Offshore News Digest for Week of July 30, 2007

GLOBAL LIVING & BUSINESS

THE DECLINE OF WESTERN INCOMES

Recent negative earnings surprises by Pfizer and Caterpillar may indicate a new reality: The income premium for being a Westerner and having access to the centuries of Western intellectual property and business acumen may be sharply diminishing. We can all rejoice as poor and middle income countries are brought up to Western levels of affluence, but our rejoicing will presumably be sharply diminished if we come to realize that much of their gains may be at the expense of our children’s living standards.

The vision of the world of 2050 or 2100, in which the great majority of Third World peoples enjoy more or less Western living standards, has always been a but fuzzy. 30 years ago, if you had asked people to imagine the world of 2050, all but the most manically environmentalist would have envisaged Third World residents enjoying living standards comparable to those of current Westerners, while the affluent West had reached living standards that could currently be dreamed of only by an affluent few.

The more thoughtful would have recognized that there was simply not enough space for the squirearchical dream of robot servants for all, together with country houses and rolling parklands. However the 18th century customers of Capability Brown did not enjoy modern plumbing, found travel impossibly time-consuming and uncomfortable, and had a nasty tendency to die in childbirth at 30 or of flying gout at 50. 2100’s median Western real income of $250,000 or so would have to be spent differently, but the income itself seemed pretty assured, given the continuance of technological development.

That is no longer the case. Elite opinion remains wedded to globalization as the best of possible economic policies, and believes with fanatical devotion that David Ricardo’s Doctrine of Comparative Advantage will ensure that there will be no significant class of people, even in rich countries, who lose out because of it. However it is becoming increasingly obvious to the populace as a whole that globalization produces substantial numbers of losers, particularly among the less well educated inhabitants of Western countries. No amount of cheaper consumer goods will assuage your pain if you have been forced to exchange a $25 an hour factory job for a $8 an hour service job.

I have discussed previously the effect of outsourcing and international migration on living standards at the bottom of the scale. Here I want to examine the extent that the advantages which have traditionally kept Western countries affluent – in particular those of financial capital, intellectual capital and a near-monopoly on innovation – are all losing their power to differentiate living standards.

The period of monetary expansion since 1995 has reduced both interest rates and risk premiums on emerging market investments. This has caused a huge reorientation in the world financial markets, albeit so far of a very comfortable type. The lack of credit discrimination in world bond markets, for example, is shown by the total lack of emerging market defaults since Argentina in 2001-02. Capital has become more readily available for emerging markets, narrowing their traditional capital cost disadvantage against Western countries and speeding the process of outsourcing and resource transfer to cheap-labor environments.

If this were all that had happened, it would be a purely temporary phenomenon. Once monetary policy was finally tightened and interest rates rose, risk premiums would reappear and the flow of resources to emerging markets would be correspondingly slowed. However, on the savings side, very low interest rates and continued asset price inflation have depressed savings rates in Western countries far below their historical norms. This has caused not only an excess in consumption but also in the U.S. a persistent and very large payments deficit that has transformed the country as a whole into the world’s largest debtor.

This is much more serious. Once interest rates rise again, the U.S. and much of Europe will find themselves in a major savings deficit position, having run down their savings through consumption and devoted excessive amounts of capital to unproductive investments such as luxury housing. Asset prices will decline, causing bankruptcy among those consumers who have over-borrowed on mortgages and credit cards, and the world’s capital stock will be found largely concentrated in Asian countries such as China, Taiwan, and (because of high oil prices) the Middle East, where savings rates have remained robust.

At that point, the wealth of the West will no longer be an advantage to it in the search for resources. Instead the major Asian countries will have the lowest real interest rates and capital will flow to projects in those countries, which will offer the prospect of the greatest net returns. The imagined nightmare of the late 1980s, in which Japan’s lower capital costs were thought likely to transfer much of the West’s industrial base to Tokyo, will be played out in reality on a much larger scale with respect to East Asia as a whole. With lower capital investment and higher financing costs, the West’s living standards will inevitably enter relative decline.

Intellectual property (IP) is a second area where the value of the West’s assets is declining. As globalization intensified in the 1990s, the major Western media, IT and pharmaceutical companies saw it as an opportunity. Poor countries could only be expected to buy modest quantities of U.S. software, media products and drugs, and would operate active black markets to keep prices low. However countries that were becoming richer, and exporting their products to the West, could be compelled to enforce intellectual property rights, raising the domestic prices of software, media products and pharmaceuticals to world levels. U.S. IP owners imposed a draconian new copyright regime in 1998, they ensured that the WTO’s membership rules included protection of IP, and they pushed for a further extension of Western IP rights via the Doha round of trade talks.

This effort is now coming unstuck. The widespread adoption of broadband technology and high-level cellphones have increased the means by which media products can be reproduced to such a point that it appears unlikely that rights owners can protect their property adequately, except to a limited extent in their domestic markets. The slowing rate of innovation hardware has made “open source” software much more competitive with copyright software, so that the Linux operating system now has a world market share of 15% and the Firefox browser a market share of 25%. The Doha round of trade talks has collapsed, as dying Western farming industries proved themselves more politically powerful than soaring Western IP owning industries.

Probably most important in terms of long term value, two changes have weakened the hold of the major pharmaceutical companies on the patent system. First, new competitors have arisen in emerging markets, and their research capabilities have become comparable to those of the drug majors. Thus in any third country in which property rights are weak, drug buyers will quickly have a credible alternative to patented drugs, manufactured outside the magic circle of the major Western drug companies. Second, drug research itself is changing. Many of the new drugs invented in the future will be designed through gene manipulation, and will be effective only for patients with the appropriate genetic markers. With more new drugs being invented and smaller potential markets for each one, the patented “blockbuster” drug is likely to disappear, and Third World drug manufacturers with lower research and manufacturing costs will prove themselves highly competitive against the majors.

Intellectual property is not just a mechanism to reward the likes of Time Warner, Microsoft and Pfizer, it is the principal barrier to entry protecting millions of highly paid skilled workers in Western countries. If that barrier disappears, and those workers are subjected to competition from countries with much lower labor costs, their living standards must inevitably decline.

Finally, the West has lost its near-monopoly on innovation. Knowledge, capital and entrepreneurial skill are much more broadly shared globally than was the case in the past, so a much higher share of innovation, in the form both of new products and new ideas, will come from non-traditional sources. This is important. Innovative products and services, by definition, face limited competition in their earlier years and so can bear higher prices than would be the case if their provision were fully competitive. Again, not only will Western entrepreneurs find returns lower and commoditization faster than was previously the case, but the returns to higher education will also decline, as a Ph.D. from Harvard will prove to be worth little more than a Ph.D. from Kolkata.

Westerners have always supposed that a free-market regime and high levels of international trade will allow the world’s economic growth to accelerate, providing higher living standards not only for the newly enfranchised citizens of emerging markets, but also for Westerners themselves. There is in reality no reason why this should necessarily be the case. If the West’s advantages of capital, intellectual property and near-monopoly on innovation are dissipated more rapidly than global growth enriches the planet as a whole, then the West’s share of global wealth will decline more quickly than global wealth itself increases. The result will be declining Western living standards, likely to be a major feature of the next generation’s economic changes.

There are no solutions to this problem, whose causes have been mostly a decade of cheap money and the communications revolution, together with technological changes reducing the salience of intellectual property. However, there are palliatives. Tight money, imposed as quickly as possible, will preserve the remainder of the West’s capital stock and begin the lengthy process of rebuilding it. Increased resources to education will indeed produce a more highly skilled workforce, which will be able to command higher remuneration. A tax system heavily weighted towards taxes on consumption will increase savings rates. Restricting immigration will preserve as far as possible the living standards of those engaged in the vast personal service sector – a barber in Bangalore is paid less than in Boston – thus providing adequate opportunities for those unable to benefit from the highest levels of education.

Above all, steps should be taken to reduce the level of population growth, particularly in the poorest countries. In a market that is becoming increasingly global, only by reducing the supply of undifferentiated labor will it be possible to maintain its price. A more modestly growing African population will allow Africa to enter more quickly into the joys of rapid economic growth, and will lessen the disruption to the rich West from it doing so.

By speeding the rate of global growth, while at the same time reducing the rate by which the West’s share of the world’s income is reduced, policymakers can ensure that the decline in Western living standards from globalization is moderate, and hasten the day when the entire world is close to Western living standards, so that the free market of ideas, products and services increases the wealth of all.

SUMMER OF SETBACKS FOR OPEN MARKETS

The world economy continues to exhibit amazing resilience to events that in the past would have hurt it severely. Economic strength persists irrespective of deficient economic policies in many countries, including the key ones. Why? Because the engines of modern globalization – international trade and investment – keep on propelling and shielding overall economic performance. It is thus somewhat ironic and rather suicidal that politics, especially in those countries that have historically benefited from economic integration and interdependence the most, is dancing more and more to the tune of protectionism and isolationism.

Examples of this dangerous trend abound. At a June summit in Brussels European leaders bent to the wishes of France’s new president, Nicolas Sarkozy, and dropped the principle of free and undistorted competition from the treaty that, if ratified, will replace the EU constitution sacked by French and Dutch voters in 2005. Industrial interventionism, dressed up as economic patriotism, and opprobrious agricultural protectionism have new and powerful champions on the European continent, and that is not good news for global prosperity.

