Tax Evasion on Offshore Profits and Wealth
Gabriel ZUCMAN1 May 31st, 2014
Abstract: This article attempts to estimate the magnitude of corporate tax avoidance
and personal tax evasion through offshore tax havens. In the United States, corporations
book 20% of their profits in tax havens – a tenfold increase since the 1980s – and tax
avoidance reduces corporate tax revenues by up to a third. Globally, 8% of the world’s
personal financial wealth is held offshore, costing more than $200bn to governments
annually. Despite ambitious policy initiatives, profit shifting to tax havens and offshore
wealth are rising. I discuss the recent proposals made to address these issues, and I
argue that the main objective should be to create a world financial registry.
1 London School of Economics and UC Berkeley. Comments are welcome ([email protected]).
Introduction
Globalization is making it increasingly easy for corporations to shift profits to low-‐tax
countries. Modern technology has also made it simpler for wealthy individuals to move
funds to undeclared bank accounts in offshore tax havens.
Both issues have featured prominently in the news and global economic debates since
the financial crisis. Yet quantifying their macroeconomic importance has proven
difficult. For some analysts, there are huge sums hidden abroad, enough to curb
government deficits and dramatically reduce the public debt. For others, rich countries’
residents make a legitimate use of offshore financial centers to minimize their tax
burdens. If any illegal activity takes place there, Russian oligarchs and African dictators
are to blame. On both sides, however, arguments tend to be based on relatively little
empirical evidence. What do we know about the activities taking place in tax havens and
their costs to governments?
This article attempts to make progress on this issue by bringing new data to the
discussion.
Measuring tax non-‐compliance is fraught with difficulties. However, balance of
payments data, national accounts, and corporate filings show that U.S. companies are
shifting profits to Bermuda, Luxembourg, and similar countries on a massive and
growing scale. 20% of all U.S. corporate profits are now booked in such havens. Since
multinationals usually try to operate within the letter – if not the spirit – of the law, this
profit shifting is better described as “tax avoidance” rather than outright fraud.
Corporations essentially exploit the loopholes of the current tax system. These
loopholes, by my estimate, cost the U.S. government about a third of its corporate tax
revenues.
Wealthy individuals, too, use tax havens, sometimes legally – to benefit from better
banking services than available in their home country – and sometimes illegally – to
evade taxes. Substantial progress has been made in attempting to curb that form of
evasion over the last years. Yet the available evidence – coming from Switzerland,
Luxembourg, and systematic anomalies in the international investment data of countries
– shows that offshore personal wealth is growing fast and that the bulk of it still seems
to be evading taxes. The fight against tax fraud remains an uphill battle.
To improve tax enforcement in the global economy of the 21st century, I argue that the
main objective should be to create a world financial registry. As we shall see, such a
registry could permit to both fix the loopholes of the corporate tax and make personal
tax evasion much more difficult.
1. Multinational corporations tax avoidance
The corporate tax is a key component of developed countries’ tax systems. In both
Europe and the United States, it accounts for 60% of capital tax revenues – more than all
taxes on properties, estates and inheritances, dividends, interest and capital gains
combined. Yet it is seriously challenged by globalization, and if the current trends are
sustained it could well disappear in the next two or three decades.
1.1. The three pillars of international taxation
To understand the sources of the current predicaments, a brief journey through history
is in order. In most countries, the corporate tax was born just before or during World
War 1, at the same time as the personal income tax. That is not a coincidence. Absent
corporate taxes, personal taxation would not work: People would incorporate and
shareholders would make sure money remains within companies, dodging taxation
entirely. The easiest way to prevent that scenario from happening is to tax profits
directly at the corporate level. The corporate tax is thus fundamentally a backstop; as
such, contrary to the income tax, it has no redistributive role and is usually levied at a
flat rate. When profits are paid out, the taxman recognizes that shareholders have
already been subject to corporate taxes by granting them tax reliefs. The reliefs can take
the form of relatively low dividends and capital gains tax rates, like in the United States,
or of a refund of previously paid corporate taxes, like many European countries used to
do until recently. (Over the last years European countries have tended to adopt the U.S.
system).
Corporate taxation would be straightforward in a closed economy but gets more
complicated as soon as companies operate in different countries. A U.S. person pays
taxes on all her income, wherever it comes from. Because the corporate tax is essentially
a prepayment, so too should U.S.-‐owned corporations pay taxes on all their profits,
whether they originate from the U.S. or abroad. A problem, then, arises: there is a risk of
two countries taxing the same profits. Concerned with such double taxation, in the
1920s the League of Nations asked four economists to think about how best to avoid it
(Bruins et al., 1923).
They came up with three principles, which since then have been the pillars of
international taxation.
First, the corporate tax is to be paid to the “source” country’s government. If a U.S.
person owns a Brazilian coffee producer – call it Coffee Rio – then Brazil ought to levy
the tax. In formulating that rule, the League of Nations was heavily influenced by the tax
laws of 19th century Europe, when what determined taxation was not a taxpayer’s ability
to pay but the nature of income – rents, dividends, wages, etc., were all subject to what
were known as different “schedular” taxes. To many 1920s economists, corporate
profits were just another type of income to which a tax was attached. The ultimate
economic payer did not matter much.
