Global Financial Integrity


Tax Havens

If you live in the United States, the phrase “tax haven” might bring to mind palm trees, sand lodged in toe crevices, and small countries brimming with peculiar corporate offices. If you live in Europe, you may think of Luxembourg’s wealth management industry, Switzerland’s infamous banking system, or Jersey’s castle-studded and not-so-sandy shores. If you live in sub-Saharan Africa, you might think of how over $1 trillion in illicit financial flows has been siphoned from the continent in recent decades in a process largely facilitated by tax havens.

At its simplest, the term denotes a jurisdiction that has intentionally enacted policies which enable it to tax individuals’ or businesses’ income or wealth at lower rates than other jurisdictions. But because users of tax havens typically don’t live (in the case of an individual) or operate (in the case of a business) in the jurisdiction, tax havens must provide secrecy to hide non-residents’ incoming wealth from other governments. In other words, not only do tax havens offer lower tax rates, they also offer regulatory environments that ensure secrecy for non-residents, allowing users to geographically relocate profits and income-generating assets without creating a publicly-accessible paper trail. 

This secrecy, which is usually provided by legal and quasi-legal structures available in tax havens like trusts, anonymous companies, or opaque banks, makes it impossible for tax officials at home to track untaxed wealth sitting in tax havens abroad or “offshore”. One of the problems with the term “tax haven,” then, is that it underemphasizes the integral “secrecy” component of tax havens and overemphasizes the importance of low tax rates. Another problem with the term is that it advances the idea of a dichotomous world comprised of tax havens and non-tax havens. As scholars have pointed out, this dichotomous portrait is not reflective of reality: most countries, including countries not conventionally considered to be tax havens, contain varying levels of financial secrecy. Jurisdictions, then, vary in their degree of tax haven-ness in quantifiable ways. The world is full of different kinds of tax havens that operate under different levels of financial secrecy, and because of its broadness, the term “tax haven” fails to capture effective complexity.

Tax havens are inimical to the global financial system because they facilitate both tax avoidance and tax evasion. These terms appear prima facie similar, but they have legally important, though often hazy, differences. Tax avoidance is commonly described as a “legal reduction in taxes,” whereas tax evasion implies using illegal–and therefore adjudicable–means to reduce taxes. When individuals use tax haven secrecy to reduce taxes on assets and income, they are typically engaging in “tax evasion,” since most countries require citizens to report any interest-generating assets held abroad. If individuals don’t report this form of income, they are illegally dodging taxation. When corporations use tax havens to reduce taxable income, however, the legal status of their actions are less clear. Some experts argue that profit shifting–a practice whereby corporations shift taxable profits from high-tax jurisdictions to low-tax jurisdictions and costs from low-tax jurisdictions to high-tax jurisdictions–is a form of tax evasion, while others argue that it is a form of legal avoidance.

In addition to threatening the stability of the international financial system, tax evasion–at both individual and corporate levels–exacerbates poverty and inequality on a global scale. It’s hard to overstate the magnitude of this latter point. Using a fairly conservative methodology, Gabriel Zucman estimates wealthy individuals are stashing over US$8.7 trillion in tax havens around the world–a number tantamount to 11.5 percent of 2017 global GDP. Loftier estimates put the figure around US$36 trillion. If we go by Zucman’s conservative estimate, individuals using tax havens to evade income taxation account for US$200 billion in government revenue losses annually (to say nothing of losses in capital gains tax revenue). 

If we combine this loss of individual income tax revenue with losses due to corporate tax avoidance, the number quadruples. Over US$600 billion in would-be corporate income tax is siphoned away from governments and into tax havens annually, and this massive tax drain disproportionately affects low-income countries. In fact, low-income governments’ revenue losses attributable to tax havens far outpace inflows of foreign aid. Addressing these resource drains is crucial; tax havens dramatically dampen international development efforts. Multilateral campaigns to fight global poverty will fall flat without a substantive plan to reign in the excesses of tax havens.

In addition to sheltering massive amounts of tax-evading cash, tax havens function as laundromats for corrupt, illicit wealth. Funds accrued through criminal means, such as drug trafficking, the pilfering of public resources, extortion, bribery, human trafficking, and fraud, are routinely wired through tax havens, whose opaque financial structures (offshore banks, shell companies, trusts, law firms) decouple illicit wealth from its owner/s. By wiring illicit wealth through a patchwork of offshore entities–a process called ‘layering,’ which often involves multiple financial structures in multiple tax havens–criminals make it impossible for authorities and journalists to connect the proceeds of criminal enterprise to actual perpetrators. After illicit funds are scrubbed clean, they can be re-invested in legitimate global financial markets.