• Transparency, Financial Crisis and Tax Havens

  • Μάτι Ιλόνεν | 20 May 09
  • Transparency has been a major topic ever since the explosion of the financial crisis. There are several reasons for this. We need more transparency in order to make the global financial system stabler, more predictable and equitable. Transparency has also been one of the defining words in the vocabulary of the contemporary global economy. The crisis has increased its importance even further. 

    The concept of transparency

    Multinational companies have been eager to adopt the concept of transparency in their corporate social responsibility reports and statements. But as often happens in matters of corporate social responsibility, the content of transparency can be quite different from its form. It took the financial crisis to make politicians and corporate leaders start discussing in earnest what kind of transparency the world economy needs, and the process is now accelerating. An international consensus is emerging on the need for greater transparency in the world economy and international finance, since all have an interest in preventing the re-emergence of a crisis of this sort. A critical issue is whether reforms will help pry open the secrecy structures of tax havens. If successful, this would have far-reaching impact not only on the way in which financial markets and the world economy work, but also on politics. Expanding the transparency of the world financial system would create many new opportunities for citizens to win back democratic control over markets. First, addressing tax evasion would lead to growing tax revenues for all countries, providing more fiscal space in which to operate. Second, taming creative accounting and corporate use of secrecy jurisdictions would reduce their markets and hence also the relative power of increasingly transnational corporations vis-à-vis states, giving back some of the lost regulatory powers to elected parliaments and reducing the self-regulation of the market. Third, increasing transparency in accounting would also give movements of civil society a whole new set of tools for shifting the corporate responsibility debate to focus on corporate accountability. As a consequence, elimination of unjustified tax and regulatory advantages could help promote more corporations at the local level, co-operatives and local banks. They would no longer find themselves disadvantaged in the face of multinational companies who do not pay their taxes. Now – more than ever – is the time for ambitious political agendas for eliminating the use of secrecy jurisdictions. In recent years, civil-society organisations and progressive governments (such as Norway and many developing countries) have developed a set of concrete, feasible proposals that would either strengthen the capacity of states to tame tax and regulatory flight, or would create pressure by forcing the end users or facilitators of the offshore economy to change their behaviour. Current initiatives by the OECD and other intergovernmental organisations to fight banking secrecy are a welcome step forward, but it seems unlikely that this Spring will see solutions that will be comprehensive enough really to tame corporate tax evasion, regulatory flight and other uses of secrecy jurisdictions. The campaigns are likely to take major steps forward, but at the same time they need to continue.

