TACKLING Tax Havens

6 FINANCE & DEVELOPMENT | September 2019

The billions attracted by tax havens do harm to sending and receiving nations alike
Nicholas Shaxson

U ntil the 2008 financial crisis, tax

havens were generally seen as exotic
sideshows to the global economy,
Caribbean islands or Alpine finan-
cial fortresses frequented by celeb-
rities, gangsters, and wealthy aris-
tocrats. Since then, the world has
woken up to two sobering facts: first,
the phenomenon is far bigger and more central to
the global economy than nearly anyone had imag-
ined; and second, the biggest havens aren’t where
we thought they were.
borders. I prefer such a broad definition because
these havens affect far more than tax: they provide
an escape route from financial regulations, disclo-
sure, criminal liability, and more. Because the main
corporate users of tax havens are large financial
institutions and other multinationals, the system
tilts the playing field against small and medium
enterprises, boosting monopolization.
Political damage, while unquantifiable, must be
added to the charge sheet: most centrally, tax havens
provide hiding places for the illicit activities of elites
who use them, at the expense of the less powerful
Tax havens collectively cost governments between majority. Tax havens defend themselves as “tax
$500 billion and $600 billion a year in lost corporate neutral” conduits helping international finance and
tax revenue, depending on the estimate (Crivelli, investment flow smoothly. But while the benefits
de Mooij, and Keen 2015; Cobham and Janský for the private players involved are evident, the
2018), through legal and not-so-legal means. Of same may not be true for the world as a whole; it is
that lost revenue, low-income economies account now widely accepted that in addition to tax losses,
for some $200 billion—a larger hit as a percentage allowing capital to flow freely across borders carries
of GDP than advanced economies and more than risks, including the danger of financial instability
the $150 billion or so they receive each year in in emerging market economies.
foreign development assistance. American Fortune As a general rule, the wealthier the individual and
500 companies alone held an estimated $2.6 trillion the larger the multinational corporation—some
offshore in 2017, though a small portion of that has have hundreds of subsidiaries offshore—the more
been repatriated following US tax reforms in 2018. deeply they are embedded in the offshore system
Corporations aren’t the only beneficiaries. and the more vigorously they defend it. Powerful
Individuals have stashed $8.7 trillion in tax havens, governments also have a stake; most major havens
estimates Gabriel Zucman (2017), an economist at are located in advanced economies or their terri-
the University of California at Berkeley. Economist tories. The Tax Justice Network’s Corporate Tax
and lawyer James S. Henry’s (2016) more com- Haven Index ranks the top three as the British
prehensive estimates yield an astonishing total of Virgin Islands, Bermuda, and the Cayman Islands—
up to $36 trillion. Both, assuming very different all British overseas territories. The organization’s
rates of return, put global individual income tax Financial Secrecy Index ranks Switzerland, the
losses at around $200 billion a year, which must United States, and the Cayman Islands as the top
be added to the corporate total. three jurisdictions for private wealth.
These highly uncertain estimates vary widely To grasp why rich jurisdictions top the lists,
because of financial secrecy and patchy official data ponder how many rich Nigerians might stash secret
ART: ISTOCK / SLALOMP; FILBORG; SUESSE; SLAVICA

and because there’s no generally accepted definition assets in Geneva or London—then consider how
of a tax haven. Mine boils down to two words: many rich Swiss or Britons would hide assets in
“escape” and “elsewhere.” To escape rules you don’t Lagos. Offshore capital tends to drain from poor
like, you take your money elsewhere, offshore, across countries to rich ones.