Source-‐based taxation raises a problem. Imagine that Coffee Rio is the subsidiary of
Coffee America, a U.S. company whose activity involves importing and distributing
Coffee Rio’s products in the United States. How to determine the source of Coffee
America’s profits? Do they come from the United States or from Brazil? Here the League
of Nations came up with a principle known as “arm’s length pricing”. Both entities must
compute their own profits separately, as if they were unrelated. In particular, the
American parent must do as if it purchased the products of Coffee Rio at the market
price for coffee. Since then, this is how the profits of multinationals have been allocated
across countries.
Last, the League of Nations decided that international tax issues ought to be addressed
not by a multilateral, global agreement, but at the bilateral level. As a result, since the
1920s countries have been signing thousands of bilateral “double-‐tax treaties” that
follow the general League of Nations guidelines of source-‐based taxation and arm’s
length pricing, but differ in a myriad of specificities.
The League of Nations experts foresaw many of the deficiencies of the plan they had
come up with. British economists were particularly skeptical (Coates, 1925, being a
prime example). But just at the time the principles were agreed upon, globalization
retreated. From the Great Depression to the late 1960s, foreign profits accounted for
barely 5% of total U.S. corporate profits (Figure 1). During almost half a century, what
had been decided by the Great Powers of the 1920s turned out to be inconsequential.
The situation started changing in the 1970s, but only slowly; it is only in the 21st century
that a surge in international investments brought the problems to the frontlines.
Globalization is back – on a much broader scale than in the late 19th and early 20th
century – and the choices made by the League of Nations are coming back haunting the
taxman.
Figure 1
1.2. Treaty shopping, transfer pricing, tax competition
Each of the three core principles agreed upon in the 1920s – source-‐based taxation,
arm’s length pricing, and bilateral agreements – raises issues of their own.
First, the choice of thousands of bilateral treaties over a multilateral agreement has
created a web of inconsistent rules. By carefully choosing the location of their affiliates –
what is known as “treaty shopping” – multinationals can exploit these inconsistencies to
avoid taxes.
A prime example is given by Google’s “double Irish Dutch sandwich” strategy – so named
because it involves two Irish affiliates and a Dutch shell company squeezed in between.
The first Irish affiliate, “Ireland Limited”, licenses Google’s intangible capital – its search
and advertisement technologies – to all Google affiliates in Europe, the Middle East and
Africa. (A similar strategy, with Singapore in lieu of Ireland, is used for Asia). Google
France, for instance, pays royalties to “Ireland limited” in order to have the right to use
the firm’s technologies. At this stage, the bulk of Google’s non-‐U.S. profits end up being
taxable in Ireland only, where the corporate tax is 12.5%.
But 12.5% is still a lot. The next stage involves sending the profits to Bermuda, where
the tax rate is a modest 0%. To that end, Google has created a second affiliate, “Google
Holdings”. Although it is incorporated in Ireland, for Irish tax purposes “Holdings” is a
resident of Bermuda (where its mind and management are supposedly located). Because
Ireland withholds a tax on royalty payments to Bermuda, Google cannot directly send
the profits collected by its first Irish affiliate to the Irish/Bermuda hybrid. A detour by
the Netherlands is necessary. “Ireland Limited” pays royalties to a Dutch shell company
– a tax-‐free payment because Ireland and the Netherlands are both part of the European
Union – and the Dutch shell pays back everything to the Irish/Bermuda holding – tax-‐
free again because to the Dutch authorities the holding is Irish, not Bermudian.
Playing tax treaties against each other – and in particular exploiting their inconsistent
definitions of “residency” – Google thus generates “stateless income”, nowhere taxed
(Kleinbard, 2011). Over the last years, according to the company’s filings, its effective
tax rate on foreign profits has ranged from 2% to 8%.
The issues raised by treaty shopping are compounded by the growing ability of
multinational firms to choose the location of their profits – and thus exploit treaty
inconsistencies – irrespective of where they produce or sell. The main way this profit
shifting happens is through the manipulation of transfer prices, the prices at which
companies exchange goods and services internally.2 In principle, these transactions
should be conducted at the market price of the goods and services traded, as if the
subsidiaries were unrelated. If that rule – arm’s length pricing – worked well, it would
not be possible for firms to record much profits in countries like Bermuda where no real
activity takes place.
In practice, however, arm’s length pricing faces severe limitations.
Coffee Rio, first, can sell its products to Coffee America at artificially high prices to make
the profits appear in Brazil (where they are taxed at 25%) rather than in the United
States (where the tax rate is 35%). There are billions of intra-‐groups transactions every
year, making it impossible for tax authorities to check all of them are correctly priced.
Kimberly Clausing (2003) finds compelling evidence of transfer mispricing by U.S. firms.
More important, in many cases the relevant market prices simply do not exist. What was
the value of Google’s technologies when it transferred them to its Bermuda holding in
2003, before even being listed? In retrospect, it is apparent it was manipulated down.
The issue is growing, as a rising number of transactions – such as the sale of proprietary
trademarks, logos, and algorithms – are not replicated between third parties.
Third, arm’s length pricing is conceptually flawed. A multinational company derives part
of its profits from the synergies of being present across the globe. There is no
meaningful way to attribute that income to any particular subsidiary.
2 The other popular method is the use of intra-‐groups loans, whereby low-‐tax country subsidiaries grant loans to high-‐tax country subsidiaries.