    The long history of tax havens

    The first corporate tax havens were set up in the US states of Delaware and New Jersey at the end of the 19th century. Modern bank secrecy emerged in the 1930s in Switzerland. After that, it took decades before the offshore economy started its tremendous expansion to today’s scale. In view of this history, it is remarkable how long it took before tax havens appeared on the agenda of international politics and global governance. The first major international attempts by the OECD to curb tax havens were initiated only in the mid-1990s. While several definitions of tax havens and offshore finance exist, the key characteristics are high levels of secrecy, low regulation and often low or no taxes. The key problem is secrecy – the possibility of hiding the owners who benefit or other constituencies – which has led many to prefer term secrecy jurisdiction over tax havens. Many of the biggest bankruptcies and corporate scandals in the last ten years have involved misuse of tax havens. These episodes have helped draw political attention to the offshore economy. They have also helped influence public opinion and have stimulated more interest in the issue. For example, Enron had hundreds of subsidiaries in the Cayman Islands, which it used to build a façade to cover up its huge losses. Yukos, Parmalat and Worldcom abused offshore entities as well, with the help of major banks and the big four accounting firms. Recent nationalisations of European banks have brought to light examples not unsimilar to that of Enron. British Northern Rock, one of the first banks that was nationalised when the crisis broke out, hid its high-risk subprime investments through “a web of special purpose vehicles, many in Jersey”, the Guardian newspaper reported in November 2007.1 Most of the mortgage investments were “cleaned” from the accounts of Northern Rock in non-transparent special-purpose vehicles. Nationalisation also brought attention to the tax haven operations of Fortis bank, based in the Benelux countries. It operated more than seven hundred subsidiaries in tax havens such as the British Virgin Islands, the Cayman Islands and Panama.2 Accounting firms and the banking sector have been extremely active in giving advice to multinational corporations and investors on how to exploit loopholes offered by secrecy jurisdictions. Several authorities have accused banks and the big four accounting firms of assisting in tax flight. Already in 2003, the US Senate concluded in its investigation that “the sale of potentially abusive and illegal tax shelters has become a lucrative business in the United States, and some professional firms such as accounting firms, banks, investment advisory firms, and law firms are major participants in the mass marketing of generic ‘tax products’ to multiple clients.”3 The most recent US Senate investigation dealing with the global offshore economy (September 2008) focuses on the misconduct of two well-known banks, UBS and LGT. In a press statement, Carl Levin, chairman of the permanent investigative committee, noted that “Offshore jurisdictions routinely unleash anonymous corporations, hedge funds, trusts, and other financial entities on the world, and hinder international efforts to detect, stop, and punish misconduct. Inaction by the international community has encouraged an alphabet of countries to engage in offshore abuses, from Austria to the Cayman Islands, the Isle of Man, Liechtenstein, Monaco, Singapore, Switzerland, and more. It is long overdue for the world community to take a collective stance against the offshore jurisdictions’ secretive, unregulated way of doing business. The nations of the world must adopt mechanisms to bar uncooperative offshore financial institutions from accessing international financial systems.”4 Intergovernmental institutions such as the World Bank and the IMF have been reluctant to take the problems seriously, and most of the studies on the scale of the offshore economy have been done by NGOs and think tanks. The Center for International Policy published its most recent study on the scale of the world’s illegal money flows in January 2009. The study shows that illicit global flows from developing countries alone are on a scale of $858 – $1060 billion, with a growth rate of 18.2 % between 2002 and 2006. The definition covers funds that are “illegally earned, transferred, or utilised. If it breaks laws in its origin, movement, or use it merits the label”5. The study does not cover tax avoidance or other legal uses of tax havens. Global Financial Integrity has estimated earlier that approximately half of the illicit flows originate in developing countries. Tax Justice Network has estimated that high-net-worth individuals have invested at least $11.5 trillion in tax havens, creating annual tax losses of 255 billion, almost twice the budget of the European Union. It is important to bear in mind that secrecy structures not only help economic crime, tax evasion and money laundering, but can also lead to the accumulation of huge risks that will not be noticed before it is too late.

    Initiatives address offshore economy

    In the last couple of years, several initiatives have been organised to address the offshore economy. The Tax Justice Network has gathered some of the key demands that civil-society organisations have been focusing on in a position paper published in March 2009 and targeted to the G20 meeting in April.6 Its three main topics are: improving coordination between fiscal and financial regulators, international cooperation in tax matters and improved corporate financial transparency. While it is not possible to cover the initiatives here at any length (the entire document can be accessed from the Tax Justice Network website7), some of the key principles include developing automatic information exchange on tax matters between governments, and more stringent definitions for tax compliance in IMF and World Bank reports and in the OECD. Furthermore, the initiatives cover reforming the international governance of tax issues among broad constituencies, for example by strengthening the UN Tax Committee. These changes would have tremendous effect on how companies and investors operate in the global economy and the role that states can have as regulators and supervisors. First, automatic information exchange would free governments from massive amounts of administrative work required by preventative and investigative action regarding economic crimes and other tax matters. Currently, international cooperation on tax matters works mostly in the framework of information exchange treaties. Under these treaties states agree to share information in criminal cases, i.e. when there is enough evidence to suspect someone of hiding assets in a foreign country. There are many potential problems with the treaties. For example, tax evasion has traditionally not been a crime in Switzerland, which has assisted other countries only in the prosecution of more “serious” crimes such as tax fraud (although this might be changing now due to US pressure). Moreover, getting enough evidence for a successful information-exchange request can be a burdensome task. For example, in December 2008 Jersey Finance reported in its website that the information-exchange agreement between Jersey and the US had been applied only four times in the previous year. Many new tax treaties between secrecy jurisdictions such as the Cayman Islands, Jersey, the Isle of Man, Andorra, Hong Kong and Liechtenstein have been signed this year, which is a clear signal that secrecy jurisdictions are no longer tolerated in the way they have been. New treaties are a promising step forward, but the ultimate goal has to be automatic exchange of information. The most important initiative in automatic information exchange so far has been the EU Savings Tax Directive introduced in July 2005. The directive introduced an automatic exchange of bank account information within the EU and a few tax havens outside the union, although some member states – most notably Switzerland – were given a transition period. A major problem of the directive has been its failure to address many other investment forms, such as trusts and foundations. These flaws made the directive extremely easy to circumvent. Registering a trust or other legal entity is inexpensive and relatively easy. In November 2008, the EU Commission proposed significant changes to the directive. The new version is intended to include legal entities. The EU has furthermore been seeking to open up negotiations with Hong Kong, Singapore, Macau, Japan, as well as with Canada, Bahrain, Dubai and the Bahamas.8 Secrecy jurisdictions are currently being discussed in several formal and informal groups, organisations and initiatives, which can only be mentioned here briefly. The EU and its Commission has been pushing forward some important initiatives – most notably the Savings Tax Directive. On the other hand, the World Bank and IMF have been very slow to wake up to the magnitude of the problems presented by the offshore economy.

