TACKLING
Tax Havens

6FINANCE & DEVELOPMENT | September 2019

The billions attracted by tax havens do harm to sending and receiving nations alikentil the 2008 financial crisis, tax
havens were generally seen as exotic
sideshows to the global economy,
Caribbean islands or Alpine financial fortresses frequented by celebrities, gangsters, and wealthy aristocrats. 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 imagined; and second, the biggest havens aren’t where
we thought they were.
Tax havens collectively cost governments between$500 billion and $600 billion a year in lost corporate
tax revenue, depending on the estimate (Crivelli,de Mooij, and Keen 2015; Cobham and Janský2018), through legal and not-so-legal means. Of
that lost revenue, low-income economies accountfor some $200 billion—a larger hit as a percentage
of GDP than advanced economies and more thanthe $150 billion or so they receive each year inforeign development assistance. American Fortune
500 companies alone held an estimated $2.6 trillion
offshore in 2017, though a small portion of that has
been repatriated following US tax reforms in 2018.
Corporations aren’t the only beneficiaries.
Individuals have stashed $8.7 trillion in tax havens,
estimates Gabriel Zucman (2017), an economist at
the University of California at Berkeley. Economist
and lawyer James S. Henry’s (2016) more comprehensive estimates yield an astonishing total ofup to $36 trillion. Both, assuming very different
rates of return, put global individual income tax
losses at around $200 billion a year, which must
be added to the corporate total.
These highly uncertain estimates vary widely
because of financial secrecy and patchy official data
and because there’s no generally accepted definitionof a tax haven. Mine boils down to two words:“escape” and “elsewhere.” To escape rules you don’t
like, you take your money elsewhere, offshore, acrossborders. I prefer such a broad definition because
these havens affect far more than tax: they provide
an escape route from financial regulations, disclosure, criminal liability, and more. Because the maincorporate users of tax havens are large financialinstitutions and other multinationals, the systemtilts the playing field against small and medium
enterprises, boosting monopolization.
Political damage, while unquantifiable, must beadded 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
majority. Tax havens defend themselves as “taxneutral” conduits helping international finance andinvestment flow smoothly. But while the benefits
for the private players involved are evident, thesame may not be true for the world as a whole; it is
now widely accepted that in addition to tax losses,
allowing capital to flow freely across borders carries
risks, including the danger of financial instability
in emerging market economies.
As a general rule, the wealthier the individual andthe larger the multinational corporation—somehave hundreds of subsidiaries offshore—the moredeeply they are embedded in the offshore systemand the more vigorously they defend it. Powerful
governments also have a stake; most major havens
are located in advanced economies or their territories. The Tax Justice Network’s Corporate Tax
Haven Index ranks the top three as the British
Virgin Islands, Bermuda, and the Cayman Islands—
all British overseas territories. The organization’s
Financial Secrecy Index ranks Switzerland, theUnited States, and the Cayman Islands as the top
three jurisdictions for private wealth.
To grasp why rich jurisdictions top the lists,
ponder how many rich Nigerians might stash secretassets in Geneva or London—then consider how
many rich Swiss or Britons would hide assets inLagos. Offshore capital tends to drain from poor
countries to rich ones.

September 2019 | FINANCE & DEVELOPMENT

ART: ISTOCK / SLALOMP; FILBORG; SUESSE; SLAVICAU

Nicholas Shaxson

7

Until a decade or so ago there were few politicalbrakes on the expansion of tax havens.
And the offshore system is growing. When one
jurisdiction crafts a new tax loophole or secrecy
facility that successfully attracts mobile money,
others copy or outdo it in a race to the bottom. That
has contributed to a dramatic decline in average
corporate tax rates, which have decreased by half,from 49 percent in 1985 to 24 percent today. ForUS multinationals, corporate profit shifting into
tax havens has risen from an estimated 5 percent
to 10 percent of gross profits in the 1990s to about
25 to 30 percent today (Cobham and Janský 2017).
The principles of the international corporate tax
system were laid down under the League of Nations
almost a century ago. They treat multinational enterprises as loosely connected “separate entities.” This isa fiction: multinationals in fact draw great strengthfrom their unitary nature, reaping market powerand economies of scale. If the whole is worth morethan the sum of its (geographically diverse) parts,
which countries get to tax that extra value? It is rarely
lower-income countries, since the system tends togive preference to the place where multinationals
have their headquarters, usually rich countries.
What is more, multinationals can manipulate
the so-called transfer prices of transactions between
these affiliates to shift profits from high- to lowtax jurisdictions. For example, a firm’s affiliate
may hold a patent in a low-tax haven and chargeexorbitant brand royalties to affiliates in high-tax
countries, thus maximizing profits in the low-tax
jurisdiction. In theory, transfer prices are meant
to reflect market prices that would prevail in arm’s
length transactions between two unrelated parties.
But such prices often cannot readily be established:
try valuing a unique widget for a jet engine that
isn’t sold on the open market, or a drug patent.
In practice, the value is often what the company’s
accountants say it is.
The main alternative to “arm’s length, separateentity” is something called “unitary tax with formulary apportionment.” This system considers amultinational to be a single entity and apportions
profits geographically according to a formula reflecting real economic activity, which could be a mix ofsales, employment, and tangible assets. In theory,
8

