W.I.L. Offshore News Digest for Week of September 8, 2008

THE AMERICAN EMPIRE IS ANOTHER BUBBLE

The situation is actually significantly worse than the mere bailout of Fannie, Freddie, and the FDIC would suggest, once one places the bailouts in their proper historical and political contexts.

This article by Don Rich for the Ludwig von Mises Institute is an excellent and concise summary of where we are today and why. Rich notes that there are fundamental disequilibria between the U.S. government's promised spending versus expected revenues and between American living standards and economic productivity. Through the use of the fiat money system and with the help -- sometimes head-scratch inducing -- of China, Japan, and Russia, among others, the U.S. has been able to defer having to deal with those disequilibria, while financing a worldwide military empire. More frequent and worse financial crises suggest this game cannot go on much longer.

If Ludwig von Mises were to peruse today's newspapers, he would recognize the symptoms of a worldwide central-bank-generated credit bubble and its oncoming collapse. What increasingly characterizes the global financial order, Mises would say, is an arrangement where regulators encourage a "heads I win, tails everyone else loses" mentality, backstopped by the willingness of quasi-governmental entities to print and borrow money without bound.

A gentle man by all accounts, Mises would resist the temptation to say, "I told you so," and focus on how to avoid a full-blown global economic and political catastrophe.

The announcement by the FDIC that it might have to "temporarily" borrow money from the Treasury, i.e., the taxpayers, is the latest squawking canary that the dollar-centric global-fiat-money and regulatory era in place since World War II is approaching a final ugly dénouement.

The FDIC now fails to meet its required statutory minimum of 1.15% of capital per insured dollar in deposits due to the ongoing mortgage and credit market carnage; hence the hint for the life preserver thrown out by the FDIC to the Treasury Department the last week of August 2008.

The FDIC, like Fannie and Freddie, says, "Of course we will pay this loan back when everything returns to normal." The accounting "profession" and "civil servants" at the CBO et al are likely to give their seal of approval to an FDIC bailout with the assurance that "all is well" in the short run. In fact, the bailouts of Fannie, Freddie, and the FDIC in the long run by themselves are likely to be as effective as the Niedermeyer character from the movie Animal House was in attempting to stop the John Belushi–triggered stampeding crowd at the end, pitifully screaming, "Remain calm, all is well."

As in the case of Fannie and Freddie, the FDIC promise to repay the taxpayers when things return to normal is worthless, because there was nothing normal about the real estate and associated credit bubble in the first place. The FDIC, Fannie and Freddie will assure everyone that "the public will receive its money back when the assets of failed banks, etc. ... are sold." That is unhelpful nonsense.

By definition, a bubble is an economic disequilibrium caused by the excessive creation of money in relation to the intrinsic value of the asset class to which the money is drawn. In long-run equilibrium, therefore, the money stock (and therefore asset prices) must return to their productively useful value in relation to the size of economic output, or the general price level must rise to restore the fundamental relationships between the marginal utilities of goods and their prices: Mises 101.

In other words, in the case of the fallout from the real-estate and associated credit bubbles, either housing and bond prices must fall dramatically, or there must be a dramatic increase in inflation, or a combination of the two. This is not rocket science, whatever the sophists of the political class would have us believe.

Without wishing to cause a panic, the situation is actually significantly worse than the mere bailout of Fannie, Freddie, and the FDIC would suggest, once one places the bailouts in their proper historical and political contexts.

For the last 60 years, the United States has provided military protection for the European and Asian capitalist powers, all possessing economies governed by regulatory apparatuses analogous in character to the apparatuses of the American postwar New Deal. These apparatuses, especially when coupled to fiat money, have in common the fundamental flaw that they create economic instability via moral hazard.

This provision of American military protection has been supported by the imperial tribute of the acceptance of paper dollars -- dollars at first theoretically backed by gold. Of course, this charade, described by Robert Triffin in 1960, ended in 1971 with the collapse of the Breton Woods system, exposing holders of dollars to massive losses and causing the Great Inflation of the 1970s.

Through the 1970s and 1980s, the U.S. did not abandon the course of empire, or statist regulation, but instead expanded, especially the imperial side of the interventionist mentality and especially in the wake of the collapse of the Soviet Union. Whatever the deregulation of other sectors of the economy, the financial sector -- due to its role in imperial finance -- retained its peculiar regulatory privilege through its ability to generate unlimited losses at taxpayer or dollar-holder expense.

This expanded American empire was, for a time, bizarrely aided by the People's Republic of China as part of an industrialization policy in which the Chinese sterilized the purchase of dollars by massive domestic security sales to soak up excess liquidity. This is a strategy that is rapidly running out of steam and has created a dangerous inflation in Chinese real-estate and stock prices that is unlikely to end well.

Japan, capitalist-oriented East Asian and to a lesser degree Western central banks, the oil states, and Russia (yes, Russia) also purchased huge quantities of dollar-denominated assets from the 1990s onwards, with the effect of subsidizing the Pax Americana -- probably because alternative security arrangements seemed more expensive. Alas, that willingness to subsidize the United States would seem to be rapidly waning. Russia's recent assertiveness is a hint of things to come, as more and more foreigners are taking a hard look at their subsidization of an America living beyond its means. The stocktaking economic signal globally is the increasingly punishing foreign-credit-related losses caused by the Fed's last imperial bubble, a credit bubble that has infected the entire planet.

It was fun for the U.S. in the short and medium run, since, at least in the 1980s, it got to have its imperial cake and shopping-mart icing too. The United States thereby avoided having to deal with the fundamental disequilibrium between both the federal government's promised expenses versus expected revenues, as well as the associated disequilibrium between American living standards and economic productivity.

That era is coming to a close, with the increasing amplitude in the financial oscillations of the world economy at lower frequencies, demonstrating systemic instability dating, at the latest, to the Asian financial crisis of 1998.

In response to that crisis and to concerns over Y2K, and with especially intense initiation at the time of the LTCM fiasco (an event itself of course made possible by the intrinsic moral hazard of Greenspan and the postwar regulatory mentality), the Fed lowered rates, thereby pushing the tech-stock bubble into a final frenzy. Raising rates in 1999 to combat Fed-fiat-money generated inflation, the creature from Jekyll Island succeeded in crushing the NASDAQ et al, and, in the process, generating a global economic downturn.

In 2002, now concerned about deflation, the Fed took rates to absurdly low levels, thereby generating the housing bubble. Worried about inflation in 2006, in which the housing bubble was the inevitable consequence of trying to maintain American asset prices and output valuation at nonequilibrium levels, Greenspan's fall guy Bernanke took rates up, killing the housing bubble, and then took rates down while revving up the printing presses to stave off a credit-market collapse. This leads us to the current juncture with Fannie, Freddie, and the FDIC, and what Mises would clearly identify as the "policy" trap.

Viewed in isolation, the Fed can take rates neither substantially up nor down. If it fights its own inflation by taking rates up, it sends the economy into a depression. If it fights a credit-contraction-generated recession with lower rates, it risks a hyperinflation and a run on the dollar. If the federal government were to try to use any more fiscal stimulus on the tax or spending side, the Ricardian equivalence theorem would apply to an entity with a present discounted budget deficit/solvency problem of $30 trillion dollars. That is, there will be minimal effect. A bump in second-quarter GDP changes nothing about the long-run picture, and in equilibrium actually means merely a shift of output from the future to the present. It is, however, popular with politicians under the electoral gun and Wall Street types looking for suckers.

In other words, Mises would point to the bailouts of Fannie, Freddie, and the FDIC as the hint that a general system event had arrived, in which we need a new policy mentality. Mises would clearly see the solution to the fiat-money-generated world disequilibrium as a global return to a commodity-money standard with 100% reserve banking as the only monetary policy rule and a banking order that avoids the disequilibria generated by the politically motivated manipulation of the money supply.

Although the author was trained in a very different mentality, he now sees an irreducible truth in the argument that, under the current discretionary monetary policy arrangements, we keep observing the same cycles in under and overextension of credit, because the political temptation to do so is overwhelming. In the long run, when monetary authorities around the globe play the same game -- and especially when the use of that credit is so often indirectly used to finance war -- the results of central-bank activities are likely to be so poor in terms of system risk that the seemingly radical step of a return to commodity-based money and a new reserve order for the banking system might well be the most responsible step to take, provided that the move is done in an orderly fashion.

Given the need to avoid an implosion of the world political order, such a transition would probably have to be created in conjunction with negotiations with our foreign creditors for a new gold-based monetary order to avoid a panicked run on the dollar, amid attempts to attack a grossly overextended American imperial position. In the regulatory field, what is needed at a minimum is the effective creation of an adults-only area where losses are credibly understood as not subject to a Greenspan-like put in order to permanently rid ourselves of the "heads I win tails you lose" financial-system externality that is getting increasingly expensive and disruptive.

Although this analysis of the meaning of the FDIC bailout in its broader consequences cannot be regarded as cheery -- and, to some, may seem radical -- human beings do poorly when imitating ostriches, and any of the alternatives available to policy makers are likely to be gratuitously destructive in character.

