TAX HAVENS, TAX FLIGHT AND TAX AVOIDANCE
Facts, Consequences and Measures
By Silke OtschSummary
States have lost considerable sums through tax flight and tax avoidance. A parallel legal system has arisen that the privileged systematically exploit. Despite its relevance, sociology has hardly focused on this theme. This study gives a survey on this theme and discusses the state of regulations and prospects of success. Based on interdisciplinary academic research on tax flight and tax avoidance, publications of international organizations and NGOs and analyses of politics, this study describes the following facets: 1. The institutionalization of the offshore economy; 2. The terms of the offshore economy; 3. Techniques of tax flight and tax avoidance; 4. Profiteers, losers, and consequences of tax flight and avoidance; 5. Political-technical measures of tax flight and avoidance and 6. Social causes of offshore practices and possible actions.
Institutions of the offshore economy arose out of the systematic actions of elites and not only by exploiting structural conditions or national legal frameworks by international economic actors. Politics is now passing over from a primarily symbolic to a stronger substantial regulation after the offshore economy was formed over decades. However, retraction of this regulation and a relapse into location competition is a possible scenario because structural forces like institutionalizing competition in the framework of the European Union, increasing inequality, problems of regulation, complex systems, path dependencies, asymmetrical power relations, gaps in regulation and long-term interests of elites counteract regulation. Purely technical regulatory approaches are not enough. Combating the offshore economy has better chances as a broader social project.
Tax havens, tax flight and tax avoidance – described as the offshore economy – are a form of a parallel economy or a parallel legal system in taxation that grants advantages to multinational corporations and rich private persons. Since the 1970s, countries introduced increasing offshore legislation and institutionalized the parallel economy. After tax havens, tax flight and tax avoidance were tolerated for decades, institutions are now put in question – following some data leaks, investigating commissions and increased pressure burdening the public sector.
Nevertheless, recourse to tax havens and tax avoidance are the rule more than the exception for multinational corporations. Rich private persons use tax havens disproportionately compared with the whole population. The volume of financial transfers to tax- and regulatory havens grew intensely between the 1970s and 1990s and up to today according to estimates of experts. Practices of tax avoidance in corporations have also increased (OECD 2013a).
Research on tax havens, tax flight and tax avoidance was long taboo and is difficult because data on allocation of funds is hard to find…Efforts at checking tax flight and tax avoidance often fall into the realm of symbolic politics (Otsch 2012). Tax flight and tax avoidance become side issues that do not substantially concern politics and society.
The Institutionalization of the Offshore Economy
Ronen Palan, Richard Murphy and Christian Chavagneux assume central institutions of the offshore economy were created in the late 19th and early 20th centuries… As a central institution, Palan et al (2010) names the corporate legislation of New Jersey and Delaware in the 1870s – 1890s. Businesses there were recognized as legal persons (alongside natural persons) so businesses and persons could be taxed separately. The concept of the business in the business is a provision that makes possible tax reductions by manipulating transfer prices.
Another instrument of the offshore economy originated through the principle of virtual residence accepted in Great Britain. According to Picciotto (1992), conflicts occurred after 1914 in connection with the rise of direct taxation and the rise of multinational corporations and varied national tax systems. While the US applies the source principle and taxes revenues where they are generated (in the source), other states like Great Britain use the residency principle. Individuals are taxed who are registered with their residence in the country. With the expanded activity of multinational corporations (MNCs), the authorities must increasingly grapple with questions how these actors can be taxed so they are neither taxed twice (in two states) nor not taxed at all. In 1929, a British court declared a multinational business does not need to pay any taxes in Great Britain when owned by a foreign country even when it is registered in Great Britain. This decision on virtual residences was the original idea for the genesis of different tax havens since British law was applied in colonies like the Bermudas, Bahamas and later the Cayman Islands and Hong Kong…
The 1934 banking secrecy negotiated by Swiss banks as a return favor for other agreements with the government is another central institution of the offshore economy. Bank employees are prohibited from releasing account data under threat of civil and
criminal prosecution (not to their own national authorities). Banking secrecy was later adopted by Beirut, the Bahamas, Lichtenstein, Uruguay and panama (Palan 2010). The list of newly introduced institutions of offshore legislation in the late 19th or early 20th century included a multitude of miniature states (like Panama, the Canary Islands, the Netherlands, Monaco etc). Strikingly, the institutions arose partly independent of each other in different places at a time when businesses intensely internationalized and national laws were no longer clearly interpreted. In many cases, legally-trained professionals lobbied governments (Otsch 2016a).
