Havens in a Storm

The Struggle for Global Tax Regulation

J. C. Sharman

• Publisher: Cornell University Press
• Year: 2018
• Print ISBN: 9780801445040
• eBook ISBN: 9781501732904
• Topic: Economics
• Subtopic: Taxation
• Index: Economics

Small states have learned in recent decades that capital accumulates where taxes are low; as a result, tax havens have increasingly competed for the attention of international investors with tax and regulatory concessions. Economically powerful countries including France, Britain, Japan, and the United States, however, wished to stanch the offshore flow of domestic taxable capital. Since 1998 the Organisation for Economic Co-operation and Development (OECD) has attempted to impose common tax regulations on more than three dozen small states.

In a fascinating book based on fieldwork and interviews in twenty-two countries in the Caribbean, North America, Europe, and islands in the Pacific and Indian Oceans, J. C. Sharman shows how the struggle was decided in favor of the tax havens, which eventually avoided common regulation. No other book on tax havens is based on such extensive fieldwork, and no other author has had access to so many of the key decision makers who played roles in the conflict between onshore and offshore Sharman suggests that microstates succeeded in their struggle with great powers because of their astute deployment of reputation and effective rhetorical self-positioning. In effect, they persuaded a transnational audience that the OECD was being untrue to its own values by engaging in a hypocritical, bullying exercise inimical to free competition.

CHAPTER ONE

Death, Taxes, and Tax Havens

The struggle between rulers and ruled over the collection of taxes, whether for the maintenance of the city-state, the feudal domain, the empire, or the modern state, has been one of the longest and most keenly fought contests in world history. The efforts of subordinate populations to escape taxation have taken on a vast array of forms; they stand as an enduring testament to human ingenuity. From great revolutions that overthrew ancient dynasties and recurrent peasant rebellions to countless daily evasions, dissimulations, and adaptations, conflict over tax has been a prime motive of political change throughout the centuries. Charles Tilly has taken the lead in investigating the interaction of war, taxes, and the development of the state across a millennium of history.¹ The vast majority of attempts to conceal taxable revenue from the ruler’s agents have taken place within the borders of a given polity. Yet despite the comparatively recent pedigree of many of the tax havens and the even more contemporary notion of international tax competition, neither is without precedent, perhaps even in ancient times.²

This chapter is devoted to four main tasks. The first is to give a brief account of the rise of tax havens and the sorts of services they provide. The second is to put the OECD’s initiative against harmful tax competition in the broad policy context of other European- and U.S.-sponsored multilateral initiatives that either had similar goals of restraining international tax competition or adopted similarly confrontational tactics in trying to secure the compliance of small states. Relevant are the efforts of the EU in relation to tax competition and the Financial Action Task Force’s efforts to pressure tax havens to adopt new regulations against money laundering. The third task is to review the prevailing debate over the positive or negative aspects of tax competition among economists, a debate that has been strangely underutilized by the OECD and its opponents. Finally, in this chapter I set out the OECD’s case against “unfair” or “harmful” tax practices: how they can be recognized, why they are harmful, and what should be done about them.

In a 1998 report that provided the rationale and road map for the campaign to date, the OECD Committee on Fiscal Affairs presented its diagnosis of harmful tax competition. It proposed a set of minimal standards, together with a strategy for bringing countries inside and outside the organization into line. This confrontational “top-down” strategy marked a crucial departure for the OECD. It also tested a new strategy of global regulation by international organizations in general. In contrast to the usual methods of inclusive rule-making, consensus-seeking, peer review, and issuing models of best practice, the campaign against tax havens sought to secure the unwilling compliance of nonmember states that had no say in designing or evaluating the standards against which they were to be judged. My final section is a link to the argument about how regulative norms defined the scope of the conflict and the means available (chapter 2) and the content and significance of the public exchange of claims and counterclaims (chapters 3, 4, and 5).

The Birth and Proliferation of Tax Havens

The term “tax haven” lacks a clear definition, and its application is often controversial and contested. The term has increasingly become pejorative. As discussed in chapter 4, what is counted as a tax haven has much less to do with objective features of the tax regime or financial regulations than a country’s reputation and the motives of the observer. This caveat to one side, the development of tax havens, from the late nineteenth century up until the last few decades, cannot be adequately explained by any single variable. Historically, tax haven status has often resulted from the unintended consequences of quirks of the legal or tax codes or through the interaction of changing economic circumstances with static rules and regulations. By the 1980s at the latest, however, small island states in particular began to copy established tax haven jurisdictions as a deliberate development strategy. It was easy to pass a suite of legislation adapted from the state of the art in the field.³ Often this development strategy was adopted by small states on the advice of former colonial powers and development agencies.

