Lost Finances: The fight against secrecy jurisdictions

Gerhard Schick

This post from Gerhard Schick will be his last, as he will no longer be a regular blogger. Triple Crisis thanks him for his insightful and timely contributions.

Estimates of the total amount of untaxed resources held offshore by individuals range from $7.4 trillion (the 2010 Global Wealth Report of the Boston Consulting Group) to $11.5 trillion  (Tax Justice Network (TJN)). By definition, it is impossible to identify the exact figure, but these are highly instructive estimates. Taking TJN’s number as a basis, approximately $250 billion in taxes are illegally evaded on an annual basis.  If these resources had been collected from 2000 to 2015, they could have almost entirely financed the attainment of the Millennium Development Goals.

Tax evasion has an even more direct impact on developing countries since they are entitled to the majority of unpaid taxes. James Henry, former Chief Economist at McKinsey & Co, estimates that about $6.2 trillion of the total amount held offshore by individuals represents developing country wealth.  He calculates that failure to tax this wealth deprives developing countries of an amount estimated between $64 billion to $124 billion in annual tax receipts.

The above estimates are based on the offshore wealth of individuals.  By including money moved offshore by private companies, the scale of losses would easily exceed the roughly $103 billion that developing countries receive annually in overseas aid.

Capital flight is a growing problem, too, with an additional $200 billion to $300 billion being moved offshore each year.  OECD’s Secretary-General Angel Gurría even says: “Developing countries are estimated to lose to tax havens almost three times what they get from developed countries in aid.” And the 2010 African Economic Outlook notes: “The challenge is for African countries and their partners to end the vicious circle of aid dependence that shifts government accountability away from citizens towards donors. Instead, they need to start a virtuous circle of aid working to make itself redundant, by supporting public resource mobilisation.”

How are these devastating effects possible? In 2009, TJN published a Financial Secrecy Index, ranking the 60 most important so called “secrecy jurisdictions”. The Index identifies the jurisdictions that are most aggressive in providing secrecy for international finance and which most actively shun co-operation with other jurisdictions. With the help of these jurisdictions, both individuals and companies are able to shift their capital and profits to locations that are inaccessible to their home-country tax authorities. Interestingly enough, among some of the top ranked secrecy jurisdictions we find several that are linked directly to powerful developed nations, such as Delaware (Rank 1) or the City of London (Rank 5). This reveals that the problem of tax havens goes beyond small countries refusing to co-operate internationally. Jurisdictions sponsored by the US or UK are among the most secretive  worldwide. It is thus not very credible when the governments of these nations advocate for the closure of tax havens, as they did at the G20 summit in London in 2009. The final Leaders’ Statement  reads: “The era of banking secrecy is over.”  But, to date, few actions have been taken to end this era.

Secrecy jurisdictions are used not only to evade taxes, but also to hide hazardous or even illegal assets from the balance sheets of banks and other companies.   This underscores the fact that the fight against secrecy jurisdictions is necessary not only to recoup public finance, but also to achieve  global financial stability.  Of course, this fight must take place alongside other efforts to stabilize the system, but it is a critical lesson of the financial crisis. For example, the Deutsche Bank has about 500 subsidiaries in secrecy jurisdictions; in Mauritius alone, a small island with an opaque banking system, the bank employs over 180 persons. Even the German state-supported Commerzbank has 76 subsidiaries in tax havens. It can be assumed that these subsidiaries are mainly used to evade taxes, but during the financial crisis, we  also observed  the outsourcing of dangerous assets and liabilities to subsidiaries which could not  be monitored by German regulatory authorities.

What must be done to impede the use of secrecy jurisdictions? As is increasingly common in many policy fields, the best solution would be a global one.  Opaque jurisdictions pose a co-ordination problem, since every jurisdiction has an incentive to retain the comparative advantage provided by opacity. However, if all tax havens were closed, everyone could benefit.

In reality, however, a global solution is not in the offing. But we need institutions that provide knowledge, coordination capacities, and the possibility of “naming and shaming” in this matter. Among others, the OECD has been rather active in this role during recent years. However, its criteria are very lax: First, the OECD standard recommends a so-called “exchange of information on request”.  Jurisdictions that are signatories to a treaty including this provision must provide information to the tax authorities of another treaty member only when their request is based on a specific suspicion. However, this is hardly possible since almost all information is hidden – this is the definition of a secrecy jurisdiction. Second, if a country has signed twelve such treaties, it is removed from OECD’s “grey list” of tax havens. But what happens to this country’s relationship with the other 180 countries in the world?  This question is especially pertinent if the country has signed treaties with twelve  other tax havens.  This scenario is not unrealistic.

The first step toward dealing with secrecy jurisdictions should be to require an automatic exchange of tax information among those countries on the OECD “white list.” This step has already been taken  in the European Union (although there are several provisions needing improvement). Only when there is the automatic exchange of information, will the evasion of taxes and regulation become really difficult.

In a second step toward transparency developed nations must require that their companies issue  financial reports on a country-by-country basis.   Today, multinational corporations report on a consolidated basis, making it impossible to analyze where and  how it does business.  Systems of country-by-country reporting, which could be defined by the International Accounting Standards Board (IASB), would not prevent the use of secrecy jurisdictions per se, but it would provide much more transparency, making it possible to put pressure on companies engaged in the extensive use of secrecy jurisdictions.  At the end of 2010, the EU Commission started a first consultation on this topic.

In a third step toward transparency, countries can act unilaterally, as France has effectively demonstrated.  The French Government created its own “black list”, using more rigorous criteria than the OECD.   An almost prohibitively high tax is imposed on every transaction with one of the jurisdictions on this list.  Among other measures, the capacity of tax authorities has also been strengthened.  Unfortunately, Germany , has chosen another way:  Instead of keeping up the pressure for transparency, German finance minister Schäuble has openly agreed to sign a bilateral treaty with Switzerland allowing tax dodgers to remain anonymous and pay only a flat rate withholding tax.

This is but one example that shows the slow and uneven progress is in this area and how national fiscal aims are given priority over a coordinated approach to curb secrecy.  One of the major political challenges for 2011 will be to change these priorities and to show that bringing transparency to secrecy jurisdictions is an answer to both the development and the financial crises.

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