NEW ZEALAND STILL ONE OF WORLD’S BEST PLACES FOR BUSINESS

This week the World Bank released its Doing Business 2009 report. New Zealand retained its #2 "ease of doing business" rank while Singapore came in at #1. The U.S. was #3 and Hong Kong was #4. This overall ranking averages rankings across 10 categories. The ranking methodology is decribed in this document (PDF). An Excel spreadsheet of all 181 countries surveyed across all categories is available here.

Sometimes the specifics are more interesting than the aggregate. For instance, New Zealand is #1 for starting a business while Singapore is #10. But for "trading across borders" Singapore is #1 while New Zealand is #23. If you plan on transacting a lot of international business you might tolerate Singpore's somewhat more onerous startup process in light of the subsequent ease of conducting ongoing business. Naturally New Zealand trumpets its #1 ranking in starting a business, as highlighted in the article below.

Another category which might be of special interest is "paying taxes," which is derived from "number of tax paymments, time to prepare and file tax returns and to pay taxes, total taxes as a share of profit before all taxes borne." The #1 ranked country is the Maldives, whose overall rank is only 69. Quatar is #2 here, vs. an overall rank of 37. Singapore is #5, New Zealand #12, Hong Kong #3, Ireland #6, and the U.S. #46.

Under "enforcing contracts," Hong Kong is #1, Singapore #14, New Zealand #11, and the U.S. #6. Overall #11 Iceland is #3, while overall #50 Luxembourg is #2. Other categories include registering property, employing workers, closing a business, and "protecting investors."

The World Bank's survey is a very interesting one. Given that it is free, if one is thinking of relocating or starting a business abroad there is no reason not to avail oneself of the resource.

New Zealand's Minister for Small Business, Clayton Cosgrove, has welcomed Wednesday's release of the World Bank's Doing Business 2009 survey, which shows that New Zealand has retained its second place ranking for ease of doing business.

Mr. Cosgrove said New Zealand's regulatory environment has been consistently ranked either #1 or #2 by the World Bank since the survey began. He said for New Zealand to retain its 2nd-place spot in the face of an increasingly competitive global business environment is a fantastic result.

"This survey recognizes the government's ongoing drive to improve the regulatory environment," he remarked. "We have worked hard to minimize the amount of time business people spend on paperwork so they can focus on their businesses. Today's number two ranking is an endorsement that our approach is working, and that this country is one of the most business friendly in the world."

The World Bank's Doing Business survey is an annual cross-economy study that measures government regulations and their effect on business across 181 economies. The Survey uses 10 key indicators to measure and compare ease or difficulty of operating a business. Economies receive a ranking for each key indicator, and an overall "Ease of Doing Business" ranking.

Mr. Cosgrove said a highlight from [the World Bank report] is New Zealand's jump from 3rd to 1st place for the "Starting A Business Indicator."

"The average number of days to start a business in the OECD is 13.4 days while in New Zealand it takes approximately one hour. This is thanks to the cooperation between the Companies Office and Inland Revenue which means new businesses can be given their GST number at the same time as incorporating their company online -- a major time saver for small businesses," he continued. "It is also worth noting that comparative to our Australian neighbours, businesses here pay a lot less in tax as a percentage of their profits. In Australia the total tax rate as a percentage of profits is 50.3% whereas in New Zealand businesses pay 35.6%. This is also below the OECD average of 45.3%."

Mr. Cosgrove said the government recognizes it must continue its programme of improvements to retain New Zealand's internationally competitive business environment: "Recent initiatives such as changes to the tax regime announced in Budget 2008 will have a positive effect on future survey results.

"The Standard Business Reporting project we are currently developing will revolutionise government and business interactions, by allowing businesses to file information only once with government, in one place, therefore reducing the compliance burden and saving time."

In addition, Mr Cosgrove said [the] findings by the World Bank is one of several independent studies showing ongoing improvement for New Zealand's business environment. These include the latest Business New Zealand-KPMG Compliance Cost Survey of business people that shows compliance costs have fallen by a third since 2005 for firms employing five or fewer staff.

TOP 30 OFFSHORE LOCATIONS FOR 2008

India has garnered most of the publicity in the offshore outsourcing business. Now well-known IT consultant Gartner Consulting has announced its ranking of the top 30 offshore services locations. Obviously there are a lot of choices out there now.

India might not be the only country that comes to mind when considering outsourcing work overseas, according to Gartner, which recently unveiled its list of the top 30 leading locations for offshore services in 2008.

Countries such as Argentina, South Africa and New Zealand could take the some of the spotlight off India as the offshore industry darling, according to the research firm, but India remains in the list of leading locations. The location selection is a key factor companies need to consider when thinking of sending work overseas, Gartner says, and the city they choose will impact the success of the offshore engagement.

"Whether you have a country-led or vendor-led approach to offshore services, you must understand the offshore location landscape," according to a presentation by Gartner research vice-president Ian Marriott.

Gartner evaluated 30 countries in three world regions that could address enterprise companies' outsourcing needs. Considering 10 key criteria, Gartner scored the potential of numerous cities to provide the right mix of English language proficiency, local government support, infrastructure and technical considerations such as data security and privacy. The research firm released the data at its Outsourcing & Vendor Management Summit it hosted recently in Washington, D.C.

Gartner indicated Argentina, Brazil, Canada, Chile, Costa Rica, Mexico and Uruguay as the key locations within the Americas. In the Asia/Pacific region, Gartner listed Australia, China, India, Malaysia, New Zealand, Pakistan, Philippines, Singapore, Sri Lanka and Vietnam. In Europe, the Middle East and Africa, Gartner selected Czech Republic, Hungary, Ireland, Israel, Northern Ireland, Poland, Romania, Russia, Slovakia, South Africa, Spain, Turkey and Ukraine.

The 10 criteria Gartner used to rate countries ranged from language proficiency and availability, including written and verbal competency, to the local government support of offshore business to the potential labor pool available in the country. The infrastructure of the country including roads, rail service, air travel and ports into and around the country is also a key consideration, and the quality of the country's educational systems were also considered in Gartner's evaluation.

Costs of labor and other compensation, real estate and other considerations such as labor rate should be considered, as well as the political and economical environment, Gartner says. Companies considering offshore services must also consider cultural compatibility and the global and legal maturity of the country they choose to locate offshore services. And lastly, Gartner says data and intellectual property security and privacy must be considered from the effectiveness of legislation around data protection and privacy as well as the country's enforcement of such legislation.

"Determine which vendors are the right fit for your organization," Marriott advised in his presentation. "Don't just seek the leaders."

LONDON’S STATUS AS FINANCIAL CENTER THREATENED

London has been a world financial center (or should we say "centre") for centuries, helped by the British Empire's one-time preeminence. Now that status is being threatened by Britain's persistence in maintaining a high tax and regulatory burden on businesses when an increasing number of competitors undercut it in those departments. The appropriate response to the new competition does not take a brilliant intellect to figure out: cut taxes; reduce regulations. But this is not so easy in the face of pressure on the ruling Labour party to increase taxes on the wealthy and cut taxes of the lower-earning. Hedge funds and their managers are not well represented among the later.

London cannot say it was not warned. Over the past year, people have been arguing that the rising tax and regulatory burden of doing business in the British capital threatened its status as a world financial center.

Now there is a hint that firms are quitting. Henderson Group Plc, a U.K. money-management firm, said in August it planned to move its tax base to Ireland. The hedge fund company Krom River Partners LLP said this week it planned to move its base from London to Zug, Switzerland.

London needs to respond fast -- or else watch a trickle turn into a flood. As other financial centers become more competitive, London is becoming less so. Unless it can turn that around, the city is going to face a real threat to its position. And cities such as Dublin and Zug will grow in importance.

"The one issue that stands out above all others when companies discuss quitting London is tax -- either corporation tax or personal tax," says Mark Yeandle, a senior consultant at Z/Yen Group Ltd., which has produced reports for the city of London on its competitiveness as a financial center.

There is little doubt that financial firms are starting to review whether the British capital is the best place to base themselves. Henderson Group is one of the best-known names in U.K. fund management. It dates back to 1934 and has £59 billion ($103.8 billion) under management. Now it has decided that U.K. taxes are too high, and has opted for Dublin instead. Irish corporate taxes at just 12.5% are less than half the British rate of 28%. It might just be a tax base at first. Yet it is a fair bet that once the headquarters have moved, other jobs will follow.

Krom River, a $180 million hedge fund based in London's Mayfair district, had similar concerns. Taxes were not the only reason for its decision, according to a senior manager already based in Switzerland. The company resolved to make the switch after weighing lifestyle issues as well.

Insurance companies are on the move, too. Lloyd's of London insurers such as Hiscox Ltd. have moved from London to Bermuda: They pay almost no corporate tax in the Caribbean. "The tax treatment of Lloyd's in the U.K. must be amended," Peter Levene, Lloyd's of London chairman, said at a dinner in London's financial district last week. "It is under threat from other markets."