On this side of the Atlantic, China-bashing and the threat of imposing arbitrary trade barriers against that country look to be entrenched in American politics. Not even relatively minor U.S. trade partners are safe from protectionist lobbies. To curry favor with Congress the proposed U.S. trade deals with Peru and Panama have been imbued with labor standards enforceable by trade sanctions – a protectionist artifice hotly discussed and ultimately rejected by the WTO’s members a decade ago. Despite that unfair concession, Congress is still dragging its feet in approving those deals and appears close to killing the trade agreements with South Korea and Colombia, not to mention how it trashed comprehensive immigration reform earlier this summer.

On a global scale, the worst blow to the future of open markets resides in the latest collapse of the Doha Round negotiations. For all practical purposes this took place on June 21 when a ministerial meeting among the so-called G-4 (the U.S., the EU, India and Brazil) that was supposed to provide the essentials for a broader deal among the entire WTO membership broke down abruptly and acrimoniously. Although the round is not yet formally defunct, its successful conclusion looks more remote than ever. U.S. leadership in trade negotiations will be further undermined by the new farm bill that is expected to be voted on in the fall.

Just as when the talks collapsed at the ministerial meeting in September 2003, U.S. officials blamed the latest failure on India’s and Brazil’s intransigence. It is true that throughout the negotiations those leading emerging countries held fast to their highly defensive positions and to the last minute were unwilling to offer meaningful cuts in industrial tariff ceilings. But the fundamental cause of the Doha Round’s failure lies in the rich countries’ refusal to seriously reform their agricultural protectionism. The debacle is rooted in the lack of political will in those countries to dismantle a system that costs their taxpayers and consumers huge amounts of money and channels most of that money to only a small proportion of rich producers and other rent seekers in the farm sector. This protectionist system severely distorts world agricultural markets to the detriment of poor farmers in developing countries and serves as an argument for this group of countries to stick to their own protectionist policies.

The cost of the failure is not only in the income opportunities lost to both developed and developing countries by not opening their markets further but also, and more important, in the enormous losses all will incur if the round’s collapse causes the multilateral trading system to deteriorate to the point that countries fall into a protectionist spiral. Because it would be so economically devastating, this scenario may appear unlikely even to those politicians who talk isolationism to enhance their popularity but, when it comes to the consequences of closed and distorted markets, know better. The problem with this is that delusion and bad politics are coming together as usual, and sooner or later bad politics will lead to bad economics. This may be the real and wretched legacy of this summer of setbacks for open markets.

BOOM TO BUST

When people have more money than they can spend and invest wisely, they tend to start spending and investing unwisely. They are captives of the old belief that you must always have your money at work. Sometimes, I think, it needs a rest. A bad investment is a bad investment, regardless of how much money you have. There has been an excess amount of money in the system, thanks to government spending and borrowing, and this has been the cause of a lot of what economists have called “growth”.

Economics got off on the wrong foot when some people started believing it was about numbers and statistics and formulas. Economics is about human psychology and human behavior. It is not too much of an oversimplification to say that economies fluctuate between greed and fear. Human greed leads to booms, which in turn lead to busts. Despite all the bullish talk, I think our economy is on the verge of going bust shortly after the leaves change color this year.

Inflation created the false impression in many people’s minds that housing values could only go up. As happened in the past, speculators started buying houses as an investment, figuring they would turn them over in a few months. Lenders started making bad loans to people who normally would not qualify. Inventory eventually exceeded demand.

Now we are seeing the natural course of human events. Housing prices are dropping, mortgage interest rates are going up, foreclosures are going up, and the housing boom has turned into a housing bust. Since most of these mortgages were packaged and sold and resold to hedge funds, some of these hedge funds now find themselves with an inventory of junk. All of a sudden, lenders are getting cautious. Consumers are getting cautious. Fear is beginning to replace greed.

I am not predicting a Great Depression, though I suppose one is possible, but there definitely will be a recession. Yes, I know it is a global economy, but when Americans slow down their buying, the global economy will slow down with it. China’s and India’s consumers are not quite ready to buy the same number of Japanese cars that Americans buy.

The Hollywood and Wall Street crowds will still be able to afford their cocaine and booze. Our esteemed public servants in Washington will stay in the top 5% of income. Recessions affect mainly the middle and lower income groups. They are the people who get laid off, foreclosed on, evicted and have their credit cards shredded. It will put those folks in a bad mood – hopefully a bad-enough mood that they will vote out of office most of the incumbent politicians.

The Founding Fathers did not contemplate lifelong careers in politics. They certainly did not foresee that the people would allow their politicians to vote themselves into the upper income bracket and to devise the most lucrative set of perks and pensions this side of Mars. But that is an aside. Economies run in cycles, and so if we have a recession, it will eventually end as the bad debt is liquidated and the excess inventories are used up. The thing to learn from a recession is to be extraordinarily careful about getting into debt, because nobody today who works for a paycheck can be sure those paychecks will always be there.

ST. KITTS AND NEVIS HOLD JOINT CABINET MEETING

Last week, the cabinets of the St. Kitts and Nevis Federal Government and the Nevis Island Administration (NIA) held their first joint Cabinet meeting in Nevis, under the Chairmanship of the Prime Minister of Nevis, Joseph Parry. After the Mr. Parry’s Reformation Party regained power last year, he told an audience including the Prime Minister of St. Kitts and Nevis, Dr. Denzil Douglas, “I can definitely say that the Nevis Island Government is working very closely with the Federal Government to make sure the people of Nevis and the people of St. Kitts have mutual benefit.” Nevis came close to seceding in a 1998 referendum, falling just short of the required two-thirds majority.

The opening of the Caribbean Single Market and Economy (CSME) is pushing the two islands towards a more cooperative arrangement. Under the CSME regional firms will have the right of establishment in both St. Kitts and Nevis. Dr. Douglas called for consultation and collaboration between the two jurisdictions on the issue of business licences, which he said ought to apply on both islands.

Last week’s meeting was held in keeping with a commitment by both Cabinets to meet regularly. It was the second of its kind since the Nevis Reformation Party took up office one year ago. The first meeting was held in October 2006 in Basseterre. In a post-meeting communiqué, Nevis Cabinet Secretary Ashley Farrell described the meeting as frank, cordial and one which sought to advance good working relations between the two governments and by extension the people on both islands. The Ministries of Finance reaffirmed their commitment to working closely together to harmonize their economic policies with particular regard to fiscal stabilisation and debt management issues.

Despite the protestations by Nevis’s governing Reformation Party that it seeks closer ties with federation partner St. Kitts, government legal advisor Patrice Nisbett recently called on members of the legal fraternity to assist the administration in its efforts to move towards greater autonomy. He made the call during a press briefing on Thursday June 28, 2007, and claimed that the initiative – the devolution of power – was in keeping with a campaign promise by the NRP one year ago.

Mr. Nisbett said that that a committee set up by the Administration had already met and arrived at a plan of action as to how best the desired objectives could be achieved. “For example we would want to give the Nevis Island Legislature legislative competence over matters such as education. We would want to be in a position to vote in our local Parliament and be in a position to pass laws governing our education system in Nevis and at present you cannot do that. This is a matter that can be achieved by a two thirds majority in the Federal Parliament all you will be doing is adding to the specified matters,” he explained. Mr. Nisbett said that there were other sensitive areas which included immigration, the police and taxation on which the administration hoped to negotiate a different arrangement with the Federal Government.

PANAMA CANAL PRESENTS EXPANSION PLANS TO INTERNATIONAL INVESTORS

Continuing to move forward with expansion plans, Panama Canal executives have presented the Canal’s Expansion Program to international financial institutions. “Our main goal is to understand the alternatives we have and weigh the pros and cons in terms of financing. And we are very pleased with the interest of the market and we hope to continue our dialogue with them in the coming months,” said Panama Canal Authority (ACP) Administrator and CEO Alberto Alemán Zubieta.

More than 100 people representing financial institutions from the U.S., Asia, Europe and the Americas participated in the presentation, consisting of investment and commercial banks, multilateral institutions and credit rating agencies. Banks with branches in Panama were also present during the event. “To date, the ACP has been conducting meetings with banks now numbering to about 60 – a process which began in Panama. We have much room for flexibility and we would like to hear from the market based on the financial requirements we have outlined,” said ACP CFO and Deputy Administrator José Barrios Ng.

Expansion will build a new lane of traffic along the Panama Canal through the construction of a new set of locks, which will double capacity and allow more traffic and longer, wider ships. The ACP is the autonomous agency of the government of Panama in charge of managing, operating and maintaining the Panama Canal.

STANDARD AND POOR’S RESTORES GRENADA’S CREDIT RATINGS

S&P has raised its long-term sovereign credit rating on Grenada to “B-” from “CCC+”, affirmed its “C” short-term sovereign credit rating and assigned a “stable” outlook in recognition of the government’s efforts to contain its debt. “Administrative measures taken by the government in June 2007 to streamline its debt-payment mechanism significantly reduce the risk of new intermittent arrears on Grenada’s domestic commercial debt,” commented S&P credit analyst Olga Kalinina.

However, Kalinina added that the ratings remain constrained by the persistently difficult fiscal situation, which is being compounded by inefficiencies in tax revenue collection, the government’s decision to cancel the introduction of VAT in October 2007 and slower-than-expected economic recovery following the devastating Hurricane Ivan in 2004. Difficulty in containing capital expenditure, especially spending related to the Cricket World Cup, are also hampering efforts to rein in Grenada’s debt, S&P noted. The country has fiscal debt of 118% of GDP, the third largest among speculative-grade-rated countries.

