Category Archives: Transparency

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.

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.