11 Tax Havens in an Austere World: The Clash of New Ideas and Existing Interests
RICHARD WOODWARD
Aside from fleeting interest in some particularly egregious scandals, tax havens rarely pervaded the public consciousness prior to the global financial crisis of 2007–8. Likewise, some notable exceptions notwithstanding (see, for example, Hampton 1996; Palan 2003; Sharman 2006), tax havens and offshore finance were seldom the subject of serious scholarly study. Indeed the academic community and the public at large appeared to regard tax havens as some kind of “exotic sideshow” (Shaxson 2011, 7) remote from everyday life and unrelated to broader developments in the global economy. In fact, as a spate of recent literature has demonstrated (Palan, Murphy, and Chavagneux 2010; Shaxson 2011; vanFossen 2012; Brooks 2013; Eccleston 2013; Gravelle 2013; Findley, Nielson, and Sharman 2014; Urry 2014; Deneault 2015; Zucman 2015), nothing could be further from the truth. During recent decades tax havens have become integral parts of the global economic landscape whose existence is indispensable to the overarching economic strategies of major economic actors and central to many of the most pressing conundrums of global governance (Wojcik 2013), including underdevelopment, prudential regulation, money laundering, and, the main theme of this chapter, tax evasion and avoidance.
The global financial crisis hammered home the truth about tax havens. Although they were not directly incriminated in the causes of the crisis, it is widely held that tax havens hastened its arrival through regulations that allowed and encouraged the build-up of debt and secretive financial structures that prevented financiers from accurately assessing the creditworthiness of their counterparties, thus intensifying the initial credit crunch (OECD 2009; IMF 2009). Against this background it is unsurprising that tax havens have been a key focus of post-crisis efforts to reform the international financial architecture; however, two other factors generated extra momentum. First, whereas tax policy and administration were previously treated as technical matters whose discussion was dominated by lawyers, accountants, and government revenue officials, the post-crisis environment lent oxygen to civil society organizations campaigning for curbs on tax havens as part of a broader package of measures to promote “tax justice.” By gleefully and imaginatively seizing upon some of the most blatant examples of tax avoidance and evasion by corporations and high-net-worth individuals and juxtaposing this with the austerity inflicted upon the majority of citizens, the tax justice campaigns have alerted governments and public opinion to the distributional consequences of these seemingly technical discussions. As well as stoking considerable public discontent, these campaigns have advanced the case for enhancing tax transparency, pointing out that it would make it difficult, or at least potentially embarrassing, for corporations and rich individuals to sidestep their tax obligations, an innovation that would obviate, or at the very least alleviate, the need for austerity. Second, for governments looking to stanch bloodletting on their public balance sheets, a crackdown on tax shirkers was fiscally and electorally appealing. By its very nature, a precise measure of the “tax gap” arising from tax avoidance and evasion remains elusive. Nevertheless, Zucman (2014, 140) estimates that governments lose $190 billion in tax revenue annually from undeclared offshore assets, while Citizens for Tax Justice (2014, 7) believe the United States alone loses $110 billion each year to corporate tax avoidance.
The combination of gaping deficits, public anger, and an increasingly animated campaign agitating for international tax transparency created a climate conducive to a crackdown on territories thought to be facilitating tax avoidance and evasion. Desperately casting around for policies that would give the impression that they were mounting an effective response to the crisis, the G20 latched onto and gave fresh impetus to the Organisation for Economic Cooperation and Development’s (OECD’s) seemingly moribund international tax transparency project. At its London Summit in April 2009, the G20 (2009) proclaimed that “the era of banking secrecy is over,” pledged to take “action against non-cooperative jurisdictions,” and stood “ready to deploy sanctions to protect our public finances and financial systems.” The gradual strengthening of the OECD’s project, as well as further tax transparency initiatives aimed at individual tax evasion (such as the unilateral US Foreign Account Tax Compliance Act [FATCA] [2010] and the European Union’s Directive on Administrative Cooperation in the field of taxation), and latterly corporations (e.g., the G20/OECD’s Base Erosion and Profit Shifting [BEPS] scheme [2013] and the EU’s Tax Transparency Package [2015]) give the outward appearance of a determined effort to constrict tax haven activities. Nonetheless, the authors cited in the opening paragraph and the civil society groups monitoring this issue have heaped scorn on the weaknesses of these initiatives. Indeed, despite protests from many tax havens, the empirical evidence suggests overwhelmingly that they continue to prosper (Boston Consulting Group 2014; Johannesen and Zucman 2014).
