Special Reports
 
 


Tax Havens

A Blight on Democracy and Development

by

Peter Crisell

________________
  

   
Tax or no tax?

American founding father, Benjamin Franklin (1706-90) famously remarked: "'In this world nothing can be said to be certain, except death and taxes." However, taxes aren’t so certain if you’re rich enough to avoid them by going offshore to a tax haven. New York millionairess and tax fraudster, Leona Helmsley, got it right when she remarked, “We don’t pay taxes. Taxes are for the little people”. In this article, we draw attention to the fact that ‘free riding’ in relation to tax is a multi-million dollar global industry.

It is self-evident that tax havens undermine democracy. They do so by contributing to inequality and poverty, distorting markets, undermining financial and other regulation and curbing economic growth. They accelerate capital flight from the poor to the rich countries, and promote corruption and crime around the world.

Why pay taxes?
Most of us don’t much like paying taxes and do so with some reluctance. But we know that in representative democracies, the money raised in taxes provides us with services that we cannot provide for ourselves and which can only be provided collectively. Only the state can do such things as enforce law and public order, provide roads and other infrastructure, fund health, welfare and education and defend the population against external attack. These benefits are public goods that can only be provided at public expense. No one has yet devised a better way than general taxation in aggregating individual desires to collective advantage. If individual citizens and corporate bodies are beneficiaries of these public goods, it is only right that they contribute to them and not use offshore tax havens to avoid their responsibilities.

This is certainly not the mindset of the corporate world where shareholder value is the overriding priority. There is no sense of obligation towards the wider society which pays for the public goods that enable it to operate. Tax is not seen as a production cost but as a cost to be minimised for the benefit of shareholders. The wider social consequence of ‘tax efficiency’ as it is euphemistically described, is clear: those who go offshore leave the less well-off and the poor to shoulder the burden on their behalf.

Tax incentives and tax havens
It is the case that many governments pass legislation to help their own successful business sectors to compete in the world economy or to encourage the growth of new competitive sectors. In so doing, they often combine fiscal subsidies and ‘sweeteners’, including reductions in taxation and removal of 'red tape' (i.e. regulation) to attract or retain mobile capital. Tax havens, on the other hand, are more permanent and general and are not focused on a specific industry or developmental goal. They not only offer low or zero tax rates. They are places of escape that seek to attract business by offering facilities to help people or entities to get around the rules, laws and regulations of jurisdictions elsewhere. The blurred dividing line between legitimate avoidance of tax and illegal evasion can be seen in relation to double taxation. Where a business owned in one country invests and earns income in another, it may be taxed twice on the same income. Tax treaties and credits between countries can ensure that double taxation is legitimately avoided and the business is taxed only once. By using a tax haven however, the business avoids being taxed at all. Double taxation turns into double non-taxation.

Secret bolt holes for big money
Essential to the offshore process is the facility of secrecy. Tax havens allow non-disclosure of information, such as business accounts and ownership of assets, trusts and companies. Many would consider this kind of disclosure as necessary in a democracy. Secrecy appeals to wealthy elites, as well as to criminals and terrorists, anxious to protect their fortunes and to unlawfully evade tax. The complexity of offshore activities also helps to divert the public gaze. Bankers, accountants, lawyers and the rest are adept at using jargon, acronyms and euphemisms to mask underlying realities. The low profile thus created gives the impression that offshore is both technical and peripheral - as the name suggests - and is therefore of negligible concern to ‘little people’. However, the available evidence is somewhat different. In his recently published book ‘Treasure Islands’ Nicholas Shaxson draws together available data to point out that more than half of world trade passes through tax havens. More than half of all banking assets and a third of foreign direct investment by multinational companies are routed offshore. 85 per cent of international banking and bond issuance takes place in the offshore financial market known as the Euromarket. The IMF estimates that a third of global gross domestic product passes through small island tax havens.

