A world without tax havens?

G20 leaders at the recent London Summit made a commitment to tackle tax havens, but this will require taking measures against powerful financial centres like the City of London, Switzerland and Delaware in the USA.  Despite evidence that tax havens have contributed to the current financial crisis, it is by no means certain, says John Christensen, that the G20 leaders will deliver on their commitments.

ADDRESSING a joint session of the US Congress in the run-up to the London Summit of the Group of 20 developed and leading emerging economies, G20 President Gordon Brown asked rhetorically, 'How much safer would everybody's savings be if the whole world finally came together to outlaw shadow banking systems and offshore tax havens?'  Judging from the ensuing standing ovation, a new political appetite exists for taking action, but is this change of mood driven by domestic public finance pressures rather than recognition that tax havens have evolved into engines of chaos within the global financial system?

At their Summit, held in London in April, G20 leaders issued the following commitment: 'to take action against non-cooperative jurisdictions, including tax havens. We stand ready to deploy sanctions to protect our public finances and financial systems. The era of banking secrecy is over. We note that the OECD has today published a list of countries assessed by the Global Forum against the international standard for exchange of tax information'.  

This was welcome news for campaigners against tax havens, but the devil, as always, lies in the detail, and what is known about the detail of the G20 plan is not promising.  For starters, the OECD (Organisation for Economic Cooperation and Development) has responsibility for implementing the anti-tax-haven agenda, but past experiences suggest that OECD processes are vulnerable to intense lobbying, not least from member states like Switzerland, the USA and the UK.  By contrast, however, the interests of developing countries are largely unrepresented.   The significance of this problem was highlighted at the G20 Summit when the tax haven black/grey and white lists published by the OECD omitted key players like the City of London, Delaware and Wyoming, and ranked the British Crown Dependencies as cooperating jurisdictions despite clear evidence that they remain committed to blocking effective tax information exchange.

However, the biggest concern about the G20 commitment against tax havens relates to the timidity of the measures outlined in London.  If, as most people agree, the world would be better off without tax havens, the most effective way for tackling them would involve making offshore accounts much more transparent to national tax authorities.  This is best achieved by a multilateral treaty for automatic transfer of relevant information between national authorities (as is currently done, for example, with passport checks at border controls).  But the OECD programme is based on a programme of bilateral treaties for information exchange 'by request', which is vastly more expensive and time-consuming than automatic processes, and, because of legal barriers set up by tax havens, lacks the desirable deterrent qualities required of an effective international standard.

A shadow economy

For obvious reasons reliable statistics about tax haven activity are scarce, but a few figures help illuminate the enormity of the problem. Since financial market deregulation in the 1980s the number of tax havens has more than trebled. Over $600 billion - nearly three times current levels of external debt - has leaked from sub-Saharan Africa in illicit financial flows since 19751, almost all disappearing into secret bank accounts and offshore companies in places like the British Channel Islands, Luxembourg, Switzerland and London.

The scale of tax evasion is mind-boggling. In 2006, a World Bank report on Latin America concluded that tackling tax evasion was the number one priority for fiscal policy-makers. It is estimated that HNWIs (high net worth individuals) have parked $11.5 trillion offshore - allowing them to evade around $255 billion each year in tax. That alone far exceeds what the UN requires for its Millennium project to tackle global poverty.   Christian Aid has estimated the cost of corporate tax evasion to developing countries at $160 billion per year, which is a comparatively greater problem for these countries due to their relatively narrow tax base compared to industrialised countries in the North. 

But that is just part of the picture: the haemorrhaging of domestic capital resources to offshore accounts has been happening on a truly awesome scale. The World Bank has reported that cross-border flows of the proceeds from criminal activities, corruption and tax evasion range from $1 trillion to $1.6 trillion per year, with half (or $500 to $800 billion) coming from countries in the South. The rich countries currently spend about $100 billion on aid. So for every dollar of aid in, five to eight dollars flow out under the table. The tax evasion component of the global sum is by far the biggest, with commercial tax evasion making up $700 to $1,000 billion of the global figure. 