The last – and core – problem of today’s tax international tax environment is the rule
that profits should primarily be taxed in source countries. Absent that rule, there would
be no point in trying to make profits appear as if they originated from zero-‐tax Bermuda.
Source-‐based taxation provokes two types of inefficiencies. First, it causes a wasteful
expenditure of resources: multinational companies spend billions in treaty shopping
and transfer pricing (the tax department of General Electric employs close to one
thousand individuals); tax authorities devote substantial effort to curb abuses, in turn
triggering even bigger corporate expenses. The end result is tax revenue and welfare
losses in non-‐haven countries (Slemrod and Wilson, 2009).
But while profit shifting to Bermuda mostly involves notional transactions, source-‐based
taxation also gives firms incentives to move real activity – factories, headquarters, etc. –
where taxes are low. There will always be small open-‐economies choosing a 0% source
tax – for them, that is indeed the optimal thing to do (Diamond and Mirrlees, 1971). To
non-‐haven countries such competition can be more costly than artificial profit shifting,
because it involves losses of physical capital and employment.
Ironically, artificial profit shifting and tax competition for real investments cannot be
fought simultaneously: Every time the taxman attempts to limit shifting to Bermuda, it
makes it more valuable for firms to relocate to Singapore or Dublin (Hong and Smart,
2009; Johannesen, 2010). In brief, a corporate tax founded on source-‐based principles
only is self-‐defeating: there are powerful forces pushing toward zero rates – and indeed
nominal rates are declining globally, with few exceptions.
1.3. The costs of corporate tax avoidance by U.S. firms
While many analysts worry about the costs of tax competition for real investment,
available evidence suggests corporate revenue shortfalls are mostly due to artificial
profit shifting.
The U.S. case is particularly striking. Tax avoidance of the “double Dutch Irish” type
extends much beyond firms like Google. Data collected by the Bureau of Economic
Analysis show that U.S. multinationals book 55% of their foreign profits in six tax
havens, the Netherlands, Bermuda, Luxembourg, Ireland, Singapore, and Switzerland
(Figure 2), where only 5% of their overseas workforce is employed. Although the
country allocations in Figure 2 should not be over-‐interpreted – they mostly reflect the
location of the last holding involved in the tax avoidance scheme – the point is that profit
shifting has steadily increased since the 1980s and continues to rise. At current pace, all
the foreign profits of U.S. firms will “originate” from tax havens in 30 years.
Figure 2
Since tax havens rise as a share of foreign profits and foreign profits rise as a share of
total profits, the share of tax havens in total – domestic plus foreign – U.S. profits is
booming. As shown by Figure 3, this share is about 20% today, despite the fact that
many companies have no overseas activity. That is a tenfold increase since the 1980s.
(The rapid increase during the financial crisis is due to the relative strength of offshore
profits at a time when domestic profits collapsed.)
Figure 3
The U.S. profits booked in tax havens barely bear any tax at all. On average, they are
taxed at a rate of 3% by foreign governments. In principle, they should also be taxed in
the United States, because the U.S. corporate tax is supposed to be worldwide (i.e., to tax
domestic and foreign profits alike). Foreign earnings, however, are not taxed until they
are repatriated in the United States – and so in practice companies let their offshore
profits accumulate abroad tax-‐free. To prevent abuses Congress has – like most other
countries – enacted rules to immediately tax some type of undistributed foreign income
(what is known as “subpart F” income). The application of these complicated rules, in
turn, has been largely suspended over the last few years. The bottom line is that, if the
profits in the top 6 havens were taxed at the same rate as other profits, U.S.
multinationals would pay 20% more in taxes.
Yet even this estimation is probably conservative. International tax avoidance extends
beyond profit shifting to places like Bermuda; it also encompasses transfer price
distortions on intra-‐group transactions between, say, U.S. and U.K. affiliates. Another
way to assess the total revenue cost is to study the evolution of the effective tax rate
paid by U.S. corporations. As Figure 4 shows, the effective tax rate is always below the
nominal rate. The Tax Reform Act of 1986 attempted to bring the two rates in lines – the
nominal rate was reduced to 34% in 1988 in exchange for a base broadening. For about
a decade, that strategy proved successful. But the situation changed in the late 1990s.
Over the last 15 years, the effective tax rate paid by U.S. firms to the U.S. and foreign
governments has been reduced by a third (from 30% to 20% today). If it had stayed
constant, these companies would have, all else equal, paid $200 billion in additional
taxes in 2013. Given that U.S. tax laws have changed little over that period – the nominal
federal tax rate has remained constant – it is reasonable to attribute a large fraction of
the decline in the effective tax rate to increased international avoidance. In sum, tax
havens enable U.S. corporations to reduce their taxes by at least 20% and up to a third.
Figure 4
The cost of tax avoidance by U.S. firms is born by both the U.S. and other countries’
governments. Some of Google’s profits shifted to Bermuda are made in Europe; absent
tax havens, Google would pay more taxes in France and Germany. The IRS would grant
Google credits for these foreign taxes paid; no extra revenue would be raised in the U.S.
On the other hand, some U.S. corporations also use tax havens to avoid taxes on their
U.S.-‐source income. It is hard to know who loses most. In both cases, U.S. shareholders –
everybody who owns equities, either directly or through pension plan – win. Since
equity ownership is very concentrated (Saez and Zucman, 2014), so too are the benefits.
