The Truth About Tax Havens

Fri, May 8, 2009 - 1:00am

Suddenly in March, the news was full of denunciations of “tax havens.” While there is no standard definition of this term, tax havens are generally nations with low taxes, privacy in financial matters, and limited reporting to foreign tax bureaucracies. These countries, generally smaller and less developed, are being blamed for much of the world’s economic and social ills.

Europe is leading the charge against offshore banking centers, with Germany demanding greater transparency from these nations. French Financial Minister Christine Lagarde advocated cracking down on countries not following the guidelines of the Organization for Economic Cooperation and Development (OECD), claiming they are promoting terrorism by allowing money laundering. British Prime Minister Gordon Brown stated he wants to "outlaw offshore tax havens." Other European leaders have argued that financial privacy contributed to the global banking crisis.

The complaints are not limited to Europe. American Treasury Secretary Timothy Geithner also pushed for sanctions on "secrecy jurisdictions” who refuse to disclose information on account holders in accordance with OECD standards. Senator Carl Levin is a sponsor of anti-tax haven legislation, and he stated that US$100 billion per year would be raised if “offshore tax abuses” were ended. U.S. journalists have supported the Democratic Party’s stance, calling for citizens with offshore accounts to pay their “fair share” of taxes and end their “economic war” against their country.

With all the references to the OECD, I decided to investigate this organization. The Paris-based coalition consists of 30 countries, and most are wealthy like Japan and Sweden. Its mission statement includes working to improve economic growth, but it repeatedly attacks “tax havens” who simply attempt to improve their economies by encouraging foreign investment. The OECD advocates moving to greater “tax harmonization,” which really means that every nation would have the same stratospheric tax rates. Although Jeffrey Owens of the OECD tax division says, “It’s up to each country to decide its own rate of tax,” states that set the bar too low can be blacklisted and called “uncooperative.” George Orwell would be astonished at this level of doublethink.

The OECD regularly threatens sanctions against countries who decline to set punitive tax rates or inform on banking customers as its “standards” would dictate. The recent initiative to name countries to the organization’s “blacklist” resulted in four nations - Uruguay, the Philippines, Costa Rica, and Malaysia - immediately agreeing to work toward compliance with global tax reporting regulations.

At the same time, criticism of OECD member nations was absent or muted until the recent economic stress caused wealthy countries to turn on each other. Although Gordon Brown has postured about the damage allegedly caused by offshore banking centers, the UK is famous for foreign capital streaming into favorable tax jurisdictions like the Channel Islands.

When confronted about its banking secrecy laws, Luxembourg’s Prime Minister Jean-Claude Juncker counter-attacked. He labelled American states like Nevada as tax havens for foreign billionaires, with “limited reporting and disclosure requirements.”

In reality, offshore financial centers are but a mere shadow of their former selves, and hardly bastions of secrecy as the OECD claims. Uruguay’s President Tabaré Vázquez complained about his state’s inclusion on the blacklist, stating, “Uruguay may not be a monastery, but it is not a casino." In fact, as I wrote in my February 2008 newsletter, the country has already added an income tax, and mandated public filing of financial statements. Uruguay cooperates with some neighbors in resolving tax disputes and suspected money laundering activities.

In addition to the blacklist, the OECD also has a “gray list” of countries that partially meet its standards. It includes some traditional financial destinations like the Cayman Islands, Vanuatu and Switzerland. Many of these gray list nations had already been pressured to erode the privacy of their account holders, leaving few choices for investors who want to avoid punishing tax rates in their home countries. While most of the alleged tax havens have little global power, the Swiss vetoed part of the OECD budget as a protest against criticism over the country’s bank secrecy laws. At the same time, Switzerland has promised to move closer to compliance with OECD policies.

What does this mean for investors with funds in the Alpine nation? While I believe there will be some unfortunate compromises on privacy, I expect any changes will be small. As a rich OECD member, Switzerland can advocate strongly for itself. It has a history of standing alone, as it did in World War II when it maintained neutrality, so I doubt the Swiss will cave under some political pressure. Since Switzerland manages about a third of global offshore wealth, it will not make any changes to ruin its reputation or cause that capital to exit the country.

Rhetoric Not Reality

Most of the criticisms of tax havens are totally unfounded. Nations with favorable tax laws not only help the investors who place their money in these financial centers, but the citizens of every country. After the breakup of the Soviet Union, many former republics adopted low flat tax rates in order to develop their economy and compete with other nations that had attractive investment policies. Even the OECD admits that all governments are incentivized to lower tax burdens in order to prevent capital flight. In addition, the organization’s economists acknowledge that tax evasion can be reduced by more rigorous enforcement, but the “root of the problem appears in many cases to be high tax rates.”

The push to regulate so-called tax havens is at its base anti-competitive. It damages the capital inflows and growth prospects of these nations, most of which are small and poor. Powerful nations like China are exempt from this pressure, so Chinese possessions Macau and Hong Kong were not added to the blacklist.

European nations like France became rich a few centuries ago when they had no income taxes. In a disgusting burst of hypocrisy, they are trying to prevent many of their past colonies from prospering from low taxes themselves. French President Nicolas Sarkozy is one of the biggest hypocrites, as he helped set up tax shelters himself as a lawyer in the 1980s and ‘90s.

Naturally, politicians are in favor of any actions that would add more money to the treasury, especially during a financial crisis. However, it’s clear that another motivation is to distract the public from the real causes of the economic bust. It’s easy to get the public lathered up about hypothetical billionaires living a luxury tax-free life when so many are unemployed. Tax havens didn’t cause bank failures, as some politicians would like you to believe, but unbridled speculation encouraged by the government did.

Citizens may want to move money offshore if they fear confiscation of wealth by their government. This action may be especially urgent if they are part of an unpopular minority. In fact, the Swiss passed their Bank Secrecy Act in 1934 in response to the Nazi persecution of Jews who attempted to protect their assets from the Gestapo.

Contrary to the media spin, moving your money offshore isn’t limited to ultra-rich tax cheats. If you lived in Robert Mugabe’s Zimbabwe, you would want to move your cash into a country with sane policies and a stable currency. The nation suffered from an incredible 230 million percent official inflation rate last year before abandoning the Zimbabwe dollar and allowing the use of multiple foreign currencies.

Just saving in another currency may not help you if you don’t expatriate the funds. In 2001, Argentines who trusted their government were impoverished by capital controls, also known as the corralito (child’s playpen). Withdrawals were limited to a small weekly stipend. Only Argentine pesos could be accessed, even if the account was originally denominated in U.S. dollars. Later, after the peso was debased, dollars were forcibly exchanged for peso-denominated bonds which sunk further in value.

Unfortunately, pressure from world leaders continues to erode financial privacy and choice for small investors. If you do not already hold assets overseas, it will become more difficult to do so. However, there is no need to panic if you have an account in one of the “tax haven” countries as long as you are obeying the law.

Despite the fiery rhetoric, I doubt there will be any fundamental change in the distribution of global wealth. Serious criminals will continue to flout the law. Average citizens will be scared into admitting they hold money offshore, and this tiny added tax revenue will be a drop in the bucket compared to the bank bailouts. The super-rich will continue to legally avoid most taxes. Some assets will be repatriated only to be moved offshore again. Politicians will crack down on their own citizens, but continue to give large tax breaks to rich foreigners and corporations. The smart investors will protect their wealth by moving it out of fiat paper into real money - bullion.

Copyright © 2009 Jennifer Barry

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jennifer [at] globalassetstrategist [dot] com ()