The almost-ceaseless looting of Nigeria's assets and that country's continuing slide towards gangsterism and violence vividly illustrate the problem. According to the Economist newspaper: 'When Sani Abacha was dictator of Nigeria at the end of the 1990s, the Central Bank [of Nigeria] had a standing order to transfer $15 million or so to his Swiss bank account every day.' Embezzlement on this scale cannot occur without the active involvement of an extensive pinstripe-suited infrastructure of financial specialists and tax haven governments who profit by providing an interface between crime and mainstream financial systems. Approximately 100 banks around the world were involved in handling Abacha's loot, including major names like Citigroup, HSBC, BNP Paribas, Credit Suisse, Standard Chartered, Deutsche Morgan Grenfell, Commerzbank, and the Bank of India. According to Raymond Baker, an expert on money laundering at the Washington-based Center for International Policy, 'With a fortune estimated at $3 billion to $5 billion, a feeding frenzy arose to receive, shelter and manage Abacha's wealth.'2

Much of Abacha's ill-gotten loot ended up in European banks, which would undoubtedly have known the origin of this money and charged top dollar for managing funds on behalf of such a politically exposed person (PEP). Needless to say, when international pressure finally forced the repatriation of this looted money to Nigeria after Abacha's downfall, not a cent of this fee income was repaid, and not a single white-collar criminal was indicted - let alone punished in any way - for having aided and abetted one of the most flagrant crimes in Africa's recent history. Instead, bankers have trumpeted loudly about how virtuous they have been in repatriating the money.

Alongside the tax evasion, corruption and embezzlement by local elites, it is also clear that international trade and investment flows have been shaped to make extensive use of tax havens for tax-dodging purposes.  The British Channel Island of Jersey, for example, has been used for many years to import primary commodities like bananas and coffee into Europe. Of course, neither of these tropical crops could actually grow in the cold and windy English Channel, but on paper this trade passes through Jersey, partly in order to shift the profits offshore but also to disguise the true ownership of the companies involved in this trade and avoid disclosing the extent to which these markets have become dominated by only a handful of oligopolistic businesses. The British government has estimated that at least  half  of  all  world  trade  now passes - on paper - through tax havens, so the scale of profit shifting is immense.

The City of London is probably the largest offshore financial centre. In the 1950s, during decolonisation, Britain was trailing on competitiveness and investment and the City was stagnant. Decolonisation allowed Britain to create a network of quasi-autonomous states to funnel capital flows towards London.Almost half the world's tax havens, including the Cayman Islands, the Channel Islands, the British Virgin Islands and Bermuda, have close political ties to Britain, and they host some of the most substantial offshore financial centres, largely staffed by expatriate specialists originating from the City.

By encouraging its Overseas Territories and Crown Dependencies to become tax havens, the British government set in motion a global financial octopus with the City as its head, heart and mouth, and the satellite tax havens as its tentacles, scooping up vast sums of money from around the world and feeding it into London.  The latest recruit is Ghana, a Commonwealth country, which, at the prompting of British banking giant Barclays, announced in 2007 plans to transform Accra into a tax haven. Given the porous borders in the West African region, and the huge illicit wealth flows arising from oil, diamonds, and other minerals in the region, it doesn't require much imagination to see how this tax haven is likely to harm regional development.

Britain and British banks are not the only culprits, of course: many people are aware of the massive tax evasion scandal that rocked the principality of Liechtenstein in 2008.  A similar scandal is engulfing Swiss private banking giant UBS, which has been required by a US court to provide information relating to the accounts of 52,000 wealthy US citizens suspected of using that bank for tax evasion purposes. Singapore is energetically attracting dirty money from Asia and Europe. US states like Delaware and Miami have tax haven characteristics, which allow wealthy people, especially from Latin America, to disguise their identity when they invest in US Treasury Bonds. With more countries getting in on the act, a process of beggar-thy-neighbour between jurisdictions has been triggered, as countries and microstates compete to offer incentives to footloose capital. Secrecy and lax regulation serve as the major lures. In April 2008, for example, Jersey set up its first unregulated hedge fund. Others will follow. In the 1990s the OECD tried to address the problem of global fiscal degradation with its 'harmful tax competition' project, but the initiative was neutered by financial lobbies and President George W Bush's incoming administration.