How can we reconcile the sharp decline in the effective tax rate paid by U.S. corporations
with the widely noted fact that as a share of national income, corporate taxes have not
declined in recent years – they still amount to about 3%? Figure 5 provides the answer:
corporate profits have boomed, because of a rise of the share of capital in corporate
value added.3 This increase has more than offset the fall in the effective tax rate. Capital
is back, but capital taxes, not at all.
Figure 5
3 The corporate profits depicted in Figure 5 are net of interest payments, and so another factor behind the U-‐curve is the evolution of interest rates (high in the 1970s-‐1980s, low in recent years). Whether one should look at corporate profits before or after interest payments is a matter of perspective: if the aim is to look at the evolution of factor shares, then it’s better to look at profits gross of interest payments, but if one is interested in comparing nominal and effective corporate tax rates, then it’s better to look at profits net of interest payments, because these payments can be deducted from the corporate tax base.
1.4 Corporate tax reforms
There is no shortage of plans to fix the corporate tax. The proposals differ in their
willingness to reconsider any of the three pillars of international taxation –
decentralized rules through bilateral treaties, arm’s length pricing, and source-‐based
taxation.
A first class of reforms pushes for more harmonization of treaty rules. Advocates
acknowledge that the thousands bilateral tax treaties have created scope for “treaty
shopping” and transfer mispricing, but remain committed to the principles of source-‐
based taxation and arm’s length pricing. That is broadly speaking the OECD position. In
2013, the organization has disclosed an ambitious “action plan on base erosion and
profit shifting” along those lines (OECD, 2013).
A second class of proposals suggests abandoning arm’s length pricing. The profits of
multinational companies would instead be apportioned to each country according to
some formula, such as a combination of sales, capital, and employment – analogous to
the way that corporations are taxed by the states within the United States.4 For instance,
if Google makes half of its sales, has half of its capital and workers in the United States,
then half of its profits would be taxable there. This method would address the issue of
artificial profit shifting. If capital and employment entered the formula, there would
remain incentives for firms to move real activity to low-‐tax countries. A more radical
proposal thus allocates a multinational’s profits to each country based on where it
makes its sales only.5 Starbucks can easily shift its profit or move its headquarter to
Ireland, but not its customers. Profit apportionment based on sales would therefore
address both artificial profit shifting and tax competition. Yet this proposal raises an
issue. Sales, capital, or employment, are only mildly correlated with profits (Hines,
2009). So if one considers that corporate taxes ought to be paid to the countries from
4 Clausing (2013) evaluates the U.S. experience with formula apportionment. 5 Auerbach et al. (2008) discuss several options for a “destination-‐based” corporate tax that follows broadly similar principles.
which profits originate – the third key League of Nations principle – then formula
apportionment would misattribute taxing rights.
A third class of proposals abandons source-‐based taxation. Remember that the
corporate tax is fundamentally a pre-‐payment for the personal income tax. From that
perspective, profits should not be attributed to the countries from which they originate,
or where sales are made, but to the countries where shareholders live. If a U.S. person
fully owns a company that has all its capital and employment in Germany but sells all its
products in China, then in today’s tax system all the taxing rights are allocated to
Germany, with formula apportionment based on sales they would be allocated to China,
although, as the corporate tax is essentially a pre-‐payment for the U.S. income tax, they
should be attributed to the United States.
The League of Nations favored source-‐based taxation because it thought it would be
technically impossible to allocate corporate profits to the countries where shareholders
live. And indeed, in the 1920s it was hard to identify who shareholders were: equity
shares took the form of paper certificates – similar to banknotes – that could be moved
across borders easily. Today, however, paper certificates have been replaced by
electronic records; anonymous “bearer” securities do not exist anymore; shareholders
could be easily recorded in a world financial registry.
1.5 A world financial registry
The registry would enable countries to run a proper residence-‐based corporate tax. If
Google belongs 60% to U.S. residents, 7% to German residents, 5% to French residents,
etc., then 60% of its global profits would be taxable in the United States, 7% in Germany,
5% in France, and so on. There would be no point anymore in trying to make profits
appear in Bermuda, or in moving headquarters and factories across the globe for tax
purposes. Then, once the profits are paid out to shareholders, each government would
reimburse any corporate tax previously withheld. European countries abandoned this
imputation system because they found it unacceptable to reimburse domestic
shareholders for corporate taxes levied by foreign countries, and also because it became
apparent that some were reimbursed for taxes that had actually never been paid in the
first place. With a corporate tax based on the residence of shareholders, drawing on the
information contained in the world financial registry, both these concerns would
disappear.
Is a world financial registry utopian? There are a number of potential obstacles.
First, the register would have costs – but they must not be overstated. In each country a
central securities depository already keeps track of who owns the equities and bonds
issues by domestic firms (the Depository Trust Corporation in the United States,
Euroclear in many European countries, or Clearstream, in Luxembourg, for example).
The name of the game is to merge these partial, privately-‐managed registries to create a
comprehensive one that would be used for running a proper residence-‐based corporate
tax. Europe and the United States – which together account for close to 50% of world
GDP – could pave the way by jointly moving to a residence-‐based corporate tax and
joining forces to identify the ownership of U.S. and European companies.
