Editorial: Disconnect growing between theory and practice

The funding of development and change through venture and other financial securities could become the lightning rod that highlights this gap between rhetoric and practice.

Reality and theory can make for awkward bedfellows.

While organisations as diverse as the World Bank or search engine provider hold a maxim of “do no harm” to people or the environment or “do no evil”, respectively, change can bring displacement to some and opportunity to others.

In tax and regulation, societies sometimes try and hold to a progressive principle that those who can afford to pay more should do so to help those less-advantaged.

But as two articles this month show, it can be hard to action.

A great investigation by the International Consortium of Investigative Journalists (a project of the Center for Public Integrity), Huffington Post and other media partners found the World Bank’s projects had since 2004 physically or economically displaced an estimated 3.4 million people, forcing them from their homes, taking their land or damaging their livelihoods. The investigation found “systemic gaps” in the institution’s protections for displaced families and the bank acknowledged that its oversight has been poor, and promised reforms.

While these development projects are often funded in part by loans from the bank, it and its private investment member, International Finance Corporation (IFC), have supported emerging industries through venture capital. In Kenya, the World Bank has supported the opening of Kenya Climate Innovation Centre‘s (KCIC) to aid crowdfunding in six green startups -  Wanda OrganicGlobal Supply SolutionsiCoal ConceptsSkynotch Energy Africa,Develatech, and the Human Needs Project.

The IFC this month has led a $23m second tranche of funding for Planet Labs, a US-based satellite imaging company, to close its series D round at $118m. The IFC was unavailable to comment on its investment in Planet Labs, which now has more than 100 satellites in a network providing updated images of the earth.

Better and more frequent images from space could help show more clearly and failures in the policies regarding displaced people. This could help solve what the investigation found was the bank “frequently has no idea what happens to people after they are removed”. However, it will do little to help if the culture remains one that “neglects to properly review projects ahead of time to make sure communities are protected” or shows “no intent on the part of the bank’s management to enforce” penalties if governments fail in their duty of care.

This joining up of ability and intention remains a source of concern about government activity in regulating or supporting venture capital.

Last week in a thoughtful article for news provider PEhub, Eileen Appelbaum, senior economist at the US-based Center for Economic and Policy Research, said private equity (PE) firm partners were illegally converting the ordinary income they receive from their fixed management fees into additional capital gains.

By email afterwards, Appelbaum said this issue exists outside of the US as well, such as in the UK, where the tax authority HM Revenue & Customs published a Technical Note on 29 March 2015 “making it clear that this was an unlawful conversion of ordinary income to capital gains”.

She added by email that while this tactic “is most common among private equity funds,” it could “arise in other situations where there is a GP/LP [general partner/limited partner] relationship” between fund manager and their investors, such as venture capital funds.

She concluded: “PE fund managers are able to structure these management fee waivers so that there is virtually no chance they will not collect priority profit income equal to the fee. This would be much more difficult for a VC fund.”

Governments want to encourage VCs to invest and encourage job creation and economic growth but using taxpayers’ money to effectively support an industry that tries in turn to minimise its tax bill and in the words of one industry leader “pay less tax than its cleaners” is fraught with political sensitivity.

As we head into the next round of UK and then US elections this could become an issue to watch. But few predict meaningful change. Previous attempts to encourage changes to tax policies, such as equalising debt and equity treatment or the taxation of capital gains versus income, have received short shrift over the past 30 years in most countries.

But if a disconnect between theory or mission statement and practice remains too wide then change can be forced through and be more radical. The funding of development and change through venture and other financial securities could become the lightning rod that highlights this gap between rhetoric and practice.

See more from this Government Report: Kenya, UK, US

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