Category Archives: Tax havens

The Paradise Papers should lead us towards a new global tax system

Last week, I published an op-ed in Danish newspaper Politiken with my colleague Saila Stausholm. I reproduce it below, liberally translated, for those interested. Given the op-ed format, it naturally has certain limitations and a certain style that differs from my usual writings on this blog – so take that into account. Here we go:

The Paradise Papers should lead us towards a new global tax system

Last Sunday, the International Consortium of Investigative Journalists (ICIJ) lifted the dam that had been holding back a new giant offshore leak, the Paradise Papers.

While the stories of tax haven usage do not necessarily reveal any illegal activity, the reactions tell us that citizens and politicians are outraged by the implications in the leaks of leaders and elites in the world’s richest countries.

Exactly because much of this activity is legal, the leak highlights the massive chasm between what ordinary people see as reasonable, and what the global elite can do within the limits of the law.

The Paradise Papers thus clearly showcase the structural problems of a nationally anchored tax system that works globally for mobile capital.

It is outdated, and there is a need for not just outrage and political attention, but also new, concrete ideas and the courage to change the system radically.

Small “quick fixes” here and there are not enough. On the contrary, we need to change the tax system fundamentally in order for it to match the ongoing reconfiguration of the global economy.

As illustrated by the tax haven leaks of the past few years, the opportunities to use tax havens and the offshore world are a key symptom of a tax system where regulation has not kept pace with globalisation.

Before the Paradise Papers, we had the Panama Papers, which created outrage in 2016, implicating the Icelandic Prime Minister, the Saudi Arabian king, the Pakistani Prime Minister, football world star Lionel Messi, and actor Jackie Chan.

In Denmark, too, the Panama Papers had consequences: The Danish tax administration is continuing its investigations into the affairs of at least 500 Danes.

Before the Panama Papers, we had the LuxLeaks, which revealed that PwC had helped a string of global corporates attain hugely favourable tax terms in Luxembourg. This had happened while current European Commission President Jean-Claude Juncker was Prime Minister in the Grand Duchy.

LuxLeaks also fostered significant political reactions, and became the starting point for Margrethe Vestager’s high-profile state aid cases against Luxembourg involving Amazon, Fiat, and McDonald’s.

And again before LuxLeaks, we had the Offshore Leaks in 2013. In addition, we have had the SwissLeaks and the Bahamas Leaks. These many leaks must be viewed in light of the increasing focus on tax havens and the issues created by the international tax system for both rich and poor countries.

Since the global financial crisis broke out in 2007-08, nation-states have increasingly identified the strengthening of national and international tax systems as a central part of the solution to the economic challenges we face today: debt crisis, public budgets under pressure, low growth and growing inequality.

As a consequence, both national governments and the international community has ramped up political initiatives against tax havens, against aggressive tax planning, against money laundering, and against tax evasion.

Today, we have much more transparency and better international exchange of tax information; we have closed some of the worst loopholes; and we have changed what is acceptable in terms of bank secrecy, shell companies, etc.

But the political reforms from the past decade have not really taken on the fundamental causes of the problems we are seeing today in tax havens and in the international tax system.

All the key components of the international tax system, established in the early 20th century, have not changed substantially.

Countries can still undermine each other by commercialising their sovereignty and offer favourable terms to foreign capital and thus reduce the economic and democratic capacity of their neighbours. And despite initiatives in the EU and the OECD, international cooperation is still relatively limited and, to a large extent, controlled by a small core of actors from the world’s richest nations.

Global corporations are still, essentially, taxed like they were 100 years ago, when they were small regional networks primarily trading physical goods.

This means that global capital – large corporations and rich individuals – are still able to structure tax liabilities with little friction across borders, while governments are largely bound by geographical and territorial borders.

If we want to address the fundamental challenges facing the international tax system today, we need a complete overhaul of the system. We need global innovation. Innovation is needed because old solutions will not do. And global scope is needed because solutions need to encompass all relevant countries and interests, if we harbour any ambition of finding sustainable and lasting answers.

First of all, we need innovation in terms of more and better inclusion of various interests in political decision-making processes. This is particularly relevant at the international level, where the group of decision-makers involved has historically been very narrow.

Our research has shown that a small group of actors play a disproportionate role in international tax policy-making. And that a core group of technical experts contribute to setting a course for regulatory initiatives that widely differs from the perceptions and goals of the general public and of politicians.

International tax policy is very important, and should have broad participation in all phases from the public, from civil society, from researchers, from interest organisations, and from politicians from all sides. This is not the case today. This would improve the quality of the democratic system and the political decision-making.

One model for such an expansion of participation is a World Tax Organisation. Today, taxation is just about the only major global political issue area where we do not have a global organisation with active participation from across the globe, where global challenges can be discussed, and common guidelines can be laid out.

We have a World Trade Organisation, a World Bank, a World Health Organisation, and so forth. But we do not have a World Tax Organisation.

This is not to say that these organisations are flawless, nor that a new organisation will solve all of our problems on its own. It is just one suggestion and just one part of the solution. What such an organisation does provide is a common global forum, where a broad range of issues can be raised and addressed, which simply does not exist in the area of taxation.

The “global” political discussions we have today largely take place in the OECD, the G20 and the EU; they play a key role in setting the agenda.

This makes it difficult for other countries and other stakeholders to join and influence discussions, despite the fact that many of the issues caused by the current international tax system hit emerging and developing countries disproportionately hard.

Without assuming the full design of a World Tax Organisation, we can at least imagine that it would function as a global forum that could take up key questions about international tax policy and tax havens, start political reform discussions, carry out global consultations, set out global guidelines, etc.

A more expansive idea of such an organisation could, like the World Trade Organisation, be entrusted with the power to assess and enforce whether any one country’s tax system would live up to globally agreed minimum standards, in order to ensure that it did not harm other countries with its policies or allow harmful discrimination of certain persons or companies.

In addition to creating a better forum for the negotiation of common ground rules, we also need to rethink how we tax cross-border activities in the global economy of today.

Today, global corporations and rich individuals have particularly large scope to lower their tax bills by manipulating mobile income across borders because our tax systems are still based around outdated ideas of how and where value is created in a global economy.

For instance, a substantial part of global corporate assets today are intellectual property: patents, copyrights, etc. In short: ideas.

In contrast to traditional assets such as factories, ideas and mobile and malleable. Where and when does an idea originate, and how does it create value?

Despite hundreds of pages of guidelines and regulation, multinational companies retain a great deal of flexibility in answering these questions and thus determining the location and size of their taxable incomes.

Large and complex global ownership networks equally allow corporations to move ideas, services and profit relatively friction-less across borders.

This is why taxation of corporations, and individuals, who effectively operate on a global scale, should also work effectively globally.

In the area of corporate taxation, one proposal in this vein is unitary taxation, where global corporations’ taxable income is consolidated at the global level, before it is distributed to each country of operation based on a predetermined formula.

In this way, it becomes far less important where corporations locate their profits, and thus harder to avoid tax liabilities as in today’s system.

In the area of personal taxation, a truly global tax regime might utilise multilateral tax assessments and audits for globally mobile individuals.

Again, these proposals are not silver bullet panaceas that will solve everything in a second. But they may be part of the solution, and they serve as important pointers towards a positive future for tax systems.

In order for these innovations to realistically happen, we also need a complete rethinking of attitudes to national sovereignty.

A key cause of today’s relatively limited international cooperation in tax matters, and of continued resistance towards a World Tax Organisation, is that governments across the world are terrified to surrender absolutely sovereignty over their tax systems.

However, as German philosopher Peter Dietsch has illustrated, international tax cooperation is not about surrendering sovereignty, it is about strengthening it.

Today, we have de facto lost sovereignty when tax havens induce limitations on our economic and political latitude. And yet we refuse to challenge their rights to do so.

Paradoxically, this insistence on the absolute sovereignty of others’ in tax matters thus weakens our own sovereignty.

If we are to achieve the needed global innovation in tax matters, we need to acknowledge that global cooperation provides a unique opportunity to regain lost sovereignty.