One or two firms quitting the U.K. might be a coincidence. Yet the warnings have been there for some time. In February, the city of London published research on the emerging problems. "Until fairly recently the U.K. had what was felt to be a very attractive tax regime as regards both corporate and personal tax rates, but this has changed," the report said. "The main competing financial centres were seen to be Dublin, the Netherlands and Switzerland. Each of these scored very well, and much better than London, on the competitiveness of their tax regimes."

It looks as if no one was listening. For an exodus to start you do not just need London to become less attractive. You need somewhere else to start becoming more attractive as well. ... That is now happening. Dublin has its low corporate-tax rates. Switzerland has revamped rules on taxing hedge and private-equity funds, allowing individual cantons to lower tax rates for those entities. Do not be surprised if they start vying with one another to come up with the most competitive tax regime.

Two forces are now at work that will seriously erode London's position.

First, money managers like clusters. The reason they flock to London and New York is because they can mix with their peer group. Even in cities they gather within small locations. In London, for example, the hedge funds are mostly in Mayfair. Once a cluster emerges in Dublin and Zug, more and more will make the same switch. It is like a dam bursting. It starts as a trickle but can turn into a flood very fast.

Next, other cities will see what is happening, and make their own moves. How about a tax-free zone for hedge funds in Amsterdam or Paris? If Scotland breaks away from the U.K., perhaps it will attempt to turn Edinburgh into an even more significant money management center with a special tax regime.

Financial firms bring well-paid staff with them, boost property markets and create local jobs. A tax-free zone could easily be self-financing for those countries -- and there would be the added satisfaction of stealing from the English.

London needs to act quickly to protect its position. Three moves could be made immediately to shore up its attractiveness.

Corporate taxes should be cut from their current 28%. If necessary, that should be restricted to the City financial district and Canary Wharf. It might be expensive, but not as costly as letting the financial firms flee.

Next, the U.K. should relax the tax rules on carried interest and options, techniques used to pay financial-industry staff. That would make the overall tax regime a lot more acceptable and would not have the same impact on the budget deficit as a cut in the standard rate of tax would have.

Finally, it should look at special tax breaks for industries such as insurance, where London has traditionally been strong. It has to remain competitive with offshore centers.

The U.K. might well need to rebalance the economy to reduce its dependence on financial services. But there is no good argument for losing its most successful industry. If it does not take action soon, the battle will be lost.

REPORT HIGHLIGHTS CONTRAST IN SAVINGS TAXES BETWEEN “NEW” AND “OLD” EU

A report by independent thinktank the European Policy Foundation starkly highlights the tax policy differences between the orignal EU member states and newer ones. The later tend towards flat, low tax rates, while the older regimes have stuck to their higher rate, progressive income tax schedules. This shows up in the treatment of interest income. The newer states apply a withholding tax on interest payments and it largely ends there, if interest is taxed at all. Contrarily, the "original 15" want to include interest income in the taxpayer's overall income and tax it at the high marginal rates from the progressive schedule. This drives such mischief as the European Savings Tax Directive.

A new report commissioned by the European Policy Foundation, an independent international research institute, has shed light on the marked difference between how savings are taxed in the 12 "new" EU member states in Central and Eastern Europe compared with the "old" member states of the original EU15.

The report, entitled "Taxation of Income From Capital In The EU" examined tax on savings income across Europe and concluded that, on the whole, countries in the new EU12, which joined in the 2004 and 2008 expansions of the bloc, tend to have much less burdensome systems of withholding tax on interest than their counterparts in the old EU15.

This is because the new member states almost without exception have adopted a "final withholding tax" system in which tax -- usually at a flat rate -- is deducted from the interest payment by the bank or other paying agent concerned, with little additional input needed by the taxpayer themselves. Indeed, some EU 12 countries, such as Bulgaria, Estonia, Latvia, Lithuania and Romania, exempt some or all types of interest from tax altogether.

By contrast, most of the EU's previous 15 member states tend to insist that interest income is included as part of a taxpayer's overall income which is then subject to progressive income tax rates, which tend to be higher than the tax rates imposed by the new member states.

The report painted a similar picture with regard to dividend taxation, with all 12 new member states applying a final withholding system to dividend income. Over in the old member states, 7 out of the 15 countries apply a final withholding tax on dividends (Austria, Belgium, Italy, Netherlands, Portugal, Spain and Sweden). However, the study concluded that in general, dividends receive more favorable tax treatment than interest in the EU15, whereas in the EU12 dividends do not tend to receive more favourable tax treatment than interest income.

The report also highlights that in the older member states, there are pressures to harmonize the taxation of interest income in an upwards direction within the context of the EU Savings Tax Directive. This contrasts sharply with the prevailing trend among governments in the newer member states to lower tax rates where possible, including corporate and personal income taxes, as well as savings taxes.

ARE OFFSHORE ACCOUNTS USED AS MONEY LAUNDERING VEHICLES?

This introduction to offshore banking by "news magazine" 3×24, which looks like it is a bulletin board with a make-money-from-home orientation, dispells certain myths for latecomers to the arena; namely, that it is a haven for money launderers and tax evaders. The increased regulation and oversight by international financial policemen renders this reputation largely obsolete.

An offshore bank account is an account at a bank located outside the United States or other country of residence of the banking client. These bank accounts are known for having low tax liabilities, thus making them also commonly known as tax havens. Offshore bank accounts also tend to provide financial and legal benefits. These benefits may include:

• Less controlling legal regulation
• Little to no taxation
• Greater secrecy
• Easy access to funds
• Protection against local financial or political instability

The most infamous and popular offshore banking centers in the global market are the Cayman Islands and Switzerland. Other well-known established destinations for offshore banking include the following (in alphabetical order):

• Bahamas
• Barbados
• Belize
• Bermuda
• British Virgin Islands
• Cyprus
• Dominica
• Gibraltar
• Ghana
• Hong Kong
• Labuan (Malaysia)
• Liechtenstein
• Luxembourg
• Malta
• Macau
• Mauritius
• Monaco
• Montserrat
• Nauru
• Panama
• Seychelles
• Turks and Caicos Islands

Because of the seemingly lax regulation of moneys deposited in offshore bank accounts, offshore banking has gotten something of a bad rap over the last few years. These types of bank accounts have often been associated with tax evasion, money laundering and organized crime. Offshore banking has been erroneously linked to shady business practices and underground economy.

Legally, however, this type of banking does not exempt personal funds from being subject to income tax on earned interest. U.S. taxpayers are required to report (on penalty of perjury), any offshore bank accounts which may be in their possession. [This requirement kicks in once the sum value of offshore financial accounts hits $10 thousand.] Offshore banking institutions are not obligated to declare any [client] income to foreign tax authorities because they are protected by bank secrecy. This lack of regulation toward reporting suspected tax evaders does not make not reporting the income (or evading income tax associated with it) legal.

Proponents of offshore banking have condemned any efforts towards supervision and control. They claim the process is driven, not by safety and financial issues, but by the aspirations of local banks and the IRS to control the funds stored in offshore bank accounts. They refer to the alleged fact that offshore banking offers a competitive threat to the established banking and taxation systems in countries such as the U.S

Even for those hoping to find easy tax havens and money laundering shelters in offshore accounts will find that the old rules no longer apply. The regulation of offshore banking is improving in many ways. The regulation of these elusive banking institutions is increasingly monitored by supranational nongovernmental organizations such as the International Monetary Fund. Offshore banks are required to report at least quarterly on many different aspects of their business. The increased focus on anti-money laundering initiatives in several different countries signifies that bank employees at all levels are encouraged to report suspicion of money laundering to the local authorities despite bank secrecy. Additionally, there is increased cooperation between police authorities across international borders.

Though offshore banking has traditionally been notorious for money laundering, tax evasion and for being a tool for organized crime, increased regulation is making those stigmas a thing of the past. There are many advantages of offshore banking, most of which are legal and perfectly honorable. The desire of local banks to control all funds originated in the U.S. and "get a piece of the pie" does not immediately translate to dishonest money laundering schemes.

TAX PROBES TO DOG LIECHTENSTEIN BANKS FOR YEARS

Liechtenstein has publically pledged to "cooperate with foreign states on tax evasion." See, e.g., this news item and this one. Exactly what this will mean in practice remains to be seen, but clearly Liechtenstein has bowed to some degree to international pressure to cooperate more fully with other governments against citizens who attempt to hide assets in its financial institutions.

Liechtenstein Prime Minister Otmar Hasler was quoted: "We will not give up bank secrecy. But we are willing to collaborate with other nations when it comes to the misuse of bank secrecy laws for tax evasion." The Financial Times quoted "unnamed sources" as saying that one measure being considered was an offer to share information with foreign governments about clients with undeclared accounts, provided that they would not be too severely penalized.

Yeah, sure.

Liechtenstein Crown Prince Alois added, "We have the opportunity in our hands to show the world that not only individual institutions, but also the entire financial sector can be successful within the framework of greater cooperation in tax matters."

Not exactly reassuring to those with a lot to lose from being revealed.

Unsurprisingly, such clients are not waiting around to see how all this works out, and are moving their assets elsewhere. This is showing up in reduced assets under management in Liechtenstein's banks, or at least reduced growth rates in assets under management.