As the burgeoning post-crisis literature on tax havens and global tax governance avers, the reasons why meaningful reform of the international tax regime is proceeding slowly, despite ostensibly propitious circumstances, are complex. Virtually all of this writing points to the fact that fresh ideas to inject greater transparency into international tax affairs have struggled to gain traction, because they have run headlong into entrenched interests, not least the transnational tax-planning industry and their clients. This chapter takes a slightly different tack, arguing, perhaps counterintuitively, that a systematic campaign to eradicate tax havens is not in the interests of many leading states. In particular it suggests that the preference of elites for austerity rather than a genuine clampdown on tax havens is because the latter have become crucial elements of their overarching economic strategy. Indeed many states have aggressively promoted themselves as tax havens, writing laws with the express purpose of soliciting non-resident business. Although most commonly associated with small states, this “commercialisation” (Palan 2002) of state sovereignty is widely used by OECD states to siphon off rent surpluses that would otherwise accrue to their competitors. Since the 1950s, offshore finance and tax havens have developed in a haphazard manner, often as states have sought to advance their own interests or manage the instabilities and contradictions of the international economy. However, with each response, tax havens and the instruments they supply have progressively become intrinsic to the strategies and interests of key economic actors. The closure or a significant tapering of tax havens would endanger those economic strategies. Thus when faced with a choice between clamping down on tax havens and imposing austerity, leading states have invariably plumped for the latter. The choice of austerity represents the latest stage in the entrenchment of tax havens in state economic strategies, because the successful delivery of austerity is critically dependent on the instruments they supply.
The Rise of Offshore Financial Centres and Tax Havens
Popular conceptualizations of offshore, “special territorial or juridical enclaves characterised by a reduction in regulations” (Palan 1998, 626), conjure images of idyllic island settings whose physical detachment from the mainland provides sanctuary from the tentacles of “onshore” authorities. This view is somewhat misleading. While significant financial activities do occur in islands dotted around the Pacific and the Caribbean, many of the world’s biggest offshore centres are located, in a physical sense, “onshore,” most notably in London and New York. Increasingly therefore, most commentators argue the significance of offshore lies in its juridical rather than its physical properties. Offshore refers to the set of legal rules under which a transaction takes place, rules that may be very different from those prevailing in the physical location in which the transaction occurred (Palan 2003).
Tax havens are one of the most conspicuous manifestations of this offshore world (Urry 2014). The definition of a tax haven remains contested, but there is some agreement that they are jurisdictions that specialize in financial transactions for non-resident investors whom they attract by offering indulgent fiscal, regulatory, and legal frameworks. These inducements are complemented by a cloak of secrecy that camouflages these transactions, thus enabling them to circumvent tax and regulatory obligations in their country of residence (see Sharman 2006, 21; Hines 2010; Slemrod 2010). For example, although tax havens typically apply no or very low rates of taxation to investment income received by non-residents, alone these generous tax rates are not conducive to non-resident investors fleeing their tax obligations. This is because most countries tax investment income of their residents on a worldwide basis. This system relies on taxpayers declaring income earned overseas to their local revenue authorities. Taxpayers “have an economic incentive to under-report their true income. Because of this the enforcement of resident taxation relies on the intense exchange of information between tax authorities” (Rixen 2008, 61). Unfortunately the intensity and effectiveness of these exchanges are undermined by the failure of many tax havens to collect and share the necessary information. Although they have been weakened by the recent slew of international initiatives aimed at boosting transparency, for individuals the main attraction of tax havens was strict banking secrecy laws that made it a heavily punishable offence to reveal information about the owners of assets, except in criminal cases and structures such as trusts and foundations that conceal the real beneficiaries of assets. For corporations the principal attraction was the ability to set up a network of anonymous “shell” companies that cleave their “real” geographic activity and revenue from their profits. Using accounting tricks such as transfer pricing, multinational corporations are able to artificially shift their profits to tax haven jurisdictions and their losses (which can be used to reduce tax liabilities) to high-tax countries.