HONG KONG VULNERABLE TO FINANCIAL SHOCKS, MONETARY AUTHORITY CHIEF WARNS

Questioning the status quo is the best way to spot emerging risks in Hong Kong’s financial system, according to Monetary Authority Chief Executive Joseph Yam. Writing in his latest “Viewpoint” column, Yam stated that Hong Kong must remain alert to potential financial crises, noting that its size – not too big, but liquid enough to attract international capital – and openness makes it more vulnerable than many of its peers in an environment of financial globalization.

“In a financial system as open and externally oriented as Hong Kong, we obviously should not let our guard down, although for precisely the same reasons it is not always possible for us to control our destiny,” he wrote. Being a financial regulator makes him a “natural worrier”, Yam added, although he expressed the belief that the 1997-98 Asian financial crisis is unlikely to repeat itself.

Yam urged people however to remain vigilant, and ask unorthodox questions. “In any case, the Hong Kong economy seems to be doing well, the financial system to be quite robust, and everybody seems to be having a good time. If there are disruptions, I think it is more likely that they will come from external sources. But still, readers should watch their radar screens because vigilance is a good habit,” he wrote. “It is also a good practice to look behind the screen and ask unorthodox questions, even if you do not always find satisfactory answers. I can assure you that this will have a positive effect on your welfare.”

SEYCHELLES PRESIDENT PREDICTS STRONG GROWTH IN 2007

President James Michel has claimed that the jurisdiction’s economy is set to grow by 7.5% this year as investment in the Seychelles continues to increase. “Things are going well and we have been able to progress,” said Michel as he reflected on his first year in office since being elected last year. “The level of growth has come up to 5.3%, which shows an increase of 1.2% from the previous year, and I feel this is considerable progress since we restarted our economy, and we expect that this year our growth will be 7.5%.”

He contined, “During the first six months of this year we have seen an increase of 3% in the level of foreign exchange coming into the country, together with the boom in construction and what is happening the demand for foreign exchange has increased so if the inflows have increased it is not that visible due to the high demand but all these will be resolved once we are able to bring in enough foreign exchange and I feel soon enough we will be able to do that.”

Michel said that around US$100 million in foreign exchange has flowed into the Seychelles this year and the country’s reserves at the end of June were $110 million, a 16% increase on 2006. He predicted that reserves will continue to rise as the Seychelles economy grows.

Michel has been President since 2004 after France Albert Rene, who had ruled the Seychelles for almost 30 years, stepped down, but won his first election in July last year. In his manifesto he pledged to raise the international profile of the Seychelles to help bring in more foreign investment and increase living standards for the local populace by, among other policies, increasing the country’s profile as a unique tourist destination and expanding the double taxation treaty network. The manifesto also pledged to establish a simple tax structure which generates income for the government “in a responsible manner,” protect local production “where needed,” and implement a tax system that “provides an equal footing for all operators.”

In March 2007, Michel said that the government would seek to expand the offshore business sector with new products, and would seek to boost foreign investment with further liberalization of foreign exchange controls. The government has also attempted to promote investment in the onshore business environment with a new law that exempts payment of business tax on the first SR250,000 ($41,000) of profits for all companies, which became effective on January 1, 2007. The Seychelles government has also cleared a substantial amount of its arrears with the African Development Bank, World Bank, European Investment Bank and with Paris Club Creditors with a $200 million bond, launched last year.

TAXES

THE COMING BLUE STATE TAX REVOLT

The median sales price for the American dream – new house, land included – is $236,000, according to government census figures. The average price, $313,000, is higher than the median. Many new houses are palatial. In Manhattan you can pay nearly the U.S. median new home price for a parking spot. And, no, you do not really own the land.

Here is a Blue State irony: In areas where U.S. real estate costs are highest– Manhattan, the tonier parts of Boston, Washington, D.C., San Diego, Los Angeles, the San Francisco Bay Area, and Hawaii – taxes are also among the highest. New York City residents face a 6.85% top state income tax and a 3.65% top city tax. High salary earners are hit with a combined 45.5% income tax rate before they start paying sales taxes and property taxes, which add 14% to the cost of living. Some taxes might be deductible, but do not get too cute. The dreaded alternative minimum tax will rise up and smite thee.

California state income tax rate is a gagging 9.3%, and it kicks in at a school janitor’s salary of $43,500. California adds a “mental health tax” of 1% if you make more than $1 million a year – a joke on dysfunctional Hollywood, one supposes. Is the higher house plus taxes overhead in the Blue States made bearable by higher salaries? Only at the very top. The average partner at Goldman Sachs in Manhattan may pull down $20 million a year, but the average Manhattan income is only 2.0 times the national average – pretax. Aftertax, where it counts, Manhattan salaries are only about 1.5 times the national average. But median house prices are 4.2 times as high.

Millionaires cash out of California.

The San Francisco Business Times noted recently that Bay Area millionaires are starting to take their gold out of the Golden State. The paper writes, “The Bay Area’s wealth boom is producing an explosion of millionaires – in Nevada, Wyoming and perhaps Canada. Advisers to the well-heeled say ‘wealth migration’ – taking the money and running – is behind a surprising drop in the number of Bay Area millionaires.”

The annual loss of millionaires from the Bay Area, home to Silicon Valley, knocks this extremely rich and fertile place down near the bottom of the new millionaire list, putting it in the company of Detroit, Pittsburgh and Cleveland. Of course, the middle class has been fleeing California for years. High house prices have been the main culprit. Long commutes and deteriorating public services play a part. But the flight of millionaires is very 21st century. The cause? You guessed it. Taxes.

The S.F. Business Times quotes Diane Kennedy, a Phoenix accountant and financial adviser to the wealthy: “Effectively, you have the state of California subsidizing [a client’s] relocation through the tax savings.” Which proves that tax rates do indeed influence behavior.

Some of the outgoing California millionaires of recent years include Netscape’s founder, Jim Clark, who moved to Florida, and eBay’s Pierre Omidyar, who moved to Nevada. More common among Cal expats are small business owners like Dave Barton, asset millionaires trying to live well on middle-class salaries. I wrote about Dave’s move from San Jose to State College, Pennsylvania – nicknamed Happy Valley – in my 2004 book, Life 2.0. Dave shut down his machine tooling shop and now designs tooling configuration software.

Writes Dave, “There’s a lot I don’t miss about Silicon Valley and California. It was not a pro-business climate, but it was uniquely pro-startup and pro-innovation. ... That can overcome a lot. Here in flyover country old money was made in low-risk, long-held real estate. They can’t comprehend what a startup does and needs. And don’t get me started on the politics.

“But looking at my Valley (Silicon vs. Happy) comparison, the raw brain power is here, as it is in other major research university towns, and it’s coupled with incredibly low costs and a high quality of life. But the risk aversion is suffocating. What a dichotomy: Our cost structure in the boonies is so low we could handle much more risk, but there isn’t the will.”

Good analysis. Would you prefer low costs or an innovative culture? Manhattan and the Bay Area teem with cultural richness, creative people, capital and confidence. But with a cheap dollar kicking everyone – janitors included – into higher tax brackets, what kinds of companies can operate there? Google can live in Silicon Valley and Goldman Sachs in Manhattan, for now, because each company yanks in more than $1 million per employee. But what if your company’s revenue-to-employee number is $500,000? $250,000?

Markets decide house prices. People decide tax rates. I have a hunch we will see a Blue State tax revolt soon.

TOP TAX LAWYER TO HEAD U.S. JOINT COMMITTEE ON TAXATION

Edward Kleinbard, frequently cited as one of the world’s top tax lawyers, has been named as the next head of the Congressional Joint Committee on Taxation by the leaders of the House and Senate tax writing committees. The Joint Committee is closely involved in every aspect of the tax legislative process, from the development and analysis of tax proposals for Members of Congress to the drafting of tax bills, estimates of all revenue legislation considered by the Congress, and investigations of various aspects of the Federal tax system.

Kleinbard is currently a partner in the New York City office of Cleary Gottlieb Steen & Hamilton LLP. His practice focuses on federal income tax planning and controversy, including taxation of new financial products, derivatives, financial institutions, and international mergers and acquisitions. He is frequently cited as one of the world’s top tax lawyers, and his firm credits his “intellectual rigor and passionate innovative spirit” for the growth of its leading tax practice.

PAULSON KICKS OFF NEW U.S. CORPORATE TAX REFORM DEBATE

Kicking off a new debate on the state of America’s business taxation system, U.S. Treasury Secretary Henry Paulson said that the corporate tax base is too narrow, and contains too many special interest tax breaks which hinder the most efficient use of capital. He suggested that now is the time for a “comprehensive look” at the whole area of business taxation.

“My goal is to promote the policies and conditions for economic growth that will maintain and enhance our competitiveness, and lead to greater American prosperity,” Paulson declared in his opening statement at the U.S. Business Tax Competitiveness Conference. “Our current business tax system is clearly not optimal. It includes ad-hoc policies and preferences that result in a narrow tax base and create distortions that divert capital from its most efficient use. These include complex, targeted provisions; depreciation schedules without clear rationale; taxation of capital income that discourages saving and investment; and, double taxation of corporate profits that can lead to misallocation of capital.”