A German-led clampdown on tax dodgers has scared savers away from Liechtenstein's banks and it could take years to win them back, prompting the tiny state to seek to lessen its reliance on the tax haven business.

The Alpine principality nestled between Austria and Switzerland has long relied on its tradition of banking secrecy to attract foreign customers wanting to hide their money from the taxman, but it has come under mounting pressure to open up.

In February, Germany launched a major investigation into thousands of its citizens suspected of parking savings in Liechtenstein banks to evade tax. Other countries including the United States also joined the hunt for tax dodgers.

Liechtenstein's three main private banks -- Swiss-listed LLB , VP Bank and unlisted LGT Bank -- all took big hits in their first half results published in recent days. "Recent tougher measures against tax evaders in Germany, the U.S. and other countries could threaten the very existence of the financial center of Liechtenstein," said Vontobel's Tobias Bruetsch.

Thomas Kalbermatten from Credit Suisse said it would take time for customers to regain trust in Liechtenstein's banks, noting they were scared off for several years after the state was blacklisted at the start of the decade. Liechtenstein is one of only three countries on the OECD's list of uncooperative tax havens, alongside Andorra and Monaco. "It will take two to three years to get back on track," Kalbermatten said.

The #1 bank LGT, owned by the ruling family, said net new money fell to SF335 million ($305.9 million) in the first half from 6.2 billion a year ago, while assets under management fell SF7.5 billion to SF95.3 billion ($86.8 billion). It was client data stolen from LGT by a former employee and allegedly bought by the German authorities that triggered the investigation.

Swiss-listed LLB said it was also suffering from the German probe, rocky financial markets as well as the ongoing German trial of a man who blackmailed the bank with stolen client data. LLB, the #2 bank, had a net outflow of SF67 million from international clients, partly offset by inflows from domestic clients and institutional clients to bring net new money to SF353 million, compared to SF1.4 billion a year ago.

VP Bank said it saw a net outflow of SF99 million compared to a net inflow of SF1.8 billion a year ago.

Shares in LLB and VP Bank have both lost about a quarter of their value since the German tax scandal erupted and have been under pressure again since the banks reported results last week.

"The LLB Group expects the difficult business environment to persist through the second six months of 2008," it said, although it reiterated its medium-term target of growth in net new money inflow of at least 3 percent a year.

Helvea's Peter Thorne had forecast a bigger outflow of funds at LLB, but said clients would probably keep withdrawing cash: "It will be a slow burn. It will take several years."

Vontobel's Bruetsch said the Swiss and Liechtenstein wealth management sector was trading at an average of 11.7 times earnings, but due to the concerns about Liechtenstein's future he was targeting 11 times 2009 earnings for LLB and VP Bank. But he favors LLB over VP Bank as its core business seems more stable, it has costs better under control and it still managed a net inflow in the first half.

As clients in Europe have taken fright after the German tax investigation, the banks are looking for new customers among Asia's burgeoning population of millionaires. LLB is opening an office in Dubai in November, which it said would help it expand in the Middle East, as well as India. VP Bank is also growing in Singapore. "They are expanding internationally, but that will cost in the short term," said Helvea's Thorne.

Liechtenstein, a country of 35,000 residents whose economy is heavily dependent on the financial sector, also wants to do more to develop "onshore" financial services and industry.

In a speech last month, head of state Prince Alois von und zu Liechtenstein said the country would move to cooperate more closely with other states in relation to tax matters. "Liechtenstein is no longer an offshore center, but rather a financial center with strong growth in onshore business as well as a successful industrial location," he said.

Rather than attracting individuals seeking to evade taxes, Liechtenstein will seek companies who want to cut their tax burden. The government last week announced a plan to cut corporate taxation to 12.5% from around 20%.

Credit Suisse's Kalbermatten said Liechtenstein's banks were not just responding to international pressure over tax evasion, but also to younger customers who wanted easier access to their cash than their parents who parked savings in Liechtenstein.

"They have to change the business model ... and not just because of tax reasons. A new generation of clients is looking for alternatives because they know if their assets are not taxed they can't use them," he said.

Liechtenstein Announces Tax Reform Package

As part of its "We are an offshore financial services center, not a tax haven" repackaging, Liechtenstein has introduced new tax laws which apply to international businesses that set themselves up there. Details are sparse, but Liechtenstein is joining a crowded field there. Heretofore its competitive advantage has been laws and a culture which safeguard clients' privacy. With that advantage dissipated the country will have to work hard to replace lost business.

Liechtenstein should continue to have an attractive, competitive, and high-performance tax system that takes account of the country's tax tradition while ensuring international compatibility, according to Prime Minister Otmar Hasler.

The "Future of the Liechtenstein Tax Location" proposal, recently introduced to the public, aims to update the jurisdiction's tax laws, which have remained largely unchanged since 1961. The government expects that, by the end of October, the draft of a new Tax Act will be made available.

For the taxation of individuals, the new tax system continues to apply a combination of fixed property and income taxes. The property tax will be calculated by reconciling assets to a special type of income, thus more closely linking property and income tax. The initial goal is to standardize the taxation of income from assets. In the long term, this type of taxation will be integrated into an interest-adjusted income tax.

The focus of the reform package, however, will be the introduction of a uniform profit tax for companies. The current capital tax and the coupon tax on securities will be abolished. The new profit tax envisages a moderate tax rate of 12.5%, combined with a deduction for equity capital and an exemption for earnings from holdings.

The planned introduction of group taxation for group companies aims to compensate for any losses within a corporate group. The taxability of corporate income is coupled to the Liechtenstein domicile of corporate management or the existence of business premises in Liechtenstein: If the domicile of the general management is in Liechtenstein, unrestricted tax liability applies; if the company only maintains business premises in Liechtenstein, tax liability is restricted.

"For the Liechtenstein financial center, it is of fundamental importance to preserve the attractiveness of the location for asset management structures for individuals or for multiple investors," the government stated.

"The tax concept therefore pays particular attention to the taxation of companies for asset investments by individuals. As private asset companies, such investments will henceforth be subject to an attractive taxation regime," it added.

SWITZERLAND ASKED U.S. NOT TO PUSH UBS FOR SWISS CLIENT DATA

According to Swiss law, bank secrecy can only be lifted in connection with a criminal offense. Tax evasion is not a crime in Switzerland. Swiss Bank UBS has been identified as helping Americans evade taxes. The IRS has asked UBS to supply information on these American clients. Since UBS has a substantial U.S. presence, this polite request from the IRS cannot be politely ignored. But if UBS supplies the IRS with the information demanded it will be breaking its home country laws. The situation is the proverbial caught between a rock and a hard place.

The Swiss government has stepped in an asked the U.S. not to pressure UBS for the data until it has completed its own investigations. A good guess is that if the Swiss discover that UBS was helping American clients evade taxes, they will figure out some face-saving way to allow the disclosure without penalizing UBS.

Several points we have emphasized previously apply in the UBS case and bear repeating: (1) Do not evade taxes or reporting requirements. (2) Do not rely on secrecy as part of your asset protection strategy. It is icing on the cake, at best. Laws change. Gatekeepers can be bribed. (3) Use offshore financial services providers who have no physical or legal presence in your home country.

Switzerland asked the U.S. not to pressure UBS AG for client data located in the Alpine country as investigators look into whether the world's largest wealth manager helped American clients evade taxes.

Swiss State Secretary Michael Ambuehl, who met last month with U.S. officials including Undersecretary of State William Burns and Treasury Undersecretary Stuart Levey, told his U.S. counterparts that any request for client data must be decided by the government, as UBS would breach Swiss bank secrecy law by handing out the records, he said in an interview.

"I reaffirmed the offer by the Swiss government to cooperate constructively with the U.S.," Ambuehl said in his Bern office on Aug. 19. "I underlined, however, that we expect them not to take unilateral steps against UBS to obtain information which is located in Switzerland as long as the agreed, bilateral legal cooperation is ongoing."

The Swiss Finance Ministry is examining whether to allow UBS to identify U.S. customers who may have committed fraud while using accounts at the bank to evade taxes, after the bank received a summons from the IRS. Switzerland's largest bank, which may have hidden as much as $17.9 billion for 19,000 Americans, according to a Senate subcommittee report, said July 17 it will stop servicing accounts for American clients at units that are not licensed in the U.S.

The Swiss Finance Ministry has not yet replied to the U.S. request for assistance, spokesman Dieter Leutwyler said. He declined to comment on which action his ministry would take should UBS disclose client data, saying he does not answer "hypothetical questions."

"UBS is seeking to address these requests with both Swiss and U.S. government authorities within the legal framework for intergovernmental cooperation and assistance established between Switzerland and the U.S.," UBS spokesman Serge Steiner said by telephone from Zurich.

According to Swiss law, bank secrecy can only be lifted in connection with a criminal offense, such as tax fraud or money laundering. Tax evasion is not a crime in Switzerland. Should the finance ministry agree for the account details to be given out, account holders would be informed before their details are handed over, giving them the option to go to court, Leutwyler said.

Ambuehl said pressure from the U.S. and the European Union for Switzerland to amend bank secrecy laws has not increased and he sees no need to revise them, because they include "strict internal rules and good external cooperation."