Another acknowledgement that is required for global tax innovation is that international tax politics is not a zero-sum game.

Today, many governments resist good ideas for change because they fear an absolute reduction in national tax revenue.

The Danish government, for instance, has expressed skepticism about a common European corporate tax system, proposed by the European Commission, which has the purpose of eliminating many of the most important current channels of tax avoidance used by large corporations in Europe. This skepticism is caused by a fear that Danish tax revenue would suffer due to our small market size.

There are many good reasons to be skeptical of the European Commission’s proposal, but tax revenue fears must be understood in the context of the long list of indirect benefits to the Danish public coffers, which are likely to outweigh any direct, absolute revenue losses. These include administrative cost savings and reduction in tax avoidance.

There are countless examples of hesitation around new political ideas because of this zero-sum mentality in tax matters.

But it is crucial that we view global innovation in tax policy as a unique opportunity to ensure a sustainable international tax system for the future.

Global tax innovation can be a critical way to future-proof our tax systems and thus our public finances. With a typical Treasury expression, the dynamic effects of global tax innovation are potentially enormous.

A World Tax Organisation and a global tax system will not solve all of our problems on their own, but they are a important steps in the right direction – and it is unlikely that we can effectively address our current challenges without effective organisational support and global policies.

However, global fora and global politics of this kind today are also plagued by large inequalities in resources, competencies and capacity between national representations. This will not be solved by establishing a new global organisation or new global policies.

This is why we also need to acknowledge the broader global political inequalities that lead to lack of cooperation, both in terms of a lack of will and in terms of lack of capacity.

For instance, a key reason that many small island states have historically pursued “tax haven strategies” is that they simply have not identified or been able to execute viable alternative strategies for economic development, and that they have been encouraged to do so, for instance by successive British governments.

Another challenge lies in the dominance that large Western states exercise in global politics. They tailor global tax rules to their advantage, while small tax havens and developing countries have almost no influence on international standards and regulation.

This gives substantial incentives to defect and to counteract global cooperation.

The USA, for instance, has played a key role in reducing bank secrecy in Switzerland, but in parallel it has strengthened its own secrecy industry at home, effecting what political scientists Lukas Hakelberg and Max Schaub have called “redistributive hypocrisy”.

We need to recognise and address these types of global political inequalities if the fight for global tax innovation is to succeed.

And there are good reasons for trying to do just that. The Paradise Papers and the increasing public attention to the challenges of tax havens and the international tax system underline the necessity of altering the current political course.

Small “quick fixes” of an outdated international tax system will not do.

We are hoping that the continuing stream of offshore leaks will not just lead to outrage but also to fundamental disruption of our whole approach to questions of global political inequality, globalisation, and, specifically, global taxation.

There is a need for broader and better participation in global political discussions of tax havens and tax systems. A World Tax Organisation would be a great place to start.

And there is a need to move towards tax systems that are truly anchored at the global level in order to deal with global economic activity.

There is also a need to rethink our approach to national sovereignty and to depart from the zero-sum mentality.

And finally, we need to address the global political inequalities that pose such a significant barrier to progress in the fight against tax havens.

If we can begin to move in this direction, just a bit, the future suddenly looks much brighter for the international tax system, for public finances, and for the modern global economy.

ParadisePapers and guilt by association

The new leak is upon us. 13,4 million new documents from Appleby, an upscale offshore service provider headquartered in Bermuda, as well as 19 company registries have provided fodder for politicians, professionals and the public since the stories began to flood in late Sunday night.

Inevitably, the headlines will tell tales of the various offshore activities of the rich and famous, with extensive detail provided by corporate ownership documents, contracts, internal communications, and so forth.

However, the leaks illustrate a range of different activities which might usefully be segmented in terms of both law and broader societal concerns.

At the “very bad” end of the law spectrum, there is likely some outright evasion of taxation or regulation, corruption, and some highly dubious and opaque dealings involving problematic individuals and corporations. Although many more stories are to come, the lack of adequate anti-money laundering management on the part of Appleby points in this direction, as does the secret loans of Glencore, and the case of Mrs Brown’s Boys.

At the other end of the law spectrum, there will be relatively innocuous investments, holdings, etc. Queen Elizabeth’s offshore investment vehicle, for instance, appears in line with common investment practice. (I realise many will say these are not innocuous whatsoever – I’ll pick this up below).

And in between, in the “grey zone”, there will be instances of tax avoidance, structures established in unusual and unexpected locations and manners, secretive ownership set-ups that do not pass the sniff test, etc.

While these different issues vary in terms of their relation to the law, they are bound to be bundled together in stories from and in reactions to the Paradise Papers.

And the reason for that is broader societal concerns. From the perspective of many people, the mere association with “the offshore world” and with Appleby implies guilt in some sense, morally if not legally. No doubt this is partly caused by recent years’ rise in media stories and political rhetoric on “cracking down on tax havens”, which leaves little room for nuance.

But the broader societal perspective is no less important to take into account than strictly legal questions. Here we need to understand the association with Appleby and offshore in the context of the implicit or explicit support granted to “the offshore system” and the large system issues in the international order by such association.

The use of offshore structures bring with them increased risk – reputational risk certainly (as the leaks firmly illustrate), but also risk of exacerbating the problems of the international system (both in terms of tax, economy, investments, etc.) through financial and normative support to those profiting from these problems and/or to the offshore system as a whole, and even to the issues of the global economy as a whole, such as inequality. I stress risk here because offshore structures may well not lead to such a result but nonetheless they maintain the potential for it, even if that is not the intention.

Increased risk implies increased responsibility. In the same way that the corporate tax mantra may not suffice for the public when corporations are explaining their tax affairs, the reference to purely legal compliance (which in itself is difficult to impossible for journalists and others to challenge without detailed insight) may not be sufficient to really address broader societal concerns. There is a responsibility, whether you think it is fair or not, to address the broader societal concerns, to take them into account, not just in communicating actions but also in assessing those actions in the first place.

This responsibility to address claims of “guilt by association” simply comes with the territory of offshore investments. Some may not like it, but that’s reality.

And this responsibility is especially incumbent on high-profile individuals and corporations, who are figures of society, and who play a heightened role in shaping society-wide norms, e.g. the trust and belief in the tax system and the willingness of ordinary people to pay the correct amount of taxes.

And it is also especially incumbent in an era where there is widespread polarisation of debates on tax and the offshore, as well as widespread problems with the international tax system.

The answer to this responsibility, I hope, should not be to avoid entirely engaging with cross-border investment involving “offshore” sites, or to shy away from the discussions entirely in order to shield one self. Encouraging a total shutdown of the Bermudan economy, or a total shutdown of discussions on the offshore, is clearly not advisable. In order to fix the underlying structural issues, we need to continue working towards a better offshore system, better global cooperation, a better international tax system, a better global economy. This may sound like platitudes but really the root cause of many of the issues we are faced with, and the issues people perceive today, run deep.

In the short term, we should be able to move discussions and policy forward by paying attention to and responding to both legal concerns and the concerns of a wider societal nature. We should not accept outright claims of “guilt by association”. But we should also not accept outright claims that this boils down exclusively to an issue of legal compliance.

Varieties of Something

What is a tax haven really (if anything at all)? How can we classify them? And what are the existing attempts at doing so? In connection with a research project, I recently asked for your help in pointing out sources discussing different “varieties” of tax havens, i.e. what different countries “specialise” in. That fostered a series of long and detailed discussions. (Thanks for the comments all.) In this post, I will try to sum up some of the insights and some of my own thoughts on these questions.

What is a tax haven?

Let me start with the first ponder: What is a tax haven really, if anything at all? This is not an easy question. In fact, it is an absolutely grueling question. In popular culture, tax havens are typically thought of as sun-kissed islands full of bankers with money-stuffed suitcases – the Curaçaos and Bermudas of the world. But in reality, the binary “either/or” classification fails to capture the true nuance. As Aisling Donohue noted, “every country has some aspect of their tax regime more favourable than that of others.” And the world of tax havens have changed substantially over the past half century; today, there is more transparency than ever and regulatory reform has fundamentally altered the possibilities for and in tax havens.

