Nick Shaxson ■ Tax havens: beyond illicit financial flows
Capital flows, tax havens and offshore secrecy
A guest post by Prof. Sol Picciotto, a TJN Senior Adviser. This was first published in African Agenda, vol. 18 No. 2, published June 2015
The discussion of the Mbeki Panel report in the last issue of African Agenda, in both the Editorial and the article by Tetteh Hormeku, rightly drew attention to the need to look beyond the issue of ‘illegal flows’. While the Panel’s concern with ‘money illegally earned, transferred or used’ is important, there are much wider implications raised by the report.
The Mbeki report rightly included a discussion of tax losses from techniques used by multinational companies (MNCs), but these techniques were described as involving ‘aggressive tax practices’, and ‘abusive transfer pricing’. These descriptions misstate the nature of the issue, since MNC tax avoidance employs standard practices, which are not only allowed but encouraged by current international tax rules.
It also pointed to the role played by ‘financial secrecy jurisdictions and/or tax havens’, as an enabling factor. In fact, it was MNCs themselves, together with wealthy families, who devised and developed the tax haven and offshore financial secrecy system, and they are still its main users. For example, a report by Action Aid in 2011 showed that 98 of the 100 largest companies registered on the London Stock Exchange (the FTSE 100) between them had over 34,000 affiliates, a third located in tax havens. The heaviest user was the banking sector, which especially favours the Cayman Islands (where Barclays alone had 174 companies). In effect, the perfectly legal and indeed normal tax avoidance practices of MNCs operate in collusion with the wider spectrum of corruption and criminality sustained by the offshore system.
Tax Justice Campaigns
Hence, the tax justice campaign which has spread rapidly both in Africa and around the world in the last 15 years, has focused on this tax haven and offshore secrecy system. Our main demands have been:
- to combat secrecy: a comprehensive system for all countries to exchange information automatically for tax purposes, and to obtain necessary information by overriding tax and professional secrecy, together with registration of the actual owners (beneficial ownership) of companies, trust and other legal entities;
- for MNC taxation: reform of international tax rules to enable them to be treated in accordance with the economic reality that they function as unitary enterprises.
As a result of worldwide political pressures, especially following the financial crisis of 2008-9, the G20 world leaders took up both these issues, although they handed the work of formulating policy proposals to the technical experts of the OECD, the rich countries’ club.
Lobbying and Policy Communities
This is not the place to discuss these issues in any detail. However, it is important for campaigners to continue to monitor the development and implementation of these measures by the OECD. Our experience has been that, despite the strong political pressures, the policy proposals which emerge from global governance institutions envisage only weak reforms. A major factor of course is the enormous lobbying effort mounted by the MNCs and the large accounting, law and corporate service firms which support them, which clearly have a lot to lose.
Another reason is the technical complexity of the rules, resulting from the investment of intellectual and cultural capital by the specialists who devised and elaborate them. International tax advisers form a closed community of expertise, which includes not only the well-paid practitioners in private firms, but also many academics and government officials, who participate in specialist conferences and other forms of knowledge production. These processes tend to produce a generally accepted orthodoxy, rejecting alternative approaches. Although concerned with technical expertise, such communities are inevitably dominated by the interests and perspectives of MNCs, which can apply enormous resources to these activities. This undermines the independence of academics, who often become dependent on corporate funding, and of officials, who frequently take the revolving door which enables them to join private firms, and (less often) movement in the other direction. Many of the top private sector specialists on issues such as transfer pricing have spent time working for OECD governments, and indeed in the OECD itself.
Why Tax is Central
Taxation is often thought of in terms of its distributional effects, as an instrument which can perhaps be used to reduce inequality and improve social welfare or protect human rights. On a wider view, taxes are the basis for collective social provision of public goods, ranging from transport networks to education, from investment in basic research to social and public security.
During the 20th century tax enabled the emergence of the welfare-warfare state in the capitalist metropoles, growing from under 10% to an average of as much as 40% of GDP. In contrast, of course, the distorted economies of colonised and dependent territories, treated mainly as sources of extraction of primary products, could sustain only minimal levels of public spending, even after political independence. This has been a major cause of the deadly cycle of dependency and underdevelopment.
Even more importantly, systems of taxation and public spending are central to the forms of production and reproduction of capitalism. The growth of revenues depends on acceptance of the legitimacy of taxation, which powered capitalist growth in the last century, underpinned by the liberal egalitarian principle that all citizens should contribute in proportion to their income to the costs of government. Income tax applied initially only to the wealthy, but as top tax rates were hiked in wartime, evasion grew, and the rich found ways to hide their wealth in trusts and tax havens.
