Tax havens siphon $500 billion a year from gov’t revenues
In today’s globalized world, tax evasion is occurring on a massive scale. As corporations and wealthy individuals shift their assets into offshore tax havens, the annual loss in global tax revenues is more than $500 billion.
This huge revenue shortfall is constraining the ability of governments to provide vital services to their societies, especially in the aftermath of the colossal bailouts of financial institutions. At the G-20 meetings in London, Toronto, and Seoul, civil society groups have advocated for improvements in the transparency of the international economic system and an end to offshore secrecy jurisdictions.
To date, however, little progress has been made.
Offshore tax havens are the centerpieces of a shadowy economic system that has developed since the 1960s. Today there are more than 70 tax havens, many but not all based in small states such as the Cayman Islands, the Bahamas, Bermuda, Panama, the Channel Islands, Monaco, Luxembourg, Lichtenstein, Singapore, and Switzerland.
Offshore tax havens are “secrecy jurisdictions” that exist expressly to enable their clients to escape the scrutiny of regulators and tax authorities in their own countries. The service providers based in these jurisdictions are insurance and accounting companies, legal and financial firms, and the subsidiaries of mainstream banks headquartered in Geneva, London, New York, and Toronto.
Tax havens have become an entrenched part of the international economy. At least half of all international bank lending and approximately one-third of foreign direct investments are routed via these secrecy jurisdictions.. More than half of all global trade is conducted through tax havens, and half the global monetary stock is estimated to pass through them at some point.
Banks and multinational companies routinely establish offshore affiliates to conceal their financial practices and to reduce or eliminate their taxes. Frequently these offshore affiliates, or international business corporations, are shell companies that conduct no business in the offshore jurisdiction and whose presence is little more than a postal address and a bank account.
Tax havens host more than two million international business corporations. One modest building in the Cayman Islands is home to more that 12,000 of these firms. A January 2009 report from the U.S. Government Accountability Office revealed that 83 of the 100 largest publicly-traded companies in the U.S., including big banks receiving bail-out money, have scores of offshore subsidiaries.
Offshore shell companies are used for profit laundering, assigning profits and losses on paper so that taxes can be minimized. To conceal profits, a company might transfer the ownership of patents, copyrights, or other intangibles to an offshore shell company and collect royalties in a low-tax jurisdiction.
In 2007, the pharmaceutical company Merck was assessed $2.3 billion in U.S. back taxes for transferring its drug patents to a Bermuda shell company and then deducting from its taxes the royalties it paid itself.
Tax havens are also used to conceal liabilities. Before being exposed as a spectacular fraud, Enron had established a network of 3,500 shell companies, 600 of which were registered in the Cayman Islands. When the British government nationalized the failing Northern Rock Bank in 2007, officials were stunned to discover that £50 billion of mortgages had been shifted to an offshore account disguised as a foundation benefiting Down’s syndrome children.
* * *
One of the most common methods of concealing corporate income and profits is through falsified transfer pricing. Today, more than half of all global trade is conducted among affiliates of the same parent company. Much of the trade between parent companies and affiliates is falsely priced so that companies can allocate profits in low tax jurisdictions. A company might, for example, sell an export item to an offshore affiliate at a sharply reduced price; the affiliate then sells the item at market price, with the profits remaining offshore. Alternatively, the offshore affiliate might import an item at the real market price, but sell it to the parent company at a grossly inflated price so the company has a huge cost to deduct on its tax returns.
A U.S. expert on tax evasion calculates that the percentage of U.S. tax revenues from corporations has declined since the 1960s from around 30% to 8%, largely due to shifting income to offshore havens. In a recent study of the 250 largest U.S. corporations, a third paid no income tax between 2001 and 2003. Although these companies reported pre-tax profits of $1.1 trillion to their shareholders, they reported only half of this amount to tax authorities.
In the United Kingdom, a parliamentary public accounts committee estimated that tax losses due to the offshore system are at least £8.5 billion annually; the Trades Union Congress, however, estimates that the real figure is more than £25 billion. A
U.S. Senate investigation of offshore tax abuse assessed the cost to the U.S. treasury as $100 billion annually.
In 2002, Canada’s Auditor-General warned that corporate “tax arrangements with foreign affiliates have eroded Canadian tax revenues of hundreds of millions of dollars over the past ten years.”
A June 2008 study by the University of Quebec at Montreal concluded that the five major Canadian banks avoided $16 billion in federal and provincial taxes through offshore affiliates between 1991 and 2003.
A 2004 Library of Canada report noted that, between 1990 and 2003, Canadian corporate investments in Barbados increased from $1.5 billion to $24.7 billion, exceeding the GDP of Barbados by a factor of six. The report concluded that at least some of these investments could only be explained as tax avoidance measures.
Statistics Canada reported that $88 billion of Canadian corporate assets were held offshore in 2003, mostly invested in the tax havens of Barbados, Ireland, Bermuda, the Cayman Islands, and the Bahamas.
* * *
Wealthy people are also escaping their tax obligations. Financial institutions have aggressively pursued “high net worth individuals,” encouraging them to move their assets to offshore accounts and trusts. The London-based Tax Justice Network estimates that US$11.5 trillion of the wealth of the world’s richest individuals is held offshore, resulting in lost tax revenues of $255 billion annually. The Cayman Islands alone holds US$1 trillion of the assets of the world’s wealthiest people.
A 2006 U.S. Senate subcommittee report concluded that wealthy Americans avoid $40 to $70 billion in taxes each year by holding their assets offshore. A few years ago, the German intelligence service bribed a former employee of Liechtenstein’s LGT bank to provide secret information on clients, setting off investigations of wealthy Germans for tax evasion. (The former LGT employee is now in a witness protection program).