Moreover, the act of classification itself – of designating the “tax haven” label to some country – has always been and remains an exercise marked by political inequalities and a fragmented, confused nature. As Allison Christians rightly pointed out, this labeling is almost always a “rich countries deride poor countries” type of dynamic – which is a key reason we typically think of tax havens as these precarious resorts. Blacklisting is a geopolitical power game, an uneven discriminatory battleground that does not recognise the different constraints faced by different countries.

The sheer volume of different “lists of tax havens” or “criteria for identifying a tax haven” is testament to the general confusion around the phenomenon. Today, practically every country, every NGO, and every international organisation has their own unique list with distinct criteria, for different purposes and for different audiences. When asked by a journalist recently for help to identify “the best list of tax havens”, I had to disappoint by pointing out this messiness. The reply came back: “It would be nice if we could just agree what a tax haven is”. Indeed, but alas. In the absence of anything resembling agreement at any level, people usually have recourse to their personal favourite list. This creates significant bemusement and obscures discussion.

(A brief anecdote: When I wrote one of my very first papers at university on tax havens almost ten years ago, my student colleague and I concluded that, “perfect consensus definition is not necessary in order to deal with the offshore world”. This remains true but I have certainly grown more skeptical of how much it actually hinders effective action.)

Is tax havens the right label?

The corollary to the question of what a tax haven really is, is: is “tax havens” even the proper label? While tax-related activities remain a core component of this world, it is equally a secrecy and regulatory avoidance more broadly. (And there are many detailed discussions of this definitional/framing challenge – I refer you e.g. to this piece by Cobham, Jansky and Meinzer). Should we perhaps forget the “tax haven” framing altogether? Should we rather subscribe to alternatives such as “secrecy jurisdictions”, “offshore financial centres” or “uncooperative territories”? I’d argue that these alternatives pose many of the same problems as the tax haven label, although some are certainly better than others. The “secrecy jurisdictions” framing, for instance, comes from the Financial Secrecy Index, which has contributed to dispelling the idea of tax havens as small island retreats, highlighting the problematic regimes of major global powerhouses.

However, the convenience of the “tax havens” label is unparalleled; it has instant and widespread recognition. People know what it is, or so they think. Beyond the specialist audience, the words “tax havens” have a distinct connotation that gives them unique discursive value. The framing is problematic and confusing, but popularly recognisable. As a researcher – and I suppose that goes for stakeholders more broadly – the challenge is to resolve those underlying issues whilst still using the “tax haven” or related concepts, suspect as they may be, and at the same time not feeling bound by popular framing.

Varieties of …?

While keeping these thoughts in mind, grouping or classifying havens through analysis can be of use, though one needs to be very careful in doing so. Perhaps surprisingly, there are very few systematic attempts at divvying up the world of tax havens/offshore financial centres/etc. And those that exist vary widely in their approaches. You can imagine categorising countries in a million ways – by their size, region, service industry, client type, client location, income source, and so forth. In my original question, I had thought of service specialisation, but the ‘varieties’ wording clearly means different things to different people. Let’s look at some of the existing typologies:

Citation Categorisation Examples
Garcia-Bernardo et al. 2017 Global ownership chain position Sinks (e.g. BVI, Jersey, Bermuda) and conduits (e.g. Netherlands, UK, Ireland)
Bruner 2016 Service specialization Insurance (e.g. Bermuda), wealth management (Singapore) and business entities (Delaware)
Sharman 2012 Growth trajectory Leaders (e.g. Cayman), stagnants (e.g. Vanuatu), growing (e.g. Belize), exited (e.g. Nauru), and entering (e.g. Somalia)
Avi-Yonah 2000 Value proposition Production (e.g. Ireland), HQ (e.g. Belgium) and traditional (e.g. Luxembourg) tax havens
Z/Yen Connectivity, diversity, specialty Globally connected, deep and diverse (e.g. Singapore); locally focused, emerging and narrow (e.g. Cyprus)

Most recently, the folks over at University of Amsterdam categorise offshore financial centres (although that definition includes decidedly “onshore” countries such as the Netherlands and the United Kingdom) by their function and position in global corporate ownership structures, as “sinks” (where ownership chains “end”) and “conduits” (where ownership flows through). The former includes the British Virgin Islands, Taiwan, Jersey, Bermuda, the Caymans and other such “tax havens” as popularly understood. The latter, however, features the Netherlands, the United Kingdom, Ireland, Singapore and Switzerland. The UvA paper also contains the geographical specialisation for each of these conduits. For instance, the UK conduits from Europe to Luxembourg and the Cayman Islands, while Ireland is a primary conduit from Japan and the US to Luxembourg. Finally, the paper discusses industry sector specialisation. Here, it figures that the Netherlands specialises in holding companies, while administrative entities are Luxembourg’s metier.

In another relatively recent piece, Georgia law professor Christopher Bruner also categorises offshore financial centres (in the conventional sense of small jurisdictions) based on a number of characteristics, but the one I will highlight here is (service) specialization. Bruner follows six case studies, noting Bermuda as an insurance specialist, Dubai as an Islamic finance specialist, Singapore as a wealth management specialist, Hong Kong as a mainland finance specialist, Switzerland as a cross-border banking specialist, and Delaware as a business entities specialist:

Udklip.PNG

Elsewhere, Cambridge professor Jason Sharman has also categorised offshore financial centres, but based on their strategic growth trajectory in the face of the post-financial crisis tax haven crackdown. He groups countries into five: leaders, stagnants, growing, exited and entering. The leaders, long-standing havens who have fared well in the post-crisis era, include the British Virgin Islands, the Cayman Islands and Panama. The stagnants include Montserrat, the Netherlands Antilles and Vanuatu. The growers include Belize, Mauritius, Samoa and the Seychelles. The exited include Nauru and Niue. And finally the new entrants include Anjouan and Somalia.

A little further back in time, Michigan professor Reuven Avi-Yonah proposed a 3-way typology of tax havens based on their market value proposition. Avi-Yonah distinguishes between production tax havens that attract production investment through tax incentives (e.g. Ireland), headquarter tax havens that attract (virtual) ownership relocation through lax permanent establishment rules or management exemptions (e.g. Belgium), and traditional tax havens that attract mobile capital with low tax rates or secrecy laws (e.g. Luxembourg).

On the quasi-academic front, there is also the Global Financial Centres Index, published twice a year by think-tank/consultancy Z/Yen with backing from the Qatari Financial Centre Authority, which categorises financial centres (not tax havens or offshore centres) based on connectivity (to other financial hubs), diversity (the breadth of service offering), and specialty (depth of service offering). This creates a complex typology, but we can draw out some examples. Singapore, for instance, is a globally connected centre, a leader with a broad and deep service offering. Meanwhile, Cyprus is an evolving, locally focused centre with a narrow service offering.

Udklip.PNG

Finally, there are all the crowd-sourced service specialisations noted by the kind people of Twitter, which has no particular systematic to it. I’ll just list them here for brevity: Jersey – real estate, Bermuda – insurance, British Virgin Islands – banking, Cayman – asset finance, Gibraltar – gaming, Delaware – shell companies, Panama – flags of convenience, Vermont – captive insurance, Ireland – tech giants, Mauritius – Indian/African assets, Cyprus – Russian assets, London – “we have favourable opinions from respected QCs” (I thought that was funny), Nevada – IP licensing, and Netherlands – holding companies.

The takeaway

So what can we take away from all of these typologies? First, while there are problems and absences in each of the analyses, together they allow us to draw out some quite comprehensive descriptions of countries. The Cayman Islands, for instance, features in almost all of the above contributions. Based on that, we can say that the Cayman Islands is:

  • A global corporate ownership conduit, in particular from and to Asian hubs (Taiwan, Hong Kong and China)
  • A leader in the offshore financial services centre pack
  • A traditional/headquarter haven type
  • … with an international (not global) specialisation and a relatively deep service offering, in particular asset finance.