September 2019 | FINANCE & DEVELOPMENT 7

 Until a decade or so ago there were few political
brakes on the expansion of tax havens.
And the offshore system is growing. When one this method cuts out tax havens: if a firm has a
jurisdiction crafts a new tax loophole or secrecy one-person office in Bermuda, the formula allocates
facility that successfully attracts mobile money, a minuscule portion of its global profits there, so it
others copy or outdo it in a race to the bottom. That hardly matters whether Bermuda taxes its portion
has contributed to a dramatic decline in average at a zero rate. In practice, this system also suffers
corporate tax rates, which have decreased by half, technical difficulties, and the choice of formula is
from 49 percent in 1985 to 24 percent today. For highly political—but it is simpler, fairer, and more
US multinationals, corporate profit shifting into rational than the current system.
tax havens has risen from an estimated 5 percent Indeed, many US states, Canadian provinces,
to 10 percent of gross profits in the 1990s to about and Swiss cantons have for some time used lim-
25 to 30 percent today (Cobham and Janský 2017). ited versions of the system for subnational taxes,
The principles of the international corporate tax even though it is not yet used internationally. A
system were laid down under the League of Nations move is already underway to require multina-
almost a century ago. They treat multinational enter- tionals to break down and even publish financial
prises as loosely connected “separate entities.” This is and accounting information on a country-by-
a fiction: multinationals in fact draw great strength country basis, which could provide relevant data
from their unitary nature, reaping market power for an international allocation formula. Many other
and economies of scale. If the whole is worth more incremental stepping-stones toward the alternative
than the sum of its (geographically diverse) parts, are possible, so change can be evolutionary rather
which countries get to tax that extra value? It is rarely than revolutionary.
lower-income countries, since the system tends to Until a decade or so ago, there were few political
give preference to the place where multinationals brakes on the expansion of tax havens. After the
have their headquarters, usually rich countries. 2008 crisis, however, governments came under
What is more, multinationals can manipulate pressure to close large budget deficits and to pla-
the so-called transfer prices of transactions between cate voters furious about taxpayer-funded bank
these affiliates to shift profits from high- to low- bailouts, widening inequality, and the ability of
tax jurisdictions. For example, a firm’s affiliate multinationals and the wealthy to escape tax. The
may hold a patent in a low-tax haven and charge Panama Papers and Luxembourg Leaks revealed
exorbitant brand royalties to affiliates in high-tax the use of tax havens for often nefarious purposes
countries, thus maximizing profits in the low-tax and reinforced the pressure to do something. So
jurisdiction. In theory, transfer prices are meant the Organisation for Economic Co-operation and
to reflect market prices that would prevail in arm’s Development (OECD), the rich-country group
length transactions between two unrelated parties. that is the main standard-setter for international
But such prices often cannot readily be established: tax matters, launched two big projects.
try valuing a unique widget for a jet engine that One is the Common Reporting Standard (CRS),
isn’t sold on the open market, or a drug patent. a regime to exchange financial information auto-
In practice, the value is often what the company’s matically across borders so as to help tax authorities
accountants say it is. track the offshore holdings of their taxpayers. But
The main alternative to “arm’s length, separate the CRS contains many loopholes; for example,
entity” is something called “unitary tax with for- it allows people with the right passport to claim
mulary apportionment.” This system considers a residence in a tax haven, rather than in the coun-
multinational to be a single entity and apportions try where they live. The United States constitutes
profits geographically according to a formula reflect- an even bigger, geographic loophole: under the
ing real economic activity, which could be a mix of Foreign Account Tax Compliance Act, it collects
sales, employment, and tangible assets. In theory, information from overseas on its own taxpayers,

8 FINANCE & DEVELOPMENT | September 2019

 Shaxson, 7/23/19
HIDDEN CORNERS

Too much finance?

Most advanced economies, including the United States, are past the point at which
financial sector growth is beneficial.
(effect on GDP growth rate, percentage points)
but it shares little information the other way, so 6
nonresidents can hold assets in the country in Morocco Poland
Ireland
conditions of great secrecy, making the United 5
States a major tax haven. Ecuador
4
Still, the CRS brought some results. The OECD
estimated in July 2019 that 90 countries had shared 3
information on 47 million accounts worth €4.9
2
trillion; that bank deposits in tax havens had been The Gambia 95% confidence United States
reduced by 20 to 25 percent; and that voluntary band around the
1 “turning point”
disclosures ahead of implementation had generated
0
€95 billion in additional tax revenue for members
of the OECD and the Group of 20, which includes –1
major emerging market economies. 0.0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1.0
The other big initiative was the base erosion and Financial development index
profit shifting (BEPS) project, aimed at multinational Source: Sahay and others (2015). Data updated in July 2019.
corporations. This was the OECD’s effort to “realign
taxation with economic substance” without disrupt-
ing the long-held international consensus supporting
the arm’s length principle, which was bolstered by plan was “extraordinarily radical” and would have
tax-escaping multinationals and their allies. While been “almost inconceivable” even five years ago.
BEPS did improve transparency for multinationals, We are now at the start of the most significant
it was ultimately seen as something of a failure by period of change to the international corporate
the OECD, especially for the digitalized economy. tax system in a century. Progress will hinge on
The United States also belatedly recognized power struggles: between countries, rich and poor,
that, with a consumption-heavy economy, it made and within countries, between ordinary taxpayers
sense to shift taxing rights toward the place where and those that profit from the current system.
sales occur. And emerging market economies, But radical change is feasible. The Tax Justice
including Colombia, Ghana, and India, which Network, which I have worked with, now sees its
gained more clout starting in 2016, have pushed four core demands, initially dismissed as utopian,
for new approaches. The OECD began consider- gaining global traction: automatic exchange of
ing sales-only formulas, but some lower-income financial information across borders, public reg-
countries favor a formula that includes employees isters of beneficial ownership of financial assets,
and tangible assets, which would give them greater country-by-country reporting, and now unitary
taxing rights. These shifts away from arm’s length tax with formula apportionment.
orthodoxy represent a step toward tax campaigners’ But corporate tax is just a start. To understand the
demands for formula apportionment. broader issues, we must consider the forces that make
In January 2019 the dam began to break. For the the offshore system tick. Switzerland’s example is
first time, the OECD conceded publicly a need for illustrative. In past decades, politicians in Germany,
“solutions that go beyond the arm’s length principle.” the United States, and elsewhere have clashed with
In March, Christine Lagarde, then managing direc- Switzerland over banking secrecy, with little success.
tor of the IMF, called the method “outdated” and In 2008, however, after discovering that Swiss bank-
“especially harmful to low-income countries.” She ers had helped US clients evade tax, the Department
urged a “fundamental rethink” with moves toward of Justice took a different tack: it targeted not the
formula-based approaches to allocating income. In country, but its bankers and banks. In response,
May, the OECD published a “road map” proposing the embattled private players became major lobby-
reforms based on two pillars: first, determining ists for reform, and Switzerland soon made major
where tax should be paid and on what basis, and concessions on banking secrecy for the first time.
what portion of profits should be taxed on that The lesson: any effective international response must
basis; and second, getting multinationals to pay a include strong sanctions against the private enablers,
minimum level of tax. Professor Reuven Avi-Yonah, including accountants and lawyers—especially when
of the University of Michigan Law School, said the they facilitate criminal activity such as tax evasion.