The contested definition of tax havens and their secrecy means the precise value of assets stockpiled offshore is unknown. Nevertheless, conservative estimates suggest that personal financial wealth held in tax havens grew from $11 billion in 1968 to $7.6 trillion in 2013 (Zucman 2014, 139). These figures, however, exclude financial assets hidden in trusts and non-financial assets such as yachts, works of art, and real estate. Transparency International’s (2015) revelations that £122 billion of property in England and Wales is held by companies operating in tax haven jurisdictions gives credence to Henry’s (2012) calculations that $21 trillion to $32 trillion of private wealth is held in tax havens. Figures from the Bank for International Settlements and the International Monetary Fund suggest that around half of banks’ cross-border assets and liabilities and a third of foreign direct investment are routed offshore (Palan, Murphy, and Chavagneux 2010, 51) while 85 per cent of banking and bond issuance originates in the offshore Euromarkets (Lane and Milesi-Ferretti 2010). In short, “the offshore system is not just a colourful outgrowth of the global economy, but instead lies right at its centre” (Shaxson 2011, 9).
The centrality of tax havens to the contemporary global economy is far from accidental. While states have periodically checked the development of offshore for the most part, to paraphrase Polanyi, the road to offshore financial markets was opened and kept open by an enormous increase in continuous, centrally organized and controlled state interventionism. Many of the initial post-war developments in the rise of tax havens and offshore reflected unplanned responses (and non-responses) by states to specific developments, but the world soon witnessed the rise of “interests … seeking to strengthen the institutional machinery that makes possible offshored worlds” (Urry 2014, 14) and the steady embedding of tax havens and offshore finance into the strategies of major economic actors. Indeed, by the mid-1980s, virtually all OECD countries had transformed themselves into tax havens and have subsequently subjugated their economic policies to the needs of tax haven interests.
The first tax havens appeared in the late nineteenth century, with several more, most notably Switzerland, Austria, and Liechtenstein, developing in the interwar period (Palan, Murphy, and Chavagneux 2010; see also Picciotto 1992). The placing of tax havens and offshore finance at the centre of the global economy gathered pace in the 1950s with the establishment of the Euromarkets. Scholars still debate the exact order of events and the constellation of ideas, interests, and institutions that gave rise to the Euromarkets (see, for example, Burn 1999, 2006; Helleiner 1994). Nevertheless, there is some agreement that the process commenced when banks in the City of London started accepting US dollar deposits from non-residents that were unrelated to trade or commerce. These banks then began lending to non-residents in dollars, effectively putting control over dollar credit at one remove from the American regulators. This practice was boosted by limits imposed by the United Kingdom on the use of sterling in response to periodic balance of payments crises. These restrictions endangered those City institutions whose core business was international lending to finance trade between third parties, and many responded by using dollars to finance them. Instead of intervening to restrict this innovation, which offered a way to circumvent the capital controls imposed under the Bretton Woods system, the Bank of England, sensing an opportunity to restore the City’s international role by substituting a sterling empire for a dollar empire, chose to ignore it, arguing that even though they took place in London, financial transactions between non-residents in a foreign currency were not subject to UK regulation (Burn 1999; Kane 1983).
During the 1960s, the Euromarkets expanded briskly as persistent US deficits ensured a constant outflow of dollars and US investors flocked to London to escape regulatory oversight. Unenamoured about these developments the US government attempted to stifle the use of the Euromarkets, most notably through the Interest Equalisation Tax of 1963, a levy on foreign securities designed to deter US banks from exporting capital. This move backfired when US financial institutions scrambled to invest in the UK before the new regulations took effect. Thereafter the US softened its stance and was often a subtle supporter of the Euromarkets. Burn (2006) demonstrates that powerful banking interests in New York neutered proposals that would have subdued the budding offshore environment. Furthermore, successive US governments came to understand that the Euromarkets provided another means of preserving the dollar’s pre-eminence as the international reserve currency, providing it with the “exorbitant privilege” of issuing debts denominated its own currency (Eichengreen 2010). As Douglas Dillon, US Under Secretary of State commented, Eurodollars provided “a good way of convincing foreigners to keep their deposits in dollars” (quoted in Helleiner 1996, 21) and allowed the US to shift the burdens of adjustment onto other countries. Various tax concessions were introduced to encourage US firms and banks to invest offshore as a method of entrenching US power. Underpinned by the interests of leading states and private financial actors assets invested in the Euromarkets grew from a value of $200 million in 1959 to over $1 billion in 1970.