The Tax Justice Network (TJN) estimates the amount of funds held offshore by individuals is about $11.5 trillion. The resulting annual loss of tax revenue on the income from these assets amounts to about $250 billion. This, incidentally, is five times what the World Bank estimated was needed to address the UN Millennium Development Goal of halving world poverty by 2015. The TJN also discovered that ninety nine of Europe’s hundred largest companies used offshore subsidiaries. Unsurprisingly, the banks were the greatest users.

Such statistics clearly show that, far from operating at the margins of the world economy, tax havens are an integral part of it.

www.taxjustice.net

According to a report in 2009 for the charity Oxfam, developing countries miss out on up to $124 billion every year in lost income from offshore assets held in tax havens.

www.oxfam.org.uk

It is reckoned that the UK alone loses at least $20 billion a year from tax havens.

The UK and other ‘offshore islands’
The United Kingdom, through the City of London, plays a prominent role in the tax dodging industry through the remnants of its former empire and dependencies. These include Crown Dependencies, the Channel Islands, Jersey, Guernsey and the Isle of Man. British Overseas Territories among which the most significant tax havens like the Cayman Islands, Bermuda, British Virgin Islands, Turks and Caicos and Gibraltar, and former colonies such as Hong Kong, Singapore, the Bahamas, Bahrain and Dubai. There are also a few newly independent British Pacific territories involved. They all catch, as Shaxson puts it, “financial business from nearby jurisdictions by offering lightly taxed, lightly regulated and secretive bolt holes for money …. yet far enough from the City of London to minimise any stink”.

As orchestrator of these secrecy jurisdictions, the City is itself an ‘onshore’ tax haven. Other such havens in Europe are the Benelux countries (Belgium, Netherlands and Luxembourg), and Ireland. Switzerland and Liechtenstein are old hands at the tax haven game. Together with Luxembourg, they have been operating ‘offshore’ since the 1920s.

The offshore competition
Within the tax haven world, each jurisdiction competes with the others to attract mobile capital. To stay in the race, taxes are lowered, financial regulations relaxed further or a new secrecy facility is offered. This race to the bottom is accompanied by threats by financiers to onshore politicians in the larger economies that they will go offshore if taxed or regulated too heavily. The politicians, eager to secure jobs and investment and perhaps even a consultancy or seat on the board when their political careers expire, give in and onshore takes on the characteristics of offshore. The tax burden of these economies is then shifted onto the shoulders of the ordinary citizens. The rich pay less and those less financially adroit and the rest pay up.

‘No tax’ and ‘low tax’ corporations
A dramatic example of corporate tax avoidance is General Electric (GE), the largest corporation in the USA. In 2010 it reported worldwide profits of $14.2 billion, of which $5.1 billion came from operations in the USA. A bonanza for the taxman, one might think. Not so. GE paid no tax at all, thanks to fierce lobbying for tax breaks and the innovative accounting that enables it to concentrate its profits offshore. This trend has been evident for years. As Shaxson points out: “US corporations paid about two-fifths of all US income taxes in the 1950s; that share has now fallen to a fifth. The top 0.1 per cent of US taxpayers saw their effective tax rate fall from 60 per cent in 1960 to 33 per cent in 2007, as their income soared. Had the top thousandth paid the 1960 rate, the Federal Government would have received over $281 billion more in 2007.”

In the U.K. corporate tax avoidance has been thrust into the spotlight by the pressure group UK Uncut and other campaigners. They allege that multinationals such as Vodafone, Barclays and Tesco, have avoided huge sums in tax mainly by being based offshore. Barclays, for example, revealed this year that it paid £113m in corporation tax to the UK in 2009, 2.4% of its £4.6bn global annual profit. This compares with the £3.4 billion set aside for bonuses! In Vodaphone’s case, UK Uncut alleged that the company struck a ‘sweetheart deal’ with the British tax authority whereby its tax bill was cut from £6 billion to £1 billion. Another example, if true, of onshore becoming offshore.

