Money laundering, a very hot topic in the Nordics, especially after several scandals that interested major banks like Swedbank, Nordea and Danske Bank.
Is money laundering such an evil thing as described by media and politicians?
Well, the answer is: it depends.
Money laundering is often connected to some sort of illegal activity, hence it is understandable to have an adequate legislation attempting to prevent individuals to make profits with revenues arising from drug dealing, corruption, trafficking or tax evasion.
Money laundering is the process of making illegally-gained proceeds (i.e., “dirty money”) appear legal (i.e., “clean”). Typically, it involves three steps: placement, layering, and integration. First, the illegitimate funds are furtively introduced into the legitimate financial system. Then, the money is moved around to create confusion, sometimes by wiring or transferring through numerous accounts. Finally, it is integrated into the financial system through additional transactions until the “dirty money” appears “clean”.
“History of Anti-Money Laundering Laws”. United States Department of the Treasury. 30 June 2015. Retrieved 30 June 2015.
However, there are some cases when a laundering activity may produce positive effects for the aggregate economy, one of these is the laundering of tax evaded money.
I have nothing against money laundering when the money is originated from domestic tax evasion.
In a macroeconomics environment torn apart by persistent and unjustified austerity measures, tax evasion is not a harm to the domestic economy, it is actually a benefit.
Under certain conditions, I don’t consider tax evasion such a bad thing that needs to be condemned at any cost.
If we take for instance the case of Sweden, where the Swedish government is impoverishing the private sector with its criminal fiscal policy, tax evasion is a legitimate action.
I wrote about the fiscal devastation in Sweden in this article: The collapse of the Swedish state.
Tax evasion is a non-violent reaction to an oppressive fiscal policy.
Misconception about taxation
We have been hearing over and over the famous lie about tax evasion:
we must pay taxes in order to finance our public services (school, healthcare, welfare, etc.) and those who evade taxes are harmful for our societies, since they deprive the community of important resources.
This is, in general, not true, a sovereign government (like the Swedish one) does not need taxes to finance its spending, and in such a situation when the level of taxation is considered too high, evading taxes can produce a beneficial effect for the economy.
The main source of confusion here is that a large majority of the population sees a government as a sort of household that first needs to get the resources (the money) and then can spend the resources in its possession to buy products and services. In other words, the government requires the population to pay taxes so that it can use the accumulated money to spend and provide public services (to build a school or to repair a street as an example).
The reality is that this process works the other way around, the government must spend first (i.e. put money in the system) and then eventually requires part of the money (it has already spent) to be paid back (taxation). By spending more than it is taxing the government creates a public deficit which corresponds, one-to-one, to the private sector surplus.
The government spends first, and then taxes, it is not the other way around.
The government is the monopolist of the money, it is the only entity that can actually create money, this means that whenever it needs to spend, it just creates the needed funding out of thin air. The idea of a sovereign government requiring tax money for its spending is indeed absurd since the private sector needs to get the money from the government before they can pay any sort of tax.
All sort of limitations on government spending are self-imposed and often the people imposing these constraints do not really know how a monetary system works (or they know very well but don’t tell you).
One big objection usually arises from what I have just written above:
if the government spends without collecting any taxes the government deficit will grow out of control and the whole economy will be in serious danger.
This is also fundamentally wrong, again the majority of the population believes that the government deficit equals the private sector debt (i.e. the government debt is the citizens’ burden).
Wrong, the government deficit equals the private sector net wealth.
The higher is the deficit the richer is the population.
If a government is running a budget deficit, it spends in the economy more of what it is taxing hence the private sector is better off.
If a government is running a budget balance, it spends and taxes in the economy by almost the same amount hence the population is left with zero resources.
The extreme case in which a government run a budget surplus (like Sweden today) generate an impoverishment of the population since the government is requiring them more money than it ever provided.
Government deficit is the private sector net wealth.
Some macroeconomics basis
For those of you who are aware of the functioning of fiscal and monetary policy for a monetary sovereign country, the previous paragraph is just obvious, for all the others I need to go through some macroeconomics (in the simplest way I can think of).