REPUBLICANS PRESSURE RANGEL TO QUIT OVER TAX SCANDAL

Democrat Rep. Charles Rangel is perhaps best known for his repeated calls to bring back the draft. Rangel is chairman of the House Ways and Means Committee, which presides over tax legislation. Recently he succeeded in getting a law imposing an "exit tax" on expatriating Americans passed. He has been a consistent, vocal critic of offshore "tax havens." Well, it seems Charlie failed to declare rental income derived from a Caribbean property. He also failed to declare the implied income from an interest-free loan he received from an offshore entity. Naughty boy, Chuck. Perhaps you ought to consider following the rules you inflict on everyone else, just for empathy's sake.

House Republican leaders have written to House Speaker Nancy Pelosi (D-California), urging her to remove Rep. Charles Rangel (D-New York) as chairman of the House Ways and Means Committee, which presides over tax legislation, until mounting ethical charges against him, including claims of unreported income, are resolved.

Last week, numerous media outlets reported that Rangel has failed to report to both the IRS and the Clerk of the House at least $75,000 in income from a luxury vacation property in the Caribbean and that he received an interest-free loan for the property -- allegations, the GOP leaders cite, that have been confirmed by Rangel's own attorney.

These latest revelations follow allegations which emerged earlier this summer that Chairman Rangel has been occupying four rent-controlled apartments in New York City, one of which he has illegally used as a campaign office. The Republicans pointed out that this violates House rules, as well as state and federal law.

"Given Chairman Rangel's continuing ethical lapses, he cannot effectively carry out his duties as Chairman of the Ways and Means Committee," the leaders wrote to the Speaker.

"Thus, in order to remove one obstacle to this Democratic Congress actually addressing and solving working families' concerns, you, as the Speaker of the House, must insist that Rep. Rangel step down from his Ways and Means chairmanship pending an investigation of his ethical lapses," their letter to Pelosi added.

“CORPORATE AMERICA’S NEXT BIG SCANDAL,” ACCORDING TO THE RAND CORPORATION

The ability of corporate America to avoid income taxes is brewing as “corporate America’s next big scandal,” according to the think tank.

Think tank the Rand Corporation notes that a "scandal" is brewing due to the declining percentage of U.S. federal tax revenues contributed by corporations. Corporations contributed (so to speak) over one quarter of the total in the 1950s, but now contribute less than 10%. The U.S. Government Accountability Office, not illogically, hypothesizes that this shrinkage is due to the IRS reviewing only 1% of corporate tax returns every year.

And what might be behind this low 1% number, one might ask? We suspect the complexity of the Internal Revenue Code is the root cause. Corporations will find it economic to hire tax specialists to burrow through the IRC's nooks and crannies to discover tax savings, by which point they will know the relevant areas of the Code better than any IRS auditor. Ergo, the IRS is uninclined to even try and discover where corporations may be pushing the rules too far.

Rand suggests some think-tankish solutions to the scandal and resulting crisis -- after close study Rand has apparently discovered the federal government is running a huge deficit and more of the same is forthcoming -- like making fuzzy avoidance practices illegal, and laying a "social responsibility" rap on the corporations. An ill-worded but sane suggestion made is to lower corporate income taxes in "hopes" of broadening the tax base. Hopes? Perhaps they mean that lowering rates will lower the avoidance incentive, which is entirely reasonable.

At the risk of stating the obvious, lowering tax rates while broadening the tax base and simplifying the tax code is an almost surefire winner, assuming the goal is to stimulate wealth creation and increase tax revenues. Ah, but such an assumption would be wrong. The goal of those creating the tax laws is to pay back their supporters while leaving their capacity to grant such special favors intact. With that objective, the more complex and convoluted the tax rules the merrier. This gerrymandering of the tax code to keep the politicking game in place at the expense of everyone else is the true "scandal."

In an intriguing study titled "Issues over the Horizon," RAND examined 11 areas -- from reproductive science to failed voting machines to defense-spending reallocation -- that it sees as likely crises in the future. But one of the most urgent problems related to a corporate tax issue that Rand says could pose a threat to the U.S. economy.

Specifically, the study noted a dramatic decline in corporate taxes as a percentage of total federal tax revenues during the last 50 years -- despite the company-led chorus singing about how much higher U.S. corporate income taxes are, compared to taxes in other nations.

"Corporations routinely engage in extensive tax planning and elaborate schemes to minimize their tax burdens," write Rand social scientist Michael Greenberg and civil-justice expert Robert Reville. They note in particular such tactics as offshore tax sheltering, stock option write-offs, and synthetic leases to take advantage of loopholes and fuzzy areas in the tax laws.

But sometimes, such schemes that start with capitalizing on the law end up breaking it. Rand points to the 2006 incident in which when accounting firm KPMG marketed tax shelters to wealthy clients as an example of what might lie ahead. Many other frauds that have thus far gone undetected may be at work.

According to the IRS, in 2001 the corporate "tax gap" -- the difference between what companies pay compared to what they are legally obligated to pay -- reached $32 billion. Moreover, despite rising profits corporate income taxes represented just 9.6% of federal tax revenues between 2000 and 2009, according to Rand. From 1950 to 1959, by comparison, they represented 27.5%. One reason that the Government Accountability Office sees for this shrinkage is that the IRS only reviews 1% of corporate tax returns every year.

Greenberg and Reville argue that, while a serious problem now, such corporate tax avoidance could become calamitous for a U.S. besieged by an aging population, and rising costs of Social Security and Medicare creating represent "tropical instability", they say, by cash-strapping the government.

"The 'warm water' of corporate tax avoidance strategies together could create the conditions for a perfect storm," write the researchers at Rand -- an organization long known for its government defense work, but which has diversified its interests substantially in the past 20 years.

One way to prepare for that brewing storm could be to make fuzzy tax avoidance practices clearly illegal. Another, the authors suggest, would be to take after the British system of scrutinizing corporate board audit committees and making the payment of corporate income taxes a part of social responsibility programs.

An alternative solution -- which companies would likely find favorable -- would be to lower corporate income taxes in hopes of broadening the tax base. Robert Carroll, of the Tax Foundation, claims that the tax cuts implemented by President George W. Bush in 2001 and 2003 "induced taxpayers to report more taxable income." He finds that the broader base offset between 25% and 40% of the lost revenues from cutting the top two tax rates.

However, companies tend to be cleverer than individuals, and might be less likely to see a lower tax rate as an incentive to pay more. In fact, as Carroll notes, one reason for the apparent eagerness of individuals to pay their taxes was probably due to companies wisely shifting from the corporate tax base to the more "advantageous" individual rate.

INTERNET TRAFFIC BEGINS TO BYPASS THE U.S.

The era of the American Internet is ending.

The internet as we know it today was invented, nurtured, and initially exploded in America. This gave U.S. companies a head start in commerically exploiting the technology. Furthermore, despite the network going worldwide, for many years a large proportion of the network traffic still routed through the U.S. -- even local traffic between two nodes within a far-off country. This later feature made American intelligence's ability to monitor the internet far easier than otherwise. Now internet traffic is increasingly bypassing the United States.

Part of the bypass was inevitable as the network grew. Part of it is an all too familiar story: As profit margins in service provision and basic products went down, American companies sought out higher margin, value-added, segments of the market and ceded the commoditized core to overseas companies. Fine in business management theory, but with a possible long-term consequence of loss in market leadership.

And part of the increasing bypass is driven by the increasing distrust of American motives and self-restraint. As Marc Rotenberg of EPIC, a civil liberities advocacy organization, said: "Since passage of the Patriot Act, many companies based outside of the United States have been reluctant to store client information in the U.S. There is an ongoing concern that U.S. intelligence agencies will gather this information without legal process. There is particular sensitivity about access to financial information as well as communications and Internet traffic that goes through U.S. switches."

Invented by American computer scientists during the 1970s, the Internet has been embraced around the globe. During the network's first three decades, most Internet traffic flowed through the United States. In many cases, data sent between two locations within a given country also passed through the United States.

Engineers who help run the Internet said that it would have been impossible for the United States to maintain its hegemony over the long run because of the very nature of the Internet; it has no central point of control. And now, the balance of power is shifting. Data is increasingly flowing around the United States, which may have intelligence -- and conceivably military -- consequences.

American intelligence officials have warned about this shift. "Because of the nature of global telecommunications, we are playing with a tremendous home-field advantage, and we need to exploit that edge," Michael V. Hayden, the director of the Central Intelligence Agency, testified before the Senate Judiciary Committee in 2006. "We also need to protect that edge, and we need to protect those who provide it to us."

Indeed, Internet industry executives and government officials have acknowledged that Internet traffic passing through the switching equipment of companies based in the U.S. has proved a distinct advantage for American intelligence agencies. In December 2005, The New York Times reported that the National Security Agency had established a program with the cooperation of American telecommunications firms that included the interception of foreign Internet communications.

Some Internet technologists and privacy advocates say those actions and other government policies may be hastening the shift in Canadian and European traffic away from the United States.