No two lists of tax havens look quite the same; the number of entries ranges anywhere from around twenty to almost one hundred jurisdictions.⁴ Nevertheless, there is usually a good deal of overlap in the lists of places included. Featuring prominently on these lists is a cluster of small island states in the Caribbean and the South Pacific. Many others are European microstates and dependencies that escaped the pull of centralizing states in the modern era. In Central America, Belize and Panama are often included; in Africa, Liberia; in the Indian Ocean, the Seychelles and Mauritius; in the Persian Gulf, Dubai and Bahrain; and in Asia, the Malaysian island of Labuan, Brunei, and perhaps such prominent financial centers as Singapore and Hong Kong, although left off the OECD list, might qualify. Crucially for the OECD campaign, two of its own members, Luxembourg (also a member of the EU) and Switzerland, are often classified as tax havens.

The oldest present-day tax havens are in Europe; they are holdovers from a previous era and exist in association with a larger neighbor. The Isle of Man, Gibraltar, and the Channel Islands are affiliated with Great Britain; Monaco is affiliated with France; Andorra is affiliated with France and Spain; San Marino is affiliated with Italy; and Liechtenstein with Switzerland.⁵ Palan notes that

The distinguishing feature of European tax havens . . . is that they tend to be small anachronistic formations. Originally, these jurisdictions did not set themselves purposefully to establish laws that would attract tax evaders; rather, it was the other way around: the world around them launched on a course that has led to an unprecedented rise in taxation and regulation. These small and conservative states refused to follow suit.⁶

Specifically, European tax havens such as Andorra and Monaco declined to follow the example of larger states that introduced personal and corporate income taxes, or they have combined low taxes with the Swiss model of banking secrecy laws, like Liechtenstein.

Switzerland has in many instances been the standard-bearer for European tax havens. Immediately after World War I, investors responded to rising taxes elsewhere in Europe by transferring their savings to Swiss accounts, though as far back as the French Revolution exiled aristocrats had sought to safeguard their wealth in Geneva’s banks. The security of Swiss bank accounts was enhanced when in 1934 the federal government passed strict banking secrecy laws that made it a criminal offense to pass on any details relating to accounts and account-holders to either foreign or domestic government agencies. Switzerland differs from most countries in adopting a particularly narrow definition of tax evasion, which sharply limits its obligations to exchange information with foreign authorities on tax matters.⁷

Outside of Europe, a large variety of countries have evolved into or have deliberately chosen to become tax havens by copying existing models. The diversity of this list notwithstanding, the conventional picture of a tax haven is a small “island in the sun,” recently independent and (apart from financial services) relying on a handful of commodities and tourism for economic viability. This stereotype has a good deal of truth to it. Naylor points to the importance of organized crime networks displaced from Cuba by the revolution of 1959 in explaining the rise of Caribbean havens. However, even though laundering drug money was a crucial fillip for some havens, this is an overly simplistic account.⁸ The regional leaders were the Bahamas, Bermuda, and the Cayman Islands. The latter two British dependencies, with their long tradition of self-rule and fiscal autonomy, have successfully attained first world standards of living, thanks to financial services. Rather than competitively cutting taxes, these islands merely maintained traditional low or zero rates. Successive battles with foreign (mainly U.S.) tax authorities meant that firms gradually expanded on their initial “brass plate” or letterbox presences to shift employees and operations to the islands in order to beat the accusation of having “no substantial economic activity” in the low-tax jurisdiction. Ironically, but in some ways typically, the sequence of pressure from the U.S. tax authorities and corporate responses meant that successively greater layers of substance were added to the fiction of island-based companies until, for example, Bermuda and the Cayman Islands became world leaders in some aspects of the insurance and hedge fund industries.⁹

The tide of drug money that washed over the region in the 1970s and 1980s compounded the U.S. government’s worries about tax evasion by American individuals and corporations. Together with fears of Communist subversion after the 1983 invasion of Grenada, the Reagan administration responded to these concerns with the Caribbean Basin Initiative. The initiative comprised a package (designed in Washington with little if any input from the Caribbean countries) of concessions on import duties for commodities like bananas, rum, and sugar.¹⁰ Whatever it might have done to contain Communist forces, the initiative did not persuade islands to abolish their banking secrecy laws. Through the 1980s and 1990s, other countries in the region were also entering the market for offshore financial services, including Turks and Caicos (1981), Antigua and Barbuda (1982), British Virgin Islands (1984), Nevis (1984), Grenada (1990), Anguilla (1991), St. Kitts (1996), St. Vincent and the Grenadines (1996), Dominica (1996), and St. Lucia (1997), such that of the thirty-five tax havens listed by the OECD in 2000, seventeen were in the Caribbean Basin (including Belize and Panama). Pacific islands face the challenges of small size and remoteness to an extreme degree. Since Norfolk Island set the precedent in 1966, Vanuatu (1970–71), Nauru (1972), the Cook Islands (1981), Tonga (1984), Samoa (1988), the Marshall Islands (1990), and Niue (1994) have increasingly taken the standard route of copying legislation from the current leaders in the field and then engaging in fierce competition for business that has often generated only the thinnest of margins.¹¹