The income tax was rescued by establishing pay-as-you-earn (PAYE), which provided effective collection in the era of mass industrial employment. Taxing income from capital poses much greater obstacles, as it’s difficult even to define income, let alone deduct tax at source. Since the main tax burden fell on wage and salary earners, it’s not surprising that developed countries have faced fiscal crises since the end of the Keynesian boom years and of Fordist mass employment, while underdeveloped countries found it hard to expand their tax base.
International Tax Avoidance
Economic globalisation has also undermined taxation. International tax rules were formulated in the 1920s, under the League of Nations, when international capital flows mainly took the form of portfolio investment, through bonds or loans. Hence, the right to tax business profits was assigned to the country where the business was located, while the investment income (interest, dividends) should be taxed by the country of residence of the investor.
However, it was also understood that MNCs were different, since they had branches or affiliates in various countries, and it could be hard to identify how much profit was made in each country and the proper level of investment returns. Tax authorities were given powers to adjust the accounts of entities forming part of a corporate group, to ensure a fair allocation. Some did this by starting from the profits of the MNC as a whole and apportioning them according to relevant factors, such as assets and employees. However, following the report for the League of Nations in 1933 by Mitchell Carroll, a US lawyer, the model tax treaty specified that the accounts of the affiliates of a corporate group could be adjusted by treating them as if they were independent entities.
This ‘separate entity’ or ‘arm’s length’ principle created a fundamental flaw, which has been increasingly exploited by MNCs. In the 1950s they began to set up affiliates in convenient countries, which developed as tax havens, such as Panama, the Bahamas and the Netherlands Antilles. Such entities could be used to reduce the taxable profits of operating affiliates in source countries, by charging interest on loans, fees for services or royalties for intellectual property rights, since such payments are usually tax deductible. If these profits are held offshore they are generally not tax as income of the parent company either, but they are available for reinvestment. The enormous expansion of MNCs from the late 1950s was largely financed from these untaxed retained foreign earnings.
The ability of MNCs to transfer enormous sums of money internationally, and their large pools of liquid capital, fuelled the emergence of the Eurodollar market, and undermined the fixed exchange rate system set up by Bretton Woods. Financial liberalisation in turn led to the astronomic growth of the ‘offshore’ financial system, which provides MNCs with privileged access to low-cost finance, while also channelling and sheltering the ill-gotten gains of corrupt politicians, arms dealers, and tax-dodgers.
International Corporate Capitalism and the State
Tax is only one example, although an important one, of the way that the power of MNCs has grown through their interactions with states. A major competitive advantage of MNCs is their ability to take advantage of differences between states, not only of geographical, economic and social factors, but also of government regulation. This enables them to lobby for favourable terms, for example tax incentives. Although it is widely recognised that these are beggar-thy-neighbour policies which in the end weaken all states, they are very hard to combat. They range from the tax exemptions and holidays offered to mining companies by poor states, to the special treatment of financial holding companies revealed by the Luxembourg Leaks.
It should be clear that the only way to strengthen national sovereignty, in the face of multinational corporate power, is through international coordination and cooperation. Yet governments find this hard to achieve, preferring to give priority to short-term national interests. Politicians are also often closely bound to business interests, either overtly (e.g. Berlusconi, Shinawatra), or through various forms of corruption. There is clearly an important role for civil society activists, who in the last couple of decades have begun to match the ability of the big business bosses and their professional advisers in navigating the networks of global governance. One of the most important of these is the tax justice movement.
Sol Picciotto is emeritus professor of Lancaster University (UK), has been a Senior Adviser of the Tax Justice Network since 2003, is a member of the Advisory Group of the International Centre for Tax and Development, and is the coordinator of the BEPS Monitoring Group, a civil society body monitoring an OECD project to tighten up the international tax system.
 Civil society efforts on these issues include the Financial Secrecy Index http://www.financialsecrecyindex.com/ and the BEPS Monitoring Group https://bepsmonitoringgroup.wordpress.com/ , both affiliated with the Tax Justice Network.
 This history is outlined in more detail in my paper ‘Is the International Tax System Fit for Purpose, Especially for Developing Countries?’, available at http://ictd.ac/sites/default/files/ICTD%20WP13_0.pdf
Some things never change: the use of Swiss banks by crooks
New study and tool for assessing risks of illicit financial flows in Latin America
Vulnerability and exposure to illicit financial flows risk in Latin America
28 January 2021
The US beneficial ownership law has its weaknesses, but it’s a seismic shift
Argentina keeps pushing to be at the vanguard of transparency. Now they need to make more information public
How a mini movement overturned secret US shell companies
Taxing Wall Street: the Tax Justice Network December 2020 podcast
Researcher vacancies at the Tax Justice Network: Latin America and Francophone Africa
The Corporate Tax Haven Index: a Joint Research Centre audit
The State of Tax Justice 2020
20 November 2020