In February 2009, UBS Switzerland, the world’s largest private bank, paid a US$780 million fine to the U.S. government for helping wealthy Americans evade taxes. Services provided to U.S. clients by UBS employees reportedly included smuggling diamonds in toothpaste tubes.
In September 2010, a joint CBC/Globe and Mail investigation reported that more than 1,700 private accounts belonging to Canadians were held by the HSBC Private Bank in Geneva.
* * *
If tax evasion is cause for concern in Northern countries, the situation facing Southern countries is even more serious. Southern countries often have weak tax administration systems and lack the capacity to track the complex financial maneuvers of multinationals. A December 2008 report from the Washington-based Global Financial Integrity project calculated that developing countries lose $858 billion to $1.06 trillion in illicit capital outflows every year, ten times more than they receive in international aid.
In a follow-up report in March 2010, Global Financial Integrity found that Africa lost a staggering $854 billion in illicit financial outflows between 1970 and 2008, far more than what is needed to wipe out the region’s external debt of $250 billion. This is a conservative figure — based on one form of trade mispricing — and the real figure could be as high as $1.8 trillion.
A March 2009 report commissioned by Christian Aid (UK) found that falsified pricing transferred US$8.5 billion out of the world’s 49 poorest countries between 2005 and 2007, resulting in tax losses of US$2.6 billion to these countries. Some estimates suggest that African political élites hold between $700 and $800 billion in offshore accounts.
It would not be an exaggeration to say that illegal capital flight from poor countries has resulted in the deaths of thousands, perhaps tens of thousands, of vulnerable people as health facilities have been dismantled and basic public infrastructure crumbled. Christian Aid (UK) estimated that, if a proportion of lost tax revenues in developing countries were invested in health programs, it would save the lives of 350,000 children annually.
Raymond Baker, of the Global Financial Integrity Project, terms the hemorrhage of resources from poor countries the “ugliest chapter in global economic affairs since slavery.”
* * *
Governments are well aware of the costs that the offshore financial system is imposing on societies. At the April 2009 G-20 meeting in London, leaders vowed to crack down on bank secrecy and tax havens and requested the Organization for Economic Cooperation and Development (OECD) to publish a list of jurisdictions that were not compliant with OECD standards on transparency and exchange of information for tax purposes.
The OECD list, released on the same day as the G-20 London communiqué, was divided into three sections: a “blacklist” of non-compliant states, a “gray” list of jurisdictions that have committed but not yet met the standard, and a “white” list of those in compliance. Astonishingly, within days of the close of the London meeting, the OECD blacklist was almost empty. Intense diplomatic pressure had successfully removed the most notorious tax havens from the blacklist.
The OECD gray zone included countries such as the Cayman Islands, Switzerland, Luxembourg, and Liechtenstein. Both the Swiss and Liechtenstein governments were outraged to be named on the gray list. Switzerland threatened to retaliate by not paying its annual dues to the OECD, an astonishingly self-righteous response from a country that is the world leader in laundering plunder from poor countries.
But there are serious flaws in the OECD framework. The OECD’s tax information sharing agreements are bilateral treaties while the challenges posed by tax havens require multilateral cooperation. In addition, under this framework a state needs to make a detailed case before requesting information from another treaty signatory. The burden of proof is on the requesting authorities. While this assists authorities in pursuing known offenders, it will do nothing to catch tax cheats authorities don’t already know about.
The biggest problem with the OECD approach, however, is that it applies to individuals, not to multinational corporations which are responsible for the majority of tax losses in Northern and Southern countries alike. Unless ways are found to address complex corporate structures, falsified transfer pricing and profit laundering, little progress will be made.
* * *
Civil society organizations are calling for substantial improvements in the transparency of the international economy. What is required is a multilateral approach to the mandatory exchange of information among all jurisdictions with respect to income, gains, and property received by non-resident individuals, as well as corporations and trusts. Improved transparency requires that information be publicly available with respect to the beneficial ownership of companies, trusts. and foundations.
Civil society organizations are also calling for changes to accounting standards and country-by-country reporting of sales, revenues, profits, and taxes paid by multinational corporations in their tax returns and annual reports. Improved transparency requires the development of systems to put an end to the practice of trade mispricing which deprives countries of tax revenues.
Ultimately, what is essential is the development of new norms of corporate social responsibility in which corporations become accountable to the societies that have nurtured them.
There were hopes that these issues would be debated at the October 2010 G-20 meeting in South Korea, but the Seoul communiqué only repeated the vague promise to crack down on secrecy jurisdictions. While this is disappointing, international recognition of these problems is much further advanced than it was a few years ago. In large part, this is due to the persistent efforts of civil society organizations such as the Tax Justice Network, Global Financial Integrity, Christian Aid, Oxfam International and others, to place these issues on the international political agenda.
The debate will continue.
(Peter Gillespie is with Inter Pares, the international social justice organization based in Ottawa.)
Box to append to this article…
Sources and Resources
Tax Justice Network (www.taxjustice.net)
Global Financial Integrity (www.gfip.org)
Illicit Financial Flows from Developing Countries: 2002-2006
Global Financial Integrity Project, December 2008
OXFAM, Tax Havens: Releasing the Hidden Billions for Poverty Eradication, Oxford (http://publications.oxfam.org.uk/oxfam/display.asp?K=002P0036&aub=Oxfam&sort=sort_date/d&m=99&dc=113)
Christian Aid, False Profits: Robbing the poor to keep the rich tax free, March 2009
(http://www.christianaid.org.uk/ActNow/the-big-tax-return/false-profits.aspx)