“Systemic distortions impact not only corporate owners, the shareholders, but also the employees. When an inefficient business taxation system discourages marginal investments, our workers pay the price,” he observed. The conference heard from a number of business, policy and academic leaders, including Michael Boskin and Martin Feldstein, former chairmen of the President’s Council of Economic Advisors; Safra Catz, President and CFO of Oracle Corporation, Alan Greenspan, and FedEx Corporation Chairman and CEO Fred Smith. According to Paulson, a strong consensus emerged from the meeting that the U.S. business tax system is far from optimal, and is undermining the country’s competitiveness.

CARLYLE BOSS DEFENDS U.S. PRIVATE EQUITY TAXATION

Raising taxes on the private equity investment industry could reduce investment in companies, lower returns for pension funds and other investors and hurt the competitiveness of U.S. capital markets, according to a senior figure from the industry. “There will be deals that won’t be done, entrepreneurs who won’t get funded and turn-arounds that won’t be undertaken,” Bruce E. Rosenblum, managing director of The Carlyle Group and chairman of the Private Equity Council told Congress as lawmakers consider new legislation that aims to reduce the apparent tax advantages enjoyed by private equity firms and their partners compared with other corporate forms.

In testimony before the Senate Finance Committee, which held its second hearing on the issue of “carried interest”, Rosenblum said the Private Equity Council opposes two bills that would significantly raise taxes on private equity investment firms because they would undermine an industry that has made a major contribution to the American economy. Legislation currently progressing through the House of Representatives would tax profits earned by private equity firms on long-term investments at the regular income rate of 35% instead of the long-term capital gains rate of 15%. Meanwhile, Senators are considering a bill which would impose a 35% corporate income tax on private equity partnerships that decide to go public.

In his opening statement at the hearing, Senate Finance Committee Chairman Max Baucus said that there is little difference between a large private equity firm and a Wall Street investment bank and that it was hard to argue that private equity firms should receive more favorable tax treatment. “Both offer merger and acquisition services. Both provide mezzanine financing for transactions. Both offer a wide array of investment strategies for their clients. But only one claims that the income from an active business is passive and is subject to capital gain treatment,” Baucus stated.

Rosenblum claimed that private equity investment firms between 1991 and 2006 returned more than $430 billion in profits to their investors, nearly half of which are public and private pension funds, university endowments and charitable foundations. Rosenblum argued that taxes on private equity firms are based on their ownership interests in long-term investments – their portfolio companies – that appreciate in value. He pointed out that PE firms are taxed at the same rate and in the same manner as any other partnership – including those that invest in real estate, oil and gas, start-up enterprises and family businesses – that owns an asset that increases in value over time and later is sold for a profit. “The tax treatment of this ownership structure is well settled by case law and administrative rulings of the Internal Revenue Service. It is anything but a loophole.” Rosenblum said.

Countering an argument made by tax increase advocates, Rosenblum said that there is a clear distinction between owners who take entrepreneurial risks to grow businesses over time and employees who are paid based on their performance. PE firms take on substantial risks, including risks to their capital, Rosenblum testified. The firms’ partners contribute significant risk capital to their funds and they can lose all or some of it, just like their limited partners.

U.K. MPs hold fire on private equity tax

An influential committee of MPs has called for a deeper investigation into certain aspects of the UK tax regime as it applies to private equity firms, although they have stopped short of recommending a change in tax legislation or an increase in tax on buy-out funds.

The Treasury Select Committee recommended that the Treasury and HM Revenue and Customs examine the issue of the tax treatment of carried interest as part of their review of the taxation of employment-related securities, and urged the government to publish the results. The report also called for an additional review into whether the tax system unduly favors debt as opposed to equity, thereby creating economic distortions.

The report follows a lengthy examination by the Committee of the risks to the economy posed by leveraged buy-out funds as they begin targeting some of the UK’s largest companies. This has led to new proposals for a voluntary code of conduct to increase transparency in the industry. However, it is the issue of taxation which has proved most contentious.

DEMOCRATS SLIP PROVISION TO TAX “INSOURCING” COMPANIES MORE HEAVILY INTO FARM BILL

House Republicans have expressed anger at a last minute provision tacked onto an agricultural bill that threatens to increase taxes for U.S. companies with domestic and foreign subsidiaries. Republicans had initially supported the farm bill, but abruptly withdrew their support when Democrats included a tax increase on “insourcing” companies operating inside the U.S. to help pay for the bill’s provisions.

According to Republicans, the tax provisions added without the consultation of the Agriculture Committee would raise taxes on companies with U.S. subsidiaries, affecting firms responsible for the employment of more than 5 million Americans. They contend that the provisions would make the U.S. a less hospitable place to do business, discourage future investment, and drive jobs abroad. The GOP also warns that the measure will open the way for retaliation on U.S. companies operating on foreign soil because they are part of numerous treaties that allow reciprocal treatment on taxes for U.S. companies with foreign subsidiaries to avoid double taxation.

ARCTIC SYSTEMS VERDICT TO BRING ABOUT CHANGE IN UK TAX LAW

Income splitting to get closer scrutiny.

The UK government has announced that it will bring forward new legislation to change the tax laws in the light of the House of Lords judgment in the Arctic Systems case. Exchequer Secretary to the Treasury, Angela Eagle announced that the case has highlighted the need for the government to ensure that there is greater clarity in the tax system regarding the tax treatment of “income splitting”. She added that the government is of the view that individuals should pay tax on their own income.

“Some individuals use noncommercial arrangements (arrangements that they would not reasonably enter into with an arms-length third party) to divert income (which would, in the absence of those arrangements have flowed to them) to others. That minimizes their tax liability, and results in an unfair outcome, increasing the tax burden on other tax payers and putting businesses that compete with these individuals at a competitive disadvantage,” Eagle stated in response to the verdict.

In the Arctic case, the tax authority challenged the way in which the owner distributed income through the firm to take advantage of his wife’s lower tax rates, but was eventually defeated in the House of Lords earlier this week. “It is the Government’s view that individuals involved in these arrangements should pay tax on what is, in substance, their own income and that the legislation should clearly provide for this,” Eagles continued. “The Government will therefore bring forward proposals for changes to legislation to ensure this is the case.”

U.K. tax experts urge legislative caution after Arctic verdict.

The Chartered Institute of Taxation (CIOT) and Institute of Chartered Accountants in England and Wales (ICAEW) Tax Faculty are asking the Government to take its time and reflect on the House of Lords decision in the Arctic Systems case before rushing to legislate. Both professional bodies are hoping that HM Treasury and HM Revenue & Customs will fully consult and listen to all interested parties before creating tax law that increases uncertainty further and puts yet more obstacles in the way of small businesses.

HM REVENUE AND CUSTOMS DEMANDS EXCISE TAX ON ITEMS POSTED FROM ABROAD

HMRC has announced that new rules which went into effect on July 19, 2007, mean that UK excise duty is due on all alcohol and tobacco products sent through the post from abroad, including occasional gifts. Since 1993, by way of a concession, the UK has not charged excise duty on tobacco and alcohol products sent by post as occasional gifts from an individual in another EU country. However, following a recent European Court of Justice ruling, HMRC said that it is now obliged to withdraw the concession.

It will still be possible to send excise goods from abroad to the UK by post, but UK duty will now be due. The new arrangements also apply to goods sent by post from non-EU countries. The recent ECJ ruling confirmed that goods are only free of UK duty where they are purchased by private individuals for their own use in another EU country and are transported by the individual to the UK (e.g., “cross Channel shopping”). If someone else transports the goods, including the postal service, duty is payable in the UK.

Under the new rules, goods will have to bear a green Customs declaration on the outside of the package. Royal Mail will then collect duty payment on delivery/collection. The sender will have to make arrangements for a tax representative in the UK to account for the UK duty before the goods are sent. If the arrangements have not been made to pay the duty (EU countries) or the goods are not declared (non-EU countries) the goods are liable to seizure. In some circumstances, seized goods may be restored for a fee, which will equate to the duty plus a penalty, HMRC said.

AUSTRALIA LAUNCHES BUSINESS TAX AMNESTY

The Australian Tax Office (ATO) is giving business owners a one-off opportunity to correct past mistakes regarding payments and loans from their private companies and avoid penalties under Division 7A of the Income Tax Assessment Act. Recent changes to tax law give the Commissioner of Taxation discretion to disregard the operation of Division 7A in circumstances where an honest mistake or inadvertent omission has been made. The offer applies to mistakes made between 2001-02 and 2006-07 and a practice statement released on Monday July 30 sets out how taxpayers can take corrective action to fix these mistakes.

“People who follow the practice statement and include any outstanding interest or previously undeclared payments in their 2007-08 return can take advantage of the new changes to the law, without being concerned about further enquiries,” said Tax Commissioner Michael D’Ascenzo. For some time the Tax Office has had concerns about whether business people were correctly paying tax on payments made for them or to them by their private companies.

JAPAN VOTES AGAINST CONSUMPTION TAX HIKE

Japanese Prime Minister Shinzo Abe’s plans for fiscal and tax reform have been dealt a blow after the opposition Democratic Party, which opposes a hike in consumption tax, won a substantial majority in Upper House parliamentary elections this past Sunday. While the Democrat Party’s victory does not give it control over the government, analysts expect their influence in the upper house to raise a barrier to an early rise in consumption tax – thought to be central to the ruling Liberal Democrat’s plans to raise the revenue it needs to meet growing spending requirements and balance the budget. It was thought the government would legislate to increase the tax in 2008, with the hike going into effect in 2009, but this is now an increasingly distant prospect.