Whereas the emergence of the Euromarkets was almost a historical accident, subsequent phases in the development of offshore financial centres and tax havens were more deliberate. One important aspect was the reinvigoration of a web of tax havens and offshore financial centres in small dependent territories, most notably those of the United Kingdom. In places such as the Channel Islands this process was driven principally by private financial institutions that set up in these locations to serve a wealthy clientele (Hampton 1996), but elsewhere, such as in the Isle of Man or the Cayman Islands (Freyer and Morriss 2013; Deneault 2015), efforts to establish offshore finance were purposefully steered by public authorities. The Bank of England, for example, foresaw the advantages of a network of havens that would funnel capital to the City of London. This strategy has been extraordinarily successful, with Foot (2009) reporting that the British Crown dependencies channelled $332.5 billion to the City in the second quarter of 2009. As well as being important booking centres for Euromarket transactions, the United Kingdom’s network of offshore dependencies were also important in repairing the competitiveness of British banks. Euromarket rules that had allowed transactions between non-residents put UK banks at a disadvantage, but the development of offshore centres in Crown dependencies allowed them to create subsidiaries that would make them “non-resident” for the purpose of City transactions.
During the economic upheavals of the 1970s and 1980s, the Euromarkets started to become critical to global economic management. Spiro (1999) reveals how the United States exploited the Euromarkets to recycle OPEC wealth resulting from the oil crisis in a manner that underwrote the expansion of US private and government debt. The offshore world also dovetailed with prevailing ideas and economic interests. As low-tax, low-regulation environments, tax havens and offshore financial centres were lionized by apostles of the free market creed. Leading states began to aggressively tout themselves as tax havens, offering inducements for non-resident corporations and individuals to invest on the basis that these activities would be camouflaged from overseas tax authorities. Indeed by the 1990s many were asserting that the United States was the world’s largest tax haven (Palan and Abbott 1996; Mitchell 2001). Policies designed to tempt non-residents to park their assets in the United States dated to the 1920s, but these were ramped up by a Reagan administration desperate to control the steepling deficits resulting from its economic and military program. In addition to introducing a raft of new exemptions for foreign-owned capital, the United States also moved closer to the United Kingdom’s Euromarket model, introducing the International Banking Facility, which allowed US-based financial institutions to offer deposit and loan facilities to non-residents outside normal regulatory controls. US banks could now do from New York what they had previously done in London and the wider network of offshore centres, making the United States a magnet for inward investment. Furthermore, a string of US states including Delaware, Nevada, and Wyoming reinforced their own provision of tax haven services. The United States also became shrewder in its calls for greater transparency in international tax matters. The US government recognized that existing tax treaties enabled it to increase tax revenues by seeking information about the assets its citizens had squirrelled away overseas. However, if it did so it would also be obliged to tell its treaty partners about their residents with assets stationed in the United States, which could stimulate capital outflows as these investors fled to jurisdictions that continued to promise secrecy. To forestall this, the United States invented the Qualified Intermediary (QI) program, which gave responsibility for reporting not to treaty partners (governments) but to foreign banks, who were asked only to reveal details about US citizens. In a forerunner of FATCA, the QI program represented a classic mercantilist strategy whereby the United States sought to maximize its own tax revenues by demanding information from foreign banks about its citizens but refused to reciprocate with those seeking information about their own citizens with investments in the United States (Eccleston and Gray 2014).
By the late 1980s, the use of tax havens had become hard-wired into the economic strategies of leading states, many of whom started to believe their own rhetoric about the hyper-mobility of capital and concerns that investment would flee if they did not deliver a tax-friendly investment environment. As Richard Brooks’s (2013) analysis of the United Kingdom has demonstrated, the result has been the craven capitulation of government to firms of lawyers and accountants peddling legislation that will allow them to design tax-avoidance schemes for their clients. While it is often assumed that lawyers and accountants engage in a cat-and-mouse game with governments, with the former looking to sneak around tightly written tax laws drafted by the latter, the reality is that the cat and the mouse conspire, and the government’s mission is “unashamedly to adjust the framework of tax legislation to suit large businesses” (28). Inversions, the relocation of a corporation’s headquarters to a foreign location while retaining its material operations at home, are merely the latest newsworthy issue in this regard.