In order to have a stronger grip on the above paragraph we need to go through some basic macroeconomics.
First and foremost:
- Sweden is a full sovereign country since is central government issues its own unpegged and non-convertible currency which is used as domestic unit of account.
- Sweden has a fiat currency. That is, a currency issued by the government, with no intrinsic value, unpegged and non-convertible.
Our macroeconomics environment (in this case the Swedish economy) is made of 3 sectors:
- domestic public sector
- domestic private sector
- foreign sector
The domestic public sector contains all the domestic government entities, hence the central government (the State), the local governments (regions, provinces and municipalities) and the public authorities (profit and non-profit organisations owned and run by the government).
The domestic private sector contains everything which is not public, and so we have households, companies and private non-profit organisations.
All public and private entities outside the domestic space belong to the foreign sector, or rest of the world.
The environment built upon these 3 sectors is nothing less than the Planet Earth. This system is therefore close because, as far as I know, we are not currently trading with any other planet of the solar system.
In this close system everything that moves from one sector has to go at least to one of the other two and if one sector is winning, by identity, at least one of the other two is losing.
One sector loss corresponds to a win for at least one of the other two.
Now we move from an abstract 3 sectors system to the real world, and for doing that we need an indicator, a measure of the wealth and income of a country, the Gross Domestic Product. Exploiting the GDP components (T – Taxes, I – Investment, G – Government Expenditure, S – Saving, M – Import and X – Export), we can formalise the balance of each macroeconomic sector.
Domestic public balance:
For the public sector, G is an outflow (spending) while T is an inflow (tax income).
Government Net Lending ⇒ (G – T)
When the government expenditure (G) is higher than government revenue (T) the public sector is lending to either the private or the foreign sector, or both.
In case T is higher than G than the government is borrowing instead.
When the domestic public sector is a net lender it is in deficit while it is in surplus when it is net borrower.
Domestic private balance:
Saving (S) and Investment (I) are endogenous to the private sector. This essentially means that the private domestic sector cannot accumulate financial wealth without the public and/or foreign outflows (we will deepen this concept in the coming paragraphs).
Private Sector Net Financial Wealth ⇒ (S – I)
When the aggregate saving is higher then the aggregate investment the private sector is having a surplus of financial wealth, net accumulation of financial wealth.
Import (M) and export (X) are respectively a financial inflow and outflow for the foreign sector.
Foreign Net Lending ⇒ (X – M)
When the export of a country exceeds the import it means that the foreign sector is lending hence it is in deficit.
The Sectoral Balances
The relations between the balances of the 3 sectors are the key to consistently understand the fluctuations occurring in the economic system.
As we saw in the above paragraph, the 3 sectors, domestic public, domestic private and foreign, compose the whole macroeconomics system. This system as whole, is close and every outflow of one sector corresponds to the inflow of (at least) one of the other two.
It follows than the sum of the 3 sector balances is equal to 0; at a global level all outflows and inflows sum to 0:
Domestic Private Balance + Domestic Public Balance + Foreign Balance = 0
which is equivalent to:
Government Net Lending + Private Sector Net Financial Wealth + Foreign Net Lending = 0
Domestic Public Deficit + Domestic Private Surplus + Foreign Deficit = 0
The public deficit is equal to the private sector surplus plus/minus the foreign balance.
If the government deficit increases the private net financial wealth also increases.
A government running a deficit allows the private sector to accumulate financial wealth.
For the sake of simplicity, let’s consider a foreign sector in balance (X-M = 0) and focus on the relation government deficit – private surplus: (G – T) = (S – I).
This leads to the conclusion that, the public deficit is equals to the private sector surplus. If the government deficit increases the private net financial wealth also increases.
A government running a deficit allows the private sector to accumulate net financial wealth.
The Government budget policies:
- Government Deficit → private sector net wealth is positive → the private sector is saving
- Government Balanced → private sector net wealth is zero → the private sector gets nothing
- Government Surplus → private sector net wealth is negative → the private sector goes into deficit.
You can find more details about the sectoral balances here: Macro Fundamentals
So why do we pay taxes if the government does not really need our money?