Not only is the Japanese government pondering how to pay for the costs of an ageing society, it is also struggling to tackle a mountainous debt which, at 148% of GDP, is the highest in the industrialized world. Despite the electoral setback, Abe resolved to forge ahead with fiscal reforms. “The (election) result shows the road ahead is tough, but Japan can no longer survive without reforms,” he told a news conference on Monday.

Prime Minister Shinzo Abe is attempting to follow through on a pledge to balance the budget by 2011, but the government has been vague on its tax and spending plans for fear of losing popularity. However, with pension provision expected to keep rising, and with the government planning to increase the amount it contributes to the social security pool from 2009, tax hikes were expected to come in 2009-10.

Japan’s consumption tax rate remains at one of the lowest rates among the thirty members of the OECD, and supporters of a hike argue that there is room for an increase in the rate to 10%, noting that this will still be much lower than consumption taxes in other major economies, especially in Europe, where such taxes typically range between 15% and 20%.

INDIA TO INTRODUCE ANTI-AVOIDANCE TAX LAWS

Improper use of the India-Mauritius Double Tax Avoidance Treaty targeted once more.

It has been reported in India that the authorities are planning a new tax law which will include anti-abuse provisions aimed at preventing improper use of the India-Mauritius DTAA. Indian worries about abuse of the residence rules under the Treaty have been holding up full implementation of a Comprehensive Economic Cooperation and Partnership Agreement signed last year.

Indian tax officials, with perhaps only lukewarm support from their government, had been hoping that Mauritius would stiffen the requirements for tax exemptions under the DTAA. They point to a new protocol Mauritius has added to its treaty with China under which capital gains arising in Mauritius on the sale of Chinese assets will be subject to a 10% tax in China in some circumstances. The protocol came into force on 1st January. The Indian tax authorities fear particularly that short-term stock market gains can be sheltered in Mauritius by Indian traders, a practice known as “round-tripping”.

The Mauritian authorities did move to placate the Indians last year, tightening up on the issuance of certain business licence applications, but India wanted further action before it implements parts of the CECPA which will be highly favorable for Mauritian exports to India. Mauritius has not done enough, however, and the new law is expected to bring in provisions to ensure that the benefits of the treaty flow only to genuine investors, a government source said. Legislation is expected to be introduced in Parliament in the winter session.

Said Ernst & Young partner Amitabh Singh, “Technically speaking, transfer pricing regulations are also anti-abuse legislation and the Indian Income-Tax Act already has some anti-abuse provisions, including transfer pricing in Chapter X of the Act. I presume the government is looking at bringing more transactions within its purview and framing laws to regulate them. A provision such as this will help in situations where India does not have a DTAA. Even if there is a DTAA, the department will be able to rely upon these provisions.”

ASSET PROTECTION / LEGAL STRUCTURES

TAX-FREE IN THE RUST BELT

Looking for a retirement tax haven? Alternatives to Florida and Nevada beckon.

When John Jazdcyk retired in 2004 from his management job at a Green Bay, Wisconsin Procter & Gamble plant, he and his wife, Susan, debated whether to move full-time to their vacation home on Lake Mullet in Cheboygan, Michigan. Then they learned that Michigan exempts $81,840 a year in private retirement income per couple, in addition to Social Security, from its 3.9% state income tax. Wisconsin, by contrast, taxes private retirement payments, as it does salary and other income, at 5.6%. “Whenever taxes can be avoided, I feel better,” says new Michigan resident Jazdcyk.

The accepted wisdom is that tax-averse retirees should move to Florida or Nevada, which have no state income or estate taxes. But what if you do not worship the sun or relish a long-distance move? In recent years other states, too, have been lavishing tax goodies on retirees, including affluent ones. With a little research you might discover your own retirement tax haven is close to home.

Most states do not tax Social Security benefits. Three states with broad income taxes (Illinois, Mississippi and Pennsylvania) exempt all private and public pension payouts, including withdrawals from IRAs, from their taxes. More than a dozen other states exempt some annual dollar amount of seniors’ income – from private pensions, IRAs and sometimes other nonwage sources. With all these special breaks the best tax locale for a retiree is not necessarily the same as for a working stiff, particularly when high real estate levies in some income-tax-free states are considered, says Thomas Wetzel, president of Retirementliving.com, which tracks taxes by state. In addition to Florida and Nevada, seven states – Alaska, New Hampshire, South Dakota, Tennessee, Texas, Washington and Wyoming – have no broad income tax.

New Hampshire has no sales tax either, which would seem to make it an ideal New England retirement retreat. Except New Hampshire taxes investment income, as does Tennessee, which can be significant if your financial assets are mostly in nonretirement accounts. Worse, New Hampshire’s real estate taxes are among the highest in the nation, at a median 1.6% of home value, double that of Massachusetts.

Plan now for later.

Even if you are years away from hanging it up, it makes sense to consider taxes in your retirement planning now. “If your taxes are a lot lower, your retirement funds are going to go further,” reasons Don R. Weigandt, 60, a managing director at JPMorgan Private Bank in Los Angeles, who is considering following the well-worn trail to Nevada himself when he retires.

Stock options and deferred compensation require special handling since, if you move, your old state might pursue you for taxes on these – particularly if that old state is New York or California. Do you hold your employer’s stock in a workplace retirement account? It may be better to cash out the stock portion than to roll it into an IRA, since gains in employer stock are taxed at the lower federal capital gains rate, which now tops out at 15%. By contrast, withdrawals from a regular IRA are taxed as ordinary income, at a federal rate as high as 35%.

The Jazdcyks sold big blocks of P&G stock to take advantage of this provision and made sure to do so before leaving Green Bay. Why? Wisconsin exempts 60% of capital gains from tax, reducing the effective Wisconsin tax on gains to 2.6%, versus the 3.9% they now pay on long-term gains in Michigan.

Better-off seniors generally pay federal taxes on 85% of their Social Security benefits. But only 15 states still tax any of these benefits, and some of those are dropping or cutting their taxes. The greediest states? Seven that follow the feds in taxing up to 85% of Social Security benefits. Among the offenders are Minnesota, with a top state rate of 7.85%, and Rhode Island, at 9.9%.

You can now accumulate large amounts in a pretax retirement account while working in a high-tax state and then move to a state that does not tax pension withdrawals without worrying about tax collectors from your old state coming after you. In 1996 Congress ordered states to stop pursuing most former residents for taxes on pensions. This stops California from going after a former resident who is living in Nevada when he taps an IRA or draws a pension from Procter & Gamble. The 1996 law protected employees. Last year Congress extended it to cover former partners (e.g., lawyers and accountants), too. This does not keep your old state from taxing deferred compensation paid out to you in a lump sum. It does, however, protect deferred compensation received in equal installments over 10 years or more. If you retire to a state that provides a limited annual exemption for private pensions, try smoothing out your income to take maximum advantage of it.

Many states give old folks higher standard deductions or personal exemptions – for example, an extra $4,200 per couple exemption in Arizona and Michigan. Plus, a handful give seniors large breaks for income from virtually any investment. Georgians 62 and older may exclude from taxable income $60,000 per couple (rising to $70,000 per couple in 2008) of interest, dividends, capital gains, rents, pensions and annuities. Substantial deductions are also available to folks who contribute to 529 college savings plans, as many grandparents do. You can check on your own state at savingforcollege.com. (Deposits in these plans are not deductible on federal returns.)

Estate Taxes

40 states exempt a certain amount of the value of a resident’s primary home from real estate tax, and many of them provide an even larger exemption to old folks. So, too, do some local governments. While exemptions have been growing, they have not generally kept pace with fast-rising assessments, causing heartburn for real-estate-rich seniors. 23 states and D.C. impose their own estate or inheritance taxes on money left to anyone other than a spouse (see map). While the federal estate tax does not, generally, hit estates of $2 million or less, most of the state levies kick in at lower levels. Ohio, for example, exempts just $338,000 from its estate tax. New Jersey, Rhode Island and Wisconsin exempt $675,000. Nine other jurisdictions exempt $1 million. Pennsylvania imposes its quirky inheritance tax on every dollar not left to a spouse, with the rate dependent on who gets the money.

One problem in deciding where to move based on estate tax – particularly for youngish retirees – is that this politically charged tax is in flux in many states, just as it is in the federal tax law. Virginia’s estate tax expired in July. Wisconsin’s expires at the end of this year. Kansas’s tax is slated to disappear at the end of 2009. Michigan eliminated its estate tax in 1993 in part to stem the outflow of retirees. Now, to patch a budget deficit, Michigan’s Democratic governor has suggested reincarnating its death tax. If she does it threatens new resident John Jazdcyk. He just might move again.

Island Savings

Tired of the cold? Consider an extreme move, all the way to the U.S. Virgin Islands. You might be able to replace a combined federal and state income tax levy of 25% to 40% with a 3.5% Virgin Island income tax bill. To qualify for this break, you have to set up a business in the Virgin Islands and live there at least 549 days in a 3-year period (and at least 60 days for each of those years).

