Dirty Secrets

How Tax Havens Destroy the Economy

Richard Murphy

• Publisher: Verso
• Year: 2017
• Print ISBN: 9781786631671
• eBook ISBN: 9781786631688
• Topic: Politics & International Relations
• Subtopic: Taxation
• Index: Politics & International Relations

The Panama Papers demonstrated that the superrich hide their wealth from the rest of us. Dirty Secrets shows that this was not by accident, but by design. It was the result of a powerful alliance of the wealthy, their advisers and the state that has undermined all attempts to solve the tax haven problem.

This is because tax havens are the unacknowledged heart of globalized capitalism. Their purpose is to provide freedom from regulation. The exponents say this makes markets work and so we all gain. But this argument has now failed. Furthermore democracy itself is being threatened by the political fallout from the mistrust this regime has created.

The result is that tax havens are now a threat to the very system that supposedly spawned it. Dirty Secrets is the most revelatory examination of the crisis by a leading expert, but also offers solutions on how governments can regulate havens and what the world might look like without them.

CHAPTER 1

The Story of Tax Havens

The existence of tax havens does not add to overall global wealth or well-being; they serve no useful economic purpose. Whilst these jurisdictions undoubtedly benefit some rich individuals and multinational corporations, this benefit is at the expense of others, and they therefore serve to increase inequality.

Three hundred economists including
Jeffrey Sachs, Thomas Piketty, Angus Deaton
and the author of this book, May 2016

In April 2016 the Panama Papers burst into the news media. The leak of 11.5 million documents bearing the news of the creation of a vast number of offshore companies, more than 100,000 of them in the British Virgin Islands alone, proved a claim that tax justice activists had been making for some time, which was that tax abuse via tax havens was being undertaken on an industrial scale.¹

The Panama Papers rightly garnered a lot of media attention. A few weeks later, the Anti-Corruption Summit held in London, and chaired by the British prime minister, received much less publicity. Firstly, this was because many people believe that nothing can really be done to stop such abuse. Secondly, despite the appearance given by that summit, there is a deep-seated belief that there is no real political will to tackle the issue: there was a palpable sense among the media and others at the summit that this was an event whose outcome amounted to less than the sum of its parts.²

These issues, in combination, form the backbone of this book, in which I will suggest that something really can be done to stop tax haven abuse, and that the political will to drive the necessary changes can indeed be generated.

Just as important, though, is my third argument, which is that, because many politicians have only a faint understanding of what financial offshoring is all about, they are currently proposing solutions to what is, at best, a small part of the problem that it poses for the world. This opinion is based on my experience as a chartered accountant, tax campaigner, and professor of political economy. What I offer here is an explanation of what tax havens really are, and what we should do about them.

Of these three issues the last matters to me the most, because I think it is the real obstacle to progress. It is not as if the tax haven problem is new, after all. There is good reason to argue that the first place to undertake what looks like modern tax haven practice was the US state of Delaware, which in 1898 created a statute deliberately intended to undermine the regulations of its neighbours New Jersey and New York. The trouble is that the Monte Carlo casino in tax-free Monaco, which had abolished all forms of tax by 1869, is the much simpler model of tax haven behaviour that most politicians use as a point of reference.³

The Panama Papers scandal fits the model of Monaco, not Delaware. This is because they are quite explicitly about tax. In some ways this is unfortunate, because it reinforces the political stereotype that the tax haven problem is about straightforward tax abuse undertaken in what appear to be exotic locations. My argument here is that, until we realise that tax abuse is just one of a range of activities undertaken in the space called ‘offshore’ that are recorded in, but do not actually take place in, locations that have been called tax havens, there are three important advances we cannot make – namely, understanding the risk that these activities pose to the world’s governments, to capitalism as our default way of organising an economy, and to democracy – and therefore to our whole way of life.

What is surprising is that a more general awareness of these three issues has not yet emerged, despite the fact that tax havens have been under almost unremitting attack for some time. The first official report to note the potential harm that tax havens represented was produced in the United States in 1981, but crackdowns on tax haven activity only really began with the issue of the European Union’s Code of Conduct on Business Taxation in 1997, and the OECD’s publication of its report on Harmful Tax Competition in 1998.⁴ The European Union Savings Tax Directive, introduced in 2005, was the next big milestone: it was the first attempt to secure information from tax havens on a systematic and comprehensive basis. But the most important development occurred in 2008.

The global financial crisis that erupted in that year made tax revenue the commodity in shortest supply to the governments of most of the western world, with the consequence that many plunged deeply into financial deficit. The immediate reaction of many of those governments was to seek someone to blame for what had happened. Moreover, they urgently needed to be seen to be taking action on the crisis, and they wanted that action to be swift. Taking on tax havens met politicians’ need on all three counts.