FINANCE & DEVELOPMENT | September 2019

this method cuts out tax havens: if a firm has a
one-person office in Bermuda, the formula allocatesa minuscule portion of its global profits there, so it
hardly matters whether Bermuda taxes its portion
at a zero rate. In practice, this system also suffers
technical difficulties, and the choice of formula ishighly political—but it is simpler, fairer, and morerational than the current system.
Indeed, many US states, Canadian provinces,and Swiss cantons have for some time used limited versions of the system for subnational taxes,
even though it is not yet used internationally. A
move is already underway to require multinationals to break down and even publish financial
and accounting information on a country-bycountry basis, which could provide relevant data
for an international allocation formula. Many otherincremental stepping-stones toward the alternative
are possible, so change can be evolutionary rather
than revolutionary.
Until a decade or so ago, there were few politicalbrakes on the expansion of tax havens. After the2008 crisis, however, governments came underpressure to close large budget deficits and to placate voters furious about taxpayer-funded bankbailouts, widening inequality, and the ability ofmultinationals and the wealthy to escape tax. The
Panama Papers and Luxembourg Leaks revealed
the use of tax havens for often nefarious purposes
and reinforced the pressure to do something. So
the Organisation for Economic Co-operation andDevelopment (OECD), the rich-country groupthat is the main standard-setter for international
tax matters, launched two big projects.
One is the Common Reporting Standard (CRS),
a regime to exchange financial information automatically across borders so as to help tax authorities
track the offshore holdings of their taxpayers. But
the CRS contains many loopholes; for example,
it allows people with the right passport to claim
residence in a tax haven, rather than in the country where they live. The United States constitutes
an even bigger, geographic loophole: under theForeign Account Tax Compliance Act, it collects
information from overseas on its own taxpayers,

HIDDEN CORNERS

Shaxson, 7/23/19

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, sononresidents can hold assets in the country inconditions of great secrecy, making the UnitedStates a major tax haven.
Still, the CRS brought some results. The OECDestimated in July 2019 that 90 countries had shared
information on 47 million accounts worth €4.9trillion; that bank deposits in tax havens had been
reduced by 20 to 25 percent; and that voluntary
disclosures ahead of implementation had generated€95 billion in additional tax revenue for membersof the OECD and the Group of 20, which includes
major emerging market economies.
The other big initiative was the base erosion andprofit shifting (BEPS) project, aimed at multinationalcorporations. This was the OECD’s effort to “realigntaxation with economic substance” without disrupting the long-held international consensus supporting
the arm’s length principle, which was bolstered by
tax-escaping multinationals and their allies. While
BEPS did improve transparency for multinationals,
it was ultimately seen as something of a failure by
the OECD, especially for the digitalized economy.
The United States also belatedly recognized
that, with a consumption-heavy economy, it madesense to shift taxing rights toward the place wheresales occur. And emerging market economies,
including Colombia, Ghana, and India, which
gained more clout starting in 2016, have pushedfor new approaches. The OECD began considering sales-only formulas, but some lower-income
countries favor a formula that includes employees
and tangible assets, which would give them greatertaxing rights. These shifts away from arm’s lengthorthodoxy represent a step toward tax campaigners’
demands for formula apportionment.
In January 2019 the dam began to break. For thefirst time, the OECD conceded publicly a need for“solutions that go beyond the arm’s length principle.”
In March, Christine Lagarde, then managing director of the IMF, called the method “outdated” and“especially harmful to low-income countries.” She
urged a “fundamental rethink” with moves toward
formula-based approaches to allocating income. InMay, the OECD published a “road map” proposing
reforms based on two pillars: first, determining
where tax should be paid and on what basis, andwhat portion of profits should be taxed on thatbasis; and second, getting multinationals to pay aminimum level of tax. Professor Reuven Avi-Yonah,of the University of Michigan Law School, said the6Morocco

5PolandIrelandEcuador

432

95% confidenceband around the“turning point”

The Gambia

1United States

0–1
0.0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

Financial development index

0.8

0.9

1.0

Source: Sahay and others (2015). Data updated in July 2019.