If you do this, be careful to follow the rules. Car dealer James A. Auffenberg Jr. is awaiting trial for criminal tax fraud. He says he lived in St. Croix and was eligible for the Virgin Island tax breaks. The U.S. government contends he really lived in Illinois while renting out his St. Croix condo to the U.S. Coast Guard. In a preliminary victory for Auffenberg, a federal judge has agreed to move his trial to the USVI.

UK MP’S URGE TREASURY TO PUBLISH NON-DOMICILE TAX STATUS REVIEW

UK lawmakers have urged the Treasury report the findings of a long-running review into the non-domicile tax rules amid reports of a dramatic rise in the number of wealthy UK residents claiming domicile offshore and paying little in UK taxes. The call from MPs on the Treasury Select Committee was included in the recommendations of the report on the private equity industry, published this week. “Given the apparently rising number of the non-domiciled, and a perception that monitoring of the status of non-domiciles is weak, it is essential that the Treasury and HM Revenue and Customs are able to demonstrate that they have a rigorous approach towards claims of non-domicile status,” the report stated.

The issue of the non-domicile tax rules were included in the wide-ranging report on the conduct of the private equity industry in the UK. The Observer newspaper has claimed that only 40 of the top 200 private equity partners are tax domiciled in the UK, but witnesses from private equity firms giving evidence before the Committee have regarded this figure as unrealistically low. However, Jon Moulton of buy-out firm Alchemy said that he thought there were abuses by individuals of the domicile rules “which allow in the case of the UK people who have lived here 50 years in some cases still to claim they are not liable to UK capital gains tax.”

In calling for an update of the non-dom review, the Committee recognized that the issue was not one exclusive to the private equity industry. Last month, Treasury Minister Jane Kennedy told the House of Commons that the 110,000 individuals claiming non-dom status in the 2004-05 tax year earned a collective £9.8 billion and paid £3 billion in tax. She was however, unable to tell the Commons how much tax might be being lost to the Treasury as a result of the scheme which excuses claimants from UK income tax on foreign earnings. The Observer has claimed that the number of individuals claiming non-domicile status hit 200,000 during the 2006-07 tax year.

While the Treasury has been reviewing non-domicile tax status since April 2003, it has seemingly been sitting on its hands in the meantime and has given little indication of when the results will be published. Despite the recent furor over the apparent inequality in tax treatment for wealthy investors such as private equity partners and low- and middle-income earners, the government continues to hint at its reluctance to alter the status quo because this could harm the status of London as Europe’s pre-eminent financial center.

ADVISOR URGES UK FOREIGN HOUSE BUYERS TO LOOK BEFORE THEY LEAP

Tax advisors PricewaterhouseCoopers have urged British buyers of holiday and investment homes abroad to make sure they are fully aware of the potential legal pitfalls that await them when purchasing and owning foreign property, particularly in the area of taxation. With many Brits returning from their holidays with dreams of owning their place in the sun, PwC has cautioned that impulse decisions can often lead to unexpected problems for buyers and highlighted the essential need for sound advice and planning to avoid expensive and time-consuming issues at a later stage.

Leonie Kerswill, tax partner at PricewaterhouseCoopers LLP, said, “While the UK rules have changed so that it is now possible to buy foreign property through a company, it is still important that any decision to buy property abroad and how to own it is well thought out. The most common issues tend to involve foreign acquisition taxes such as local government taxes or VAT on new purchases, deemed rental income charges and wealth tax. “Good advice is essential for those buying abroad and once the purchase has been made, a regular UK and foreign tax review should be carried out to ensure that owners are up to date with new rules that may increase or reduce the tax rates in each country.”

PRIVACY

FBI PROPOSES BUILDING NETWORK OF U.S. INFORMANTS

The FBI is taking cues from the CIA to recruit thousands of covert informants in the U.S. as part of a sprawling effort to boost its intelligence capabilities. According to a recent unclassified report to Congress, the FBI expects its informants to provide secrets about possible terrorists and foreign spies, although some may also be expected to aid with criminal investigations, in the tradition of law enforcement confidential informants. The FBI did not respond to requests for comment on this story. The FBI said the push was driven by a 2004 directive from President Bush ordering the bureau to improve its counterterrorism efforts by boosting its human intelligence capabilities.

The aggressive push for more secret informants appears to be part of a new effort to grow its intelligence and counterterrorism efforts. Other recent proposals include expanding its collection and analysis of data on U.S. persons, retaining years’ worth of Americans’ phone records and even increasing so-called “black bag” secret entry operations.

To handle the increase in so-called human sources, the FBI also plans to overhaul its database system, so it can manage records and verify the accuracy of information from “more than 15,000” informants, according to the document. While many of the recruited informants will apparently be U.S. residents, some informants may be overseas, recruited by FBI agents in foreign offices, the report indicates.

U.K. POLICE MAY BE GIVEN POWER TO TAKE DNA SAMPLES IN THE STREET

The Home Office is considering giving the police the power to take a DNA sample on the street, without taking the suspect to a police station, as well as taking samples from suspects in relatively minor offences such as littering, speeding or not wearing a seat belt. The move comes as an official genetics watchdog prepares a public inquiry into the police national DNA database, following concern over the retention of samples from people acquitted of any offence, and disclosure that the database holds DNA records for one in three of British black males. The database is the largest in the world, with 3.4 million profiles, more than 5% of the UK population. If the powers are granted, it would expand massively.

Baroness Kennedy, chair of the Human Genetics Commission, said the power of the police in England and Wales to take DNA samples from any arrested individual without requiring their assent was unrivalled in the world. “We want to ensure the public voice is heard on issues people think are relevant. The Citizen’s Inquiry is likely to grapple with issues such as whether storing the DNA profiles of victims and suspects who are not charged, or who are subsequently acquitted of any wrongdoing, is justified by the need to fight crime.” She added that under law it was very difficult, and sometimes impossible, to have your sample removed.

SURVEILLANCE CAMERAS WIN BROAD SUPPORT IN U.S.

Majority of Americans favor extra safety factor of cameras.

Americans, by nearly a 3-to-1 margin, support the increased use of surveillance cameras – a measure decried by some civil libertarians, but credited in London with helping to catch a variety of perpetrators since the early 1990s. Given the chief arguments, pro and con – a way to help solve crimes vs. too much of a government intrusion on privacy – it is not close: 71% of Americans favor the increased use of surveillance cameras, while 25% oppose it.

Seniors are most apt to support the increased use of these cameras, with under-30s, least so; Republicans more than Democrats; women more than men; higher educated people more than the less educated; and whites more than African-Americans. Support for increased use of surveillance systems is highest of all, 86%, among Republicans who support Rudy Giuliani.

LAW

CALIFORNIA SUPREME COURT: CITIES CANNOT SUMMARILY SEIZE CARS

A sharply divided state Supreme Court ruled that cities can no longer seize automobiles whose drivers are arrested for allegedly buying drugs or soliciting prostitutes. The ruling overturns the laws of more than two dozen cities from Oakland to Los Angeles that allowed police to seize an automobile immediately after the driver’s arrest.

The 4-3 ruling said only state law can mete out punishment for drug and prostitution offenses and that without authorization from the California Legislature, cities cannot pass seizure ordinances that are harsher than state and federal laws. Even drivers suspected of buying a small amount of marijuana, which is a low-level crime punishable by a $100 fine, faced seizures in many of the cities with the ordinances.

Lawyer Mark Clausen, whose lawsuit against the city of Stockton led to the ruling, said that since Oakland instituted the first seizure law in 1997, “several thousand” automobiles have been seized throughout the state. He said most cities release the cars after drivers pay an impound fee ranging from $200 to $2,000, depending on the city. “These ordinances were just a public relations stunt,” Clausen said. Many urban city councils said they enacted the seizure laws as a way to combat drug sales and prostitution and clean up some of their most blighted neighborhoods.

ACTING ON IMPEACHMENT

By Ralph Nader

Most readers of The Washington Post probably missed it. But probably not Attorney General Alberto Gonzales. 56 of his law school classmates (Harvard Law School, class of 1982) bought space for an open letter in mid-May that excoriated his “cavalier handling of our freedoms time and again.” It read like an indictment, to wit:

• Witness your White House memos sweeping aside the Geneva Conventions to justify torture, endangering our own servicemen and women.
• Witness your advice to the President effectively reading Habeas Corpus out of our constitutional protections.
• Witness your support of presidential statements claiming inherent power to wiretap American citizens without warrants (and the Administration’s stepped-up wiretapping campaign, taking advantage of those statements, which continues on your watch to this day).
• Witness your dismissive explanation of the troubling firings of numerous U.S. Attorneys, and their replacement with other more “loyal” to the President’s politics, as merely “an overblown personal matter.”
• In these and other actions, we see a pattern. As a recent editorial put it, your approach has come to symbolize “disdain for the separation of powers, civil liberties and the rule of law.

By now you are expecting something like a conclusion by his classmates, such as a demand for resignation or a call for Gonzales’s impeachment. No such logic. Instead, these intrepid classmates punted, urging Gonzales and President Bush “to relent from this reckless path, and begin to restore respect for the rule of law we all learned to love many years ago.”

Just last week, four Democratic Senators called for a special prosecutor to investigate their belief that Gonzales gave false testimony about the regime’s warrantless domestic surveillance program. They criticized the Attorney General for possessing an instinct “to dissemble and to deceive.” Four of Gonzales’s top aides have already resigned. The head of the FBI, Robert Mueller, just testified before Congress and contradicted Gonzales’s statements which were made under oath.

