the Bush administration would be tempted to tap into its huge database to, say, check on who might have been calling reporters where significant national security stories have been published? Or during Campaign 2004, would the White House political apparatchiks not have been eager to know whether, say, Sen. John Kerry had been in touch with foreign officials who might have confided that they were worried about Bush gaining a second term? Or what about calls to and from special prosecutor Patrick Fitzgerald while he investigates a White House leak of the identity of Valerie Plame, the CIA officer married to former Ambassador Joseph Wilson, an Iraq War critic? What if one of these “unordinary” Americans had placed a lot of calls to an illicit lover or a psychiatrist? Would Bush’s aggressive political operatives not know just how to make the most of such information?

Even before the USA Today disclosure on May 11, it was clear that Bush’s spying program was much larger than he had let on. Indeed, the operation was reportedly big enough to generate thousands of tips each month, which were passed on to the FBI. “But virtually all of [the tips], current and former officials say, led to dead ends or innocent Americans,” the New York Times reported. Also, undermining Bush’s claims about the limited nature of the NSA’s activities is why the administration would need to possess the complete phone records of the 200 million customers of AT&T, Verizon and BellSouth – if the government were only conducting what Bush and his aides have called a “targeted terrorist surveillance program”. The stated goal of tracking phone numbers that had been called by al-Qaeda operatives could be easily done with warrants from the FISA court. There would be no need to compile every personal and business call made by 200 million Americans.

In describing Bush’s policies over the past several years, the word “Orwellian” has sometimes been overused. But a government decision to electronically warehouse the trillions of phone numbers called by its citizens over their lifetimes is the essence of George Orwell’s Big Brother nightmare.

COUPLE ARRESTED FOR ASKING FOR DIRECTIONS

Baltimore City police arrested a Virginia couple over the weekend after they asked an officer for directions. Joshua Kelly and Llara Brook, of Chantilly, got lost leaving an Orioles game on Saturday. Collins reported a city officer arrested them for trespassing on a public street while they were asking for directions. “In jail for eight hours – sleeping on a concrete floor next to a toilet,” Kelly said. “It was a nightmare,” Brook said. “I was in there thinking I was just dreaming and waiting to wake up.”

Collins reported it was a nightmare ending to a nearly perfect day. He said the couple went to a company picnic and watched the Orioles beat Kansas City. It was their first trip to Camden Yards and asked two people for directions to Interstate 95 South when they left. Collins said somehow they ended up in the Cherry Hill section of south Baltimore. Hopelessly lost, relief melted away concerns after they spotted a police vehicle. “I said, ‘Thank goodness, could you please get us to 95?’” Kelly said.

“The first thing that she said to us was no – you just ran that stop sign, pull over,” Brook said. “It wasn’t a big deal. We’ll pay the stop sign violation, but can we have directions?”

“What she said was ‘You found your own way in here, you can find your own way out.’” Kelly said. Collins said the couple spotted another police vehicle and flagged that officer down for directions. But Officer Natalie Preston, a six-year veteran of the force, intervened. “That really threw us for a loop when she stepped in between our cars,” Kelly said. “(She) said my partner is not going to step in front of me and tell you directions if I’m not.”

Collins reported the circumstances got worse. Kelly pulled 40 feet forward parking next to a curb and put his flashers on while Brook was on the phone to her father hoping he could help her with directions. “(Brook’s father) was in the middle of giving us directions when the officer screeched up behind us and got out of the car and asked me to step out. I obeyed,” Kelly said. “I obeyed everything – stepped out of the car, put my hands behind my back, and the next thing I know, I was getting arrested for trespassing.”

Collins said the couple was released from jail without being charged with anything. Brook is now concerned the arrest may complicate a criminal background check she is going through in her job as a child care worker. Collins said police left Kelly’s car unlocked and the windows down at the impound lot. He reported a cell phone charger, pair of sunglasses and 20 CDs were stolen. Baltimore City police said they are looking into the incident.

