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pockets of nationalist pressure waiting to burst forth

Kitty Miv, Editor
25 September, 2014

Kitty's Kountry Rankings are below, with a description of how they are kompiled. This week, as every week, I give out Encomiums to countries which have done Good Things, and award Execrations for countries which according to my highly personal and partial views have done Bad Things.

Those who might have dismissed the Scottish independence debate and last week's referendum as a rather localized, parochial sort of issue were mistaken. Many parts of the world took a great interest in the outcome of the plebiscite. In the final hours of the campaign, President Barack Obama took to twitter to express his hope that a key ally remained strong and united. And the Scottish question has been keenly watched in Europe, where there have been pockets of nationalist pressure waiting to burst forth on the back of a "Yes" vote, notably in Spain, Belgium and France (Corsica). Even in Germany, seemingly the most settled of countries, the impending referendum was front-page news, given the potential of Scottish independence to destabilize an already unsteady European Union. One paper even reported a spike in sales of whisky in Germany and other EU countries, with those fond of a little scotch worried that their favorite tipple might in future be subject to new customs duties. And we saw how the markets reacted to the possibility of an independent Scotland as traders dumped sterling and UK stocks and ratings agencies warned of downgrades for a truncated UK, whatever the new country would have been called (Lesser Britain perhaps?). Although one suspects they would have got used to the idea pretty quickly.

With the referendum all over bar the shouting (and there has been plenty of that by all accounts) and a fairly decisive victory had by the "No" camp (although the 45 percent who voted "Yes" represents a substantial minority), these concerns are no longer pressing. But it can also be said that this is just the end of round one. Regardless of whether Scotland went independent or not, Edinburgh is going to get more powers over Scottish affairs, including taxation, under the Scotland Act. And in a desperate last-minute bid to save the Union, Chancellor George Osborne announced shortly prior to the referendum vaguely-defined plans to give Scotland even more freedom over taxation north of the border. A new constitutional settlement between Scotland and the rest of the UK will also have to be negotiated to stop Scottish MPs in Westminster having a say on affairs in England when their Right Honourable English friends can no longer vote on many Scottish issues. I neglected to mention Wales and Northern Ireland in this negotiation, which is apt because they are now feeling rather ignored by London and its deference to Scottish sensitivities. Why not a Welsh income tax too? And shouldn't businesses in Belfast be able to compete on a level playing field with less fiscally-restrained firms in the Republic paying corporate tax at 12.5 percent? Even the possibility of an English parliament is now supported by supposedly pro-union Conservatives and federalist liberals alike. Given the shaky foundations of the Scottish National Party's economic plans – in essence an expanded welfare state bankrolled by oil and gas reserves which are already substantially depleted – and the uncertainties surrounding other vital economic issues like currency and EU membership, the result is probably the best one for the UK overall. Then again, if you're sitting on the outside and contemplating a major investment in the UK, the prospect of what could turn out to be an unholy mess in terms of tax and regulation can hardly be doing wonders for your confidence. See what nationalism does? It might be a cathartic force for some, but overwhelmingly it's a negative one. Perhaps the only winners so far in all of this are the distillers. A wee dram anyone?