It is not often that a U.S. Attorney General is treated with bi-partisan inferences of perjury before a major Senate Committee (the Senate Judiciary Committee). Senator Patrick J. Leahy, the soft-spoken Chairman, said to him, “I just don’t trust you.” His counterpart, Republican Senator Arlen Specter, the ranking minority member of the Committee, extended his fellow Senator’s remark, adding, “Your credibility has been breached to the point of being actionable.”

Why do these and other Democratic and Republican Senators not say plainly what they say privately day after day – that they believe that the Attorney General has lied under oath, and not just once? Again, they avoid the logical conclusion. But then the Democrats have been doing this dance of evasion with George W. Bush on a far larger scale for four years. After all, Gonzales’s impeachable offenses are his superiors’. Bush-Cheney gave the orders. The litany of Bush-Cheney impeachable abuses extends far beyond those associated with Gonzales.

Compare the many impeachable offenses of Bush-Cheney with the certain impeachment of President Richard K. Nixon that was rendered moot by his resignation in 1974. Compare the actual impeachment of President William Jefferson Clinton by a Republican-controlled House of Representatives in 1998 for lying under oath about sex. Granted, Nixon became ensnared in the criminal laws and Clinton was caught in the tort laws. But Bush-Cheney’s “high crimes and misdemeanor”q tower in scope and diversity over those earlier Presidents.

And that remedy the Democrats took “off the table” after they won the Congress last November and before they even took office. Just what the White House recidivists needed to know to keep at it. What a lesson for future generations. Most Americans do not want their members of Congress to practice rushing to judgment. Nor do they want their members to rush away from judgment. The Democrats, with very few exceptions, are very good at escaping from their constitutional responsibilities.

It is time to hold the Bush-Cheney-Administration responsible for their indefensible acts.

SPEED KILLS (YOUR WALLET)

The Sneaky War on American Motorists

It was a beautiful afternoon in early autumn, and for an instant I mistook the brightly colored lights flashing in my rearview mirror for streaks of sunlight filtering through gently turning leaves. But only for an instant. Just past a curve on a steady downgrade a sign announced the end of the 55 mile-per-hour state speed limit and the beginning of the town 40. I hit the brakes but it was too late. That is the purpose of a speed trap. 62 in a 40, the policeman said.

Speeding tickets have always been a pain in the butt. You pay about $150, and if your insurance company chooses to be mean it uses the three fresh points on your license to justify a rate hike. In a recent legal transformation that has quietly gathered steam across the U.S., however, getting caught speeding has become far more traumatic.

A year before the incident related above, a state trooper had plucked me out of a cluster of vehicles on the Long Island Expressway, dinging me for 72 in a 55 (heavy volume had slowed traffic from its typical average of 80). That earned me a $185 fine plus six points – a point hike up from the long-standing three. A few months later the Department of Motor Vehicles sent me a letter notifying me that I owed an additional $300 – bringing the total fine to $485 – for a “driver responsibility assessment”. The 2004 law establishing the additional fees was passed in greater secrecy than the USA Patriot Act. Even this devourer of three newspapers a day had not heard of it.

My second ticket brought another letter billing me a second $300 driver responsibility assessment. But if I had plead guilty, New York would suspend my license for hitting the 12-point limit. I hired an attorney. I spent eight months and more than $2000 fighting the ticket in municipal court. My lawyers kept filing motions to delay my trial date until my cop would be away on vacation. Finally, the judge asked my attorneys what it would take to get my case off her docket. A deal was cut. I paid $850 in fines, plus the state assessment, and performed 25 hours of community service. I was allowed to pick between sorting trash at the recycling center and filing at the zoning board. You can guess which one I chose.

Final tally for two speeding tickets? $3,935. No wonder so many people drive around with suspended licenses! They cannot afford the fines.

Michigan charges $1,000 over the fine amount for driving 20 mph over the legal limit. New Jersey raises $130 million a year through supplemental state fines. Texas cashes in to the tune of $300 million. Other states, including Florida, are considering similar laws. The War on Speederists has reached its fastest boil in Virginia, where the extra fines can run over $2,500. Exceeding the posted speed limit by 20 mph, for example, earns motorists a $200 fine plus a $1,050 “civil remedial fee”. State legislators who sponsored Virginia’s stiff new penalties say they are out to make the roads safer, but admit that their main objective is funding highway repairs.

It is not just budget-mad Americans. Even the land of Mad Max and the Tasmanian Devil is getting tough on speeders. “Many people seem to believe that driving five, 10 or even 15 kilometers per hour over the limit is acceptable,” says Jim Cox, Infrastructure Minister for the Australian province of Tasmania. “For a pedestrian hit by a car, an additional [3 mph] can literally mean the difference between life and death.” Fines for speeding will be raised by 300%. OK, so speed kills. But when zealots like Cox say things like “research shows that even a one km/hour reduction in speed can result in a 3% reduction in crashes” you have got to wonder whether he has been smoking too much eucalyptus.

Virginia courts are bracing for an onslaught of angry drivers forced to fight their tickets. “For someone who is living near the poverty line, or even making $30,000,” said Fairfax attorney Todd G. Petit, draconian fees of over $1,000 have “a significant impact” that could lead to them losing their license and job. “It’s basically the Lawyer Full Employment Act,” chortled another happy member of the bar.

My friends have learned from my experience. Since every violation brings you a single ticket away from license revocation, challenging them in court is the smart way to go. Though the correlation between speeding and highway fatality rates is well established, fining speeders more than drugged drivers is disproportionate to the social impact of the offense. On the other hand, there is no denying the deterrent effect. I pay a lot more attention to speed limit signs.

OPINION & ANALYSIS

IT IS THE 1930’S ALL OVER AGAIN

Jittery stock markets, an economy drunk on credit, and politicians calling for varieties of dictatorship. What a sense of déjà vu! Let us recall that the world went bonkers for about 10 years way back when. The stock market crashed in 1929, thanks to the Federal Reserve, and with it fell the last remnants of the old liberal ideology that government should leave society and economy alone to flourish. After the federal Great Depression hit, there was a general air in the U.S. and Europe that freedom had not worked. What we needed were strong leaders to manage and plan economies and societies.

And how they were worshipped. On the other side of the world, there were Stalin and Hitler and Mussolini, but in the U.S. we were not in very good shape either. Here we had FDR, who imagined himself capable of astonishing feats of price setting and economy boosting. Of course he used old-fashioned tricks – printing money and threatening people with guns. It was nothing but the ancient despotism brought back in pseudo-scientific garb.

Things did not really return to normal until after the war. These “great men” of history keeled over eventually, but look what they left: welfare states, inflationary banking systems, high taxes, massive debt, mandates on business, and regimes with a penchant for meddling at the slightest sign of trouble. They had their way even if their absurd posturing became unfashionable later.

It is strange to go back and read opinion pieces from those times. It is as if everyone just assumed that we had to have either fascism or socialism, and that the one option to be ruled out was laissez-faire. People like Mises and Hayek had to fight tooth and nail to get a hearing.

So what was the excuse for such a shabby period in ideological history? Why did the world go crazy? It was the Great Depression, or so says the usual explanation. People were suffering and looking for answers. They turned to a Strongman to bail them out. There was a fashion for scientific planning, and the suffering economy (caused by the government, of course) seemed to bolster the rationale.

All of which brings me to a strange observation. When it comes to politics, we are not that much better off today. We may not have people running for office in ridiculous military suits. They do not scream at us or give sappy fireside chats or purport to be the embodiment of the social mind. The tune is slightly changed, but the notes and rhythms are the same.

Have you listened carefully to what the Democrats are proposing in the lead-up to the presidential election? It is just about as disgusting as anything heard in the 1930s – endless government programs to solve all human ills. It is as if they cannot think in any other way, as if their whole worldview would collapse if they took notice of the fact that government cannot do anything right. But it also seems like they are living on another planet. The private sector is creating a miracle a day, even as the stuff that government attempts is failing left and right. The bureaucracies are as wasteful and useless as they have ever been, spending is already insanely high, debt is skyrocketing, and there is no way that any American believes himself to be under-taxed.

But before we get carried away about the Democrats, let us say a few words about the bloodthirsty Republicans, who think of war not as something to regret, but rather the very moral life of the nation. For them, justice equals Guantánamo Bay, and public policy means a new war every month, and vast subsidies to the military-industrial complex and such other Republican-friendly firms as the big pharmaceutical companies. Sure, they pay lip service to free enterprise, but it is just a slogan to them, unleashed whenever they fear that they are losing support among the bourgeois merchant class.

So there we have it. We face a choice between two forms of central planning. They are varieties of socialism and fascism, but not overtly. Into this mix steps Ron Paul, with a message that has stunned millions. He says again and again that government is not the way out. And even though his political life is nothing short of heroic, he does not believe that his candidacy is about him and his personal ambitions. He talks of Bastiat, Hazlitt, Mises, Hayek, and Rothbard – in public campaign speeches. And let no one believe that this is just rhetoric. Take a look at his voting record if you doubt it. Even the New York Times is amazed to discover that there is a principled man in politics.

It is impressive how crowds are hard pressed to disagree with him. How much good is he doing? It is impossible to exaggerate it. He provides hope when we need it most. You see, the American economy may look good on the surface but underneath, the foundation is cracking. The debt is unsustainable. Savings are nearly nonexistent. Money supply creation is getting scary. The paper-money economy cannot last and will not last. One senses that the slightest change could cause unforeseen wreckage.