The Financial Crisis: The Clash of New Ideas with Existing Ideas and Interests
Today there is a rich and vibrant movement campaigning against tax havens as part of a wider battle to promote “tax justice.” For example, the Financial Transparency Coalition (2014), an alliance of civil society organizations, governments, and independent academic and professional experts urging an end to financial secrecy, now boasts over 150 members. In addition to the emergence of associations and organizations devoted specifically to these questions such as the Tax Justice Network and Global Financial Integrity, the issue of tax avoidance and evasion has been mainstreamed into the agendas of high-profile organizations such as Oxfam, Christian Aid, and Transparency International. A coruscating series of reports from non-governmental organizations and international organizations, in addition to sleuthing from journalistic organisations, most notably the International Consortium of Investigative Journalists (ICIJ) through high-profile stories like “Luxleaks” (ICIJ 2014b) (which revealed that PwC had negotiated 548 sweetheart deals with the Luxembourg government for 340 multinational companies) and “Swissleaks” (ICIJ 2015) (which highlighted HSBC’s role in assisting clients to engage in a spectrum of illegal behaviour, including tax evasion) have kept the issue in the spotlight. This contrasts sharply with the situation a decade earlier where discussions of tax issues were dominated by pro-market civil society organizations lobbying for lower taxes and, despite some ephemeral interest (see Oxfam 2000), ignored by groups pushing for social justice. Indeed as its brief official history attests, when it was launched in 2003 the ideas of the Tax Justice Network garnered little enthusiasm, even among what might be regarded as natural allies such as trades unions (Tax Justice Network 2014a). Over the next few years, the ideas of tax justice advocates slowly seeped into mainstream policy debates, but it was unquestionably the financial crisis that oxygenated these ideas and catalyzed the movement (Eccleston 2013).
Prior to the financial crisis, tax justice activists had taken issue with the orthodoxy that lower taxes on the rich and corporations, including the effective tax cuts resulting from these actors engaging in tax avoidance and evasion, would be an incentive to take risk and leave more spare capital to be invested to raise economic growth and productivity. First, they pointed out that much of this capital is tied up in offshore financial assets and never finds its way into productive investment. For example, many states create inducements for multinationals to send money overseas by allowing them to defer paying taxes on profits attributed to foreign entities. Unsurprisingly many multinational corporations choose to reinvest this money offshore rather than repatriate it. In 2013, the offshore reinvested earnings of large capitalized US companies amounted to $2.119 trillion (Audit Analytics 2014). Paradoxically Citizens for Tax Justice (2014) reckon that almost half of this offshore money resides in international banking facilities hosted by US banks. Second, they pointed out that the use of tax havens to avoid or evade taxes abrogated the social contract upon which the prosperity of rich individuals and success of corporations depended. These actors are the principal beneficiaries of public goods paid for out of general taxation, not least the range of coercive state instruments that ultimately protect private property rights, but their use of tax havens means they are able to shirk making a full contribution to this collective pot. Tax justice advocates promoted a miasma of reforms to make tax arrangements more progressive at the domestic level, such as raising taxes on income and capital gains, the introduction of inheritance taxes, and changes to remove incentives for corporations to shift profits offshore. Nevertheless, for these modifications to achieve any real impact they would have to be complemented by efforts to enhance the enforcement of tax law through promoting greater tax transparency.
Ideas connected with the notion of tax justice gained purchase in the context of austerity. Indeed tax justice campaigns cleverly exploited the austerity debate to further their agenda. The fiendish intricacy of transnational tax-planning strategies and the esoteric rules underpinning it had helped to ensure that such matters were presented as purely technical problems best resolved by experts in the cloistered surroundings of remote international organizations. The onset of the austerity agenda, however, enabled champions for tax justice to expose the expressly distributional and hence political effects of these discussions. According to the US Public Interest Research Group, for example, in 2013 the United States forfeited $184 billion in federal and state revenue as the result of tax avoidance and evasion by corporations and individuals. Each individual taxpayer would need to pay an extra $1259 in taxes to make up this shortfall (U.S. PIRG 2014; see also Gravelle 2013; Citizens for Tax Justice 2014). In other words, tax justice campaigners sought to propagate a simple message to the average citizen, that the exploitation of tax havens by rich individuals and corporations is intensifying the austerity they are suffering. Likewise, they have sold the idea of a clampdown on tax havens as a seductive alternative to austerity. In the United Kingdom, for example, the Tax Justice Network made a mockery of the then Conservative-Liberal coalition government’s “we’re all in this together” slogan by indicating that recouping the £18.5 billion in tax revenue lost through tax haven activities annually (Murphy 2008) would more than cover the cumulative £83 billion cuts by 2014/15 announced by Chancellor George Osborne in his 2010 spending review. Whereas the government has attempted to present the austerity as a burden falling predominantly on the shirkers (see Joy and Shields, this volume), the tax justice activists stress that tax shirkers are a primary cause of austerity.
