Tax Havens: Finally Storming the Offshore Bastille?

♠ Posted by Emmanuel in , at 12/03/2008 10:59:00 AM
Left-leaning IPE commentators are as fond of tax havens as Cosmopolitan is of cellulite. They are said to embody the worst features of globalization--the creation of artifactual locations for the benefit of the wealthy at the expense of their less fortunate brethren. Simply put, while Joe Average has little recourse but to pay taxes, the extraterritorial offshore world allows the wealthy to skimp on their obligations. Worse, it's complicit in hosting sinister financial machinations like various investment entities of ill repute, your various SIVs and SPVs. There is certainly some truth here. Believe it or not, however, the picture may not be so clear cut as tax havens have developmental implications.

But first, let us begin with the juicy stuff. When we think of tax havens, the conventional image that comes to mind is of a sun-drenched US or British protectorate taking advantage of regulatory arbitrage. Among other things, they may offer the creation of shell corporations, account secrecy, and low or no tax rates. What exactly constitutes a tax haven is a matter of considerable debate; although bodies like the OECD offer their own takes on the designation, locations given this nomenclature are understandably unhappy about it. After all, who wants to be continually harassed by tax authorities the world over? The instance of Germany mounting a frontal assault on Lichtenstein is instructive: the latter merely asserts that inconsistencies behind German tax codes gives rise to nationals seeking safe harbor in Lichtenstein. The case of the EU styling Singapore as an Asian Lichtenstein during bilateral trade talks has provoked a response from Singapore that it's a low tax location, not a no tax location.

It occurs to me that tax authorities do not necessarily take a dim view of tax havens all of the time. Prior to the subprime mess exploding in a big way, fat government revenues from banking fees and commissions partly enabled by the participation of offshore economies may have made these authorities less hawkish. While there are advanced countries which have always held a grudge against tax havens since they haven't encouraged them much in the first place like Germany, others have been at the forefront of their creation in the past. Think of sun-drenched American and British territories you read about in holiday brochures: Cayman Islands, Bermuda, St. Kitts and Nevis. With hedge funds, special purpose vehicles, LBO outfits and the rest now going the way of the dodo, it cannot be good for government coffers in addition to other budgetary shortfalls due to diminished economic activity.

Hence, it is no surprise the current economic downturn is triggering a reaction in the US and UK. In America, president-elect Obama was (is?) co-sponsor of two bits of legislation aimed at the offshore world, the Stop Tax Haven Abuse Act and the Transparency and Law Enforcement Assistance Act. It remains to be seen if a President Obama will make good on cracking down on tax havens. To be sure, his economic team is composed of many who have served in previous administrations largely indifferent to the issue. Meanwhile, in Britain, Chancellor of the Exchequer Alistair Darling--he of the famous eyebrows--is busy inveighing against tax havens all and sundry. Despite the appropriate qualifications, it appears tax havens will have it rough over the next few years. Consider the following:

(1) New measures to interdict terrorist finance and money laundering post 9/11;
(2) LDCs' continuing complaints about tax havens providing sanctuaries for capital flight;
(3) Persistence of off-balance sheet vehicles such as Northern Rock's Granite SIV despite past troubles with these vehicles such as Enron's LJM entity;
(4) Empty developed country coffers redoubling the search for tax cheats;

And last but probably not least -

(5) Given growing government influence if not outright control of major parts of the banking sectors in any number of hard-hit developed countries, resistance to hunting down tax cheats may be watered down.

It's all in play at the moment and how things unfold will be interesting to watch. The last hurrah of the Bush administration saw to it that tax havens were not as much on the G-20 agenda, but he will be gone soon. All the same, as this blog is devoted to development issues, there will be consequences in that department as well. What else can remote islands offer if their ability to use regulatory arbitrage is curtailed? Tourism in this day and age is not exactly a booming sector. Expect a fightback from tax havens, but with their sugardaddies terminally injured, I don't expect it to be a really vigorous one.

I much recommend the Financial Times' long but detailed article on the current state of affairs with regard to tax havens.