The True Cost Of Global Tax Havens – IMF F&D
TACKLINGTax Havens6FINANCE & DEVELOPMENT September 2019
The billions attracted by tax havens do harm to sending and receiving nations alikentil the 2008 financial crisis, taxhavens were generally seen as exoticsideshows to the global economy,Caribbean islands or Alpine financial fortresses frequented by celebrities, gangsters, and wealthy aristocrats. Since then, the world haswoken up to two sobering facts: first,the phenomenon is far bigger and more central tothe global economy than nearly anyone had imagined; and second, the biggest havens aren’t wherewe thought they were.Tax havens collectively cost governments between 500 billion and 600 billion a year in lost corporatetax revenue, depending on the estimate (Crivelli,de Mooij, and Keen 2015; Cobham and Janský2018), through legal and not-so-legal means. Ofthat lost revenue, low-income economies accountfor some 200 billion—a larger hit as a percentageof GDP than advanced economies and more thanthe 150 billion or so they receive each year inforeign development assistance. American Fortune500 companies alone held an estimated 2.6 trillionoffshore in 2017, though a small portion of that hasbeen repatriated following US tax reforms in 2018.Corporations aren’t the only beneficiaries.Individuals have stashed 8.7 trillion in tax havens,estimates Gabriel Zucman (2017), an economist atthe University of California at Berkeley. Economistand lawyer James S. Henry’s (2016) more comprehensive estimates yield an astonishing total ofup to 36 trillion. Both, assuming very differentrates of return, put global individual income taxlosses at around 200 billion a year, which mustbe added to the corporate total.These highly uncertain estimates vary widelybecause of financial secrecy and patchy official dataand because there’s no generally accepted definitionof a tax haven. Mine boils down to two words:“escape” and “elsewhere.” To escape rules you don’tlike, you take your money elsewhere, offshore, acrossborders. I prefer such a broad definition becausethese havens affect far more than tax: they providean escape route from financial regulations, disclosure, criminal liability, and more. Because the maincorporate users of tax havens are large financialinstitutions and other multinationals, the systemtilts the playing field against small and mediumenterprises, boosting monopolization.Political damage, while unquantifiable, must beadded to the charge sheet: most centrally, tax havensprovide hiding places for the illicit activities of eliteswho use them, at the expense of the less powerfulmajority. Tax havens defend themselves as “taxneutral” conduits helping international finance andinvestment flow smoothly. But while the benefitsfor the private players involved are evident, thesame may not be true for the world as a whole; it isnow widely accepted that in addition to tax losses,allowing capital to flow freely across borders carriesrisks, including the danger of financial instabilityin emerging market economies.As a general rule, the wealthier the individual andthe larger the multinational corporation—somehave hundreds of subsidiaries offshore—the moredeeply they are embedded in the offshore systemand the more vigorously they defend it. Powerfulgovernments also have a stake; most major havensare located in advanced economies or their territories. The Tax Justice Network’s Corporate TaxHaven Index ranks the top three as the BritishVirgin Islands, Bermuda, and the Cayman Islands—all British overseas territories. The organization’sFinancial Secrecy Index ranks Switzerland, theUnited States, and the Cayman Islands as the topthree jurisdictions for private wealth.To grasp why rich jurisdictions top the lists,ponder how many rich Nigerians might stash secretassets in Geneva or London—then consider howmany rich Swiss or Britons would hide assets inLagos. Offshore capital tends to drain from poorcountries to rich ones.September 2019 FINANCE & DEVELOPMENTART: ISTOCK / SLALOMP; FILBORG; SUESSE; SLAVICAUNicholas Shaxson7
Until a decade or so ago there were few politicalbrakes on the expansion of tax havens.And the offshore system is growing. When onejurisdiction crafts a new tax loophole or secrecyfacility that successfully attracts mobile money,others copy or outdo it in a race to the bottom. Thathas contributed to a dramatic decline in averagecorporate tax rates, which have decreased by half,from 49 percent in 1985 to 24 percent today. ForUS multinationals, corporate profit shifting intotax havens has risen from an estimated 5 percentto 10 percent of gross profits in the 1990s to about25 to 30 percent today (Cobham and Janský 2017).The principles of the international corporate taxsystem were laid down under the League of Nationsalmost a century ago. They treat multinational enterprises as loosely connected “separate entities.” This isa fiction: multinationals in fact draw great strengthfrom their unitary nature, reaping market powerand economies of scale. If the whole is worth morethan the sum of its (geographically diverse) parts,which countries get to tax that extra value? It is rarelylower-income countries, since the system tends togive preference to the place where multinationalshave their headquarters, usually rich countries.What is more, multinationals can manipulatethe so-called transfer prices of transactions betweenthese affiliates to shift profits from high- to lowtax jurisdictions. For example, a firm’s affiliatemay hold a patent in a low-tax haven and chargeexorbitant brand royalties to affiliates in high-taxcountries, thus maximizing profits in the low-taxjurisdiction. In theory, transfer prices are meantto reflect market prices that would prevail in arm’slength transactions between two unrelated parties.But such prices often cannot readily be established:try valuing a unique widget for a jet engine thatisn’t sold on the open market, or a drug patent.In practice, the value is often what the company’saccountants say it