UNITED 93 BROUGHT DOWN BY GUN CONTROL LAWS

Go see “United 93”, the movie, quickly, while it is still in circulation. Every gun rights patriot will recognize that the final cause of the crash can be placed at the feet of the political gun grabbers. Once the plane was in the air, nobody could have prevented the crash except those on board. Therefore, IF passengers had not been totally disarmed by the metal detectors at the airports and IF pilots had not been disarmed by the FAA 14 years ago, THEN there would have surely been a couple of passengers with concealed weapons who could have dropped the hijackers. Instead, all passengers were disarmed. And the pilots were helpless in the face of the determined hijackers, who routed them out of their seats.

This picture is living proof that disarming the law-abiding public leaves the bad guys in charge. As shown in the movie, the hijackers were able to smuggle plastic explosives through the metal detectors. Thus, one determined bad guy was able to resist the retaliation of 63 outraged but unarmed passengers. According to the portrayal in the movie, the passengers did NOT break down the cockpit door and gain entry into the cockpit. The hijacker-pilots voluntarily drove the plane into the ground.

At the point when the passengers realized they were on a suicide mission, they quietly asked the flight attendants for help in scrounging knives, hammers, screwdrivers, weapons of any kind, from the galley. A true gun rights patriot will recognize this series of fatal events. Thus we all owe it to our families and friends to make them aware of these outcomes. I have not read any mention of this element by any movie reviewer. It completely went by them.

OPINION & ANALYSIS

APOCALYPSE NOW?

“To bomb, or not to bomb?” asks the cover of the April 24 issue of The Weekly Standard, and if you know the magazine, you can guess the answer, provided by an editorial and two articles within. The U.S. must attack Iran soonest. The dithering of the Bush administration must cease. The mad mullahs who are trying to get nuclear weapons threaten not only the United States, but Israel. Time for another preemptive war, complete with regime change, democracy, and purple fingers.

Such is the conclusion of the brainy neoconservatives who gave us the Iraq war. Evidently they trust the Bush team to manage a far more difficult war against Iran with equal finesse. Sure, they admit there will be costs. Terrorism will erupt throughout the Middle East and elsewhere, maybe even in the U.S. itself. The Europeans will not like it. Anti-Americanism will spread explosively around the world. And of course there will be countless other unpredictable consequences (on oil prices, to begin with). All this can be expected even if we assume that the Bush team brings it off with more competence than it has brought to previous crises. Vice President Cheney summed up the administration’s pragmatic view when we faced the threat of Saddam Hussein’s weapons of mass destruction: “The risks of inaction are greater than the risks of action.” Words to live by!

Islam, Bush has said, is a religion of peace that has been hijacked by a few fanatics. Some, observing him, might say the same about Christianity. Bush makes one wonder where religion ends and psychosis begins. Is his foreign policy driven by a conviction that we are in the End Times, and that the Lord has anointed him to lead us? Is it mere accident that many of his remaining supporters believe so? The scandal of our time is that so many important people have failed to say what is obvious and urgent: that this president is out of his mind. Whether it is clinical madness or fanaticism, it is something more serious, and more dangerous, than stupidity. And the men around him cannot or will not restrain him.

DECLINE AND FALL OF THE ROMAN MYTH

Nobody ever called themselves barbarians. It is not that sort of word. It is a word used about other people. It was used by the ancient Greeks to describe non-Greek people whose language they could not understand and who therefore seemed to babble unintelligibly – “ba ba ba”. The Romans adopted the Greek word and used it to label (and usually libel) the peoples who surrounded their own world. The Roman interpretation became the only one that counted, and the peoples whom they called Barbarians became for ever branded – be they Spaniards, Britons, Gauls, Germans, Scythians, Persians or Syrians. And, of course, “barbarian” has become a byword for the very opposite of everything that we consider civilized.