September 2019 | FINANCE & DEVELOPMENT 9

 For many economies hosting an offshore financial
center is a lose-lose proposition.
On a deeper level, consider this. The engine of in rent seeking and loss of entrepreneurship at the
the offshore system is competition among juris- expense of productive, wealth-creating activities
dictions to provide the best ways to avoid taxes, as easy money flows in. Some scholars also decry
disclosure, and financial regulation. Traditionally, “financialization,” or a shift from wealth-creating
such a race to the bottom is framed as a collective activities toward more predatory, wealth-extracting
action problem requiring collaborative, multilateral activities such as monopolization, too-big-to-fail
solutions. But cooperative approaches have flaws. banking, and the use of tax havens.
Some jurisdictions feel inclined to cheat as they seek Financial flows seeking secrecy or fleeing corpo-
to attract mobile capital, so collective action can be rate taxes seem likely to be exactly the kind that
like herding squirrels on a trampoline. Moreover, it exacerbate the finance curse, worsening inequal-
is tough to mobilize voters in support of complex ity, increasing vulnerability to crises, and dealing
cross-border collaboration, especially when the goal unquantifiable political damage as secrecy-shrouded
is to help foreigners or low-income countries. capital infiltrates Western political systems. And
There is a radically different, more powerful, as financial capital flows from poorer countries to
approach. The relevant question is, Do the finan- rich-world tax havens, labor migration will follow.
cial flows attracted by tax havens help the receiv- As ever, more research is needed here. Yet it
ing countries? They certainly help interest groups seems that for many economies hosting an offshore
there—typically in the banking, accounting, legal, financial center is a lose-lose proposition: it not only
and real estate professions—but do they benefit transmits harm outward to other countries, but
the jurisdiction as a whole? inward, to the host. Countries that recognize this
A new and growing strand of research by the danger can act unilaterally to rein in their offshore
IMF, the Bank for International Settlements, and financial centers, simply stepping out of the race to
others suggests that the answer is no. This “too the bottom and curbing tax haven activity while
much finance” literature argues that financial sector also improving their own citizens’ well-being. This
growth is beneficial up to an optimal point, after is a powerful, winning formula.
which it starts to harm economic growth (see chart,
previous page). Most advanced economies, includ- NICHOLAS SHAXSON is author of Poisoned Wells, a book
ing the United States, the United Kingdom, and about the resource curse in west Africa; Treasure Islands,
other major tax havens, passed that point long ago. about tax havens; and most recently The Finance Curse, about
For them, shrinking the financial sector to remove countries with oversized financial sectors.
harmful financial activities should boost prosperity.
Alongside this research, John Christensen, a References:
former economic advisor to the British tax haven Cobham, Alex, and Petr Janský. 2017. “Measuring Misalignment: The Location of US
Jersey, and I have developed the concept of a finance Multinationals’ Economic Activity versus the Location of their Profits.” Development Policy
curse, which afflicts jurisdictions with an oversize Review 37 (1): 91–110.
financial sector and is analogous to the resource curse . 2018. “Global Distribution of Revenue Loss from Corporate Tax Avoidance:
that vexes some countries dependent on commodi- Re-Estimation and Country Results.” Journal of International Development 30 (2):
206–32.
ties such as oil. This “paradox of poverty in the midst
Crivelli, Ernesto, Ruud A. de Mooij, and Michael Keen. 2015. “Base Erosion, Profit Shifting
of plenty” has multiple causes: a brain drain of skilled
and Developing Countries.” IMF Working Paper 15/118, International Monetary Fund,
people from government, industry, and civil society Washington, DC.
into the high-paying dominant sector; rising and Henry, James S. 2016. “Taxing Tax Havens.” Foreign Affairs, April 12.
growth-sapping inequality between the dominant
Sahay, Ratna, and others. 2015. “Rethinking Financial Deepening.” IMF Staff Discussion
and the other sectors; an increase in local prices Note 15/08, International Monetary Fund, Washington, DC.
that renders other tradables sectors less competitive
Zucman, Gabriel. 2017. “How Corporations and the Wealthy Evade Taxes.” New York Times,
with imports; recurrent booms and busts in prices November 10.
of commodities and financial assets; and an increase

10 FINANCE & DEVELOPMENT | September 2019