Remember what I wrote above about sovereignty and currency, Sweden is a full sovereign that issues a fiat currency.
Central government is the sole issuer of the money: the government creates money from nothing, it spends money into existence.
The domestic private sector is a mere user: it can only use the money that has been already issued, spent, by the central government.
Though it is true that bank can create money, remember that banks create money things not money, see above.
The foreign sector is a user alike the domestic private sector: the rest of the world cannot issue the Swedish national currency, it can only use it.
If a government hypothetically requires the population to pay no taxes at all, the national currency of the state would be worth nothing. If I am not forced to pay taxes in Swedish crown, then I probably don’t need to get (and hold) any Swedish crown at all. By introducing a taxation, the government guarantees that there will always be a need for Swedish crown hence it indirectly sets a floor value for the Crown.
There will always be a demand for Swedish crowns by Swedish citizens since every year the government requires a given amount of crowns in tax payment. Without taxation this need would cease to exist.
So, the main purpose of taxation is the control of the inflation and it has very little to do with the financing of government spending (once again, in a fiat currency regime).
When the government spends it creates money and increases the private sector wealth. On the contrary, when the government taxes it destroys money and decreases the population wealth.
What they want you to believe about fiscal policy
- Government has budget constraints, like households and firms
- Government spending must be funded through taxation or borrowing (bond sales)
- Spending comes after taxation
- Taxes finance government spending
- Taxation has to come before spending
- Government deficit is the private sector burden
- Deficit drives interest rates up, takes away private saving and generates inflation
- Today’s deficit is the future generations’ burden
Correct understanding of the fiscal policy
- The government can always afford to buy what is on sale in its own unit of account
- As the sole manufacturer of the currency the government can never become insolvent
- Spending comes before taxation
- Taxes cannot finance government spending
- Taxation occurs after spending
- Taxes exist for a monetary purpose not for financing (same applies for bond sales)
- Government deficit is the private sector net wealth
- Today’s deficit are the future generations’ savings
The economic situation is in Sweden
Below it is a graphical representation of the three sectors system that I have introduced above.
I produced the graphs with the data available from the Swedish central statistics bureau (Statistiska Central Bureau).
This graph is interpreted in the following way:
Each coloured bar represents the balance of a sector as percentage of GDP; the higher the bar the higher is the balance.
The red bar is the public balance, if it is below zero we have a deficit.
The green bar is the private balance, if it is above zero we have a surplus or a positive financial wealth.
The blue bar is the foreign sector balance, seen it from a foreign country perspective. If it is below 0 the rest of the world is in deficit against Sweden thus Swedish export is greater than import.
You can see that this graph has a peculiar characteristic, it is a mirror, and it shouldn’t surprise you since we know that the government deficit equals the private sector net wealth plus/minus the foreign sector.
If you sum the bars for each year you will notice that the sum is exactly 0.
In Sweden the private sector economy has been regularly attacked over the last decade. You can clearly see that every time the government deficit decreases the private sector loses.
Check the period from 1996 to 2000 for instance, red bars get smaller and so do the green ones.
From 1996 until today the Swedish governments are applying tight fiscal policies which are producing significant negative effects on the private sector economy. Not surprisingly the debt-to-income ratio of Swedish households is steadily increasing from 1996.
The graph below shows the variation of the debt-to-income (black line) in relation to the government deficit (red line). Interesting to notice how well, in the most recent years, the debt variation follows the government deficit, decreasing deficit and increasing debt ratio (check the two lines from 2011 until today).
Another interesting graph is presented below, the relation between disposable income and government balance. Here the correlation of the two series is even more evident than the previous graph and it enforces the important relation between government and private sector balance. We can clearly observe how disposable income reacts in opposite direction to changes in the government balance: a decrease in the government deficit generates a decrease in the private sector disposable income.
The Swedish foreign sector is constantly in deficit hence export exceeds import (check the blue bars). Without the wealth inflow coming from the rest of the world Swedish households and firms would be in serious economic distress.