is.The main alternative to “arm’s length, separateentity” is something called “unitary tax with formulary apportionment.” This system considers amultinational to be a single entity and apportionsprofits geographically according to a formula reflecting real economic activity, which could be a mix ofsales, employment, and tangible assets. In theory,8FINANCE & DEVELOPMENT September 2019this method cuts out tax havens: if a firm has aone-person office in Bermuda, the formula allocatesa minuscule portion of its global profits there, so ithardly matters whether Bermuda taxes its portionat a zero rate. In practice, this system also sufferstechnical difficulties, and the choice of formula ishighly political—but it is simpler, fairer, and morerational than the current system.Indeed, many US states, Canadian provinces,and Swiss cantons have for some time used limited versions of the system for subnational taxes,even though it is not yet used internationally. Amove is already underway to require multinationals to break down and even publish financialand accounting information on a country-bycountry basis, which could provide relevant datafor an international allocation formula. Many otherincremental stepping-stones toward the alternativeare possible, so change can be evolutionary ratherthan revolutionary.Until a decade or so ago, there were few politicalbrakes on the expansion of tax havens. After the2008 crisis, however, governments came underpressure to close large budget deficits and to placate voters furious about taxpayer-funded bankbailouts, widening inequality, and the ability ofmultinationals and the wealthy to escape tax. ThePanama Papers and Luxembourg Leaks revealedthe use of tax havens for often nefarious purposesand reinforced the pressure to do something. Sothe Organisation for Economic Co-operation andDevelopment (OECD), the rich-country groupthat is the main standard-setter for internationaltax matters, launched two big projects.One is the Common Reporting Standard (CRS),a regime to exchange financial information automatically across borders so as to help tax authoritiestrack the offshore holdings of their taxpayers. Butthe CRS contains many loopholes; for example,it allows people with the right passport to claimresidence in a tax haven, rather than in the country where they live. The United States constitutesan even bigger, geographic loophole: under theForeign Account Tax Compliance Act, it collectsinformation from overseas on its own taxpayers,
HIDDEN CORNERSShaxson, 7/23/19Too much finance?Most advanced economies, including the United States, are past the point at whichfinancial sector growth is beneficial.(effect on GDP growth rate, percentage points)but it shares little information the other way, sononresidents can hold assets in the country inconditions of great secrecy, making the UnitedStates a major tax haven.Still, the CRS brought some results. The OECDestimated in July 2019 that 90 countries had sharedinformation on 47 million accounts worth 4.9trillion; that bank deposits in tax havens had beenreduced by 20 to 25 percent; and that voluntarydisclosures ahead of implementation had generated 95 billion in additional tax revenue for membersof the OECD and the Group of 20, which includesmajor emerging market economies.The other big initiative was the base erosion andprofit shifting (BEPS) project, aimed at multinationalcorporations. This was the OECD’s effort to “realigntaxation with economic substance” without disrupting the long-held international consensus supportingthe arm’s length principle, which was bolstered bytax-escaping multinationals and their allies. WhileBEPS did improve transparency for multinationals,it was ultimately seen as something of a failure bythe OECD, especially for the digitalized economy.The United States also belatedly recognizedthat, with a consumption-heavy economy, it madesense to shift taxing rights toward the place wheresales occur. And emerging market economies,including Colombia, Ghana, and India, whichgained more clout starting in 2016, have pushedfor new approaches. The OECD began considering sales-only formulas, but some lower-incomecountries favor a formula that includes employeesand tangible assets, which would give them greatertaxing rights. These shifts away from arm’s lengthorthodoxy represent a step toward tax campaigners’demands for formula apportionment.In January 2019 the dam began to break. For thefirst time, the OECD conceded publicly a need for“solutions that go beyond the arm’s length principle.”In March, Christine Lagarde, then managing director of the IMF, called the method “outdated” and“especially harmful to low-income countries.” Sheurged a “fundamental rethink” with moves towardformula-based approaches to allocating income. InMay, the OECD published a “road map” proposingreforms based on two pillars: first, determiningwhere tax should be paid and on what basis, andwhat portion of profits should be taxed on thatbasis; and second, getting multinationals to pay aminimum level of tax. Professor Reuven Avi-Yonah,of the University of Michigan Law School, said the6Morocco5PolandIrelandEcuador43295% confidenceband around the“turning point”The Gambia1United States0–10.00.10.20.30.40.50.60.7Financial development index0.80.91.0Source: Sahay and others (2015). Data updated in July 2019.plan was “extraordinarily radical” and would havebeen “almost inconceivable” even five years ago.We are now at the start of the most significantperiod of change to the international corporatetax system in a century. Progress will hinge onpower struggles: between countries, rich and poor,and within countries, between ordinary taxpayersand those that profit from the current system.But radical change is feasible. The Tax JusticeNetwork, which I have worked with, now sees itsfour core demands, initially dismissed as utopian,gaining global traction: automatic exchange offinancial information across borders, public registers of beneficial ownership of financial