As banks in the UK, the United States and continental Europe failed in quick succession, the option of blaming the darker, tax-haven side of the financial services sector for everything that had gone wrong had the merit of being both popular and at least partly justifiable.⁵ That sentiment underpinned the April 2009 G20 summit in London, which I attended. The closing communiqué read: ‘We have today … issued a Declaration, “Strengthening the Financial System”. In particular we agree … to take action against non-cooperative jurisdictions, including tax havens. We stand ready to deploy sanctions to protect our public finances and financial systems. The era of banking secrecy is over.’⁶

This was a bold claim, suggesting that tax havens stood outside the mainstream of the financial system and did not cooperate with other nation-states in the areas of regulation and the management of financial risk; it made clear that, in the view of the governments issuing the statement, secrecy was at the heart of the problem, and it suggested that targeted sanctions could address the issues arising.

Each idea was interesting, but the proposed solution that emerged from that summit was fundamentally wrong. In fact, it can almost be claimed as one of the successes of tax haven secrecy that the way in which tax havens work has been so misunderstood that when the world turned its attention to the abuses they permitted it had no idea how to specify the problems they created – or, therefore, how to address them.

This book will argue that, while secretive banking is a feature of some tax havens, it is a not a universal characteristic and does not need to be, since there are many other ways in which tax haven secrecy has been, and continues to be, delivered.

What is more, as I argued in Tax Havens along with my coauthors Ronen Palan and Christian Chavagneux in 2010, tax havens are not distinct, or separate part of the global financial system, but are integral to it. The supposed separateness of tax havens from the rest of the world’s financial community, implied by the 2009 G20 communiqué, was therefore a fiction. The reality was, and remains, that tax havens are totally integrated into our current global financial architecture. It is just that, for their own reasons, those who designed that system wanted to make sure that parts of it were well and truly hidden from view. Thus, to imagine that direct bilateral sanctions against a particular tax haven would create a state of compliance that would signal the end of the tax haven era seriously misunderstood how the tax haven world operated in 2009 – and continues to operate today.

Unfortunately, these misunderstandings continue to be widely circulated as if they were fact. So, for example, the Anti-Corruption Summit held in London in May 2016 focused its attention on the role of tax havens in facilitating a very narrowly defined form of corruption, largely relating to personal tax evasion and the theft of public property by public officials, whether in developed or developing countries. Meanwhile, it ignored the fact that the impacts of tax havens go way beyond those areas, incurring much larger societal costs.

Since this misunderstanding is a recurring theme of this book, it is vital from the outset to understand the exact activities and nature of tax havens – which is probably best achieved by tracing the development of current thinking on this issue.

What Regulators Think Tax Havens Do

Nearly twenty years ago, in the view of the OECD, the problem created by tax havens was what it called ‘harmful tax competition’.⁷ This was associated with what the OECD called ‘preferential tax regimes’. The motive for this judgement was clear from its 1998 report on the subject:

Countries face public spending obligations and constraints because they have to finance outlays on, for example, national defence, education, social security, and other public services. Investors in tax havens, imposing zero or nominal taxation, who are residents of non-haven countries may be able to utilise in various ways those tax haven jurisdictions to reduce their domestic tax liability. Such taxpayers are in effect ‘free riders’ who benefit from public spending in their home country and yet avoid contributing to its financing.⁸

In other words, it tax havens facilitated cheating, and the states who were losing out as a result were not happy about that. Those states made it clear where they placed the blame: ‘In a still broader sense, governments and residents of tax havens can be “free riders” of general public goods created by the non-haven country.’⁹ The focus of attention was therefore not the investor in the tax haven: the blame was to be chiefly attached to the government and population of tax havens. The OECD was equally unambitious about what the key issue was:

Tax havens or harmful preferential tax regimes that drive the effective tax rate levied on income from the mobile activities significantly below rates in other countries have the potential to cause harm by:

•distorting financial and, indirectly, real investment flows;

•undermining the integrity and fairness of tax structures;

•discouraging compliance by all taxpayers;

•re-shaping the desired level and mix of taxes and public spending;

•causing undesired shifts of part of the tax burden to less mobile tax bases, such as labour, property and consumption; and

•increasing the administrative costs and compliance burdens on tax authorities and taxpayers.¹⁰

The OECD identified those states purveying such pernicious practices by reference to the presence of:

a)No or only nominal taxes.

b)Lack of effective exchange of information [because] businesses and individuals can benefit from strict secrecy rules and other protections against scrutiny by tax authorities

c)A lack of transparency in the operation of … legislative, legal or administrative provisions

d)No substantial activities [in the tax haven that] would suggest that a jurisdiction may be attempting to attract investment or transactions that are purely tax driven.