www.ukuncut.org.uk

The unwillingness of governments collectively to tackle the powerful offshore lobby, despite their rhetoric to the contrary, is illustrated by the Organisation for Economic Cooperation and Development (OECD). The organisation consists of 34 advanced and developing countries and provides a forum in which governments can work together to share experiences and seek solutions to common problems. It identified tax havens as jurisdictions that impose nil or only nominal taxes and offer themselves as places for use by non-residents to escape high taxes in their country of residence. They are also defined as protecting personal financial information and as lacking transparency in their legislative, legal and administrative provision. The trouble is that the richer member states like the USA and Britain and other larger economies are active players in the offshore world. Small wonder that OECD criticisms in its reports over the years have tended to concentrate on the transparency shortcomings of small non-members, such as the Caribbean islands, rather than those of its own members. Self-scrutiny is not the OECD’s strong suit.

The case for tax havens
Tax haven apologists from the industry itself and beyond, usually share an ideological belief in unregulated free markets, small government and low taxes. Right wing think-tanks, The Cato Institute and Heritage Foundation in Washington are examples. Their starting-point is that taxes are a burden and a liability. No mention is made of the public goods financed by taxes from which they themselves benefit. On the contrary, by facilitating low taxes or no taxes, tax havens are seen as beacons of freedom. Freedom for whom, one might ask? The already wealthy? Terrorists? Criminals? As we have seen, the advantage to some companies is that they can escape double taxation. But this can be fixed legitimately by tax treaties and tax credits. By using tax havens, companies remove the incentive from governments to reach such agreements. Double ‘no taxation’ is the result of going offshore. This means fees are paid to the tax haven but there is no tax revenue for the often poorer countries in which these companies operate.

Those who defend tax havens as exemplars of the free market don’t mention the unfair advantage they give multinational companies over smaller local businesses that do pay tax and that may even offer better goods and services. Such a market is distorted and corrupted rather than free.

Tax dodging multinational companies frequently remind critics that their first duty is to shareholders and reducing tax by all lawful means is part of that duty. It is therefore strange how shy they are in revealing to shareholders and the public what they’re up to. TJN reminds us that “companies (astonishingly) currently are not required to break their reporting down between each country where they operate. If they were required to report their activities on a country-by-country basis in their annual accounts we would know where they are, what they are called there, what trade they undertake there and how much tax they pay in each place in which they trade. This would highlight the use of tax havens by large companies, which they work so hard to conceal”.

How can ‘free market’ advocates of the offshore industry defend such secrecy? A situation in which knowledge relevant to the market is withheld by one participant from the other can hardly be described as free.

Beneath all the technicalities we return to the fundamental moral issue: should the poor pay proportionately more tax than the rich?

Tax havens, image and reality
Tax havens themselves are always eager to project a good image. Their argument that they are well regulated is difficult to reconcile with their offer of secrecy. Although they look after their clients’ money, they are not concerned with where that money comes from. This means they are often custodians of money stolen from other people. Tax havens that attract this sort of money from elsewhere by assuring secrecy, can hardly be said to be well regulated.

The effect of offshore on democracy
The mobility of global capital in today’s world highlights the nation state’s loss of control over taxation policy. Countries, competing with offshore jurisdictions are now required to compete in a race to the bottom over tax. This diminishes the influence of ordinary citizens on taxation policy and contributes to the democratic deficit. Progressive taxation, whereby the rich are taxed at higher rates than the poor becomes impossible to sustain. In the USA, the richest one per cent owns nearly half of all financial assets. This is both ethically indefensible and economically inefficient.

In the UK, for example, professor of accounting, Prem Sikka, argues the threat to democracy is clear: “The tax avoidance industry is on a collision course with civil society. Elected governments take months and years to develop tax laws, but in pursuit of private profits accountancy firms can undermine them within hours of a chancellor’s budget speech.… The [accountancy] firms also peddle a range of avoidance schemes in the UK, which are estimated to cost the state £100bn each year in possible tax revenues.… The government continues to award lucrative public contracts to the big accountancy firms. Their partners advise government departments on legislative design and enforcement. There has as yet been no public investigation into the tax avoidance industry. Major casualties of the tax avoidance industry are ordinary people, who are forced to pay higher taxes while corporations and the rich avoid theirs. Individuals on the minimum wage have to pay income taxes, but some 65,000 rich individuals living in the UK are estimated to have paid little or no income tax. The top fifth of earners pay a smaller proportion of their income in tax than the bottom fifth. Corporate tax payments now account for just 2.5% of national income, the smallest share ever.… Without adequate tax revenues no government can deliver its legislative programme, provide public goods or redistribute wealth. We can be persuaded to vote for governments that promise to invest public revenues in education, healthcare or public transport. But the tax avoidance industry exercises the final veto by shrinking the tax base and eroding tax revenues”.