A more serious concern is that a large fraction of the world’s equities might not initially
be attributable to any well-‐identified beneficial owner. First, equities are largely held
through intertwined financial intermediaries, like investment funds, pension funds, and
the like. To identify the residence of the ultimate owner, it would be necessary to know
the relationships of the different entities involved in the wealth-‐holding chain. Progress
has started in this area since the financial crisis, under the auspices of a committee of
authorities from around the world working to create a global system of legal entity
identification.6 Second, a growing fraction of U.S. (and rich countries’) equities are
managed by intermediaries located in offshore financial centers, such as hedge funds in
the Cayman Islands, insurance companies in Bermuda, Luxembourg mutual funds, Swiss
banks, and so on (Figure 6). Who are the ultimate owners of the shares managed by
these intermediaries? Some of them are investors who make a legal use of offshore
intermediairies. But many, as we shall now see, are individuals using offshore banks to
6 See Regulatory Oversight Committee (ROC) of the Global Legal Entity Identifier System, http://www.leiroc.org.
evade taxes. To pierce this veil of secrecy, international cooperation would be necessary,
which might involve sanctions against reluctant tax havens.
Figure 6
2 Offshore evasion by wealthy individuals
2.1 Eight percent of the world’s financial wealth
Switzerland, Singapore, Hong Kong, and the Bahamas, among others, have attracted a
large offshore private banking industry. Banks located in these countries cater to
wealthy individuals from around the world and provide them with opportunities to
evade taxes.
To understand how tax evasion works, think of an American businessman, Mr. Maurice,
who owns a carpet-‐making company, Dallas Carpet. In order to send funds offshore, Mr.
Maurice proceeds in three steps. He first creates a shell company, say in the Cayman
Islands. (Findley et al., 2012, report it is even easier to form anonymous companies in
Delaware and many OECD countries). The Caribbean shell then opens a bank account in
Hong Kong, where all the major global banks operate. Last, Dallas Carpet purchases false
services (like management advice) to the Cayman company and pays for them by wiring
funds to Hong Kong.
The whole transaction generates a paper trail that seems legitimate. It is unlikely to
trigger any anti-‐money-‐laundering alarms inside the banks, because there are billions of
electronic transfers out of the United States each year, making it is almost impossible to
distinguish in real time those that are legal (such as payments made to real exporters)
from those conducive of tax evasion.
The benefits for Mr. Maurice are twofold. By paying for false services, he fraudulently
reduces Dallas Carpet’s profits and thus its corporate tax in the United States. Then, once
the funds have arrived in Hong Kong, they can be invested in global bonds, equities, and
mutual funds, and generate interest, dividends, and capital gains. The IRS can only tax
that income if Mr. Maurice self-‐reports it or if Hong Kong banks inform the U.S.
authorities. Otherwise, Mr. Maurice will evade the federal income tax as well.
How big are the sums held in offshore accounts? Until recently, evidence on that issue
was lacking. Tax havens rarely publish informative statistics. There are two exceptions,
however. Thanks to an exhaustive, detailed, monthly survey conducted by the Swiss
National Bank, we know the amount of wealth held by foreigners in Switzerland. The
latest data point, for February 2014, puts the total at $2.4 trillion.7 Luxembourg’s
national statistical office has also recently released similar information, showing that
foreign households have $370bn there.8 (Luxembourg, a country of half of million
inhabitants, has a national income of $35bn). Unfortunately, it seems no other country
publishes similar data. Even the U.S. does not disclose the assets held by, say, Latin
American residents in Florida banks.
7 See the online Data Appendix to this article, Table S.1 8 See Adam (2014, p. 8). This figure understates the true amount of offshore wealth in Luxembourg because it excludes some $350 billion not directly held by households but through family offices and other intermediaries. In actual facts the private offshore wealth managed in Luxembourg could be as high as $720 billion.
To have a sense of the global amount of offshore wealth, one has to use indirect
methods. My own attempt relies on the anomalies in global investment statistics caused
by offshore fortunes (Zucman, 2013a, 2013b). Take Ms. Smith, a U.K. resident who owns
Google equities through her Swiss account. What is recorded in the international
investment positions of countries? In the United States, statisticians observe that a
foreign investor owns U.S. securities and record a liability. U.K. statisticians should
record an asset but they don’t, because they have no way to observe Ms. Smith’s offshore
holdings. And since Ms. Smith’s equities are neither assets nor liabilities for Switzerland,
over there nothing is recorded at all. In the end, more liabilities than assets show up in
global data. Strikingly, more than 20% of the world’s cross-‐border equities have no
identifiable owner. It is as if planet Earth was partly owned by Mars.
By analyzing these anomalies in a systematic manner, I reckon that 8% of the global
financial wealth of households is held in tax havens, about $7.6 trillion at the end of
2013. Other estimates are generally larger. Based on interviews with wealth managers,
the Boston Consulting Group (2013) has an $8.5 trillion figure for 2012. James Henry’s
(2012) estimate is as high as $32 trillion.
My method probably delivers a lower bound, however, because it only captures financial
wealth and disregards real assets. Now high net worth individuals can stash works of
art, jewelry and gold in freeports – Geneva, Luxembourg, and Singapore all have one.
They also own real estate in foreign countries. Registry data show that a large chunk of
London’s luxury real estate is held through shell companies, largely domiciled in the
British Virgin Islands, a scheme that enables owners to remain anonymous and to
exploit tax loopholes. Although real assets may be growing, there is no way yet to
estimate their value.