"Since passage of the Patriot Act, many companies based outside of the United States have been reluctant to store client information in the U.S.," said Marc Rotenberg, executive director of the Electronic Privacy Information Center in Washington. "There is an ongoing concern that U.S. intelligence agencies will gather this information without legal process. There is particular sensitivity about access to financial information as well as communications and Internet traffic that goes through U.S. switches."

But economics also plays a role. Almost all nations see data networks as essential to economic development. "It is no different than any other infrastructure that a country needs," said K C Claffy, a research scientist at the Cooperative Association for Internet Data Analysis in San Diego. "You would not want someone owning your roads either."

Indeed, more countries are becoming aware of how their dependence on other countries for their Internet traffic makes them vulnerable. Because of tariffs, pricing anomalies and even corporate cultures, Internet providers will often not exchange data with their local competitors. They prefer instead to send and receive traffic with larger international Internet service providers.

This leads to odd routing arrangements, referred to as tromboning, in which traffic between two sites in one country will flow through other nations. In January, when a cable was cut in the Mediterranean, Egyptian Internet traffic was nearly paralyzed because it was not being shared by local I.S.P.'s but instead was routed through European operators

The issue was driven home this month when hackers attacked and immobilized several Georgian government Web sites during the country's fighting with Russia. Most of Georgia's access to the global network flowed through Russia and Turkey. A third route through an undersea cable linking Georgia to Bulgaria is scheduled for completion in September.

Ms. Claffy said that the shift away from the U.S. was not limited to developing countries. The Japanese "are on a rampage to build out across India and China so they have alternative routes and so they don't have to route through the U.S."

Andrew M. Odlyzko, a professor at the University of Minnesota who tracks the growth of the global Internet, added, "We discovered the Internet, but we couldn't keep it a secret." While the United States carried 70% of the world's Internet traffic a decade ago, he estimates that portion has fallen to about 25%.

Internet technologists say that the global data network that was once a competitive advantage for the United States is now increasingly outside the control of American companies. They decided not to invest in lower-cost optical fiber lines, which have rapidly become a commodity business. That lack of investment mirrors a pattern that has taken place elsewhere in the high-technology industry, from semiconductors to personal computers.

The risk, Internet technologists say, is that upstarts like China and India are making larger investments in next-generation Internet technology that is likely to be crucial in determining the future of the network, with investment, innovation and profits going first to overseas companies.

"Whether it's a good or a bad thing depends on where you stand," said Vint Cerf, a computer scientist who is Google's Internet evangelist and who, with Robert Kahn, devised the original Internet routing protocols in the early 1970s. "Suppose the Internet was entirely confined to the U.S., which it once was? That wasn't helpful."

International networks that carry data into and out of the United States are still being expanded at a sharp rate, but the Internet infrastructure in many other regions of the world is growing even more quickly.

While there has been some concern over a looming Internet traffic jam because of the rise in Internet use worldwide, the congestion is generally not on the Internet's main trunk lines, but on neighborhood switches, routers and the wires into a house.

As Internet traffic moves offshore, it may complicate the task of American intelligence gathering agencies, but would not make Internet surveillance impossible.

"We're probably in one of those situations where things get a little bit harder," said John Arquilla, a professor at the Naval Postgraduate School in Monterey, California, who said the United States had invested far too little in collecting intelligence via the Internet. "We've given terrorists a free ride in cyberspace," he said.

Others say the eclipse of the United States as the central point in cyberspace is one of many indicators that the world is becoming a more level playing field both economically and politically.

"This is one of many dimensions on which we will have to adjust to a reduction in American ability to dictate terms of core interests of ours," said Yochai Benkler, co-director of the Berkman Center for Internet and Society at Harvard. "We are, by comparison, militarily weaker, economically poorer and technologically less unique than we were then. We are still a very big player, but not in control."

China, for instance, surpassed the United States in the number of Internet users in June. Over all, Asia now has 578.5 million, or 39.5%, of the world's Internet users, although only 15.3% of the Asian population is connected to the Internet, according to Internet World Stats, a market research organization. By contrast, there were about 237 million Internet users in North America and the growth has nearly peaked; penetration of the Internet in the region has reached about 71%.

The increasing role of new competitors has shown up in data collected annually by Renesys, a firm in Manchester, New Hampshire, that monitors the connections between Internet providers. The Renesys rankings of Internet connections, an indirect measure of growth, show that the big winners in the last three years have been the Italian Internet provider Tiscali, China Telecom and the Japanese telecommunications operator KDDI. Firms that have slipped in the rankings have all been American: Verizon, Savvis, AT&T, Qwest, Cogent and AboveNet.

"The U.S. telecommunications firms have not invested," said Earl Zmijewski, vice president and general manager for Internet data services at Renesys. "The rest of the world has caught up. I don't see the AT&T's and Sprints making the investments because they see Internet service as a commodity."

RULE CHANGES WOULD GIVE FBI AGENTS EXTENSIVE NEW POWERS

New rules will give FBI agents still greater discretion to initiate surveillance, conduct interrogations, and possibly intervene in cases of "civil disorder," all with less supervision from superiors and the courts. Among the noteworthy rule changes: (1) Techniques currently available only after FBI agents have opened an investigation and developed a reasonable suspicion that a crime has been committed or that a threat to national security is developing, could be applied at earlier stages and without supervision. (2) Agents would be allowed to interview people within the U.S. about foreign intelligence cases without warrants or prior approval of their supervisors. (3) 1976 guidelines established after Nixon-era abuses that restrict the FBI's authority to intervene in times of civil disorder and to infiltrate opposition groups would be relaxed.

"It is an extraordinarily broad grant of power to an agency that has not proven it uses its power in an appropriate manner," said an American Civil Liberties Union spokesman.

What is next? Permission to conduct an on-the-scene trial and sentencing? This business of not requiring supervision from immediate superiors in the FBI, who would almost always just rubber-stamp the request, is more than a little suspicious. The idea may be to sustain "plausible deniability" when "rogue agents" start getting a little too rough and arbitrary.

The Justice Department will unveil changes to FBI ground rules today [September 12] that would put much more power into the hands of line agents pursuing leads on national security, foreign intelligence and even ordinary criminal cases.

The overhaul, the most substantial revision to FBI operating instructions in years, also would ease some reporting requirements between agents, their supervisors and federal prosecutors in what authorities call a critical effort to improve information gathering and detect terrorist threats.

The changes would give the FBI's more than 12,000 agents the ability at a much earlier stage to conduct physical surveillance, solicit informants and interview friends of people they are investigating without the approval of a bureau supervisor. Such techniques are currently available only after FBI agents have opened an investigation and developed a reasonable suspicion that a crime has been committed or that a threat to national security is developing.

Authorities say the changes would eliminate confusion for agents who investigate drug, gang or national security cases.

The overhaul touches on several sensitive areas. It would allow, for example, agents to interview people in the United States about foreign intelligence cases without warrants or prior approval of their supervisors. It also would rewrite 1976 guidelines established after Nixon-era abuses that restrict the FBI's authority to intervene in times of civil disorder and to infiltrate opposition groups.

"We wanted simpler, clearer and more uniform standards and procedures for domestic operations," said a senior Justice Department official. "We view this as the next step in responding to post-9/11 requests that the FBI become better at collecting intelligence and using that intelligence to prevent attacks."

The move comes a year after the Justice Department's inspector general documented widespread lapses involving one of the bureau's most potent investigative tools, secret "national security letters" that FBI agents send to banks and phone companies to demand sensitive information in terrorism probes.

The revisions are the latest in a series of efforts to tear down a wall that, prior to the September 11, 2001, attacks, prevented intelligence investigators from sharing some information with their counterparts working on criminal cases. Senior Justice Department and FBI lawyers who discussed the proposal yesterday said such powers are necessary to continue the transformation of the FBI into a proactive organization that can prevent terrorist strikes, as recommended by several independent commissions that addressed intelligence failures after the attacks.

The rule revisions require the approval of Attorney General Michael B. Mukasey, who has signaled that they will take effect October 1. FBI agents already are being trained on the changes, though officials said yesterday that they would consider making adjustments after receiving suggestions from interest groups and lawmakers.

Congressional aides examined the draft guidelines behind closed doors last month and FBI and Justice lawyers will present them today to an array of civil liberties and privacy advocates, as well as Arab American groups that have expressed concerns about their impact on religious and ethnic minorities.

The groups say they fear that agents will use ethnicity or religion as the basis for a threat assessment. But top Justice Department leaders, including the attorney general, noted the illegality of racial profiling and said investigations will not be opened based "solely" or "simply" on a person's race or religion.

Previous changes to FBI operating instructions, made by Attorney General John D. Ashcroft in 2002 and 2003, did not receive a public airing before they took effect. Still, civil liberties advocates are asking whether protections built into the rules will be strong enough.

"It is an extraordinarily broad grant of power to an agency that has not proven it uses its power in an appropriate manner," said Michael German, policy counsel at the American Civil Liberties Union.

The revised rules largely eliminate the requirement that FBI agents file reports to their supervisors on early-stage investigations, in favor of audits at bureau field offices by lawyers in the Justice Department's National Security Division.