Advisory institutions for tax flight and tax avoidance became widespread after the Second World War when the international financial system of the postwar era was more strongly controlled because of the first world-economic crisis and the world wars that together caused the financial turbulences. In Austria, banking secrecy for savings accounts was first introduced in 1948…
2. The Terms of the Offshore Economy
The offshore economy, according to Ronen Palan (2003), refers to economic forms that evade regular national legal jurisdictions (onshore jurisdictions) by using offshore jurisdictions for their advantage and shifting transactions or persons. Palan writes:
“I conclude that most professionals successfully imply professional ethics to justify their actions and gain support. Here, professional ethics are integrative in regard to tax ideologies, but at the same time they are disintegrative from a material point of view. Users of illegal tax services and tax professionals support each other in a process of social closure. At once they use market power and prevent competition with socioeconomic closure and tax narratives.”
The author uses the term commercialized sovereignty, the right of offshore jurisdictions to pass laws and use protection by the sovereign as a source of revenue (Palan 2003). Offshore economy implies bypassing financial market regulations, environmental and social standards in special economic zones alongside money laundering and navigation under flags of convenience (Palan 2003).
There is no generally accepted definition of tax havens… Older tax haven lists of the OECD describe tax havens as uncooperative jurisdictions… States like Luxemburg, the US and Germany are ignored although these jurisdictions have laws or executor practices that make possible non-transparency and the evasion of laws. In different US states, businesses can be founded anonymously. Agreements on information exchange are formed asymmetrically. Tax- and regulatory oases use a multitude of business models that make difficult a precise definition (Tax Justice Network, TJN 2016a). Tax havens
and `regular’ financial centers cooperate closely. Financial businesses in regular financial centers have subsidiaries in tax havens
The International Network of Tax Justice (TJN) calls tax havens secrecy jurisdictions (shadow financial centers) – a term that refers to secrecy as a central characteristic of tax havens. According to a 2009 definition of the TJN, tax havens have three characteristics. Firstly, tax havens pass laws that benefit persons (or legal persons) that are not settled in the jurisdiction. Secondly, the laws aim at evading or bypassing the regulations of other jurisdictions. Thirdly, they create a legal framework for managing the secrecy of the illegal practices of the beneficiaries (TJN 2009a). Tax havens describe themselves as Offshore Financial Centers (OFCs). Ahmed Zorome defines OFCs as follows: “An OFC is a country or jurisdiction that provides financial services to non-residents in a state that is incommensurate with the size and financing of its domestic economy (Zorome 2007). The comparison of the size of a jur5isdiction or its political economy with its share in financial services is a sensible indicator for small areas…
The Shadow Finance Index (2015) of the TJN classifies secrecy jurisdictions according to the degree of secrecy and the size of the financial center and ranks very non-transparent financial centers every two years. The list covers 92 countries. One group of countries includes miniature states… A second group of countries are larger states like the US or Germany which for a long while were not on the list of tax havens… The tax havens Cayman Islands, Jersey and Guernsey (rank 16 and 17), the British Virgin Islands (21), Mauritius (23), the Bahamas (25), the Isle of Man (32), the Bermudas (34), Gibraltar (55) and eleven groups of islands (TJN 2015)… There are no uniform terms for tax practices from the perspective of regulating tax affairs. These are defined differently in national laws. On principle, the pole of illegal tax evasion and the pole of legal tax avoidance can be distinguished. The grey area of aggressive tax planning exists.
Tax evasion covers a) those liable for taxes that pay fewer taxes by withholding earnings or information from the tax authorities and b) tax fraud – deliberately false statements or adulterated data are supplied. Tax avoidance refers to tax bypassing which conforms to the law but aims at fiscal advantages. The European Union Commission (2012) describes aggressive tax planning as the praxis in which certain obligated to pay taxes use complex partly artificial creations to shift the tax basis to another jurisdiction inside or outside the European Union. They exploit the differences between national laws (so certain revenues are not taxed anywhere) or differences between tax rates (European Commission 2012). Manipulated transfer prices for internal corporate transactions are an example of aggressive tax planning. There is also no generally recognized definition for the term aggressive tax planning…
6. Social Causes of Tax Avoidance and Tax Flight
In the following, I will argue that three bundles of causes are relevant in tax flight and tax avoidance: 1) globalization of markets, 2) path dependencies and cultural factors, and 3) organized actions of elites.