Similar descriptions could be extracted for many other countries. In sum, these “varieties of”-analyses allow us to construct a more holistic picture of the characteristics and specialisation of various tax havens/offshore financial centres/etc. compared to conventional binary labeling.

However, the analyses also illustrate the reflection on structural inequalities and confusion surrounding “tax havens” that started this post. The North v. South or rich v. poor country element is prevalent, as most typologies focus on the latter while rarely reflecting systematically on structural inequalities. When discussing and analysing tax havens, these nuances are crucial to keep in mind if one wants to avoid wholesale propagation of global power and inequality dynamics. While existing “varieties of” can be useful to help us understand certain countries’ make-up, more work is needed that takes account of the dynamics underlying financial and tax-related national and local strategies and how they are shaped by political and economic constraints. And, importantly, what the global effects are. Some “tax haven” activities are more harmful to other countries than others. (On that, I lean towards Peter Dietsch’s ethical discussion of tax competition). The work is definitely cut out for researchers, practitioners and other stakeholders alike. So, I’ll get to work then…

Why do people evade taxes?

A much talked-about recent paper by economists Annette Alstadsæter, Niels Johannesen and Gabriel Zucman has re-ignited popular attention to tax evasion and inequality.

While discussion of reliability and methodology have prevailed in some corners of social media, the broader questions raised by the fascinating new study should remain at the fore: Why do people evade taxes? Who evades taxes? How can they do so? And what are the effects – on our societies, institutions, political systems, and so forth?

In this post, I will look at what the existing academic literature has to offer on these questions related to tax evasion, in particular the former: Why do people evade taxes? And I’ll zoom in on how recent contributions, such as that by Alstadsæter et al. and others, adds to this scholarship.

What shapes tax compliance?

Existing work on tax compliance is abundant, in particular within behavioural economics, sociology and psychology (see reading list at the bottom of the post). This scholarship has highlighted five central factors that particularly shape tax compliance in the national context:

  1. Levels of wealth
  2. Tax rates
  3. Audit probability and penalty
  4. Tax morale
  5. Institutional environment

Firstly, wealth typically enhances the probability of tax evasion. Wealthy people simply have more ability to evade. They have more and more flexible sources of income, allowing for manipulating and escaping of national regulatory and administrative powers. Think of the Ultra-High Net Worth Individual (UHNWI), who can offshore his financial assets and the accruing gains or move artworks stealthily across the globe – as opposed to the carpenter or teacher, whose main income (salary) is typically taxed at source.

Second, relatively higher tax rates foster relatively more evasion. Because taxes are often perceived as an undue burden (rightly or wrongly), the willingness to evade rises with the tax burden. As I have written elsewhere, this is extensively discussed in the economic literature. Even though taxes also pay for public spending (the fiscal coin), there may be a reasonable expectation by wealthy taxpayers that any evasion on their part will not lead to a deterioration in public spending in relation to the public goods from which they benefit, or that the benefit received from corresponding taxes simply does not provide sufficient value.

However, it is worth noting that it is mostly large differences in tax rates, and at the margins, that foster tax evasion. As an indicator, a number of experimental studies have found that increasing tax rates e.g. from 30% to 50% had little or no effect on compliance, whereas raising from 5% to 25% or from 5% to 60% does have an effect. Related, recent economic modelling on optimal corporate tax rates also suggest that only very high tax rates inhibit growth.

Third, potential tax evaders assess the risk of getting caught through audit probability and penalties/punishment, adjusting their behaviour accordingly. If a taxpayer perceives a high risk of being audited (and thus caught) and/or a substantial penalty (economic or personal), they are simply less likely to engage in tax evasion. This is as much about the perception of audit risk and penalties (which can be fostered in various ways) as it is about the actual probability of audit and penalty.

Fourth, the individual taxpayer’s tax morale is a decisive factor in tax compliance. Tax morale encompasses the social and cultural norms, and individual allegiance hereto, shaping compliance motivation. Tax morale itself is a highly complex phenomenon, dependent on a host of factors. The ‘morale fibre’ of each individual – the dispositions one is ingrained with given a life history of events and perceptions – is obviously instrumental. The extent to which people perceive taxes as part of a valuable quid-pro-quo is also central. As noted above, when the cost of taxation is viewed as too high compared to the benefits received, people are more likely to engage in evasion. Finally, the social environment matters: where people trust each other and perceive high tax morale in each other, it will deter evasion.

Fifth, the institutional environment determines the taxpayers’ willingness and ability to comply. Formal (such as political organisations) and informal (cultural ‘rules of the game’) institutions associated with the tax system shape tax compliance. On the former, trust in public institutions is a well-known determinant of taxpayers’ willingness to pay; if we trust our democracy, if we perceive the tax system as fair, if we believe the political system is efficient, we are more likely to pay our taxes. This is why revelations of corruption or scandal are likely to negatively affect tax morale. For instance, in the Danish context, recent revelations of massive dividend withholding tax fraud have been found to harm societal tax morale. On the latter, socio-economic and psychological factors can help explain tax morale, such as interpersonal trust and belief in fiscal cost-benefits.

Recent contributions 1: Tax evasion and inequality

Now let’s circle back to the first paragraph of this post: the new Alstadsæter-Johannesen-Zucman paper. This is a contribution mainly to point 1 above, i.e. levels of wealth as a determinant of tax evasion. But it also raises questions more broadly about the structure of evasion and the effects on our societies. There have been plenty of media stories about the paper, so let me just highlight three particularly relevant contributions in the context here:

First, the AJZ paper illustrates the progressiveness of tax evasion by wealth more clearly than perhaps any paper before it. Using data from the HSBC SwissLeaks, Panama Papers, Swedish and Norwegian tax amnesties, as well as data from the Scandinavian tax administrations, they show a remarkably clear trend of increasing probability of hidden funds (which are likely to correlate with evasion, although this is an assumption up for challenge) with wealth. It indicates that it is the utmost wealthy, in particular the top 0.01% (owning more than $40m in assets), that evade taxes via offshore structures (which is likely to cover a similarly increasing proportion of evasion mechanisms by wealth due to fluidity of income and assets, as noted above).

Second, the paper indicates that tax amnesties may be a more effective tool to combat tax evasion than previously thought. While tax amnesties are typically criticised for merely offering a one-time free lunch to wealthy tax evaders, the study finds that tax amnesties in Sweden and Norway have had positive, lasting effect on tax payments, and reported wealth and income, by taxpayers using the amnesty. However, it is important to caution the interpretation with some key points. Firstly, the data utilised here relates largely to the mid-2000s, where we did not have FATCA, the CRS, or today’s levels of international tax administration cooperation. The presence of new modes of information exchange are likely to squeeze scope for tax evasion (and avoidance) by wealthy taxpayers, thus potentially eroding the benefits of tax amnesties. More broadly, while tax amnesties may have a positive effect on the tax compliance of individuals with a history of evasion, we know little about its societal effects. From the literature reviewed above, we might hypothesise that the presence of amnesties deteriorates trust in political institutions, belief in a fair tax system, and perceptions that others are compliant – all of which would decrease societal tax morale.

Third, AJZ touch upon the implications of their findings, in particular as it relates to inequality. Ever since Piketty, inequality has been at the top of national and global political agendas. This paper, alongside other work by the authors (and others), shows that unrecorded offshore wealth substantially skews national inequality and tax burdens, leaving national statistics incomplete. The paper estimates that the top 0.01% hide about 25% of their true wealth, and that counting hidden offshore wealth increases the wealth share of Norway’s top 0.1% from 8% to 10%. You can easily imagine what this does to national (and global) inequality statistics. Given that tax compliance is generally higher in Scandinavia than anywhere else, it is likely that the inequality skew shown from Scandinavian data provides a lower bound for the rest of the world.