In other words, unlike areas covered by some of the other chapters in this volume, campaigns for tax justice were advocating an alternative to austerity. Although they paint a mixed picture, surveys of public opinion in OECD countries indicate that attitudes towards tax avoidance and evasion have hardened. The weight of these arguments also appeared, given the commitments already made by G20 and OECD countries to promote tax transparency, to be leaning on an open door. However, the efforts of the G20/OECD have been almost unanimously derided as a damp squib (see Shaxson 2011; Brooks 2013; Eccleston 2013). Particular opprobrium was heaped upon the weakness of the G20/OECD standard, which rested on voluntary exchange of information. In order to avoid the stigma of blacklisting, the G20/OECD requested that all countries sign a minimum of twelve Tax Information Exchange Agreements (TIEAs) outlining the protocols under which they would agree, upon request, to the exchange tax information with their counterparts abroad. Unfortunately TIEAs were designed in such a way that in order to request information about the assets of residents held overseas, tax authorities would need to supply their overseas counterparts with precisely the kinds of details that tax-haven secrecy is designed to obfuscate. Consequently, as one frustrated tax inspector explained, “You already have to have pretty much all of the information you’re after to get the last piece. It’s a catch-22” (quoted in Economist 2013). Furthermore, many tax havens signed the bare minimum number of TIEAs required, assiduously avoiding autographing agreements with major economies in which the majority of investors resided. The “creeping futility” (Meinzer 2012) of the G20/OECD’s tax transparency regime generated a groundswell of support for stronger standards to counter tax avoidance and evasion based on the automatic exchange of information – a position endorsed by the G20 finance ministers in April 2013. By the end of 2015, ninety-seven territories had made commitments to implement the new Standard for Automatic Exchange of Financial Information in Tax Matters before 2018 (OECD 2015). In parallel the OECD launched its BEPS program at the behest of the G20 to overhaul the patchwork of existing tax agreements whose contradictions and imperfections facilitate the ease with which corporations can apportion taxable profits to fiscally lenient jurisdictions far from where their real business activities occur. The final package was endorsed by the G20 (2015) in November 2015, with implementation to commence immediately. These schemes have received a more enthusiastic reception from advocates of tax justice, who nonetheless argue they still possess loopholes that will be systematically exploited by tax planners (see Tax Justice Network 2014b).
Explaining Resistance to Tax Transparency
The failure to develop a more robust international tax transparency regime is normally ascribed to three interrelated factors. First, the ideas of those advocating tax transparency as an alternative to austerity have not gone unopposed. Groups agitating for tax justice have amassed most of the column inches, but they are out-muscled and outnumbered by organizations promoting financial privacy and low taxes that possess the additional advantages of bountiful funding and privileged access to political and administrative elites. For example, ICIJ (2013, 150) reports that the Centre for Freedom and Prosperity, a right-leaning think tank, has met with over 175 offices on Capitol Hill to brief them about the benefits of tax competition and tax havens. Second, should more radical ideas leach into the G20/OECD agenda, they will be swiftly defanged by lobbying from a determined coalition of tax-planning interests that have been systematically organized into the process. For instance, after a consultation dominated by the transnational tax-planning industry it was supposed to tackle, the OECD announced that it would be narrowing the scope of the BEPS campaign and dropping critical reporting requirements that have been at the heart of many profit-shifting scandals (Oxfam 2014). As one representative of a US law firm described it, the “game plan” of US corporations “is to be positive but hope as little as possible happens” (quoted in Gapper 2014). Likewise, fears about a revolving door between the guardians of the international tax regime and the vested interests of the transnational tax planners were heightened in May 2014, when Andrew Hickman, formerly of KPMG, was appointed to head the OECD’s Transfer Pricing Unit. As ICIJ (2014b) noted in the aftermath of the Luxleaks scandal, “The Big 4 accountants shuttle back and forth between the accounting industry and government so often … that it undermines authorities’ efforts to police the industry and enforce tax laws.” Third, opportunities for more fundamental change are frittered away in the process of reconciling the interests of the growing roster and diversity of states enrolled in the G20/OECD initiatives. Superficially it appears that all states have an interest in promoting international tax cooperation and information exchange, because this will facilitate the ease with which they can impose levies on the overseas earnings of their residents and boost revenues. Recall, however, that to remain attractive to mobile capital, many major states have made being a tax haven a centrepiece of their economic strategies. Thus, many states have adopted a Janus-faced position from which they argue for transparency and international cooperation to ensure they can tax their own citizens’ offshore income but simultaneously maintain tax systems that attract foreign investors by shielding them from the privations of their resident tax authorities. The remainder of this chapter argues that the onset of austerity exacerbates this tension by making states more reliant on tax haven strategies, potentially sounding the death knell for more progressive ideas connected with tax transparency.