assets,country-by-country reporting, and now unitarytax with formula apportionment.But corporate tax is just a start. To understand thebroader issues, we must consider the forces that makethe offshore system tick. Switzerland’s example isillustrative. In past decades, politicians in Germany,the United States, and elsewhere have clashed withSwitzerland over banking secrecy, with little success.In 2008, however, after discovering that Swiss bankers had helped US clients evade tax, the Departmentof Justice took a different tack: it targeted not thecountry, but its bankers and banks. In response,the embattled private players became major lobbyists for reform, and Switzerland soon made majorconcessions on banking secrecy for the first time.The lesson: any effective international response mustinclude strong sanctions against the private enablers,including accountants and lawyers—especially whenthey facilitate criminal activity such as tax evasion.September 2019 FINANCE & DEVELOPMENT9
For many economies hosting an offshore financialcenter is a lose-lose proposition.On a deeper level, consider this. The engine ofthe offshore system is competition among jurisdictions to provide the best ways to avoid taxes,disclosure, and financial regulation. Traditionally,such a race to the bottom is framed as a collectiveaction problem requiring collaborative, multilateralsolutions. But cooperative approaches have flaws.Some jurisdictions feel inclined to cheat as they seekto attract mobile capital, so collective action can belike herding squirrels on a trampoline. Moreover, itis tough to mobilize voters in support of complexcross-border collaboration, especially when the goalis to help foreigners or low-income countries.There is a radically different, more powerful,approach. The relevant question is, Do the financial flows attracted by tax havens help the receiving countries? They certainly help interest groupsthere—typically in the banking, accounting, legal,and real estate professions—but do they benefitthe jurisdiction as a whole?A new and growing strand of research by theIMF, the Bank for International Settlements, andothers suggests that the answer is no. This “toomuch finance” literature argues that financial sectorgrowth is beneficial up to an optimal point, afterwhich it starts to harm economic growth (see chart,previous page). Most advanced economies, including the United States, the United Kingdom, andother major tax havens, passed that point long ago.For them, shrinking the financial sector to removeharmful financial activities should boost prosperity.Alongside this research, John Christensen, aformer economic advisor to the British tax havenJersey, and I have developed the concept of a financecurse, which afflicts jurisdictions with an oversizefinancial sector and is analogous to the resource cursethat vexes some countries dependent on commodities such as oil. This “paradox of poverty in the midstof plenty” has multiple causes: a brain drain of skilledpeople from government, industry, and civil societyinto the high-paying dominant sector; rising andgrowth-sapping inequality between the dominantand the other sectors; an increase in local pricesthat renders other tradables sectors less competitivewith imports; recurrent booms and busts in pricesof commodities and financial assets; and an increase10FINANCE & DEVELOPMENT September 2019in rent seeking and loss of entrepreneurship at theexpense of productive, wealth-creating activitiesas easy money flows in. Some scholars also decry“financialization,” or a shift from wealth-creatingactivities toward more predatory, wealth-extractingactivities such as monopolization, too-big-to-failbanking, and the use of tax havens.Financial flows seeking secrecy or fleeing corporate taxes seem likely to be exactly the kind thatexacerbate the finance curse, worsening inequality, increasing vulnerability to crises, and dealingunquantifiable political damage as secrecy-shroudedcapital infiltrates Western political systems. Andas financial capital flows from poorer countries torich-world tax havens, labor migration will follow.As ever, more research is needed here. Yet itseems that for many economies hosting an offshorefinancial center is a lose-lose proposition: it not onlytransmits harm outward to other countries, butinward, to the host. Countries that recognize thisdanger can act unilaterally to rein in their offshorefinancial centers, simply stepping out of the race tothe bottom and curbing tax haven activity whilealso improving their own citizens’ well-being. Thisis a powerful, winning formula.NICHOLAS SHAXSON is author of Poisoned Wells, a bookabout the resource curse in west Africa; Treasure Islands,about tax havens; and most recently The Finance Curse, aboutcountries with oversized financial sectors.References:Cobham, Alex, and Petr Janský. 2017. “Measuring Misalignment: The Location of USMultinationals’ Economic Activity versus the Location of their Profits.” Development PolicyReview 37 (1): 91–110. 2018. “Global Distribution of Revenue Loss from Corporate Tax Avoidance:Re-Estimation and Country Results.” Journal of International Development 30 (2):206–32.Crivelli, Ernesto, Ruud A. de Mooij, and Michael Keen. 2015. “Base Erosion, Profit Shiftingand Developing Countries.” IMF Working Paper 15/118, International Monetary Fund,Washington, DC.Henry, James S. 2016. “Taxing Tax Havens.” Foreign Affairs, April 12.Sahay, Ratna, and others. 2015. “Rethinking Financial Deepening.” IMF Staff DiscussionNote 15/08, International Monetary Fund, Washington, DC.Zucman, Gabriel. 2017. “How Corporations and the Wealthy Evade Taxes.” New York Times,November 10.
brakes on the expansion of tax havens. After the 2008 crisis, however, governments came under pressure to close large budget deficits and to pla-cate voters furious about taxpayer-funded bank bailouts, widening inequality, and the ability of multinationals and the wealthy to escape tax
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