    In July 2007, the government of Norway commissioned the World Bank to do a study of illicit financial flows, but the Bank has not shown any commitment to the task. The World Bank’s president Zoellick condemned tax havens shortly after he took office. However, the World Bank and IMF have so far only been able to refer to studies done by think tanks and civil-society organisations. The OECD has been active, but its capacity to promote concrete political initiatives depends on the consent of the OECD’s member states. NGOs and developing countries have been pushing for strengthening and expanding the mandate of the UN Tax Committee so as to transform it into a sufficiently resourced intergovernmental body. Currently, the Tax Committee has little power. An upgraded Tax Committee would help especially developing countries to strengthen their mutual coordination in tax matters and have more influence on international standards and norms related to taxation.

    Country-by-country reporting

    The most important initiative being promoted by civil-society organisations for increasing the transparency and accountability of multinational corporations is called “country-by-country reporting”. Currently, multinational corporations have to report their income and taxes paid only on a consolidated basis. This makes it extremely difficult to get information on how much tax they pay in the countries in which they operate. Furthermore, getting information on subsidiaries and company structure can be time-consuming work, as information is scattered among different national databases. New accounting standards have been proposed that make it mandatory for multinational companies to publish this and other information of their activities in every country in which they operate. Adoption of country-by-country reporting would immensely increase transparency without entailing extra costs for companies or states. One major obstacle to the initiative has been the International Accounting Standards Board (IASB) which has not been willing to discuss the proposal. IASB is owned by the big four accounting firms that market tax-planning schemes and therefore have mixed interests in this issue. While IASB does not have legislative power, it does play a powerful role as an international standard setter. Country-by-country reporting would have many advantages over the current system. It would bring to light the results of the tax avoidance schemes, taking discussions of corporate responsibility to a new level. Benefits would be largest for developing countries whose tax administrations have minimal resources for inspecting multinational companies’ accounts. In addition, the standards would give a whole new set of tools to labour unions, consumer movements and civil-society organisations.

