The crackdown on tax havens

It’s going to be a tough year for offshore financial havens as the authorities move against them, says Matthew Partridge. But is the crackdown justified?

It's going to be a tough year for offshore financial havens as the authorities move against them, says Matthew Partridge.

What's happened?

The Economist thinks that 2013 could "turn out to be an annus horribilis for the offshore financial world". Luxembourg has become the latest country to agree to share information on private individuals holding money in its banks, having previously insisted on privacy for account holders.

This means that France and Germany are now close to securing an EU-wide agreement, similar to a 2010 US Act (see below) that would allow tax authorities to request the details of money held in European bank accounts that it suspected were being used illegally to evade tax.

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The Sunday Times also claims that Britain's chancellor, George Osborne, is close to securing a deal that will allow the British tax authorities to access bank details in the Cayman Islands and the British Virgin Islands, two British overseas territories that have been criticised for their attitude towards bank secrecy. Last year, the Isle of Man, Jersey and Guernsey agreed to similar measures.

Why these moves now?

The general suspicion is that people have long exploited banking secrecy in tax havens to hide the proceeds of domestic tax avoidance and to avoid paying taxes on investments. Some havens are also suspected of laundering money for criminal activity, including drug trafficking and terrorism.

Nicholas Shaxson of the Tax Justice Network claims that countries with bank secrecy get rich by "providing rich individuals and corporations with financial bolt holes, where they can do things with their money that they wouldn't be allowed to do at home".

The Economist also notes that tax havens "make it harder to gain a true picture of where debt and risk lie" and that's now a more serious problem, given the ongoing financial crisis.

As Nicolas Vron, of Bruegel, a leading European think-tank, notes, high unemployment and austerity have led to a public backlash against tax dodging and offshore accounts are an easy target. Recently even Jrme Cahuzac, the French budget minister, was forced to resign after it was revealed that he had kept a secret Swiss bank account for over two decades.

Is tax evasion widespread?

Due to its underground nature and the fine line between flouting existing rules (tax evasion, which is illegal) and bending them (tax avoidance, which is legal), it's hard to know exactly. However, a study at the end of 2011 by the Tax Justice Network had a go. It tried to estimate the revenue loss by multiplying the size of the untaxed "shadow" global economy by the tax rate for the rest of the economy. This suggested that lost revenue amounts to $3trn globally, equivalent to 5% of GDP.

As the world's largest economy, America loses the most, but tax evasion is endemic in the developed world and southern Europe. The Economist notes that cheating the taxman is so universal in Greece that bank records show doctors and lawyers paying more in debt servicing costs than their reported incomes. Herman Van Rompuy, the president of the European Council, claims that just 1% of the €1trn reportedly lost by EU governments to evasion could have funded the recent Cyprus bail-out.

Is anyone against all this?

Unsurprisingly, any crackdown on havens is bitterly resented by countries with strict banking secrecy laws and large amounts of foreign deposits, such as Austria, Lichtenstein, Luxembourg and Switzerland. They rightly complain that many of the countries that are at the forefront of the clampdown are behaving hypocritically by refusing to be transparent about bank accounts in their own jurisdictions.

Austria's finance minister, Maria Fekter, points the finger at Britain for its lax attitude to overseas depositors, and at parts of the US (such as the state of Delaware) that make it easy to set up complex corporate structures.

But her efforts to prevent Austria signing up to this new agreement are likely to fail. Indeed, as James Shotter points out in the FT, even Austria's chancellor has conceded that the country needs "to act faster and more aggressively" against fraud.

Are tax havens always a bad thing?

Daniel Mitchell of the Cato Institute says, in The New York Times that, "tax havens should be celebrated, not persecuted". Competition from low-tax regimes means that elsewhere "top personal income-tax rates have dropped from an average of more than 67% in 1980 to about 42% today", while corporate tax rates have also fallen "from an average of 48% to 24%".

This has made the global economy "more vibrant" than in the 1960s and 1970s. Havens also provide "a financial refuge for people who live in nations where governments are incompetent and corrupt". It's a defence that's not cutting much ice with Western politicians.

The cost of compliance with tax clampdown

In 2010, America's Congress passed the Foreign Account Tax Compliance Act (FATCA), aimed at forcing foreign banks, funds and financial advisers proactively to help the US tax authorities. The new rules, which came into force this year, require them to report the names and details, including balances and withdrawals, of all American account holders. Institutions that don't carry out such checks can be declared "non-compliant" and hit with penalties.

The cost of compliance has led some banks to close all their accounts with Americans. Meanwhile, Helena Bachmann of Time magazine reports that "thousands of American expatriates" have "taken the drastic and irrevocable step of giving up their citizenship because of what they consider to be the unjust and discriminatory taxation practices of their government".

Dr Matthew Partridge

Matthew graduated from the University of Durham in 2004; he then gained an MSc, followed by a PhD at the London School of Economics.

He has previously written for a wide range of publications, including the Guardian and the Economist, and also helped to run a newsletter on terrorism. He has spent time at Lehman Brothers, Citigroup and the consultancy Lombard Street Research.

Matthew is the author of Superinvestors: Lessons from the greatest investors in history, published by Harriman House, which has been translated into several languages. His second book, Investing Explained: The Accessible Guide to Building an Investment Portfolio, is published by Kogan Page.

As senior writer, he writes the shares and politics & economics pages, as well as weekly Blowing It and Great Frauds in History columns He also writes a fortnightly reviews page and trading tips, as well as regular cover stories and multi-page investment focus features.

Follow Matthew on Twitter: @DrMatthewPartri