Recent contributions 2: Comparative experiments in tax compliance

Another stream of scholarship that has contributed important recent insights is comparative experimental work on tax compliance. This scholarship provides insights mainly for points 4 and 5 above, i.e. tax morale and institutional contexts of tax compliance. Here I’ll highlight recent work by a group of mainly Italian-based scholars, with two recent pieces (1, 2), though I must also mention that my colleague at Copenhagen Business School, Alice Guerra, has embarked on a fascinating 2-year post-doc project to build on and strengthen this line of work. Using controlled experiments involving Italians, Swedes and Britons, the Italian-based scholars are able to gauge differences in tax compliance and its sources across national contexts. Here I’ll highlight two particularly relevant contributions for this context:

First, while Italians (and Southern Europeans more generally) are typically viewed as having low tax morale compared to Britain (Northern Europe) and in particular Sweden (Scandinavia), the studies in fact showed surprisingly little variation in the intrinsic motivation of subjects to comply, when facing similar circumstances. In fact, Italians were even showed to have higher propensity for tax compliance than Britons given identical institutional environments (simulated in the experiments). This is despite consistent measures of relatively lower trust and honesty (factors that we would think lead to higher evasion) in Italy, and a general perception of Italians as less moral. This indicates that it is not, as conventional wisdom holds, the lack of intrinsic motivation on the part of Italians that hinders tax compliance.

Second, the national “style” of evasion is important in determining tax compliance. While Swedes for instance are more likely to comply in full than Italians, they are also more likely to not comply at all. It seems that in Sweden, there is a “either or” dynamic to tax evasion. In Italy, in contrast, there is a much more significant propensity to fudge (i.e. “cheat by a small amount”). Although the overall effect is that Swedes and Italians’ tax morale is relatively similar, the structure of national tax morale varies significantly.

Policy implications

While these studies and all of their contributions are valuable in themselves, enhancing our understanding of tax compliance and evasion, we would be foolish not to look at potential policy implications. I would not recommend full regulatory overhauls based on individual studies, but taken in context of wider bodies of literature, we can sketch out some preliminary lessons.

From the tax evasion and inequality literature, it is clear that tax administrations and legislators must pay particularly close attention to evasion by wealthy people, designing and implementing targeted policies to combat offshore evasion. This realisation has not been lost; it is behind much of recent years’ surge for automatic exchange of information and tax transparency at the global levels. The emergence of FATCA and CRS, while shortcomings remain, are likely to make a substantial impact on offshore tax evasion by wealthy individuals, deterring some avenues of evasion whilst channelling illegal activity toward other vehicles (such as trusts), where new regulatory innovation must then focus accordingly.

It also points to tax amnesties as a potentially useful tool to instil lasting tax compliance in prior evaders. However, this must be balanced against any deterioration in wider societal tax morale due to perceptions of injustice. Perhaps a useful approach would be to utilise the revenue brought in from tax amnesties specifically to raise societal tax morale, such as via broad-based campaigns or strengthening the integrity of public institutions.

Finally, there is a need to recognise shortcomings in national wealth and inequality statistics. Putting offshore wealth in the spotlight provides an opportunity to gain a more real picture of inequality and wealth in national and international contexts, which should be to the benefit of polities and citizens alike – no one is better off with continuing concealment of actual wealth distributions, except for tax evaders.

Based on the experimental tax compliance literature, we would do well to start questioning prevalent narratives of a “moral North” and an “amoral South”, certainly as it relates to tax compliance. Italians are no less willing to pay taxes than Britons or Swedes.

Rather, recent studies tell us that we should focus on the institutional context in which tax compliance happens. There is no denying that tax evasion is more widespread in Southern Europe than in Northern Europe, but the literature indicates this is not due to varying individual intrinsic motivation. Instead, there is a need for policy-makers to focus on implementing policies that eliminate formal opportunities for evasion. As an example, 95.9% of Danish personal income taxes are levied based on third party reporting (from banks, employers, unions, etc.). This makes it difficult to evade taxes. Similarly, the development of expansive networks of automatic exchange of tax information is likely to contribute to this end.

Finally, we must recognise the differing national “styles” of tax evasion. For instance, given that tax evasion for Swedes is very much an “either or” question, there is a need to focus deterring efforts on the initial decision to evade or not, as compared to Italy where focus should rather be on the culture of “fudging” (‘cheating a little bit’). This may foster differing policy initiatives that emphasise intensive and extensive decisions to evade taxes, respectively.

As a very last note, I must also emphasise that, although tax evasion is certainly a serious problem in many countries, North and South, as evidenced by the literature reviewed here, all the studies discussed here found that most people are honest and want to pay their taxes correctly. While Alstadsæter, Johannesen and Zucman estimate that many of the wealthiest taxpayers hide substantial fortunes offshore, most taxpayers clearly did not. The cross-cultural experiments also found that the vast majority of people genuinely do not look to evade taxes, (almost) no matter the circumstances. This is a lesson not to be forgotten.


Reading list on tax compliance

Alm & McKee, 1998. Extending the Lessons of Laboratory Experiments on Tax Compliance to Managerial and Decision Economics. Managerial and Decision Economics, 19(4/5): 259-275. Link.

Cullis, Jones & Savoia, 2012. Social norms and tax compliance: Framing the decision to pay tax. The Journal of Socio-Economics, 41(2): 159-168. Link.

Cummings, Martinez-Vazquez, McKee & Torgler, 2009. Tax morale affects tax compliance: Evidence from surveys and an artefactual field experiment. Journal of Economic Behavior & Organization, 70(3): 447–457. Link.

Fonseca & Myles, 2012. A survey of experiments on tax compliance. HMRC Research Report 198. Link.

Hashimzade, Myles & Tran-Nam, 2013. Applications of behavioural economics to tax evasion. Journal of Economic Surveys, 27: 941–977. Link.

Onu & Oats, 2016. ‘Paying Tax Is Part of Life’: Social Norms and Social Influence in Tax Communications. Journal of Economic Behavior & Organization, 124: 29–42. Link.

Pickhardt & Prinz, 2014. Behavioral dynamics of tax evasion – A survey. Journal of Economic Psychology, 40: 1–19. Link.

Torgler, 2002. Speaking to Theorists and Searching for Facts: Tax Morale and Tax Compliance in Experiments. Journal of Economic Surveys, 16(5): 657-83. Link.

Torgler & Schneider, 2007. What Shapes Attitudes Toward Paying Taxes? Evidence from Multicultural European Countries. Social Science Quarterly, 88(2): 443–470. Link.

The new political economy and geography of global tax information exchange

The OECD has recently released information on the two most important recent global networks of global tax information exchange. They are, respectively, the networks of exchange of country-by-country reporting (CBCR) and exchange of financial account information (through the Common Reporting Standard, CRS).

These networks give a unique look into the new political economy and geography of global tax information flows. CBCR and CRS data are, arguably, the cornerstones of modern global tax information cooperation, providing crucial data on the foreign activities of national individuals and companies. The CBCR is an annual report for large multinational groups (revenue +€750m) that states their jurisdictions of operation, the nature of business in each country, the tax paid along with a host of economic activity indicators. The CBCR is typically filed in the corporate headquarter’s country of residence, then shared on request with other countries as needed. Through the CRS, each government compiles data from national banks on the financial accounts (balances, interest, dividends, and financial asset sales proceeds) of non-citizens, which is then exchanged automatically with those citizens’ home competent authorities.

Therefore, it is also highly interesting to look at the global network of these information flows – who has access, who doesn’t, and who is connected.

So I scraped the data off the OECD website and analysed it. And what I found provides a very interesting picture of the modern tax information networks.

At the time of writing, there were around 700 (CBCR) and 1600 (CRS) bilateral exchange agreements established. (I’m not sure why OECD say 1800 CRS agreements because there’s only 1600 unique agreements in their data). Given that the CRS was launched four years ago and CBCR only two, the discrepancy is natural. Taken together, the 2300+ agreements are a quite fascinating data set. Let’s look at each in turn, and then the two together.

