Offshore financial centres have taken a battering recently, but they have shown remarkable resilience, says Matthew Valencia
Feb 16th 2013
WHEN THE ECONOMIST INTELLIGENCE UNIT, a sister organisation of this newspaper, published the first bound edition of “Tax Havens and Their Uses” in 1975, a queue several blocks long formed outside The Economist’s bookshop in London. Interest in offshore financial centres (OFCs) kept growing over the following 20 years as dozens of new havens popped up, often with help from lawyers based in Wall Street or the City of London. Tax authorities did little to intervene. Beginning in the mid-1970s, Jerome Schneider, a well-known “tax planner”, hawked various tax-evasion schemes with impunity for more than 20 years, even advertising in airline magazines.
This tolerance ended in the late 1990s, when prosecutors began to catch up with Mr Schneider and his kind and the Organisation for Economic Co-operation and Development (OECD), a rich-country forum, declared war on “harmful tax competition”. Since then tax havens have been under sporadic attack, including two waves of blacklisting. In 2008-09 the G20 took up the cudgels, America put pressure on Swiss banks to reveal more about their customers and various tax authorities started paying for stolen information about offshore accounts.
Tax avoidance, the grey area between compliance and evasion, has shot up the political agenda. A recent cover of Private Eye, a British satirical magazine, caught the national mood, showing Santa Claus being booed for living offshore. Governments have been rushing out action plans. Britain has put tax compliance and corporate transparency at the top of its list of priorities for its presidency of the G8 this year. America’s media often suggest that Congress yank money back from tax havens to alleviate the nation’s fiscal woes.
The world has 50-60 active tax havens, mostly clustered in the Caribbean, parts of the United States (such as Delaware), Europe, South-East Asia and the Indian and Pacific oceans. They serve as domicile for more than 2m paper companies, thousands of banks, funds and insurers and at least half of all registered ships above 100 tonnes. The amount of money booked in those havens is unknowable, and so is the proportion that is illicit. The data gaps are “daunting”, says Gian Maria Milesi-Ferretti of the IMF. The Boston Consulting Group reckons that on paper roughly $8 trillion of private financial wealth out of a global total of $123 trillion sits offshore, but this excludes property, yachts and other fixed assets. James Henry, a former chief economist with McKinsey who advises the Tax Justice Network, a pressure group, believes the amount invested virtually tax-free offshore tops $21 trillion. His methodology is reasonably sophisticated but he admits his calculation is still “an exercise in night vision”.
Once commercial transactions are factored in, the likely total for offshore wealth balloons. Over 30% of global foreign direct investment is booked through havens. Mr Milesi-Ferretti studied a group of 32 of them and found that international banks’ claims on these were of the same order as their claims on all emerging markets. Some OFCs are giants in certain kinds of business. The Cayman Islands (population 57,000) is the world’s leading hedge-fund domicile. Bermuda (population 65,000) is number one in reinsurance.
These two are famous but in many ways atypical. Many of their smaller competitors are what Jason Sharman, of Griffith University in Australia, calls “aspirational havens”: islands that turned to finance to reduce their reliance on tourism and agriculture, but have never got beyond selling a few thousand offshore companies a year.
Nevertheless offshore finance has shown a “puzzling resilience”, confounding predictions of decline because of its supposed vulnerability to the regulatory clampdown imposed from outside, says Mr Sharman. An academic study last year found that OFCs’ foreign-owned deposits had actually risen slightly in 2007-11. Mr Sharman attributes their staying power to a growing clientele in Asia and other emerging markets which has offset a decline in America and Europe.
Offshore operators put the havens’ endurance down to their legitimate uses, such as their “tax-neutral” role in mediating international financial flows (of which more later) and the protection they offer from unstable or capricious governments—though they believe these uses are poorly understood.
Tax libertarians think the havens meet a need created by the complexity and punitive nature of some national tax codes. Their latest hero is Gérard Depardieu, who has taken Russian citizenship in protest against a proposed French supertax on the rich. Besides, they point out, OECD countries also compete on tax. Britain, for example, which has the second-lowest corporate-tax rate among the G8 (after Russia), recently cut it further.
Critics counter that the use of offshore centres involves more sleight of hand than genuine competition. Money is routed through them merely to shelter it from taxes, undermining collection in the client’s home country, where he will continue to benefit from tax-funded public services without paying his way.
Ultimately, says Nicholas Shaxson, one of the offshore industry’s most prominent critics, its appeal rests on “providing rich individuals and corporations with financial boltholes, where they can do things with their money that they wouldn’t be allowed to do at home”. He believes that legally enshrined secrecy is just as important to the havens’ success as low tax.
Individuals have a right to financial confidentiality, but only as long as they set about their business lawfully. When it comes to tax crimes, money-laundering and the like, such confidentiality needs to be set aside. Some OFCs still make this difficult, and layering by service providers compounds the problem: try penetrating a Belize bank account fronted by nominees that is owned by a shell company in the British Virgin Islands (BVI) that in turn is owned by a foundation in Panama. Over the past decade the bigger OFCs have co-operated more with foreign law-enforcement agencies, but progress is patchy, and offshore structures still crop up regularly in corruption and money-laundering cases. A recent example is the alleged use of Cayman companies as conduits for bribes to Saudis by a subsidiary of EADS, a European aerospace and defence company.
The scale of the offshore industry’s dirty-money problem is hotly disputed. Economists at Global Financial Integrity, a research group founded by Raymond Baker, an authority on financial crime, reckon that developing countries alone suffered illicit financial outflows—defined as money that is illegally earned, transferred or used—of at least $5.9 trillion over the past ten years. Some say this estimate is too high, but the figure is clearly substantial. What is less clear is the proportion that ends up in OFCs rather than in one of the laxer onshore jurisdictions.
Estimates of tax-revenue losses onshore are equally imprecise. Some think, for example, that Britain’s “tax gap”—the difference between tax owed and collected—is much bigger than the authorities care to admit: perhaps close to 7% of the total collected in 2010-11. On the other hand tax losses are sometimes overestimated, for instance by assuming that the full rate would have been paid if the money had been kept there.
At a recent conference Malcolm Couch, an official from the Isle of Man, one of the more transparent tax havens, delivered a few home truths to an audience of offshore worthies. OFCs should acknowledge that they, along with some of the big onshore hubs, have “to some extent been hijacked” by illicit money, he said, and should not be surprised when they are attacked for robbing other countries of tax revenues. They need to tread carefully because they face “an inherent existential threat”.
This special report will argue that tax havens are indeed facing serious threats but are also being presented with some enticing opportunities, especially if they have strong links with emerging economies. The best-regulated of them are no longer merely “sunny places for shady people”. They can reasonably feel aggrieved when they are lumped together with the dodgiest havens, or when onshore jurisdictions themselves fail to practise the financial rectitude they preach to their offshore rivals.
All the same, the OFCs will remain under intense pressure as tax compliance receives more political attention. They will have to show not only that they have cleaned up but that they are making a constructive contribution to the world economy.