The outcome has been disastrous. In various ways tax havens have contributed to creating the conditions for the current crisis, including:

 the issuing of opaque and complex securitised instruments (mostly collateralised debt obligations) to mix packages of risk that have been marketed indiscriminately around the world;

 the registration of 'off-balance-sheet' entities that have been used to withhold materially sensitive information from investors, regulators, rating agencies, journalists and others;

 the degrading of the regulatory regimes of other nation states;

 the creation of secretive structures criss-crossing multiple jurisdictions in order to confuse investigation and fragment regulatory effort;

 facilitating tax evasion and avoidance on an industrial scale.

An action plan for tackling tax havens

Why has the tax haven racket been allowed to flourish this long?  They lie at the heart of global financial markets - with over $2 trillion flowing daily through their circuits - but their role in undermining regulation and destroying the integrity of national tax systems is scarcely recognised let alone understood by the majority of financial commentators and analysts. There are signs, however, that this situation has changed as a result of the current crisis.   Speaking in advance of the G20 Summit, British Treasury Minister Stephen Timms acknowledged the contribution tax havens have made to financial market chaos: 'There is an important issue about transparency here because it is clear that the fact that some activities were hidden away in some jurisdictions where there wasn't any transparency . that opaqueness has contributed to the severity of the problems we are seeing in the world economy at the moment.'  But without sustained effort on the part of civil society, it is unclear whether the political momentum generated at the G20 Summit will prevail in the face of the intensive lobbying by tax havens and their clients.

The G20 leaders have accepted the need to tackle tax havens.  The stage is therefore set for creating a new  architecture  that  protects  public interest from predatory behaviour and places far greater emphasis on market transparency.  Tax havens, which create the opaque and lightly regulated financial markets within which complex yet unstable financial structures have flourished, can have no part to play in a world of globalised capital markets.

Creating effective systems for information exchange between national authorities should become a priority goal for the coming decade, with particular focus on extending the principle of automatic information exchange (as currently used within the European Union) to a multilateral programme.  This will require far faster progress towards developing personal identification numbers for information exchange purposes, and agreeing data formats for electronic information transfers.

Financial and legal professionals need to be mobilised in the struggle against illicit financial flows and tax evasion.  Too many bankers, lawyers and accountants currently take the role of the wilfully blind professional in either supporting or ignoring these activities. Financial intermediaries should be required to include tax evasion in their suspicious activity reporting procedures.

A large proportion of illicit cross-border financial flows involves trade mispricing.  An effective way of tackling this problem lies with requiring companies to report on their activities on a country-by-country basis.  This would greatly increase accounting transparency and reduce the opportunity for transfer mispricing between subsidiaries of a multinational company.

Another effective way of tackling tax evasion would be to introduce banking secrecy override clauses into information exchange agreements.  The OECD has already included such a clause in its Model Agreement, and this approach should become the norm for all such agreements.

The International Monetary Fund should take a lead in tackling illicit financial flows, starting with comprehensive enhancement of its ROSCs (Reports on the Observance of Standards and Codes) procedures to include reporting on jurisdictions which fail to implement and support measures to tackle capital flight through effective information exchange processes.  Such reporting should be made a mandatory feature of ROSCs, and those jurisdictions that do not demonstrate ability and willingness to implement effective information exchange should be blacklisted.

Tax evasion should be defined in national and international laws as a predicate crime for anti-money-laundering purposes and the activities of tax havens need to be factored into global anti-corruption measures, leading to a wholesale reappraisal of what constitutes corruption, who promotes it, and how it can best be tackled. With this in mind, the Tax Justice Network is currently developing a new global index of corruption, the FTI (Financial Transparency Index), which will highlight tax havens that are most prominent in supporting illicit financial transactions. The first FTI results are scheduled for publication in Autumn 2009.