First, however, a key caution must be noted. While the CBCR and CRS provide key recent mechanisms of tax information exchange, they are by no means the only mechanisms. Preceeding the new CBCR and CRS networks are established networks of bilateral “by request” exchange of information networks (the previous OECD standard), bilateral tax information exchange agreements (TIEAs) and tax treaties with info exchange clauses. Given that these have been in place for much longer, they are naturally more dense than the new networks. Still, CBCR and CRS are the frontier and are replacing these older standards exactly because of their limitations. Thus, the analysis below provides a picture of the emerging state-of-the-art within global tax information exchange.

The global CBCR exchange network

I tweeted out the network the other day, and it looks like this:

cbcr network

(Size by degree (number of links); node colour by region; and network layout by ‘ForceAtlas2‘.)

There are a few caveats to be noted before drawing lessons from this picture. First, the novelty of CBCR shapes the network look substantially. The picture is dominated by European countries, but that is understandable given 55% of all CBCR exchange agreements are formalised by EU Directive 2016/881/EU on automatic exchange of tax information (the rest are individually negotiated CBCR MCAAs). Second, the absence of the USA is noteworthy. While the USA has been reluctant to commit to reciprocal information exchange of bank account data, that is not the cause for CBCR. Simply, US CBCR filing requirements will kick in on 31 December 2017, as in most jurisdictions, but later. It is almost assured that the US will develop an extensive exchange network to protect US MNEs from local filing demands. Other countries with late filing requirements that will be expected to build substantial exchange networks as we go include Hong Kong, Japan, Russia and Switzerland. The whole network is expected to increase substantially over the next few years, as the remaining CBCR MCAA signatories (as of today, there were 57) conclude and report agreements.

That said, what we can see is that the current global CBCR network is all about Europe, OECD members, and a few small offshore centres. That picture likely won’t change too much. The almost complete absence of South America (beyond Brazil and Uruguay), Asia (beyond Malaysia), and Africa (beyond South Africa and Mauritius) stands out. This has attracted renewed criticism that the OECD tax policy-making processes are not inclusive of developing countries. However, it should be noted that the OECD has moved in the direction of bringing developing countries more closely in to its tax work, including through the BEPS Inclusive Framework, so there is potential for a broadening of the geographical concentration in the CBCR exchange network.

It is also worth noting that the picture indicates a very clear “you’re either in or you’re out” trend. There are currently 45 countries exchanging CBCR data, and none of these have less than 23 agreements (maximum of 43). If you are set up to exchange CBCR data, you are ready to exchange it with many partners.

More broadly, I think the network shows quite nicely the varying allegiance to the OECD international tax consensus. The European Union, in particular the European Commission, has become an increasingly autonomous player in international tax affairs but also a close ally of the OECD on many counts. The centrality of Europe in the global CBCR network is a representation of this position.

The global CRS exchange network

CRS exchange network.png

(Again, size by degree (number of links); node colour by region; and network layout by ‘ForceAtlas2‘.)

The global CRS network provides a somewhat more developed but not substantially different picture of the new political economy and geography of global tax information exchange. The fact that we have 62 countries (as opposed to 45) and more than twice the number of exchange agreements makes for a more pronounced illustration.

Again, it is worth noting some points on the data. Once more, EU is massively present. This is partly because of its speed in implementing effective CRS legislation. Thus, 35% of CRS exchange relation are down to EU instruments, including EU Directive 2014/107/EU. However, EU members have also been active in concluding agreements with non-EU members. The remaining 65% of exchange relations are concluded as individually negotiated CRS MCAAs, plus ten exchange agreements through the UK CDOT (Crown Dependencies and Overseas Territories International Tax Compliance Regulations). We can also see that, again, the US is absent. However, here we should not expect it to develop a network at a later stage. Due to the presence of FATCA, the US’ own financial account information standard, there has been no desire to also sign up to the CRS. Finally, the CRS network is also expected to increase and broaden its geographical scope over the coming years as the remaining of the AEOI-committed countries (100 at the time of writing) conclude and report on exchange agreements.

Beyond that, the political geography of the CRS network is notably similar to that of the CBCR network: It’s all about Europe and OECD members, with a few small offshore centres mixed in. Like the CBCR network, the absence of developing states has also contributed to criticism of the CRS standard. Once again, we can also see that it’s very much an “you’re in or you’re out” picture. 62 countries have CRS exchange agreements, and only one (Bonaire, Saint Eustatius and Saba) has less than 29 agreements in place.

Another nugget that I found quite interesting in the data: There are around 350 CRS agreements that are only reported by one of the two jurisdictions to the OECD. All other relationships are reported by both jurisdictions. For instance, Anguilla’s CRS exchange agreement with Argentina is only reported to the OECD by Anguilla, not Argentina. And there is a certain trend with these 350 agreements. They are all reported by the following countries: Anguilla, Bermuda, British Virgin Islands, Cayman Islands, Croatia, Cyprus, Korea, Latvia, Liechtenstein, Lithuania, Luxembourg, Malta, Mauritius, Mexico, Monaco, Montserrat, Netherlands, Romania, Saint Vincent and the Grenadines, Turks and Caicos Islands. Most of these countries are small (island) states with noteworthy financial centres, or what some might label tax havens.

There are a few possible explanations, but my guess as to what is going on here is this: Countries most at risk of reputational damage and political wrath from non-compliance are making sure they report all of their exchange relations to the OECD as soon as possible. They simply want to make sure it is noticed when they are conforming to expectations, when they are “doing good”.

The global tax information exchange network (CBCR + CRS)

Total global information exchange network

(Size by weighted degree (number of links, weighted by strength); node colour by region; and network layout by ‘ForceAtlas2‘.)

Here, I’ve added the CBCR and CRS relationships together, giving us a picture of who is truly able to access modern global tax information flows. The bolder the link, the more weight it has, indicating access to both CRS and CBCR information from international exchange.

Having noted caveats to the data above, the picture that emerges here is, as we might have expected, more pronounced but similarly indicative as the individual CBCR and CRS networks. The observations barely need repeating, but for good measure: there’s EU/OECD dominance with a few financial centres mixed in, an absence of the US and developing countries, and a strong in-or-out dynamic.

Given the current structural factors contributing to this network layout, the main factor with potential to substantially change this picture is change in the overall political economy of global tax governance. This may yet happen, e.g. through the BEPS Inclusive Framework, but may also very well not happen due to geopolitics or other factors.

There will be more analysis to do on this data, and it will be interesting to follow the longitudinal development of these networks. I will certainly continue my work in this area, as I’m sure others will. For now, however, a very interesting picture is emerging of the new political economy and geography of global tax information exchange.

Are American firms really more tax aggressive?

Are multinational groups headquartered in the United States more aggressive in their tax planning compared to non-US competitors?

That is, at least, a very popular strapline in tax circles. Negative media stories about the tax affairs of major US firms such as Apple, Amazon and Starbucks are often described as contributing factors to the OECD/G20 BEPS project and the European Commission state aid investigations. Although of course, by critics these projects are described as undue crusades against American firms.

Given the notorious difficulty in measuring effective tax rates of multinational enterprises (MNEs), there remains little systematic cross-national comparative research on the topic. Studies have varied in approach and results. For instance, economists utilising the prominent Devereux/Griffith methodology have often found relatively high effective tax rates in the United States. However, the D/G approach is based on a hypothetical domestic investment example and is not attentive to international tax arbitrage. Using financial accounts data, legal scholars Reuven Avi-Yonah og Yaron Lahav concluded in a 2011 piece that US MNEs had systematically lower effective tax rates than European MNEs. Another 2011 report from PwC found relatively high book effective tax rates in the US.

However, recent years’ academic literature has provided indications on the stand-out role of American corporate actors in the world of tax avoidance. A 2015 study by Chris Jones and Yama Temouri from Aston University found that US MNEs were more likely to locate investments in tax havens compared to firms headquartered in continental Europe.

