The costs of offshore tax avoidance, part 2

Date: 06/02/15, Category: Tax, read: 8833 times

The costs of offshore tax avoidance, part 2

Matthew C Klein              | Nov 19 2014 09:15 | 32 comments | Share

In our previous post, we looked at the ways that global corporations minimise their tax burdens by routing income through offshore tax havens and transfer pricing. The ultimate beneficiaries of these shenanigans, of course, are actual people rather than legal entities. Many of these people also take advantage of offshore tax havens to avoid reporting capital income to local authorities. In this second post, we will look at how Gabriel Zucman tracks this hidden wealth and his suggestions for governments to capture missing revenue.

According to Zucman, at least 8 per cent of global household financial assets — a figure that doesn’t include bullion, art, real estate, jewelry, and other physical stores of value — are held in tax havens, although he suspects that this is a lower bound. Switzerland alone is home to about $2.5 of non-resident holdings, while Luxembourg has about $370 billion attributable to foreign households and another $350 billion held by “family offices and other intermediaries.” (More on the exact methodology can be found here.)

Zucman’s figures were calculated by looking at discrepancies in balance of payments statistics. Globally, there are trillions of dollars more financial liabilities than there are financial assets — something that only makes sense if some people are hiding their wealth from the authorities. Similarly, more financial asset income is paid than received. Chinese exporters over-invoicing their foreign input costs is a well-known but relatively trivial example. More realistic are Europeans who stash their assets in Switzerland:

Take the hypothetical case of Elizabeth, a UK resident who owns stock in Google through her Swiss account. In the United States, statisticians observe that a foreign investor owns US securities and record a liability. UK statisticians should record an asset held by a UK resident but they don’t, because they have no way to observe Elizabeth’s offshore holdings. Because Elizabeth’s equity holdings are neither assets nor liabilities for Switzerland, over there nothing is recorded in the investment statistics. In the end, more liablities than assets show up in global investment data. Strikingly, more than 20 per cent of the world’s cross-border equities have no identifiable owner.

Different countries have different propensities to keep their financial assets in foreign tax havens. Russian oligarchs and Arabian sheikhs are most likely to hide their wealth abroad, while Americans and Asians are the least likely:


Zucman estimates the total tax loss is worth “about 1 per cent of the total revenues raised by governments worldwide”, which is small in an absolute sense but very significant for the small number of households that benefit. In the US, Zucman thinks that the top one-thousandth of taxpayers reduced their tax bill by about 15 per cent using offshore havens. But the US has one of the lowest rates of tax evasion in the world, so the losses for other countries could be higher. For example, “the European Union has about 30 times more wealth hidden in Switzerland than the United States” has hidden.

The small share of US wealth held in offshore havens is even more impressive considering that taxes on capital income represent a much larger share of total government revenue than in other rich countries, making the US system significantly more progressive in redistributing real resources from the rich to the poor:

In the United States, about one-third of total tax revenues at all levels of government came from capital taxes in 2013. Close to 30 per cent of these taxes came from the corporate income tax ($350 billion), while the rest is accounted for by property taxes ($450 billion) and taxes on personal capital income and estates ($450 billion). In Europe, the average capital share of government tax revenues is 20 per cent, which is less than in the United States because consumption taxes play a larger role.

One big problem is the ease with which the wealthy can shield their identity using layers of shell companies and trusts. Consider the following example of a fictional Texan named Maurice, who has been evading US taxes by overcharging himself for “consulting” services provided by a company he owns in Hong Kong:

Take the Hong Kong account of hypothetical Maurice…on paper, it belongs to a Cayman corporation managed by nominees with addresses in that country…Imagine now that certain documents show that the Cayman company belongs to a Jersey discretionary trust. When asked, the trustees, who were chosen by Maurice, say the beneficial owner is Chang, Maurice’s business partner in China. The Hong Kong account, then, does not belong to a foreign person and no information is sent to the IRS.

Even that example is simplified. In the real world, tax evaders can combined countless holding entities in numerous havens, generating de jure ownerless assets or effectively disconnecting them from their holdings. The prevalence of derivative financial instruments can also make it difficult to discern the value of financial holdings clearly. Thus, even though the Foreign Account Tax Compliance Act and similar laws are broad in scope, they may prove unable to catch even moderately sophisticated tax dodgers.

As an example of how these shell companies operate, consider the sharp rise in the share of the US stock market owned by entities based in the Cayman Islands, Switzerland, Luxembourg, etc:


For context, the total market capitalisation of US companies is currently about $20 trillion.

Zucman suggests that victims of tax dodging should threaten to impose, among other things, huge trade tariffs on all exports originating from havens unless they agree to cooperate in finding hidden money through the automatic exchange of bank information. Ultimately, the best approach would be to create what he calls an “international financial registry” that would make it clear who owns what and where. Then authorities could negotiate with each other about how to apportion profit tax revenue, as well as figure out who owes capital gains and dividend tax where.

This issue is particularly relevant for Europe. Europeans have more hidden wealth than anyone else — about $2.6 trillion according to Zucman — and also have very large debts that will be difficult if not impossible to service in an environment of stagnant nominal income growth.

For example, the Italian government has been running a budget surplus (excluding interest payments) worth about 2 per cent of GDP for decades, yet this hasn’t been sufficient to restrain the indebtedness of the Italian state because the denominator has been shrinking. Getting hold of the hidden wealth of Italy’s ultra-rich would make it much easier for the government to restore the health of its fiscal position.

France would also be in a much better position to stimulate its economy without upsetting the Germans if it could tax the assets squirreled away in Switzerland and elsewhere. And Greece wouldn’t need to impose as much crushing austerity on its citizens to satisfy the Troika if the government could just bring its elites to heel.

Switching from an international tax system constructed out of a thicket of bilateral treaties that favour opacity to a transparent system based on multilateral cooperation seems tricky, if not impractical. But governments certainly have reasons to try to penalise corporations that hide their profits abroad as well as individuals that take advantage of the global mobility of capital to steal from their fellow citizens.

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