    Sanctions against uncooperative tax havens

    In 1996, the leaders of the G7-countries commissioned the OECD to study ways to address harmful tax competition. Two years later, the OECD published a report called “Harmful Tax Competition: An Emerging Global Issue”. The report proposed a set of sanctions against uncooperative tax havens. This was a truly unusual demand to come from the OECD, which usually acts like a technical economists’ club. Initial reaction to the new initiative was rather mild. It took the follow-up report in 2000 to make tax havens begin to realise that their sovereignty – and businesses – was being threatened. As a result, small tax-haven states organised to lobby some of the key states to reject the OECD’s initiative. Key targets included the UK, the USA, Canada and New Zealand. Many of the small island states are members of the Commonwealth, which helped in persuading the UK. Jason Sharman has documented the process in his excellent book “Havens in a Storm: The Struggle for Global Tax Regulation”.9 In the US, a right-wing think tank called Center for Freedom and Prosperity (CFP) launched lobbying efforts to change the public mood into one of opposition to the OECD’s initiative. The CFP, with only a small staff, managed to get articles into the press that framed the OECD and its initiative as a “global tax police” – a characterisation that can hardly have a positive effect in the US. It is interesting that at the time, George W. Bush’s government was at first undecided as to how to position itself in relation to the OECD initiative. As a consequence of the CFP’s slander campaign, the US officially withdrew its support on May 10, 2001. Some other key states turned against the initiative, almost completely watering down the OECD’s blacklist. However, September 11th forced the US to put some pressure on secrecy jurisdictions – at least temporarily – but the sanctioned blacklist was no longer an option. The example may seem discouraging, but it also shows that in the right political climate very ambitious demands for global regulation could succeed. If even the Bush administration did not initially have a fixed position on sanctioning the use of tax havens, why should any other government? It is difficult to think of a better moment for pushing these issues than the present. The key issue will be to articulate to a wider public that at the moment transparency has totally different meanings for ordinary citizens and local companies on the one hand, and global finance and multinational corporations on the other – and that there are solutions for bringing things into better equilibrium. For ordinary citizens, transparency means state intervention in many everyday activities – often even more for people living on government allowances. For global finance and multinational corporations, especially when it comes to taxation, transparency has long been completely neglected. This is the contradiction that should be utilised in order to push forward ambitious agendas to tackle secrecy jurisdictions and the offshore economy. Much of the faceless “corporate power” of the contemporary globalised economy has actually resulted from the lack of transparency in corporate accounts, allowing massive tax avoidance, tax evasion and regulatory flight. By ending these loopholes we can bring part of the privatised regulation back into the hands of elected governments. This would not mean loads of “new” regulation. Instead, it would make the playing field more equal between small and large companies, as well as between ordinary citizens and the super-rich. It could also mean more space for democracy, especially in the longer term. Increased tax revenues would strengthen states in many ways. The benefits would be largest in developing countries that would gain more policy space and reduced aid dependency. Taxation is, after all, the most sustainable way to build not only public services and other state functions, but is also the basis for the social contract between a state and its citizens.

    At the same time, new forms of global governance, preferably an upgraded UN Tax Committee, could pave the way to a more ambitious International Tax Organisation. What alternatives are there? If nothing is done about secrecy jurisdictions, the result will be continued tax flight, erosion of the regulatory bases of nations, and the continued accumulation of risks in financial markets and within large multinational corporations. This would leave states as powerless in the face of “markets” as they have been. Thus the key question is whether the reforms agreed on now will really go to the core of the secrecy structures, or whether they will just cure the symptoms. In the latter case, we could well be waiting for the next financial bubble to burst.



    1. The Guardian, November 23, 2007: “How bidders took fright at the hole in Rock’s books”
    2. Volkskrant, November 7, 2008,  www.volkskrant.nl/economie/article1074902.ece/Moet_ik_Wouter_Bos_mijn_zwart_geld_opbiechten
    3. http://levin.senate.gov/newsroom/supporting/2003/111803TaxShelterReport.pdf
    4. http://levin.senate.gov/newsroom/release.cfm?id=304426
    5. http://www.gfintegrity.org/storage/gfip/executive%20-%20final%20version%201-5-09.pdf
    6. www.taxjustice.net/cms/upload/pdf/TJN_0903_Action_Plan_for_G-20.pdf
    7. www.taxjustice.net/cms/upload/pdf/TJN_0903_Action_Plan_for_G-20.pdf
    8. Chavagneux, Christianja / Palan, Ronen (2007): Europe Leads the Fight Against Tax Havens. In: Tax Justice Focus, Vol 3, No 3.
    9. Sharman, J. C. (2006): Havens in a Storm: The Struggle for Global Tax Regulation. Cornell Studies in Political Economy.