Drawing from existing economic literature, Jones and Temouri identify firm characteristics likely to relate to aggressive tax behaviour (in this case, measured as tax haven investments), including technology intensity (R&D and intangibles) and incorporation in Liberal Market Economies (LMEs), such as the US and the UK – as opposed to Coordinated Market Economies (CMEs), such as Germany or Japan. Both of these hypothesis are confirmed by the analysis. They conclude:

“We find that MNEs from the high technology manufacturing and services sectors with high levels of intangible assets are more likely to have tax haven presence. (…)

MNEs from LMEs are significantly more likely to undertake tax haven FDI compared with MNEs from CMEs.”

On the other hand, an interesting new paper by Katarzyna Habu from the Oxford University Centre for Business Taxation, draws these conclusions into question. While Jones and Temouri’s paper draws on financial accounts data, Habu utilises a fascinating new dataset of corporate tax returns, made available by the UK HMRC to researchers. This provides a more accurate gauge of corporate tax bases, although it comes with its own limitations, such as limited cross-country comparability.

In short, the paper compares the taxable profit levels of similar domestic and multinational companies operating in the UK (based on industry and level of total assets).

Buried at the far end of Habu’s paper, a compelling read, is the following table:

Udklip

Here we see the differential (ATT) between the taxable profits to total assets ratio of the two groups (domestic and multinational) for various ‘home countries’ of the MNEs.

The results indicate that, from the pool of MNEs with subsidiaries trading in the UK, MNEs headquartered in tax havens are most tax aggressive, followed by French, Asian, other European, US and German MNEs. Entirely contrary to Jones and Temouri’s findings, there is no evidence here that US firms are more aggressive than German or Japanese firms. In fact, it rather indicates that French and Asian headquartered MNEs are more aggressive than US MNEs.

There are various potential explanations for the discrepancies in the recent literature.  Tax haven FDI and UK taxable profits avoidance are not necessarily expressions of the same type of tax aggressiveness. American companies could indeed be more aggressive in locating investment in tax havens, while at the same time not being more aggressive in lowering taxable profits through tax avoidance in the UK. More broadly, the wide variety of empirical data sources, theoretical approaches, geographical scope and so forth do not allow for easy comparisons between the studies. 

And then there’s the question of the differential between effective tax rates of domestic and international economic activity – one that is substantial in particular for US technology firms due to the tax system design (thanks Heather Self for that point). Existing studies do not investigate this systematically.

We should also note, as Alex Cobham importantly pointed out to me, that the latter study expresses net numbers – the overall effect of tax aggressiveness, which may hide significant flows of profit shifting in or out of the UK. US firms could conceivably be shifting profits into the UK in a tax aggressive manner without it showing up here. However, the evidence can’t say.

Thus, we should be careful in drawing firm conclusions from this ascending literature, but we should take both studies as interesting results that shed light on our understandings of the dynamics of MNE tax planning. There may be continuing suspicions that US MNEs are generally more tax aggressive, but further research is needed in order for us to firmly confirm or deny such assumptions.

Tempering expectations for the BahamaLeaks

Hey, ho. Another month, another exotic tax haven leak. Another political storm, another media circus, another rush to condemn. And maybe this time, it will lead to lasting change. Who knows? But my guess is the Bahama Leaks won’t quite live up to whatever hype it has attracted in its short life. There are two main reasons for that:

Scale and scope

Just like the Panama Papers, the Bahamas Leaks have been shared with German newspaper Süddeutsche Zeitung by a John Doe, from where it has been passed to the International Consortium of Investigative Journalists (ICIJ) and on to their partners. And just like the Panama Papers, the documents reveal previously secret ownership lines and corporate structures in an island haven famous for its tax haven usage. But unlike the Panama Papers, the largest ever such leak, which contained a massive 11.5 million documents on, the Bahamas Leaks features only a tenth of that, at around 1.3 million files.

While the Panama Papers stories led with stories of world leaders such as Vladimir Putin, the Saudi King, the Prime Ministers of Pakistan, Malta and Iceland (who eventually stepped down), and large banks across the Western world, the Bahamas Leaks have kicked off with rather dry stories on former EU Competition Commissioner Neelie Kroes’ and UK Home Secretary Amber Rudd. Not quite the same crowd.

Simply, there seems to have been more meat on the bone with the Panama leaks. Extensive documentation of under-the-table documents between banks, trustees and Mossack Fonseca certainly looks to eclipse “the names of directors and some shareholders” from the Bahamas company registry.

Leak fatigue

Ever heard about “donor fatigue”, the notion that people (typically in the West) get tired of hearing about third world disasters and crisis? I think we may be seeing a similar dynamic with tax haven leaks. In recent years, we’ve had a plethora of such leaks – Swiss, Offshore, Lux, Panama, Bahamas, etc. The novelty factor and the outrage decreases by each one (though counteracted by the scale and scope of revelations). Thus, we have “leak fatigue”, a situation where each new leak is afforded less attention, thus limiting the associated impetus for change.

We shouldn’t be entirely bearish on the BahamasLeaks outlook, though. As ever, it does contribute to some political momentum, even if it mainly serves as an occasion for policy groups to push their existing agendas (EU: the new CCCTB, NGOs: public BO registries, OECD: automatic exchange of information, etc.). And certainly it provides a very good case for discussion of our current global transparency system. But all in all, I am tempering my expectations for any consequent political initiatives.

 

The bark IS the bite, but ..: Why tax haven blacklists are not the answer

The OECD has been working on criteria for a tax haven blacklist. At the request of the G20 Finance Ministers, this has been a work in progress since April of this year. And the results are set to be presented at the G20 finance minister’s meeting in China next month.

This morning, the FT reports that those criteria are now set, and I turned to Twitter to evaluate the news:

My immediate thoughts were aligned with comments I’ve previously made, which are clear on these types of blacklists:

Why the skepticism? Surely, tax haven blacklists are a strong and effective tool? Indeed, they are. For certain purposes.

Tax haven blacklists have been one of the key international tax policy tools to combat illegitimate and harmful tax competition throughout the past decades. Starting with the OECD ‘Harmful Tax Competition’ (HTC) project, campaigns by international organisations to ‘name and shame’ uncooperative states has been very successful. There is no doubt that the HTC project, along with similar action by the Financial Action Task Force, the G20, the EU and others, have brought about significant compliance by states around the world to international tax standards.

Jason Sharman, in his excellently titled “The bark is the bite“, explains why exactly ‘naming and shaming’ works: It creates a discourse of illegitimacy and damages the reputations of non-compliant states and those associated with them, creating key psychological and material disincentives for tax haven behaviour. Of course, we still have tax havens, so it’s not an “be all, end all” tool, but blacklists advanced the agenda of harmful international tax competition probably more than any other tool in the 1990-2010 period.

My main contentions today with tax haven blacklists and my suspicion of their effectiveness can be summed up as follows:

  • Blacklists target small states, but not larger states with proportionally greater influence
  • Blacklists are inherently political, a reflection of geopolitics and national power
  • Blacklists express the pathologies of international organisations, rather than strictly

On the first and second points, you have to look no further than the current ‘gold standard’ for international tax haven blacklists: the OECD’s list of commitments to automatic exchange of tax information:

CgB1Y3MWsAIyqnr

Three small island states are non-compliant: Bahrain, Nauru and Vanuatu*. Oh, and then the United States of course, but they are only mentioned in a footnote. In short, if you’re big and powerful, or if you have the right friends, you will not end up in any international tax haven blacklist; if you’re small and powerless, you risk the blacklist treatment.

That is why the United States, the UK (City of London etc.), Switzerland, Luxembourg, the Netherlands and others will not end up on the tax haven blacklists of the OECD or the EU, even though they are widely considered key tax havens.

To be fair, a completely factual reason these states do not figure on tax haven blacklists is that they comply with the established blacklist criteria (with the notable US exception, of course). But that is exactly the point – the established criteria favour certain states in their design, while disadvantaging others.