Let me show how the export is so crucial today for Sweden (refer to the graph above, Sweden Sectoral Balances). In 2014 the government balance was in deficit and private sector in significant surplus (look at the green bar). In 2015 the government is more or less in balance before going surplus in 2016 and 2017. The private sector suffers, look again at the green bars, they get smaller and smaller. Without the foreign sector deficit, guess who will be in deep financial problems: households and firms.
Another example on how export is keeping us alive.
Check the periods 2003-2004, the government goes from deficit in 2003 to surplus in 2004. We should legitimately expect the private balance to shrink but instead it increases. How is that possible? The export, the foreign deficit increases from 2003 to 2004 compensating the private sector of the wealth loss generated from the public surplus.
This is unfortunately not the case in the recent years, the declining export sector is not able to provide the extra financial inflow to the private sector.
The graph proves another important as well as worrisome evidence of the last 3 years, the Swedish government is maintaining a tight fiscal policy while the export sector is shrinking.
This is a straight way to destroy a country, tighten the fiscal policy and leave the private sector net wealth in the hand of the rest of the world fiscal policy.
This is the situation of today’s Swedish economy, fragile and potentially at risk of collapsing: high private indebtedness, decreasing disposable income, stressed financial sector and (worst of all) tight fiscal policy.
How is the laundering of tax evaded money beneficial for the domestic economy?
Once more, government spending generate an increase of the non-government financial wealth, on the contrary taxation decreases households and firms’ wealth.
Leaving apart the foreign sector there are only two ways for the private sector to be better off, either the government increases its spending or it decreases taxation.
Tax evasion can be seen as an involuntary deficit spending operation by the public sector induced by the private sector. Tax evaded money are resources, previously spent by the government, that are kept in the private sector instead of sending them back to the the public sector.
This mechanism by definition leads to an increase in private net financial wealth.
For every crown of evaded tax there is a corresponding increase of private financial wealth.
Let’s say you live in Sweden and have managed to evade 100,000 crown of taxes. As long as you will be spending that money in Sweden you are indeed helping the economy by stimulating aggregate demand. Instead of destroying that amount of crowns, you managed to keep it in the domestic economy, your spending will be someone else’s income.
It is important to highlight that it won’t matter where the tax evaded money are stored as long as they are spent in Sweden. You can evade 1 million crowns and have them safe in a bank in Lichtenstein, but as long as you live in Sweden, or just spend that money in Sweden you are supporting the Swedish aggregate demand.
Another example: you managed to hide from the Swedish Gestapo (Skatteverket) a significant amount of money and decided to clean it by opening a restaurant with 5 employees.
In this case, instead of destroying that sum of money you decided to reinvest it in the private sector. You just created 5 new jobs and generated 5 new incomes (5 wages that will be spent in the economy).
So if I do not pay taxes, am I a criminal? Not exactly, in a sense I may produce a benefit for the whole economy because instead of giving the money to the government and effectively destroy them I decide to keep the money and spend it in the economy, my not-paid tax will eventually become the income of another person and so on. What I did it is just an indirect increase of the government spending.
Would a complete tax evasion be sustainable?
Of course not, inflation would rampage since too much liquidity is left to circulate in the system; moreover, once unable to collect any tax the government wouldn’t be able to use the fiscal instruments to redistribute wealth (it could eventually do it by issuing more currency but that would worsen the inflation problem).
Back to cash
In such a difficult period for the retail sector a fair dose of black economy would provide some positive effect. It would be enough if the population, every now and then, pays in cash and explicitly (and discretely) ask the person at the counter to not issue any receipt. For any non-issued receipt, the shop earns 25% more (the VAT) than it would have done with the receipt.
Unfortunately, more and more retail activities are abandoning the cash effectively making it impossible to be able to receive payments without issuing a receipt.
So, next time you go to a local shop and buy something relatively cheap paying with card think about the damage you are doing to the shop owner, you preclude the possibility to not issue the receipt thus saving 25% VAT and indirectly charge him/her for the card transaction fee.
It is up to you to think about what it is worst for the Swedish economy:
a handful of tax evaders or the persistent fiscal rape of the Swedish population perpetuated by the government?