In earlier analyses, Susan Strange formulated the thesis that tax havens are a phenomenon of globalization. With advancing globalization, the power balance between state, capital and businesses shifted to the disadvantage of state power in the middle of the 1980s. This development led to the undermining of democratic institutions. Under conditions of globalized markets, states (namely tax havens) use their legislative competence for market goals which Palan described as commercialized sovereignty (Palan 2002). Strange juxtaposes the expansion of market logic for multinational economic actors with the possibilities of political action. The decision to hardly control financial markets politically in central areas has led to international actors acting according to their own whims (Strange 1996, 1986).
The absence of political rules means businesses hardly have incentives for moral and economically-rational conduct…The dominant presence of economic representatives in lobby work causes an unbalance in influencing politics. According to a study of the NGO Corporate European Observer (2014), the financial industry spends 123 billion euros annually for lobbyism in Brussels while only 1.7 billion euros are spent by NGOs, unions and consumer protection organizations… Path-dependencies, different legal frameworks and bypassing instruments help explain divergent and asymmetrical regulation together with the different political weights and negotiation tactics.
Different recent investigations have moved actors into the foreground. Technical expertise on one side is coupled with financial resources and market logic and on the other side with path dependencies enabling businesses to influence political praxis (for example, referring to the frequently instrumentalized jobs argument…
Colin Crouch (2011) puts a spin on the problem of path-dependencies when he thematicizes the (unintended) bias of regulatory authorities through regulatory capture. Authorities that should enforce the interests of politics identify with those to be regulated and adopt their perspective in trusting the technical knowledge of economic experts and ignore other argumentations and ways of thinking. This thesis is confirmed by a recent study of financial market regulation by politicians. Many new regulations are sensible but are strongly committed to the logic of the system and increase its complexity. This generates “an enormous bureaucracy of banks and monitoring authorities and a pseudosecurity.” Fewer simple but severe rules are necessary (Giegold 2016).
Experts and regulators act against the material interests of the majority out of ignorance or because of globalization pressures… The actions of elites are drivers of development.
This crisis can be interpreted as an “elite debacle” building on analyses of the 2007 financial and economic crisis.
Palan describes the offshore economy as a result of a symbiotic relation between political and economic elites and does not only take up the dichotomy of market and state. According to Palan, the nation state can only act because the ruling elites wanted to avoid Conflict with financial backers and passed specific laws for international investors that led to a bifurcation of the legal system. Thorstein Veblen’s typology of the businessman – a central actor in capitalism – also explains the genesis and dynamic of the offshore economy. The businessman realizes profits through the principle of sabotage, namely by systematically cheating others. In the case of the offshore economy, laws are systematically used against the intention of the legislators (Palan and Nesvetailova 2011).
Elite discourse exists in the realm of tax flight and tax avoidance… Oasis refers to a fruitful place in the wilderness. Tax paradise has positive connotations. The English term tax haven alludes to a haven as a protective space. The term offshore suggests an island off the coast and implies this is hard to reach. Different violent metaphors are frequently used with the term tax fraud or tax flight, persons breaking the law. Nature metaphors like the cash flow or money flow or capital as a timid deer make social institutions seem like natural laws. Counter-metaphors like shadow banks or black lists are hard to popularize and often are not accepted or are only known to insiders. One example is the term secrecy jurisdiction that the Tax Justice Network uses instead of the tax oasis with its positive connotations.… The case of tax havens also demonstrates that enlightenment and pressure can initiate a policy change if enough efforts are made…
Tax flight and tax avoidance should be prevented in the long-term. Questions of democratic control in complex societies are crucial. Questions of inequality, economic power and hegemonial thinking focus on the pressure on legal systems and privileges for the economically favored. Combating the offshore economy is a social project and not only a political-technical challenge.