And it makes perfect sense. International organisations and their member states don’t want to upset key trading partners. International trade and diplomatic relations are simply prioritised over naming and shaming on tax. I can understand that train of thought. I think most people can, in fact. But when you are trying to nudge the world towards less ‘harmful international tax competition’, this approach causes a fundamentally ineffective solution. We may name and shame small islands states all the way to tax haven extinction, but we are not addressing the wealth of similar activity generated through larger, more powerful states.

Finally, international tax haven blacklists are not, although one might think so, based on “objective” criteria. There is no such thing. When OECD and EU staff members and their member state counterparts are constructing blacklist criteria, they are surely doing what they think is “objectively” correct, but they are also influenced by their organisational, professional and national environments. They have different purposes for and ideas about the blacklists. They are influenced by organisational pathologies.

When the EU Member States publicised national tax haven blacklists in 2015, France labelled eight countries, Portugal labelled 80, Denmark didn’t offer a list. And, by the way, only eight Member States had Panama on their list.  And whenever the OECD makes a blacklist, the criteria conveniently revolve around subscribing to OECD tax standards (on information exchange, on harmful tax practices, on administrative cooperation, on transparency minimum standards, etc. etc.). This makes sense from an OECD perspective. But as Richard Woodward and Eccleston have written, the organisational culture of the OECD (and other international organisations) and the internal focus can lead to weak, lowest common denominator standards in tax. As such, while the blacklists might make sense for the individual or the organisation, it does not necessarily provide an effective solution if the goal is to diminish harmful international tax competition.

More than anything else, the new OECD tax haven blacklist criteria will probably lead small states to expand their subscription to OECD tax governance standards. Most of them already cooperate with OECD standards, but maybe they don’t subscribe to all three requirements. Currently there are eight countries past review that are not “largely compliant” with information exchange standards. And there are three* countries uncommitted to automatic exchange of information (see above). So how much will this move? I have my doubts.

(*Endnote: As Christian Hallum pointed out to me, there are in fact no longer any jurisdictions defined as non-committed.) 

 

 

Beyond the numbers: Tax haven issues outside the tax gap

Building on this write-up from last week (in Danish) on the issues posed by tax havens for Denmark, I wanted to put the main points up in English as well, as I feel they are pertinent to the wider debate on tax havens, tax evasion and so forth ongoing right now.

The question that always pops up in these debates is: How big is the problem for us? Now, if you look purely at the economic question of tax lost (the tax gap) from tax evasion in tax havens, the correct answer is: We don’t really know. Due to the nature of the activity in question, it is difficult to impossible to estimate with any precision the assets located ‘offshore’/in tax havens and the tax lost ‘onshore’. As the PanamaPapers show, tax havens and offshore tax constructions are fundamentally about secrecy. That is one reason we keep seeing examples of corrupt politicians and criminals involved in these schemes – they wanted to hide activites from sunlight. Secrecy obscures our ability to view the activities in tax havens, and this is made even more difficult by the breadth and depth of the issue. Tax evasion and associated activities using tax havens and offshore vehicles is very complex; there are many different techniques and schemes, used by many different actors, each of which is difficult to map. There are blind spots everywhere.

So we can’t really say exactly how much money is lost. The estimates available are all, more or less, based on insufficient data. That said, there is certainly good work on the topic. Probably the most recognised estimate is from Gabriel Zucman, who has argued that offshore wealth amounts to $5.9tr (roughly 8% of the gross world product). Zucman estimates that at least two-thirds (and probably more) of these funds are unregistrered, and that at least 3% of the unregistered funds are lost through tax evasion. This gives a total world tax gap from offshore wealth of at least $120bn/year (Zucman’s own “best guess” is around $190bn). And then we have work from OECD and IMF on the tax gap from base erosion and profit shifting (BEPS) – which is of course not quite the same, but which may be part of the same issue – which also run in the triple-digit billion dollars a year. Of course, we shouldn’t forget Richard Murphy’s controversial and widely cited $1tr tax lost estimate for the European Union countries.

The key point I want to bring up here is: We don’t know. There may be indications that the numbers are big, but essentially the knowledge we have on this topic is insufficient.

So why should we care about this whole tax haven issue? We don’t even know how much money is being lost. Do we need to even talk about it?

And now we get to the main point of this post: Even if you ignore the purely economic tax gap perspective, there are good reasons to have a public and political discussion about the issue of tax havens and offshore tax evasion. In particular, I want to highlight sovereignty and democracy, fair competition, tax morale, mistrust and financial stability.

First and foremost, tax havens can be viewed as a threat to other countries’ sovereignty. When citizens and companies from Denmark (or Germany or England, etc.) utilize Panama/Delaware/Ireland to evade taxes, the former countries’ tax bases are decreased, reducing collectible tax, which can be seen as a significant influence on the political and economic abilities of those countries. The same effect can occur because countries are forced into a race to the bottom tax competition in order to attract investment and capital. Opinions are divided on tax competition, but it is clear that it places an important constraint on national Parliaments. And this also causes a democratic issue. Legislation in tax havens is designed so that individuals and businesses can circumvent or minimize the effect of laws and regulations elsewhere. In this sense, the ability of other national Parliaments to effectively legislate within their borders is impaired. This may be seen as a democratic problem because tax havens limit the ability of publicly elected officials to do their job and decide the make-up of policies and society, including who pays for what.

Another argument is that tax havens hurt fair competition. When certain companies and individuals have more opportunities to evade or avoid national tax and rules, or to a greater extent takes advantage of such opportunities, everyone else is disadvantaged. When only certain actors in a competitive market are able or willing to effectively use tax minimisation strategies (or circumvent other national legislation), there is a risk of distorted markets and un-level playing fields. We know, for instance, that multinational companies have more opportunities for tax planning than purely national companies. And we also know that Anglo-Saxon companies are more tax aggressive than, e.g., continental European firms. This can hurt certain economic actors directly, and it can hurt fair market competition in general, thereby creating suboptimal economic outcomes.

A third and related point on why the issue of tax havens might be a worthwhile political discussion is tax morale. In short, tax morale is a public’s willingness to pay the right amount of tax in accordance with the rules. It is essentially a measure of tax evasion in a society. If tax morale is high, tax evasion is low, and so is the tax gap. One important factor in determining a society’s tax moral is social influences. (I recommend Martin Hearson’s thorough blog on this topic.) If people are of the perception that other tax payers are cheating, or that the risk of getting caught while cheating is small, or that the system advantages certain people over others, the tax morale will drop. It is fair to wonder if revelations such as the PanamaPapers have this exact effect. And when the tax morale drops, tax evasion is likely to rise as a result, decreasing the tax base and tax collected, which in turn forces politicians to compensate by raising taxes, taxing more activities, or cut down on public services.

A fourth and, again, related argument concerns mistrust. Just like the PanamaPapers and similar leaks can reduce the tax morale in a society because the revelations expose unacceptable behaviour, tax haven activity can also reduce trust in politicians, firms and (groups of) individuals implicated. The public campaigns against onshore banks, tax advisers, politicians and sports stars that we have seen in the wake of the PanamaPapers are apt examples. Whether or not the accused parties have actually done anything illegal doesn’t matter – the reputational damage is substantial. But trust is essential for our economies and our democracies. Less trust in economic and political actors can help create economic and political imbalance. In short, tax haven activity (and revelations thereof) can be unnecessarily costly to our economies and democracies. It can also create lasting societal change (which may be viewed as good or bad). See, e.g., the rise of anti establishment parties around Europe after the financial crisis.

A fifth point is about financial stability. After the financial crisis, there has been broad agreement that tax havens played a significant role in the crisis. Offshore markets and tax havens were said to have contributed to massive shadow banking activity, which was a key factor in increasing the overall level of risk in the financial system. While the recent Panama leaks mostly show individuals’ tax evasion, it also gives us insights into the exact kind of secrecy, offered in Panama and elsewhere, which helps create financial instability. If we can reduce the size of this shadow economy, we might potentially create a more healthy financial system in the process.

In short, there is a number of reasons why you might – even if you look beyond the purely economic tax lost focus – demand a serious public and political discussion on tax havens and their material impact on other countries.