In a world of global financial markets there is no reason for continuing to allow individuals to hide their identities behind nominee directors and shareholders.  This lack of transparency encourages corrupt activities and creates asymmetric access to important market data. Global standards are required for full public disclosure of beneficial ownership of companies and trusts and other legal entities, with minimal standards for annual reporting.

To add a bit of muscle to the process, international sanctions are required against tax havens that fail to cooperate.  Political and civil society pressure needs to be exerted on the professional associations of bankers, lawyers, accountants and other financial intermediaries who profit from the activities of tax havens: codes of best practice should be produced to assist professionals with understanding both the technical and ethical procedures for combating capital flight, tax evasion and tax avoidance. It is depressing to note that not a single professional association, anywhere in the world, has issued a code of conduct for their members relating to the use of tax havens. This reflects a generally anti-social culture which permeates the higher levels of these associations. Civil society needs to act decisively against this culture, making it clear that those who enjoy the privilege of professional status cannot continue to abuse that privilege for personal gain. In this respect, the proposal to adopt a United Nations Code of Conduct on international cooperation in combating tax evasion would be a major, and symbolically important, step forward.

Taken as a package, these measures will severely restrict the uses and abuses of tax havens. Some of the small island tax havens might need transitional support to restructure their economies. But any potential costs incurred in transitional support would be tiny in comparison to the costs imposed by tax havens on the rest of the world. The measures proposed above will restore the ability of democratically elected governments to tax on a progressive basis, and start the process of re-balancing a system that has created global instability combined with wild inequality of wealth and income distribution.

The G20 Summit has created a political momentum behind tackling tax havens, and US President Barack Obama and various European leaders have put their weight behind this project.  A widely based coalition of civil society organisations is also aligned around this objective, and the Tax Justice Network is engaging with G20 officials on the details of what is required.  But the interests of developing countries are not adequately represented in the current processes and civil society organisations in these countries need to mobilise to make their voices heard. An opportunity for change has been created, but powerful counter-lobbies are already mobilised to block the way.

For half a century the cancer of tax havens has metastasised through the global economy, causing turmoil, increasing inequality and insecurity, and undermining democracy and national sovereignty. Removing this cancerous growth must now, urgently, be made a global priority.                       

John Christensen is a development economist who went undercover to research how tax havens operate.  He also worked as economic adviser to the British tax haven of Jersey from 1987 to 1998.  Since 1998 he has helped launch the Tax Justice Network <www.taxjustice.net> and directs its International Secretariat in London.

Endnotes

1  Ndikumana, L. and Boyce, J.K. (2008),  'New Estimates of Capital Flight from Sub-Saharan African Countries: Linkages with External Borrowing and Policy Options', Working Paper Series, No. 166, Political Economy Research Institute, University of Massachusetts.

2   Baker, Raymond (2005), Capitalism's Achilles Heel (Hoboken, N.J.: John Wiley & Sons), p. 62.

Further reading

Tax Justice: Putting global inequality on the agenda.  Edited by  Kohonen, M and Mestrum, F. Published by Pluto Press, 2008.

'Tax Us If You Can'. A report for the Tax Justice Network published in September 2005 setting out its manifesto for action.http://www.richard.murphy.dial.pipex.com/TUIYC%20-20medium%20resolution%20version%20-%20SEP%202005.pdf.

'Closing the Floodgates'. A report for the Tax Justice Network on behalf of the Leading Group of Nations on how the massive tax losses by developing countries could be stemmed. http://www.globalpolicy.org/nations/launder/haven/2007/2007taxjustice.pdf

'Taxing issues: Responsible business and tax'. Paper written jointly with Sustainability on tax and corporate responsibility. http://www.sustainability.com/insight/research-article-asp?id=450.

Chu, Ke-young, Davoodi, Hamid and Gupta, Sanjeev, 2000: 'Income Distribution and Tax, and Government Social Spending Policies in Developing Countries'. Helsinki: UNU/WIDER (UNU/WIDER Working Paper 214).

*Third World Resurgence No. 225, May 2009, pp 4-7