 www.globalissues.org

Thus tax havens undermine faith in the political process by allowing corrupt politicians and business leaders to hide away their ill-gotten gains with impunity.

UK governments have left the tax avoidance industry untouched. A report in 2008 for Britain’s Trades Union Congress estimated that £25 billion annually is lost to the UK from tax avoidance. £13 billion a year is from tax avoidance by individuals and £12 billion from the 700 largest corporations. Richard Murphy of Tax Research UK estimates tax evasion at £70 billion. Add on £28 billion outstanding debts to the tax authorities and the total tax shortfall is £120 billion, about three quarters of the UK budget deficit. These are salutary figures for ordinary citizens called upon to make sacrifices to reduce this deficit. Not all the lost billions go into tax havens but tax havens lie at the centre of the avoidance industry.

Contrast the loss to the economy with that caused by benefit fraudsters. These individuals, mainly drawn from the poorest in society, are estimated to cost the UK economy about £1 billion a year. Egged on by the popular press, the government pursues them with vigour and enthusiasm. No ‘sweetheart deals’ for them. Such double standards can only increase public cynicism about politicians, especially those who assure us in these days of financial austerity: “We’re all in this together”.

The effect of offshore on development
The shift in taxation from rich to poor, aided and abetted by the tax haven secrecy jurisdictions, has a disastrous effect on developing countries. Global Financial Integrity (GFI) estimates annual illicit capital outflows from developing countries at $1 trillion per year, and rising. Director, Raymond Baker said: “Illicit financial flows siphon revenue out of poor countries, robbing them of much-needed assets and forestalling economic development”. www.gfip.org

These new figures reveal that illicit financial flows outpace Official Development Assistance by a ratio of nearly 10 to 1. This is critical to understanding global poverty and developing effective poverty alleviation and economic development strategies. Illicit financial flows refer to money that is illegal in its origin, transfer or use and reflect the proceeds of corruption, crime and tax evasion. Corporate avoidance of customs duties, VAT and income taxes constitute an estimated 60% of the total outflow.

Developing countries depend, like all other countries, on tax revenues to finance public goods and services, such as health, education and infrastructure. They are vital for reducing poverty but, as we have seen, raising those revenues has become more problematic because of tax competition. Wealthy individuals and corporations move their money to tax havens and countries with low tax regimes. Governments then have to choose between raising taxes from small businesses and ordinary citizens or cutting public services and often end up doing both. The shift in the tax burden is disastrous for development. It inhibits the growth of domestic demand and of internal markets, money for capital investment is lost, and economic growth and development are stunted. The developing countries then have no choice but to rely on overseas capital and markets.

Corrupt politicians and businessmen in developing countries are major contributors to capital flight. In his book ‘Capitalism’s Achilles Heel: Dirty Money and How to Renew the Free Market System’, Raymond Baker takes us on a tour of the global ‘free market’ system and shows us how dirty money, poverty and inequality are all intertwined. Baker estimates that over $500 billion is illicitly transferred from poor countries alone, with $1 trillion being transferred in total. $6 to $11 trillion dollars are stored in tax havens. The money leaves these countries mostly through commercial means, or by criminal and corrupt practices. The commercial trickery involves tax evasion, dummy corporations, shell banks, mispricing and transfer pricing on imports and exports between countries and companies. The startling effect of all this is that for every dollar a poor country receives in foreign aid, ten dollars leaves the country in illicit money transfers. 80-90% of this money will never return. Criminal activity such as human trafficking, drugs, racketeering, and terrorist financing accounts for a third of all money transferred. The corrupt practices usually take the form of bribery and kickbacks to politicians and other government officials.