What would happen should the bottom fall out? Scary thought. We need ever more public spokesmen for our cause. In many ways, the Mises Institute bears a heavy burden as the world’s leading institutional voice for peace and economic liberty. So does LewRockwell.com. And we are working in every way possible to make sure that the flame of freedom is not extinguished, even in the face of legions of charlatans and power-mongers. Even though the politics of our times is as dark as ever, there are bright lights on the horizon.

THE ISOLATIONIST BEAST STIRS IN AMERICA AGAIN

The unsettled mood in America right now is in that exquisitely fluid state that presages either a real shift in a country’s affairs or an intense summer storm that will be as severe as it will be short.

The numbers tell you something: A record percentage of Americans believes the country is on the wrong track. The Iraq war remains deeply unpopular. The president is experiencing approval ratings worse than any in modern history and for a longer period of time. The signs of restlessness are everywhere – from the surprising strength of a fringe antiwar Republican candidate, Ron Paul, to the enduring appeal of a first-term, anti-war senator, Barack Obama, on the left. If there is an emerging theme, it is a serious rethink of American intransigence and overreach in global affairs. This is a chastened country.

Ordinary Americans are increasingly indifferent to the classic British posture of leveraging U.S. power, money and blood for global stability. They have sacrificed enough young soldiers recently for the abstraction of a war on terror. Last week the House of Representatives overwhelmingly passed what was essentially a symbolic motion declaring the intent of the U.S. not to have permanent bases in Iraq.

In a telling squabble among the Democrats, Obama also took last week to accuse Hillary Clinton of being like George Bush and Dick Cheney. The reason? In their YouTube debate, she had ruled out meeting foreign leaders hostile to the U.S. in her first year in office. Her point: “I don’t want to see the power and prestige of the United States president put at risk by rushing into meetings with the likes of Chavez and Castro and Ahmadinejad.” Her bellicosity earned her sudden and somewhat surprising plaudits from the Republican right.

But Obama, revealingly, did not retreat. Sensing an opportunity to score with his party’s base, he counter-punched thus: “The notion that I was somehow going to be inviting [Chavez, Castro and Ahmadinejad] over for tea next week without having initial envoys meet is ridiculous. But the general principle is one that I think Senator Clinton is wrong on, and that is if we are laying out preconditions that prevent us from speaking frankly to these folks, then we are continuing with Bush-Cheney policies.”

Nobody, with the exception of Rudy Giuliani, wishes to continue with Bush-Cheney policies. But what would not continuing with them mean? Obama is taking a gamble that the bubbling discontent with the foreign policy consensus since the end of the cold war might be creating a space for something new in American politics. On the other side of the aisle, Congressman Ron Paul is making the same bet.

Paul has no hope of winning. But his antiwar, isolationist message has catapulted him from oblivion to 4th place among the Republicans in funds on hand – ahead of John McCain. Both Obama and Paul are internet-driven candidacies, crammed with small donations and hyper-enthusiastic volunteers. They are also representative of a budding and clear revival of what can only be called neo-isolationism. And they have the wind in their sails.

Since the 1930s, isolationism has rarely had a real chance at achieving the kind of ideological dominance it once had in America. At first blush, 9-11 seemed to mean the end of even the dream of leaving the rest of the world behind. War had been declared. What choice did Americans have but to fight back? But the grueling, soul-sapping war in Iraq has unsettled that idea considerably. Many Americans look at trying to coax democracy or even stability in the Arab world and conclude that it is a mug’s game. You can see why opting out has begun to appeal.

The Bush-Cheney argument that we have to fight the terrorists in Iraq or we will have to fight them in Kansas has not persuaded many. And rightly so. The core truth of Islamist terror, as 9-11 proved, is that it is not that hard for very few people to do a lot of damage. The years-long occupation of a Muslim country, moreover, seems to have made the terror threat worse, not better. Almost 65% of Americans say the war was not worth the cost. As the Iraqi parliament prepares to go on vacation, while the sons and daughters of Americans face another hellish August policing a sectarian civil war, the potential for a populist isolationist revival seems real enough.

Can it happen? Practically, it takes a long time to get 160,000 troops safely out of an occupied country. The Pentagon has contingency plans to carry on for another two years. Congress does not seem in a mood to cut off funds. Oil remains a key strategic reason for the U.S. to keep its poker in the Middle East fire. And the Israel lobby may panic at signs of swift disengagement. It is hard to see a tectonic shift that draws the US away from its late 20th-century unipolar role.

But that does not mean it cannot happen. The logic of the situation as it has emerged these past five years is powerful. Cultural pessimists note that democracy is not built in a few years, or even a generation. American conservatism is not, at its core, a utopian or imperial tradition, and the revival of the antiwar, isolationist right is one of the more striking features of the past two years. On the left, meanwhile, the Vietnam syndrome has never fully dissipated. And oil has become a poisonous excuse for staying in the Arab world.

I see only hints and guesses at this stage. But something is stirring out there – on both the left and the right. Hillary Clinton and the main Republican candidates believe they can outflank it. We will find out in these next few months if the discontent has more strength and velocity than they anticipate.

RELIGION AND THE ARTS IN AMERICA

At this moment in America, religion and politics are at a flash point. Conservative Christians deplore the left-wing bias of the mainstream media and the saturation of popular culture by sex and violence and are promoting strategies such as faith-based home-schooling to protect children from the chaotic moral relativism of a secular society. Liberals in turn condemn the meddling by Christian fundamentalists in politics, notably in regard to abortion and gay civil rights or the Mideast, where biblical assumptions, it is claimed, have shaped U.S. policy. There is vicious mutual recrimination, with believers caricatured as paranoid, apocalyptic crusaders who view America’s global mission as divinely inspired, while liberals are portrayed as narcissistic hedonists and godless elitists, relics of the unpatriotic, permissive 1960s.

A primary arena for the conservative-liberal wars has been the arts. While leading conservative voices defend the traditional Anglo-American literary canon, which has been under challenge and in flux for 40 years, American conservatives on the whole, outside of the New Criterion magazine, have shown little interest in the arts, except to promulgate a theory of art as moral improvement that was discarded with the Victorian era at the birth of modernism. Liberals, on the other hand, have been too content with the high visibility of the arts in metropolitan centers, which comprise only a fraction of America. Furthermore, liberals have been complacent about the viability of secular humanism as a sustaining creed for the young.

Liberals have also done little to reverse the scandalous decline in urban public education or to protest the crazed system of our grotesquely overpriced, cafeteria-style higher education, which for 30 years was infested by sterile and now fading poststructuralism and postmodernism. The state of the humanities in the U.S. can be measured by present achievement. Would anyone seriously argue that the fine arts or even popular culture is enjoying a period of high originality and creativity? American genius currently resides in technology and design. The younger generation, with its mastery of video games and its facility for ever-evolving gadgetry, has massively shifted to the Web for information and entertainment.

I would argue that the route to a renaissance of the American fine arts lies through religion. Let me make my premises clear. I am a professed atheist and a pro-choice libertarian Democrat. But based on my college experiences in the 1960s, when interest in Hinduism and Buddhism was intense, I have been calling for nearly two decades for massive educational reform that would put the study of comparative religion at the center of the university curriculum. Though I shared the exasperation of my generation with the moralism and prudery of organized religion, I view each world religion, including Judeo-Christianity and Islam, as a complex symbol system, a metaphysical lens through which we can see the vastness and sublimity of the universe.

Knowledge of the Bible, one of the West’s foundational texts, is dangerously waning among aspiring young artists and writers. When a society becomes all-consumed in the provincial minutiae of partisan politics (as has happened in the U.S. over the past 20 years), all perspective is lost. Great art can be made out of love for religion as well as rebellion against it. But a totally secularized society with contempt for religion sinks into materialism and self-absorption and gradually goes slack, without leaving an artistic legacy.

For the fine arts to revive, they must recover their spiritual center. Profaning the iconography of other people’s faiths is boring and adolescent. The New Age movement, to which I belong, was a distillation of the 1960s’ multicultural attraction to world religions, but it has failed thus far to produce important work in the visual arts. The search for spiritual meaning has been registering in popular culture instead through science fiction, as in George Lucas’s six-film Star Wars saga, with its evocative master myth of the “Force”. But technology for its own sake is never enough. It will always require supplementation through cultivation in the arts.

To fully appreciate world art, one must learn how to respond to religious expression in all its forms. Art began as religion in prehistory. It does not require belief to be moved by a sacred shrine, icon, or scripture. Hence art lovers, even when as citizens they stoutly defend democratic institutions against religious intrusion, should always speak with respect of religion. Conservatives, on the other hand, need to expand their parched and narrow view of culture. Every vibrant civilization welcomes and nurtures the arts.

Progressives must start recognizing the spiritual poverty of contemporary secular humanism and reexamine the way that liberalism too often now automatically defines human aspiration and human happiness in reductively economic terms. If conservatives are serious about educational standards, they must support the teaching of art history in primary school – which means conservatives have to get over their phobia about the nude, which has been a symbol of Western art and Western individualism and freedom since the Greeks invented democracy. Without compromise, we are heading for a soulless future. But when set against the vast historical panorama, religion and art – whether in marriage or divorce – can reinvigorate American culture.