Threat assessments and early-stage investigations that cover political, religious or media figures and full-scale investigations of people in the United States, however, are special cases that must be flagged for bureau supervisors and lawyers, according to both current standards and the proposed changes.

Monitoring conversations between informants who agree to wear recording devices and subjects of investigations, which now requires the permission of an assistant U.S. attorney, could occur without a prosecutor's approval, except in sensitive cases involving state and federal officials and judges, as well as federal prisoners.

One of the areas still under discussion, according to a senior Justice Department official, is the standard for the FBI's rare involvement in responding to civil disorder. Under the current standards, FBI involvement requires the approval of the attorney general and can last for only 30 days.

The new approach would relax some of those requirements and would expand the investigative techniques that agents could use to include deploying informants. FBI agents monitoring large-scale demonstrations that they believe could turn dangerous also would have new power to use those techniques.

Policy guidance for FBI agents and informants who work as "undisclosed participants" in organizations is still being written, the officials said yesterday.

RULING SAYS FEDERAL COURTS CAN HEAR NO-FLY LAWSUITS

A federal appeals court has deigned to grant marginal access to a real remedy for those consigned to the "no-fly" list: They can challenge the listing in federal court, thereby bypassing the Transportation Security Administration bureaucracy. The basis of the ruling was narrow: Since the no-fly list is technically maintained by the FBI, rather than the TSA, a federal statute limiting appeals of TSA decisions did not apply. No doubt that oversight will be fixed soon enough.

The no-fly list is something out of Kafka, or Brazil. If you are on it there are no rules about how to try to get off, or how to protest one's designation. The government usually will not even confirm that someone is on the list, and displays the usual bureaucratic indifference about helping anyone get off it or otherwise ameliorate the effects of being on it. So now there is at least some small opening into the madness.

As the writer points out, the deeper issue is that the no-fly list is inherently nonsensical. It allows the feds to act like they are "doing something" about terrorism without actually doing anything. If someone is sufficiently threatening that severe restrictions are placed on their ability to travel, then logic dictates that the person be investigated and charged with a crime ... or not. Compiling massive lists of suspected terrorists, most of whom are not actual terrorists, detracts from the public safety, not adds.

A federal appeals court ruled ... that individuals who are blocked from commercial flights by the federal no-fly list can challenge their detention in federal court. A lower court had held that such lawsuits were barred by a federal statute limiting appeals of Transportation Security Administration decisions, but the U.S. Court of Appeals for the Ninth Circuit ruled that because the no-fly list is technically maintained by the FBI, rather than the TSA, that restriction did not apply.

The case involved a Malaysian woman named Rahinah Ibrahim who had studied at Stanford. When she attempted to fly from San Francisco to Malaysia, she was arrested at the San Francisco airport, handcuffed in front of her 14-year-old daughter, and driven to the police station to await questioning by the FBI. The FBI decided that it had no use for her and ordered her release two hours later. She was finally permitted to board another flight the next day.

The no-fly list reportedly contains the names of tens of thousands of individuals whose airline travel is restricted by the government. It is not to be confused with the longer selectee list and the much longer watch list -- if your name is on these longer lists, you will get extra scrutiny but you will not necessarily be prevented from flying.

Once one's name is on the no-fly list, getting off it can be maddening. In most cases, the government will not even confirm that an individual is on the list, much less do anything to help people get their names off it. [The] ruling is a small victory for those with the misfortune to wind up on the list, because it allows them to bypass the TSA bureaucracy and go straight to federal court.

But allowing watch list detainees to sue does not mean they will win. The courts have been reluctant to second-guess measures the government regards as essential for airline security. In 2006, for example, the Ninth Circuit rejected civil libertarian John Gilmore's lawsuit challenging the requirement that he show ID before boarding an airplane. A California trial court will now hear Ibrahim's arguments, but it may very well buy government officials' claims that publicly disclosing the details of its no-fly procedures would imperil national security.

The government's treatment of Ibrahim is a good illustration of the silliness of the government's watch list approach. As my colleague Jim Harper puts it, "watch listing and identification checking are like posting a most-wanted list at a post office and then waiting for criminals to come to the post office." If the FBI or TSA genuinely suspected that Ibrahim was a terrorist, they should have been actively investigating her and preparing to arrest her. As a Stanford student, she cannot have been hard to track down. If she was not a terrorist -- and by all indications, she was not -- then harassing her at the airport is a gratuitous infringement of her civil liberties. The no-fly list allows federal officials to act like they are "doing something" about terrorism without taking responsibility for actually investigating and charging terrorism suspects. But compiling massive lists of suspected terrorists, 99.9% of whom are not actual terrorists, is not making us any safer.

SUPREME INJUSTICE

The Dirty Dozen: How Twelve Supreme Court Cases Radically Expanded Government and Eroded Freedom book review.

J.H. Huebert, an attorney and a law professor, and an adjunct faculty member of the Ludwig von Mises Institute, reviews The Dirty Dozen: How Twelve Supreme Court Cases Radically Expanded Government and Eroded Freedom by Robert Levy and William Mellor in good, old Liberty magazine. We agree with the reviewer's conclusion: While it is good to get an education on the harm the Supreme Court can do, unless freedom lives in the minds and hearts of the people -- as John Adams said of the American Revolution -- it does not really exist. And when it does, no bad Supreme Court precedent will deny it to them.

The U.S. Supreme Court has done a lot of damage to liberty, interpreting government powers broadly and many constitutionally protected rights narrowly.

Cato Institute senior fellow Robert A. Levy and Institute for Justice co-founder William Mellor have catalogued some of the Court's worst offenses in their new book, The Dirty Dozen: How Twelve Supreme Court Cases Radically Expanded Government and Eroded Freedom.

For the most part, the cases they have selected for derision are appropriate, and their discussions leave no doubts about their genuine concern for personal and economic liberty. Which cases have they chosen? Here is the list:

• Helvering v. Davis (1937) -- allowed spending for virtually any purpose under the Constitution's "General Welfare Clause."
• Wickard v. Fillburn (1942) -- gave rise to Congress's almost unlimited power under the Commerce Clause.
• Home Building & Loan Association v. Blaisdell (1934) -- weakened the Contract Clause, which forbids government interference with already-existing private contracts
• Whitman v. American Trucking Associations, Inc. (2001) -- reflected the extreme deference the Supreme Court gives to administrative agency regulations.
• McConnell v. Federal Election Commission (2003) -- upheld the McCain-Feingold restrictions on political speech against a First Amendment challenge.
• United States v. Miller (1939) -- threw doubt upon gun owners' rights under the 2nd Amendment. (The recent District of Columbia v. Heller decision casts new light on this issue, of course.)
• Korematsu v. United States (1944) -- approved FDR's Japanese internment camps.
• Bennis v. Michigan (1996) -- approved civil asset forfeiture against the wife of a man who used his car to pick up a prostitute.
• Kelo v. City of New London (2005) -- approved use of eminent domain for economic development to increase tax revenues.
• Penn Central Transportation Co. v. New York (1978) -- held that a property owner was not entitled to compensation under the Takings Clause despite losing the right to use the airspace above its current building height.
• United States v. Carolene Products (1938) -- in a footnote, essentially gave state and local governments carte blanche to restrict economic liberties.
• Grutter v. Bollinger (2003) -- upheld the University of Michigan's law school's affirmative action program against an "equal protection" challenge.

In each of these cases, liberty lost and the government won in some precedent-setting way. (Except, arguably, in the affirmative-action case, as Richard Epstein points out in his foreword.)

But is that the only criterion we should use in determining whether a Supreme Court case is good or bad? Levy and Mellor apparently think so -- they say that the "'worst' cases should be defined in terms of their outcomes, not merely bad legal reasoning."

Because they are concerned more with a given case's outcome than with its reasoning, the authors unquestioningly embrace the idea that the 14th Amendment allows federal courts to strike down laws that do not comport with liberty.

But those who value federalism may be troubled by this. Such a broad reading of the 14th Amendment centralizes power in the federal courts. No libertarian denies that it is bad for state governments, local governments, or anyone else to violate rights -- but it does not necessarily follow that an appropriate solution to this problem is to give federal judges more power. After all, what happens after we have put the fate of our liberties in the judges' hands and they decide that the 14th Amendment contains various positive "rights" that they like even more than libertarian rights?

A benevolent dictatorship could be an extremely effective means of implementing the libertarian program, too, but presumably none of us would want that because there is no telling what the next dictator will do. Although judges do not directly command armies or police, we should be similarly wary of empowering them.

Still, one might reasonably argue that the federalism battle was lost long ago, rightly or wrongly -- and because the federal courts will go on making decisions for all of us whether we like it or not, we might as well be in those courts protecting people from the government. If states' rights are a lost cause, it makes sense to sell federal judges on liberty, using whatever arguments the judges will buy. With this much, I could agree.

But Levy and Mellor are more ambitious than that in calling for "judicial engagement" on liberty's behalf. They seem to think that restoring liberty is really only a matter of overturning a handful of bad court precedents. If we can just get in front of judges and do that -- apparently through the irresistible power of our arguments and our lawyers' outstanding legal skills -- we can finally achieve liberty across the land.