plan was “extraordinarily radical” and would havebeen “almost inconceivable” even five years ago.
We are now at the start of the most significant
period of change to the international corporate
tax system in a century. Progress will hinge on
power struggles: between countries, rich and poor,
and within countries, between ordinary taxpayers
and those that profit from the current system.
But radical change is feasible. The Tax Justice
Network, which I have worked with, now sees its
four core demands, initially dismissed as utopian,gaining global traction: automatic exchange offinancial information across borders, public registers of beneficial ownership of financial assets,country-by-country reporting, and now unitary
tax with formula apportionment.
But corporate tax is just a start. To understand thebroader issues, we must consider the forces that makethe offshore system tick. Switzerland’s example isillustrative. In past decades, politicians in Germany,
the United States, and elsewhere have clashed with
Switzerland over banking secrecy, with little success.
In 2008, however, after discovering that Swiss bankers had helped US clients evade tax, the Departmentof Justice took a different tack: it targeted not thecountry, but its bankers and banks. In response,
the embattled private players became major lobbyists for reform, and Switzerland soon made major
concessions on banking secrecy for the first time.
The lesson: any effective international response must
include strong sanctions against the private enablers,
including accountants and lawyers—especially when
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 ofthe offshore system is competition among jurisdictions to provide the best ways to avoid taxes,
disclosure, and financial regulation. Traditionally,such a race to the bottom is framed as a collective
action problem requiring collaborative, multilateralsolutions. But cooperative approaches have flaws.
Some jurisdictions feel inclined to cheat as they seek
to attract mobile capital, so collective action can belike herding squirrels on a trampoline. Moreover, it
is tough to mobilize voters in support of complex
cross-border collaboration, especially when the goal
is to help foreigners or low-income countries.
There is a radically different, more powerful,approach. The relevant question is, Do the financial flows attracted by tax havens help the receiving countries? They certainly help interest groups
there—typically in the banking, accounting, legal,
and real estate professions—but do they benefit
the jurisdiction as a whole?
A new and growing strand of research by theIMF, the Bank for International Settlements, andothers suggests that the answer is no. This “toomuch finance” literature argues that financial sector
growth is beneficial up to an optimal point, after
which it starts to harm economic growth (see chart,previous page). Most advanced economies, including the United States, the United Kingdom, andother major tax havens, passed that point long ago.
For them, shrinking the financial sector to remove
harmful financial activities should boost prosperity.
Alongside this research, John Christensen, aformer economic advisor to the British tax haven
Jersey, and I have developed the concept of a financecurse, which afflicts jurisdictions with an oversize
financial sector and is analogous to the resource cursethat vexes some countries dependent on commodities such as oil. This “paradox of poverty in the midstof plenty” has multiple causes: a brain drain of skilled
people from government, industry, and civil societyinto the high-paying dominant sector; rising andgrowth-sapping inequality between the dominant
and the other sectors; an increase in local pricesthat renders other tradables sectors less competitive
with imports; recurrent booms and busts in pricesof commodities and financial assets; and an increase
10FINANCE & DEVELOPMENT | September 2019

in rent seeking and loss of entrepreneurship at theexpense of productive, wealth-creating activities
as easy money flows in. Some scholars also decry“financialization,” or a shift from wealth-creating
activities toward more predatory, wealth-extracting
activities such as monopolization, too-big-to-failbanking, and the use of tax havens.
Financial flows seeking secrecy or fleeing corporate taxes seem likely to be exactly the kind thatexacerbate the finance curse, worsening inequality, increasing vulnerability to crises, and dealing
unquantifiable political damage as secrecy-shrouded
capital infiltrates Western political systems. And
as financial capital flows from poorer countries torich-world tax havens, labor migration will follow.
As ever, more research is needed here. Yet it
seems that for many economies hosting an offshore
financial center is a lose-lose proposition: it not onlytransmits harm outward to other countries, butinward, to the host. Countries that recognize thisdanger can act unilaterally to rein in their offshore
financial centers, simply stepping out of the race tothe bottom and curbing tax haven activity while
also improving their own citizens’ well-being. Thisis a powerful, winning formula.
NICHOLAS SHAXSON is author of Poisoned Wells, a bookabout the resource curse in west Africa; Treasure Islands,
about tax havens; and most recently The Finance Curse, aboutcountries with oversized financial sectors.
References:Cobham, Alex, and Petr Janský. 2017. “Measuring Misalignment: The Location of US
Multinationals’ Economic Activity versus the Location of their Profits.” Development Policy
Review 37 (1): 91–110.
. 2018. “Global Distribution of Revenue Loss from Corporate Tax Avoidance:
Re-Estimation and Country Results.” Journal of International Development 30 (2):
206–32.
Crivelli, Ernesto, Ruud A. de Mooij, and Michael Keen. 2015. “Base Erosion, Profit Shiftingand Developing Countries.” IMF Working Paper 15/118, International Monetary Fund,Washington, DC.
Henry, James S. 2016. “Taxing Tax Havens.” Foreign Affairs, April 12.
Sahay, Ratna, and others. 2015. “Rethinking Financial Deepening.” IMF Staff Discussion
Note 15/08, International Monetary Fund, Washington, DC.
Zucman, Gabriel. 2017. “How Corporations and the Wealthy Evade Taxes.” New York Times,November 10.