Even disregarding real estate and freeports, the world’s offshore wealth is large enough
to significantly affect inequality measures. As shown by Table 1, U.S. residents own
about $1.2 trillion abroad, the equivalent of 4% of America’s financial wealth. Europe is
more affected, with $2.6 trillion offshore, 10% of its financial assets. The widespread use
of tax havens means that survey and tax data probably under-‐estimate the concentration
of wealth substantially. Take the case of Spain: according to tax records the top 0.01%
owns about 5% of the country’s financial wealth (Alvaredo and Saez, 2009, Figure 10). If
indeed 10% of Spain’s financial wealth is held unrecorded by very rich individuals, the
true figure could be as high as 15%.9 In developing countries, the fraction of wealth held
abroad is considerable, ranging from 20% to 30% in Africa and Latin America to as
much as 50% in Russia and Gulf countries. For anyone interested in studying global
inequalities, accounting for tax havens is crucial.
Table 1: The world’s offshore financial wealth
Notes: Offshore wealth includes financial assets only (equities, bonds, mutual fund shares, and bank deposits). Tax revenue losses only include the evasion of personal income taxes on investment income earned offshore as well as evasion of inheritance and estate taxes. Source: author’s computations, see Zucman (2013a, 2013b) and the online data Appendix supporting this article.
How is offshore wealth evolving? In Switzerland, foreign holdings are at an all time high.
They have increased 4.6% per year since the Swiss National Bank has started publishing
data at the end of 1998. The trend does not seem to have been much affected by recent
enforcement efforts: since G20 leaders have declared the “end of bank secrecy” in April
2009, the offshore fortunes managed in Switzerland have increased 15%.10 The growth
is stronger in the emerging Asian centers, Singapore and Hong Kong, so that globally,
according to my estimate, offshore wealth has grown 28% from end-‐2008 to end-‐2013.
9 See Roine and Waldenstrom (2009) for an analysis along similar lines in Sweden. 10 Adam (2014) similarly reports a 20% growth for Luxembourg offshore wealth from 2008 to 2012 (the latest available data point).
The post-‐2008 growth reflects valuation effects – world equity markets have recovered
from their post-‐Lehman trough – but also net new inflows.11 In turn, inflows seem to be
coming largely from developing countries: as their share of global wealth rises, so too is
their share of offshore wealth. At the stock level, more than half of offshore assets still
belong to rich countries’ residents (Table 1), but if the current trend is sustained,
emerging countries will overtake Europe and North America by the end of the decade.
Two other recent developments are worth noting.
First, tax haven banks are getting more elitist. The main Swiss banks are re-‐focusing
their activities on their “key private banking” clients, those with more than $50mn in
assets.12 Recent policy changes are indeed making it more difficult for moderately
wealthy individuals to dodge taxes: for them the era of bank secrecy is coming to an end.
But more fundamentally, offshore banks are responding to the increasing concentration
of global fortunes. In the United States, the share of wealth held by the top 0.1% –
families with more than $20mn in net wealth in 2012 – was 7% in 1980; it is now 22%
(Saez and Zucman, 2014). For the top 0.01% (more than $100mn), the rise has been
spectacular, from 2.5% to 11.5%. By contrast, households between the top 10% and the
top 0.1% have been losing ground. “Ultra-‐high net worth” clients are prospering, other
rich clients less so. The banks know it and adapt.
Offshore banking is also becoming more sophisticated. Wealthy individuals increasingly
use shell companies, trusts, holdings, and foundations as nominal owners of their assets.
This is apparent in Switzerland, where more than 60% of foreign-‐owned deposits
“belong” to the British Virgin Islands, Jersey, and Panama – the leading centers for the
domiciliation of shell vehicles.13
11 In the case of Luxembourg, the 20% 2008-‐2012 growth reported by Adam (2014) is despite a 20% drop in the EuroStoxx 500, Europe’ leading equity index. In Switzerland, the 15% since April 2009 is comparable to the growth of Europe’s financial wealth. 12 The same trend seems to be at play elsewhere. In Luxembourg, “the number of clients seems to be declining, at least over the 2009-‐2012 period” (Adam, 2014, p. 8). Offshore assets are rising, the number of clients falling, and the average wealth per client booming. 13 In Luxembourg as well, “assets are moving to legal structures such as family wealth-‐holding companies” (Adam, 2014, p. 8).
The revenue costs of offshore tax dodging are sizable. Admittedly, some taxpayers duly
declare their Swiss or Cayman holdings. Yet in Switzerland, about 80% of the wealth
held by Europeans seems to be evading taxes, according to data published by the Swiss
tax authority. On the assumption of a like basis for other tax havens, Table 1 provides
estimates of the revenue losses for the main economies. Globally, the costs amount to
about $200bn annually.14 This is about 1% of the total revenues raised by governments
worldwide, but since offshore evasion benefits a tiny fraction of the population, it makes
more sense to compare this sum to the taxes paid by the richest taxpayers. In the U.S.,
eradicating offshore evasion would raise as much revenues as increasing the top 0.1%’s
federal income tax bill by 25%. (All of these computations only include the cost of tax
evasion on investment income earned offshore and on inheritances, disregarding
evasion on the principal. The results should thus be seen as an extreme lower bound).