This approach can be compared with that of the European Commission, whose Code of Conduct on Business Taxation, issued the previous year (1997), was a ‘package to tackle harmful tax competition in the European Union’.¹¹ The similarity in language, both texts making reference to harmful tax competition, is obvious. But the EU’s suggestion of what identified this behaviour differed slightly from the OECD’s view, partly because the focus of the former was solely on business taxation. The characteristics of harmful tax practices, in the EU’s opinion, included:

•an effective level of taxation for the abusive practice which is significantly lower than the general level of taxation in the country concerned;

•tax benefits reserved for non-residents;

•tax incentives for activities which are isolated from the domestic economy and therefore have no impact on the national tax base;

•granting of tax advantages even in the absence of any real economic activity;

•the basis of profit determination for companies in a multinational group depart[ing] from internationally accepted rules, in particular those approved by the OECD;

•lack of transparency.

Picking solely on these two, near-simultaneous reports, does not, of course, provide a comprehensive review of official opinion on tax haven behaviour at the time. Nevertheless, their publication established a benchmark on the understanding of the harmful consequences of tax haven practices where none had existed before.

The 1990s consensus view was then that a tax haven could be identified by four characteristics: low tax rates available to those unlikely to be resident in the jurisdiction that offered them; those same low rates concerning an activity that had little or no relationship to the place where it was recorded; the existence of arrangements enabling such taxation structures that were very unlikely to accord with international standards of accounting or administrative conduct; and the concealment from view of such arrangements by local secrecy laws intended to throw off the scent any tax authority investigating clients’ use of such facilities. The benchmark represented by this analysis was potentially powerful, but largely failed soon after its creation, as it continues to fail today.

The first failure arose with the close of the Clinton era in the United States. In May 2001, President George W. Bush’s new finance minister, Paul O’Neil, deemed the OECD approach to harmful tax competition ‘too broad and … not in line with this Administration’s tax and economic priorities’, adding: ‘The United States does not support efforts to dictate to any country what its own tax rates or tax system should be, and will not participate in any initiative to harmonise world tax systems.’¹² For all practical purposes, this statement killed off the 1998 OECD initiative and signalled a US withdrawal from the effort to tackle all but one aspect of tax haven abuse for the next eight years. The exception was with regard to terrorist financing.

This had an impact, in turn, on the EU Code of Conduct on Business Taxation, where progress was also slow, and often ambiguous in its outcomes (harmful regimes were brought to an end, but usually replaced with something that looked remarkably similar). But there were two notable exceptions in the case if this EU initiative. The first related to the UK’s tax havens. As a result of the UK’s admission to the EU in 1973, each of its Crown Dependencies (Guernsey, Jersey and the Isle of Man) and Overseas Territories¹³ (such as Cayman and the British Virgin Islands) had entered into agreements with the EU, and the UK was now expected to impose the requirements of the EU’s Code of Conduct upon them. For the Overseas Territories this had little impact: most had no corporation tax, to which the Code largely applied. But the Crown Dependencies did have such taxes, and they were riddled with the very loopholes that the EU was seeking to close. Over years of negotiation, these places were required to transform their tax systems to meet EU demands – a process in which I played a role.

The second exception to a generally slow rate of progress was the introduction of the European Union Savings Tax Directive in 2005. As the first really effective attempt to enforce information exchange between tax havens and the governments of the countries where their users resided, this was an agreement that applied right across the EU, including the UK’s tax havens. Nothing like it had existed before. That said, the scheme, as introduced, was deeply flawed. For example, it only applied to interest paid to individuals, which meant that dividends paid by companies were outside its scope. So too were bank accounts owned by companies and trusts. All an individual had to do to circumvent the Directive, therefore, was to move their bank account into the name of a company, and the whole disclosure regime no longer applied to them: it was really that easy. It was as if those designing the arrangement had deliberately designed some barn doors into it, so that any tax evader with the...

Table of contents

• Cover Page
• Halftitle Page
• Title Page
• Copyright Page
• Dedication
• Contents
• Introduction
• Chapter 1: The Story of Tax Havens
• Chapter 2: The Problems of Secrecy
• Chapter 3: What Is a Tax Haven?
• Chapter 4: The Tax Haven World
• Chapter 5: The Cost of Tax Havens
• Chapter 6: Tackling Tax Havens
• Chapter 7: The Post-Tax Haven World
• Acknowledgements
• Appendix 1: Financial Secrecy Index
• Appendix 2: Tax Justice Network Assessment Criteria
• Appendix 3: Secrecy Index Rankings
• Notes
• Index