Where do we go from here?
It might be thought that the problem of offshore tax havens is gigantic and its vested interests so entrenched that little can be done. In the last few years there has been a growing awareness of the pernicious effects of such a system on those of us who do pay taxes and cannot squirrel our money away. The books by Nicholas Shaxson and Raymond Baker are among the growing number of individuals and organisations that make a valuable contribution to that awareness.

The fundamental problem is that of secrecy. Companies should be compelled to be more open about their financial affairs and to publish data on every country in which they operate. Wealthy individuals’ finances should be made known to their tax authorities, so they pay their fair share of tax. As TJN says: “Markets work better, and companies are more accountable in an environment of transparency. Secrecy hinders criminal investigation and fosters criminality and corruption such as insider trading, market rigging, tax evasion, fraud, embezzlement, bribery, the illicit funding of political parties – and much more”. This requires international cooperation - and not just between the wealthy countries - in an age of globally mobile capital.

Top priority must be given to the needs of developing countries. Tax is the most important, the most beneficial, and the most sustainable source of finance for development. In the longer term it should replace foreign aid. This would make governments accountable to their own citizens instead of to foreign donors. As Trevor Manuel, the South African Finance Minister said: “It is a contradiction to support increased development assistance, yet turn a blind eye to actions by multinationals and others that undermine the tax base of a developing country”.

Something has to be done about tax havens and offshore financial centres themselves. As we have seen, they undermine and corrupt national tax systems and onshore regulation. Consequently, the tax burden is moved to labour from capital, gross wealth inequality results, democracies are corrupted and the wealthy avoid any responsibility. In the UK the City of London, almost a state within a state, should be dismantled and absorbed into the wider Greater London Council.

Onshore taxation should be progressive and equitable which means the rich pay more. Some tax laws need simplification so that armies of lawyers and accountants cannot find loopholes that enable their wealthy clients to avoid payment. This will involve a sea change in corporate culture, whereby tax would be regarded as a dividend out of profits and not a cost to be avoided. Companies’ profits do not depend solely on shareholders’ capital. They use and take benefit from the public goods and services which the wider society provides – the infrastructure, defence, policing, education, health service and the legal system that protects their rights. Tax is the companies’ payback, a return due on society’s investment in them. A culture of tax compliance needs to be restored.

As TJN puts it: “Both tax evasion and tax avoidance are anti-social and equally harmful. Tax avoidance may be the more so, because it is so insidious. Highly paid professionals spend their lives devising ingenious schemes to reduce or eliminate the tax liability of wealthy people, and they have become the “experts” on international taxation, developing and propagating a world view that sees these kinds of abuses as acceptable. Huge, well-resourced vested interests support them and have skewered international efforts to address the problems. Politicians, economists and civil society groups, perhaps daunted by the complexity of the issues or unable to see or measure what is happening in the secret world of offshore, too rarely challenge this world view. Meanwhile tax authorities rarely have the staff or time to combat the enormous resources and wiles of the tax avoidance industry. The resulting mouse-and-cat game – besides its effect on corrupting democracy – is enormously wasteful”.

The global financial crisis has shown that the ‘little people’ - the poor and those on middle incomes - are once again bearing the burden of the crisis in unemployment, higher taxes and falling living standards. Meanwhile the owners and controllers of wealth who contributed to it continue to prosper. The resulting anger and resentment may provide the impetus for change. Only then will this wealthy elite face the responsibilities to the societies upon which they and their wealth depend.

Further reading:
“Treasure Islands: Tax Havens & the men who stole the world” by Nicholas Shaxson. Publ. Bodley Head. London SW1.

“Capitalism’s Achilles Heel: Dirty Money and How to renew the Free Market System ” by Raymond Baker : Publ. John Wiley & Sons. Hoboken. NJ

Web sources.
www.taxjustice.net
www.oxfam.org.uk
www.gfip.org