In the era of internationally mobile capital, governments have faced a difficult balancing act. On the one hand, to bolster their legitimacy at the domestic level, governments often make lavish public expenditure promises while, on the other, they need to maintain strict control over public finances to retain the confidence of international investors. Post-financial-crisis austerity represents a sharpening of this dilemma, but happily the embrace of offshore finance and tax haven strategies offers a number of ways of squaring this circle.
As previously described, one way in which this can be achieved is for states to become tax havens by offering the kinds of inducements previously described to non-resident investors. As well as directly easing the financial position, especially where residents earn more abroad on their foreign assets than foreigners on domestic assets, such “offshore” borrowing has the additional benefit of being cheaper because, among other things, of the lighter regulatory environment. Unquestionably the United States provides the most successful example among leading states of this strategy in action. Figures from the US Department of Commerce (2014) show that foreigners own $30.38 trillion of US assets, while assets held overseas by US residents amounted to $24.93 trillion, a $5.4 trillion gap that is helping to hold down the current account deficit. Since the financial crisis, the United States has exploited its preponderant position in the global economy to enhance its reputation as a safe haven for non-resident investors, most notoriously through FATCA. FATCA requires foreign financial institutions (FFIs) to disclose to the Internal Revenue Service the identities and personal information related to the assets of US account holders. Any FFI that fails to meet these reporting standards will be subjected to a 30 per cent withholding tax on payments related to US source income. Crucially the majority of the Intergovernmental Agreements (IGAs) that provide FATCA’s legal underpinnings have been negotiated on a non-reciprocal basis. In other words, the United States is practising precisely the strategy previously outlined whereby it simultaneously seeks to extract revenues from its own citizens whilst protecting foreign investors in the United States from investigations by tax inspectors in their country of residence. Under these provisions, which came into force for new customers in July 2014 and for existing account holders in 2016, the United States is likely to thrive as a tax haven (Eccleston and Gray 2014). Moreover, the United States appears to be backsliding on its commitment to automatic, reciprocal information exchange at the OECD (Cobham 2014), leaving “a vortex-shaped hole in global financial transparency” (Shaxson 2015).
The proliferation of private finance initiatives is a second way in which states are exploiting offshore to finesse their delivery of austerity. The basic principle of private finance initiatives is that private companies borrow money to build and own infrastructure. This expenditure is then recovered through charging fees for the provision of that service over a fixed period. In short, as Whiteside (this volume) puts it, policymakers committed to fiscal consolidation have “reconceptualized public infrastructure as untapped revenue streams.” Importantly, because this money is being borrowed by companies, the resulting debt does not appear on the government’s balance sheet. In this way governments are able to meet pledges to invest in public services without unduly alarming the international financial markets. A vast literature argues that states have deliberately stacked the deck to make private financial deals a profitable and attractive proposition (see Whiteside, this volume), but the deal is sweetened further by the financial alchemy afforded by tax havens and offshore financial centres. For example, the earnings of private finance initiative (PFI) companies ultimately derive from government-backed income capping the risks associated with the project, which should lower borrowing costs. In practice, the interest rates on PFI borrowing are invariably higher, indeed often substantially higher (see, for example, Whitfield 2013), than the rates on government gilts. Handily these higher borrowing costs generate tax-deductible interest expenses for PFI companies who, in some extreme cases, have incurred up-front losses that will wipe out potential tax bills for years to come (Brooks 2013). Furthermore, the guaranteed income arising from PFI projects made these companies ideal products to sell on secondary markets. Recognizing that the PFI process could be accelerated if the builders and investors behind the initial scheme could sell up and move on to the next project. Finance ministries have encouraged this with tax breaks and incentives. As a consequence many PFI companies and the income they generate now reside in secretive tax havens beyond the reach of the taxman.