While too much change too quickly can unsettle investors, so too can change happening at a snail's pace. Or less than a snail's pace in the case of Costa Rica. I'm struggling to think of another country that has taken so long to attempt to put into law a package of fiscal reforms. There is India of course, but you can sort of understand why that is if you are familiar with the country's numbing bureaucracy. But investor-friendly Costa Rica? The answer to this conundrum lies with Costa Rica's legislature, which is often its own worst enemy, tending to paralyze when any issue of national significance is put before it. We saw this with the Central American Free Trade Agreement, which was ratified by Costa Rica years after it was approved by its other members. And for over a decade now, the Legislative Assembly has been incapable of passing a fiscal reform package drawn up as far back as 2002. These reforms aren't exactly good news for Costa Rica; they are designed to increase tax revenues in order to tackle the country's budget deficit and rising debt, which is largely the result of previous governments' spendthrift ways. But the impasse is just fueling uncertainty and in the meantime piecemeal tax rises have taken place, making the tax system steadily less attractive. And since 2008, public debt has jumped alarmingly from 25 percent of GDP to 40 percent. Worryingly, since May, the country has been led by a President with no previous political experience (on second thoughts maybe that's not such a bad thing) who wants to raise taxes, although not for the first two years and, confusingly, has also pledged an overhaul of the tax system. Perhaps the problem is that there are too many checks and balances in the legislative system. Costa Rica was recently praised by Moody's for its "entrenched democratic tradition," but almost in the same breath the ratings agency said this was an obstacle to law-making and consensus building. Consequently, it downgraded the country's credit rating to junk status due the failure to deal with its mounting fiscal problems. Nonetheless Costa Rica remains one of the most favorable countries in Latin America for foreign investors. Although labor costs are relatively high, the territorial income tax regime is a major draw, and recent administrations have set about diversifying the economy away from agricultural staples like bananas and coffee towards hi-tech manufacturing by creating free zones and passing laws to create a small but thriving financial services sector. However, with the downgrade and the closure of Intel's microchip assembly operation – a significant contributor to the country's exports – things are starting to look quite gloomy for Costa Rica unless the clunky legislative machinery can find another gear.

One way in which Costa Rica's President Solis plans to raise revenue is through a crackdown on tax evasion, which represents something of a "go to" policy these days for any government in need of revenue. Refreshing then, that not too far to the north, Mexico is taking the opposite tack: offering small companies tax breaks for registering their workers with the tax authorities. It follows the taking of another unusual but sensible step by President Enrique Peña Nieto earlier this year when he signed a Tax Certainty Agreement, which commits to keeping Mexico's tax system unchanged throughout the remaining period of his administration, until November 30, 2018. Mexico's taxes aren't the lowest or the easiest to follow – anyone who has tried to get their head around the Maquiladora incentive regime would probably attest to that. But investors hate uncertainty, and while this means there is little prospect of taxes being cut, at least they won't increase or change at short notice. I can sympathize somewhat with the view that taxpayers attempting to flout the system shouldn't be offered bribes to comply with it. But there is far too much use of the stick by tax authorities these days, and not enough of the carrot. Dogs that are encouraged to be well behaved by the giving of rewards by their masters usually make the most docile and compliant companions. Beat him every time you think he has stepped out of line, and he might one day turn around and bite you.


Kitty's Encomiums and Execrations

Methodology: each week (this is the 123rd) one or more countries are given encomiums and one or more are given execrations. Those are the entries below with descriptive links. In the following week, each encomium counts as + 1 for that country, and each execration counts as – 1, being added to that country's existing score. Over time, therefore, a ranking will build up for each country, and further countries will join the listing. Germany is at plus 1, since in the second week it had an execration and in the first week it had an encomium, leaving it at neutral; then it had an execration in week four, thus dropping to – 1, and another one in week six, dropping to – 2; finally in week 13 it got something right, so it went back up to – 1; then in week 16 it gained a further star, so then it was in neutral territory until week 23 when it dropped back to minus one, but reverting to neutral territory in the following week, then dropping to minus one in week 50, and back up to plus one in week 51, then to plus two in week 52. Some weeks ago it dropped a place, but then quickly recovered one step. Etc etc and now it's on plus 1 again.

The rankings are intended to be a proxy for business friendliness; evidently they are highly partisan, but as time goes by they are becoming useful for decision-making. For any country in negative territory, you should think carefully before starting a business there.

Kitty's Encomiums:

Mexico sensible

United Kingdom better together

And Kitty's Execrations:

Costa Rica dilly-dallying




About the Author

Kitty Miv, Editor

Kitty was born in Argentina in 1960 to a Scottish cattle rancher and his Argentine wife. Educated in Edinburgh and at Princeton, Kitty worked for the World Bank as an economist, where she met and married an emigre Iranian banker. During her time with the Bank, Kitty worked in a number of emerging markets, including a spell in the ex-USSR as a Transition Economies Team Leader. Kitty is now a consultant in Brussels and has free-lance writing relationships with a number of prominent economic publications. kitty@lowtax.net


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