Such a plan is not only arrogant, it is also doomed to failure. Federal courts, after all, are the government. Judges must be appointed by the president and confirmed by the Senate. What president would choose a judge who would severely limit that president's own power? What senators would confirm a judge who will not just let them do whatever they want? To be confirmed, a would-be libertarian Supreme Court justice would either have to spend an entire academic or judicial career hiding his true views, or he would have to have a late-in-life road-to-Damascus conversion once he is already on the bench and employed by the very federal government he is expected to restrain. Unlikely.

You would think beltway-libertarian lawyers would understand by now that they are playing in a rigged game. After all, they took Kelo v. City of New London (the eminent domain case) and Raich v. Gonzalez (the medical marijuana case) to the Supreme Court, and failed, creating terrible anti-liberty precedents that are unlikely to be reversed in our lifetimes.

As an example of success, they might point to the public outcry and state-level reforms Kelo prompted. At best, though, this demonstrates that the states are a better place to be fighting these battles in the first place. And, unfortunately, many states' responses have been mostly superficial -- typical efforts by politicians to appear to be doing something -- and are unlikely to meaningfully protect property rights.

They will also point to the recent District of Columbia v. Heller, in which the Supreme Court struck down the D.C. handgun ban. And, yes, it is pleasant to see protection of individual rights increase, even a little bit, even if the main beneficiaries are D.C. dwellers.

But Heller is likely to be a very limited victory. The decision acknowledged that lesser restrictions on the right to bear arms -- registration requirements, bans on carrying guns, bans on certain types of guns -- probably will pass muster. In fact, lower courts are already citing Heller to uphold other gun laws.

If you are not convinced that Heller is a mostly hollow victory, take a look at almost every case that has followed the supposedly revolutionary United States v. Lopez. That 1995 decision struck down the federal Gun-Free School Zones Act of 1990 because, the Court found, gun possession at a school does not affect interstate commerce enough to bring it under Congress's Commerce Clause power. Conservatives and libertarians understandably hailed the decision because it was the first time since the Great Depression that the Supreme Court recognized any limit on Congress's Commerce Clause power. Since Lopez, though, courts have gone right back to rubber-stamping their approval on just about anything Congress wants to do, as long as Congress makes some "finding" (that is, baseless assertion) that the activity they are controlling affects commerce.

It is nothing short of bizarre to think that courts would start protecting liberty because of brilliant libertarian legal arguments. To believe this, one would have to take the naive view -- which, incidentally, animates much of the Cato Institute's work -- that government officials are really reasonable, serious people who are just waiting to have the right ideas put in front of them. But how silly is it to think you can make the government want liberty before many or most of the people want it?

Granted, all the federal judges I have known have been genuinely nice people on a personal level -- so perhaps our D.C.-based lawyers' views have been skewed by exchanging pleasantries at a few too many beltway cocktail parties.

They may be hopelessly deluded, but the rest of us should keep in mind that the important work to be done is in the realm of education, not the halls of government. When people understand and want liberty's benefits, they will cast off their government entirely, or at least elect representatives who will respect their rights. When that happens, no bad Supreme Court precedent will stand in their way.

Until then, The Dirty Dozen offers a mostly decent education on the harm the Supreme Court can do -- but should not lead us into thinking the Court could somehow become an equivalent force for good.

OF MOOSE AND PIT BULLS

Add up overt and hidden military expenditures ... The sum is backbreaking for a nation in decline, but the public knows neither that it is backbreaking nor that the country is in decline.

Fred Reed encapsulates the Gordian knot that must be untangled for the United States to revive itself economically: The American military budget represents money the U.S. cannot spend to become more competitive. But too many political interests -- jobs, military-dependent towns, and corporate profits -- depend on the budget. Moreover, the American public is not even aware of the burden on the American standard of living imposed by military spending. And the spending rolls on despite the American military being unsuitably outfitted to intervene in today's conflicts (if that were a good idea, which it is not).

Expect the economic decline to continue until a crisis forces a change, all while the politicians continue to promise both guns and butter.

I wonder whether the United States had not ought to re-ponder the place of the military in society and in the world. There is not the slightest chance that this will happen, but wondering has not yet been forbidden. It appears to me that bureaucratic clotting set in years back, and is now having its effect in spheres martial. A robust economy can afford frivolities that one in derobustion cannot. And that is where America is.

The U.S. military is the military of World War II, but with better technology. The Navy still consists of carriers surrounded by ships intended to protect the carriers. The heart of the army is still armored and infantry divisions with artillery and close-air support. The Air Force too. All are designed to fight enemies like themselves. However, there are no enemies like themselves, and WWII forces do not well fight the enemies they do have, such as ragtag dispersed guerrillas, because they are not intended to fight them.

Why a World War II military? Because of institutional inertia, because men delight in fast, powerful things that make loud and stirring noises, because the ships and tanks and submarines are magnificent. Relinquishing them is too painful to contemplate. Instead of changing its forces to suit present needs, the Pentagon keeps them as they are and tries to use them where they do not work well.

WWII militaries are intended to destroy expensive point targets and to conquer crucial territory. For example, they try to destroy the enemy's aircraft and conquer his cities. This America does very well indeed. The difficulty is that dispersed guerrillas do not have any expensive point targets, crucial territory, or cities. The Pentagon is using baseball bats to fight mosquitoes. The absurdity of using a B1 intercontinental bomber for close air support is manifest. But you have got the plane, the pilots do not want to miss the war, and so you find something for them to bomb.

A current American weakness is that it has a small army. Controlling large countries full of dispersed enemies requires large armies. America's is a small army because it is an All Volunteer army. Not many young men want to be soldiers. The Pentagon likes the All-Vol for two reasons. First, volunteer soldiers are much better than unwilling short-term conscriptees. Second, the public does not care if volunteers get killed. After all, they volunteered. They come from blue-collar families. These regard the death of a son as a noble sacrifice rather than a human sacrifice for large commercial firms. And they have little political influence anyway.

This matters. The Pentagon has learned that it cannot sustain a war in the face of united public opposition. If students in college were drafted, hell would follow. The key is not to disturb the public, which the military recognizes as more of a danger than the enemy actually being fought.

The true enemy, always, is the press. Should reporters turn against a war, they would rouse that great sleeping Public Monster, and then the military would face a war on two fronts. Fortunately the press consists of a few large corporations and holding companies owned by people of the same social class, who are not opposed to the current wars.

Since World War II, political power has become increasingly concentrated in the presidency, the concentration having become very rapid in recent years. Most crucially, the Congress has relinquished its power to decide whether the country goes to war. Thus wars are no longer determined by the national interest but by presidential whim. These whims can be directed by the desires of the president's friends, by powerful groups with agendas, by writers at intellectual magazines. Quite often these know nothing of war. And the military by enshrining obedience avoids responsibility.

The U.S. is phenomenally if discreetly militarized. The country is neither a democracy, nor a government of laws, nor of men, but an oligarchy of lobbies that press for whatever is of benefit to themselves, though not necessarily to the country. The underlying principle is that honey attracts flies. The federal government collects vast sums in taxes and the lobbies come to get it.

In the military racket, the money is in big-ticket weaponry. The carriers, Aegis boats, subs, fighters, tanks, B1s, B2s, and satellites sell for billions. These sums attract a vast aerospace industry that would collapse without sales to the military. The Pentagon is a captive market, and often a haven for firms that could not compete in the commercial marketplace.

Much of this money goes for pricey gear that is both unknown to the public and of little use for the wars the country fights (but probably should not). To hide a program from the public, you do not have to make it secret, which would only draw attention. Just don't talk about it. The press, which is owned by big business and manned by reporters of preternatural technical puzzlement, will say little. For examples, search on JSF, F22, V22, ABL, and ABM.

As always, the key is to avoid waking the public. Thus the military avoids attention. But add up overt and hidden military expenditure: the "defense" budget, appropriations for the wars, the black programs, the Veterans Administration, the national laboratories, TSA, and so on. The sum is backbreaking for a nation in decline, but the public knows neither that it is backbreaking nor that the country is in decline.

To countries competing with the U.S., as for example Japan, the American military budget is a godsend, the equivalent of a golf handicap on a rival, because it represents money the U.S. cannot spend to become more competitive. Fortunately for Asia, American military expenditure cannot readily be cut back. Too many jobs, military towns, and corporate profits depend on it. Consequently China builds infrastructure while the U.S. builds fighter planes. The only plausible brake will be conflict with Social Security and Medicare, cuts in which will wake the Public Monster.

The illusion of omnipotence dies hard. The American military has been dominant for so long that neither it nor Americans can grasp that there are limits to its power. America now tries militarily to encircle Russia, Iran, and China, which increasingly looks like an aging pit bull trying to encircle a herd of moose. The Pentagon is planning for a war with China and talks of "Full Spectrum Dominance." The current government in Washington wants to attack Iran and Pakistan, threatens Syria and Venezuela, and seems bent on igniting another Cold War with Russia (if one ignites cold wars). The Army is to be expanded.

Meanwhile China builds infrastructure.

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