Several pressures in the 1990s pushed small island states toward offshore finance as a solution to development problems. Bilateral aid from major countries was in decline. Commodity prices for agricultural goods were volatile in the short term and stagnant or declining in the long term, with trade preference concessions under the EU’s African Caribbean Pacific program under threat. High birthrates coupled with the emigration of those with education and skills marketable in North America, Europe, and Australasia meant that these countries faced stiff challenges with chronically limited resources. Compounding these difficulties are inherent geographical limitations that made diversification difficult and left the islands vulnerable to devastating natural disasters.¹²

In these circumstances, it is not surprising that financial deregulation in the world’s major economies and technological innovation prompted some small countries to set themselves up as tax havens. The proliferation of tax havens was also a product of low barriers to entry, combined with the example of earlier success stories in the field. Other forms of the “commercialization” of small state sovereignty¹³ have included offering shipping flags of convenience, selling citizenship, selling internet country codes,¹⁴ hosting on-line casinos, acting as routing centers for telephone or on-line pornography, and the older expedient of bargaining for recognition of either the Republic of China on Taiwan or the People’s Republic of China on the mainland.

Small states did not come to the tax haven option unaided, however, as both former imperial powers and the international development community suggested that they try to build a financial services industry based in large part on the lure of a low-tax regime.¹⁵ Vanuatu, the former Anglo-French condominium of the New Hebrides in the Pacific, made its first bid for financial services while still under colonial administration and with strong encouragement from London.¹⁶ Strapped for other alternatives aside from tourism, British administrators followed the reasoning that

If you have a largely subsistence agricultural sector and virtually all your revenue is raised by indirect taxes or resource rents, you do not need income taxes, capital gains taxes, withholding taxes or death duties. If you do not have these taxes, there is no need to enter into tax treaties. Vanuatu is thus a natural tax haven.¹⁷

In recommending financial services to small developing economies, the World Bank pointed out that for small jurisdictions to attract mobile capital, they had to offer a tax rate at or very near zero.¹⁸

What sort of financial services do tax havens offer their individual and corporate customers? Individuals and firms invest in tax havens for an enormous variety of reasons. Aside from a host of “do it yourself” guides to tax evasion, perhaps the authoritative source is made up of the various editions of Caroline Doggart’s Tax Havens and Their Uses, produced for the Economist Intelligence Unit from the 1970s until 2002.¹⁹ Most simply, tax havens allow rich individuals, often celebrities like Sean Connery (Barbados) or Luciano Pavarotti (Monaco) a place of residence free of income tax. But much more commonly than physical relocation, tax haven products create a legal separation or, better still, layers of separation between an owner and an asset or income. In this sense, talk of “borderless finance” is highly misleading, in that tax havens’ legal separation from other regulatory spaces is the foundation of their activities.²⁰ The aim is to enjoy the benefits of ownership while simultaneously erasing the legal link to an asset or revenue stream as it concerns tax collectors, creditors, and other claimants. To be sure, such a separation is at the heart of nearly all modern business and corporate law, with the idea of limited liability, legal personality, and so on, but tax havens allow for this concept to be used in more radical and complex ways.

As mentioned earlier, one of the chief attractions of putting money in tax havens is privacy. Many havens have copied the famous Swiss numbered bank accounts where the identity of the account holder is known to only one or two bank officials (or in some cases none at all). Heavy prison terms are often mandatory for bankers and other financial professionals for releasing information about their clients. Furthermore, as tax evasion cannot be a crime where there are no direct taxes to evade, authorities in such jurisdictions are commonly not under any legal obligation to cooperate with investigations by foreign tax authorities. Individuals may engage in estate planning in tax havens or protect their assets in the event of divorce or in order to ensure that disinherited parties cannot dispute wills. Trusts can be set up and structured in such a way as to escape creditors, or to distance the owners of assets from the income derived, which thus no longer counts as a tax liability in their home jurisdiction. Companies may be composed of “bearer shares,” whereby there is no central share register and thus individuals holding share certificates are the only ones able to disclose this asset. Such companies may also be relieved of the duty of conducting audits and filing accounts. Tax havens often make special deals for foreign investors, so-called ring-fencing, meaning that certain entities like International Business Companies (IBCs) or international trusts are barred to residents of the jurisdiction in which they are incorporated and must carry on all activities outside that jurisdiction (though similar special tax deals and sweeteners for foreign investors are also widely employed in OECD countries as well).

One example of a popular product that epitomizes the principle of establishing a legal separation between individuals and their assets is the Asset Protection Trust. Such trusts were first created in the Cook Islands in 1984 and widely copied by other jurisdictions thereafter, including Alaska. Trusts, a common law concept, usually comprise a person transferring ownership of money or property to the trust, with these assets managed by a separate party in line with a document drawn up by the origin...

Table of contents

• Acknowledgments
• Introduction
• 1. Death, Taxes, and Tax Havens
• 2. Regulative Norms and Inappropriate Means
• 3. Hearts and Minds in the Global Arena
• 4. Reputation, Blacklisting, and the Tax Havens
• 5. The OECD Rhetorically Entrapped
• 6. Implications for Policy and Theory
• Notes
• Bibliography