A third way offshore is central to the delivery of austerity is as a mechanism for expanding the stock of private debt. Even austerity’s devotees recognize that it is a self-defeating strategy. Rapid fiscal consolidation, combined with private sector deleveraging, runs the risk of dragging countries back into recession, curtailing tax receipts and amplifying pressure on public expenditure (Delong and Summers 2012). With wages stagnating (see Peters, this volume) and inequality mounting, proponents of austerity envisage this gap in aggregate demand being offset by private borrowing. In the United Kingdom, for instance, the Office for Budget Responsibility (2014) forecasts that household debt will soar by £566 billion by 2019 (see Lee, this volume). Since the crisis, many financial institutions have been more concerned to repair their balance sheets than extend lending facilities to the private sector. Such risk aversion has been heightened by the introduction of tougher capital adequacy requirements and stress tests designed to inhibit the ability of financial intermediaries to expand and leverage their balance sheets. This raises the question of where the additional lending needed to deliver a private sector–driven economic recovery will come from. As well as providing a cheap source of wholesale finance, offshore financial centres and tax havens are helping to open the private lending spigot in three main ways. First, tax havens have played a central role in mopping up the toxic assets left by the 2007–8 financial crisis. The Cayman Islands was the domicile of choice for fund managers investing in the bad assets of US banks. Second, although most tax haven jurisdictions now meet international standards, lighter offshore regulatory regimes will allow financial institutions to set up structures that permit them to take “off-balance sheet” risks far in excess of, and hidden from, those mandated by national and international authorities. Recall that the near-collapse of the British high street bank Northern Rock was prompted by the failure of Granite, an offshore securitization vehicle located in Jersey, designed to allow the parent bank to sell on its mortgage book. Although Granite was ultimately controlled by Northern Rock, it was a separate legal entity, meaning that Northern Rock was not obliged to find additional capital to cover its extra liabilities. Financial institutions still maintain thousands of these offshore entities that bolster their capacity to take and (mis)manage risk. Finally, some governments are encouraging private borrowing by underwriting the risks. For example, having had their fingers burnt by the housing bubble, many financial institutions now require prospective customers to put down large deposits before granting a mortgage. Despite the financial crash, house prices remain high relative to incomes in many countries. Consequently the need for a large deposit effectively excludes many prospective borrowers. Since 2013, the UK government has sought to overcome this through a succession of schemes devised to enable borrowers to buy homes with deposits as small as 5 per cent. In exchange for their willingness to make 95 per cent mortgages available, the lenders get an effective guarantee from the government that protects them against losses in the event of the property being repossessed. Interestingly, however, the instrument that makes this initiative possible is a protected cell company (a corporate structure in which a single legal entity comprises several cells with separate assets and liabilities) in Guernsey, which provides the insurance to the lenders and is the channel for the guarantee from the UK government (Gorringe 2012).
Conclusion
Since the financial crisis there has been significant progress in the quest to promote greater tax transparency. In 2008 it would have been quixotic to suggest that five years later states that had long maintained strict financial secrecy would consent to a new international norm centred on the idea of the automatic exchange of information for individuals. If the current proposals for automatic exchange of information are implemented as planned, then the G20 will have fulfilled its promise to end the era of bank secrecy, making it much more difficult for individuals to engage in outright tax evasion. Likewise, if the BEPS initiative is successfully implemented, it may signal the end, or at least the reduction, of possibilities for corporate tax avoidance. The key word here, however, is if. This chapter has suggested that offshore financial centres and tax havens are central to the economic strategies of a host of powerful actors, not least many of the leading states in the OECD and G20. Intuitively the onset of the austerity and the desire for fiscal consolidation should have strengthened the case against tax havens. However, this chapter has sought to argue that austerity has further sensitized states to their dependence on offshore financial centres and tax havens, indeed that the successful delivery of the austerity agenda is heavily reliant upon them. Therefore this chapter predicts that while the rhetorical commitment to tax transparency will remain, this is unlikely to result in comprehensive deals that will prompt the demise of tax havens.
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