The Romans kept the Barbarians at bay for as long as they could, but finally they were engulfed and the savage hordes overran the empire, destroying the cultural achievements of centuries. The light of reason and civilization was almost snuffed out by the Barbarians, who annihilated everything that the Romans had put in place, sacking Rome itself and consigning Europe to the Dark Ages. The Barbarians brought only chaos and ignorance, until the renaissance rekindled the fires of Roman learning and art. It is a familiar story, and it’s codswallop.

The unique feature of Rome was not its arts or its science or its philosophical culture, not its attachment to law. The unique feature of Rome was that it had the world’s first professional army. Western society’s enthusiasm since the renaissance for all things Roman has persuaded us to see much of the past through Roman eyes, even when contrary evidence stares us in the face. Once we turn the picture upside-down and look at history from a non-Roman point of view, things start to look very, very different.

LIBERTARIANS, SOCIALISTS, AND THE WHISKEY REBELLION

In the summer and fall of 1794, President George Washington, Secretary of the Treasury Alexander Hamilton, and General Henry Lee began making mass arrests of American citizens. Authorized neither by warrants nor by any resolution of Congress, federal troops rousted from beds, rounded up, and detained on no charge hundreds of people against whom the executive branch knew it had no evidence. Officers administered warrantless searches and seizures of property and subjected would be hanged unless they gave false testimony against the elected officials who had vainly opposed this and other executive-branch policies and operations.

After spending various lengths of time in privation and fear, most of the detainees were released. Detachments of troops meanwhile arrived at every home, in a region defined solely for the purposes of this operation, and required every male over the age of 18 to sign an oath of loyalty to the government. Not surprisingly, most people complied. Then, in the winter, the few remaining detainees were marched almost 400 miles to the capital, poorly shod and clothed, under the authority of an officer well-known by his superiors for the pleasure he took in denigrating prisoners. On arrival, the suspects were paraded in the streets as victory trophies, then imprisoned under conditions that were even more extreme than normal. Some still had not been charged with a crime. Others had been charged only because the presiding federal judge – whom President Washington’s orders explicitly subordinated to an ad hoc military authority – himself felt intimidated by the federal troops and allowed indictments on what he later said he considered insufficient evidence.

In the end, therefore, juries indicted few and convicted almost none of the prisoners, many of whom had been left in jail for many months. Failure to prosecute did not inhibit the president from stationing federal troops indefinitely in the region where he had rounded up those and so many others. The military occupied the area, directing and assisting the civil judiciary. In that process, the sovereignty of the United States was at last established.

Although a disturbingly large number of otherwise well-informed history readers are not aware of those activities of the first executive branch of U.S. government, a good many libertarian students of American history do know about the 1794 suppression, know too that it came in response to a series of protests, petitions, acts of violence against federal officers, skirmishes with soldiers of the U.S. Army, and threats of outright insurrection and regional secession, which Secretary Hamilton – adding insult to injury – trivialized for all time as “the whiskey rebellion”. Hamilton’s insult was well calculated. It achieved the obliteration from history of the seriousness of his rural opponents’ criticisms of federal economic policy.

What is not an issue in the competing visions are the Whiskey Rebellion’s central importance, wide extent, and impressive success in obstructing federal policy; the denial by mainstream historians of all of those qualities; and the outrage to supposedly fundamental American values of the rebellion’s suppression. What is at issue? Who the whiskey rebels were; how they viewed the relationships among government, economics, democracy, and liberty; and what they wanted. Who gets the Whiskey Rebellion right? Here the author must abruptly intrude. For my new book The Whiskey Rebellion: George Washington, Alexander Hamilton, and the Frontier Rebels Who Challenged America’s Newfound Sovereignty – a narrative history of the Rebellion for general readers, in which I do not shirk from confronting founding finance – I studied the primary record exhaustively, and delved into everything scholarly I could find on that and all related subjects. And I drew my own conclusions. Though libertarians and socialists have long been virtually the only keepers of the Whiskey Rebellion flame, I now believe that living through the Rebellion will challenge not only consensus mainstream historians but also both left and libertarian students of American history.