2.2. Recent progress and challenges ahead
Since the financial crisis, remarkable progress has been achieved in curbing bank
secrecy. Prior to 2008, tax havens refused to share any information with foreign tax
authorities. The tipping point occurred in 2010 when the U.S. Congress enacted the
Foreign Account Tax Compliance Act (Fatca), which compels foreign banks to
automatically disclose accounts held by U.S. customers to the IRS, each year, under the
threat of economic sanctions – a 30% tax on all US-‐source income. Other rich countries
are following suit, and under the impetus of the OECD (2014), the automatic sharing of
bank data is becoming the global standard. Key havens, including Switzerland,
Singapore, and Luxembourg, have already agreed to participate. In 2008, the vast
14 As with any attempt at quantifying the underground economy, there is a margin of error involved. While it is beyond doubt that global offshore wealth is on the rise, the main uncertainty relates to the fraction of it that evades taxes. The 80% assumption I retain is an estimate for 2014. We know that up to 2008, 85% to 95% of U.S.-‐owned accounts at UBS and Credit Suisse were undeclared (U.S. Senate, 2008, 2014), so my assumption factors in some improvements. Some observers believe that enforcement has improved much more dramatically, but this view is inconsistent with the fact the funds declared to tax authorities in recent years, though not negligible, have been quite modest (see Johannesen and Zucman, 2014, Section V). The share of offshore wealth dodging taxes may decrease more substantially in the future. To compute it, we would ideally like to compare the data published by the Swiss National Bank (and other tax havens’ authorities) to the assets that taxpayers report to the IRS (and other tax agencies). The problem is that very few havens publish any useful statistics and tax authorities do not systematically disclose the amounts declared to them. Filling in these data gaps should be of the highest priority to policymakers.
majority of tax experts deemed such worldwide cooperation utopian. One lesson of
recent history is that tax havens can be forced to cooperate if the threats are big enough.
Despite this achievement, however, current enforcement efforts face a number of
obstacles.
First, not all bankers in Switzerland, the Caymans and elsewhere may truthfully report
to foreign authorities. For decades some of them have indeed been doing the contrary,
hiding their clients behind shell companies, smuggling diamonds into toothpaste tubes,
handing bank statements concealed in sports magazine, all of this in violation of the law
and the banks’ stated policies (U.S. Senate, 2008, 2014). More than a handful “rogue
employees” were involved: in 2008, over 1,800 Credit Suisse bankers were servicing
Swiss accounts for U.S. customers. They made vast fortunes from it. Can offshore wealth
managers now be trusted to do the taxman’s job?
Securing their cooperation will partly depend on the penalties cheating financiers will
face and the rewards whistleblowers will be able to claim. In the United States, the IRS
has paid as much as $104mn to the employee who denounced UBS’s wrongdoings, the
Justice Department has imposed fines, and regulators have threatened to revoke
banking charters a number of times over the last years. Yet Europe, which has about 30
times more wealth hidden in Switzerland than the United States, has done none of that.15
Looking forward, countries unwilling or unable to impose sanctions and reward
informants will remain vulnerable – this includes nations with corrupt governments,
small economies, most of the developing world, and, as it stands, the European Union.
15 Even the U.S. approach has been weak in many ways, according to a bi-‐partisan Senate staff report (2014). In May 2014, only two banks (Wegelin and Credit Suisse) had been indicted, and the United States had obtained few names and little account information (Credit Suisse sent less than 1 percent of its 22,000 American accountholders, Wegelin none). More fundamentally, the United States has so far failed to put pressure on other tax havens. Among the taxpayers who have voluntarily disclosed previously hidden assets, 42% reported a Swiss account, 8% one in the U.K., but almost none reported any holdings in Hong Kong (3%), the Caymans (1%), and Singapore (1%), where the bulk of U.S. offshore money lies (Government Accountability Office, 2013, 2014). Only about a quarter of the funds that left Credit Suisse between 2008 and 2012 have been repatriated to the United States, half have stayed in Switzerland, and the remaining quarter have moved to other countries (US Senate, 2014, p. 114). Accounts disclosed have also tended to be small, with a median amount of $570,000. Overall, just $6bn in back taxes, interest, and penalties had been paid by January February 2014 – which pales in comparison to the yearly losses for the IRS (table 1 above).
Another important factor will be the evolution of the size distribution of banks.
Whistleblowing by rational (or moral) employees is more likely to occur in big than
small firms (Kleven, Kreiner and Saez, 2009). If tax evasion activities move to small
“boutique” banks, shielded from U.S. outreach, then enforcement might prove
increasingly hard. On the other end of the spectrum, systemic banks might find it
profitable to continue conducting criminal activities, because charging them with a
crime, regulators often fear, would endanger financial stability – they seem “too big to
indict”.16
Second problem: the automatic sharing of bank information will bump into financial
opacity. Take Mr. Maurice’s Hong Kong account: on paper, it belongs to a Cayman
corporation managed by nominees with addresses in George Town. The law makes it
clear that such a widespread trick should not be enough to dodge taxes. Yet because of
one “gaping loophole” in Fatca’s implementing regulations, banks are not systematically
required to treat this account as a U.S.-‐account that must be reported to the IRS (U.S.
