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Taxing lessons of a flawed ETS

This article was published in The Australian Newspaper on Dec 30th, 2010.

CONNIE Hedegaard, the EU Climate Commissioner, appeared on these pages on Monday promoting the outcomes of the Cancun climate summit and offering to work with Australian Climate Change Minister Greg Combet.

Combet, for his part, is committed to putting a price on carbon.

What Hedegaard didn't mention in her piece, but to which Combet and Australia should pay close attention, is that the Danish tax authority has been robbed blind by a carbon trading scandal that has rocked the market for carbon offsets. While the story saw some coverage a year ago, significantly higher losses have since been reported and this has largely been ignored.

The Danish auditor general is on the case now as the scope of the crime has become obvious, and grown exponentially since it was first reported. Originally discussed as a quasi-small-time dollar scam, the reality a year later is a lot larger: Europol is estimating a value on the case of 38 billion kroner and the values seem to keep going up.

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Hedegaard, then Denmark's Climate and Energy Minister, helped set up and manage a system where there were no background checks on the listings of permitted traders. This removal of identification was done even though the EU requires at least a passport. This helped a group of fake, rogue traders set up a program that looted the Danish economy of up to 2 per cent of its GDP in lost VAT taxes.

Here's How:

The Denmark CO2 permit registry was set up with extremely lax rules and regulations, possibly intentionally. In 2007, Hedegaard removed the requirement for identification and in a very short period of time traders figured out the loopholes and started to back up the proverbial truck. How? To put it simply: you could round robin CO2 credits, booking the VAT as a bonus each time.

What is painfully obvious is that more than 1100 of the 1256 (about 88 per cent) of the registered traders listed in their system were illegally set up for fraudulent activity. The traders have since been delisted as the scope of the crime becomes obvious.

The fake but registered traders used made up, unique addresses for their business: in one famous case, a trader was listed as trading out of a parking lot in London. In another, the trader took the name of a dead Pakistani national.

The fraud centred on the use of VAT as a mechanism to generate real non-taxed cash flow. An international trader would buy VAT free credits from one nation, and then resell them to a VAT added customer in a second nation, pocketing as much as 25 per cent of the cost of the trade as a personal commission. The trader then kept the VAT difference in lieu sending in the VAT to the necessary tax system, effectively arbitraging the VAT system (See, e.g., Cap and Trade; Leaving Las Vegas, "The Hole You're In"). This trade was coined a "carousel" as the traders would re-export the credits, claiming the VAT only to re-import the credits and reselling them again with a new VAT assigned. They could wash, rinse and repeat booking up to a 25 per cent VAT in the process each time.

The Danish Emissions Trading Registry CR User Manual explains how to do it. It should provide a guide to Australia of how not to do it.

Jack H Barnes was named the audited Top Stock Picker in 2005 by Forbes's "Best of the Web". He is a retired hedge fund manager. He now writes about Global Macro Economic issues at jackhbarnes.com.

www.theaustralian.com.au/news/opinion/ta...


Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.