Senate, 2014, p. 8, p. 173). Even if this loophole were addressed, the fundamental
problem that many assets cannot be traced to they real owners would remain. Imagine
that Mr. Maurice’s Hong Kong bankers enquire about who owns the Cayman shell
company. Will they find out? In 2012, Findley et al. attempted to create anonymous
companies by asking 3,700 incorporation agents in 182 countries: in about a quarter of
cases, they were able to do so without providing any identification document. But the
problems don’t stop there. Imagine there are documents showing that the Cayman
company belongs to a Jersey discretionary trust. In such a trust, who is to benefit from
the assets is left to the discretion of the trustees. When asked, the trustees, who are
goods friends of Mr. Maurice, say the beneficial owner is Mr. Chang, Mr. 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. And even that example is much simplified.
16 In 2014, Credit Suisse pleaded guilty of a criminal charge of conspiracy to defraud the IRS, yet it was able to keep its U.S. banking license. In 2012, U.S. authorities decided against indicting HSBC over concerns that it would destabilize markets, despite evidence the bank enabled Mexican drug cartels to move money through its American subsidiaries, in violation of basic anti-‐money laundering regulations. Instead, the bank was fined $1.92bn. Once criminal charges are considered off-‐limit, it is unclear whether such fines are enough to deter illegal behavior. (HSBC’s pre-‐tax profits were $22.6bn in 2013).
In the real world, tax evaders can combine countless holding entities in numerous
havens, generating de jure ownerless assets or effectively disconnecting them from their
holdings.
Thus, even though Fatca and similar laws are broad in scope – indeed, some lament the
burden they impose on banks and the law-‐abiding, in particular U.S. citizens living
abroad – they may prove unable to catch even moderately sophisticated tax dodgers.
Evasion opportunities are disappearing for those who do not use sham corporations but
may remain for those who do.
Last, to be effective, any crackdown on offshore evasion needs to be global. The OECD
has convinced many offshore centers to automatically share bank information. Yet the
more havens agree to cooperate, the bigger the incentives for the remaining ones not to
(Elsayyad and Konrad, 2011). The data analyzed in Johannesen and Zucman (2014)
show that when two countries like Switzerland and France agree to share information,
French tax evaders move their assets to less cooperative places like Hong Kong. Such
transfers are child’s play, because the funds remain within the same banks that have
subsidiaries all over the world. A handful of non-‐cooperative centers can quickly attract
a lot of money.
The obstacles to current enforcement actions are not insuperable, though.
Global cooperation can be achieved by threatening havens with sanctions proportional
to the income they generate in abetting tax dodgers. This approach is not unlike that
adopted by the United States with Fatca, but opposite to that of Europe. Threats may not
always be necessary: the recent success of the OECD and the G20 shows that diplomacy
can go a long way in securing commitments. Yet a number of small havens derive a large
fraction of their income from illegal activities; at this stage they have little incentive to
give up this lucrative business. Clearly specified incentives may also foster effective
cooperation on the part of the havens that have already promised to implement the
automatic exchange of bank information. In addition to fines, criminal charges, and the
revocation of banking licenses, credible threats include trade tariffs. A 30% tariff jointly
imposed by Germany, France, and Italy on Swiss exports, for instance, would cost
Switzerland more than what Swiss banks gain by managing the evaded wealth from
these three countries (Zucman, 2013b).
Progress can also be made in curbing financial opacity, by using the world financial
registry described above to administer a residence-‐based corporate tax. A world
financial registry would enable tax authorities to check that taxpayers duly declare their
offshore holdings, whatever information bankers are willing to disclose. More
important, it would make it possible to address major flaws in public statistics that have
adverse consequences for tax enforcement, financial stability, and policymaking. As we
have seen, about 20% of the world’s cross-‐border equities are “ownerless” – recorded as
liabilities but nowhere as assets. This is a serious impediment to the surveillance of
global financial stability. The problem is magnified for derivatives – in 2008, who knew a
London firm, AIG, had insured hundreds of billions of U.S. banks’ bonds? In many
countries, there is no publicly available information on the distribution of wealth at the
top – a void that magazine like Forbes attempt to fill in – making it harder to have an
informed discussion on inequalities. A world financial register would help addressing
these challenges.
For fixing the corporate tax, the world financial registry only needs to include equities.
For tax enforcement purposes, it would be necessary to include other types of financial
claims, bonds, and derivatives. Some argue it would threaten individual privacy. But
countries have public property records for land and real estate – anybody can connect to
acris.nyc.org and find out about who owns real estate on Park Avenue – and there seems
to be little misuse. These records only capture part of people’s wealth, but when they
were created, centuries ago (e.g., in 1791 in France), land accounted for the bulk of
private wealth, so that they indeed recorded most of peoples’ fortunes. Not all countries
have the same attitudes toward transparency (and these attitudes change over time): in
Scandinavia taxpayers’ income and wealth is made public, not in the U.S. (although that
was the case in 1924). So there’s a case for keeping the world financial register private,
or to initially start it with only those countries sharing similar attitudes toward
transparency. In any case, the stakes go beyond tax enforcement, as financial opacity
facilities money laundering, bribery, and the financing of terrorism.
While progress has undoubtedly been achieved over the last years in curbing tax
avoidance and evasion, the data currently available should force us to be very cautious,
and much more could be done to go after the dark sides of capital mobility.
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