Taxes

Offshore Havens Show Policy Failures at Home

The Paradise Papers provide more evidence of how tax havens corrupt both the developed and the developing world.

Taking the wind out of reform drives back home.

Photographer: David Rogers/Getty Images

The release of the so-called Paradise Papers may produce a few disparate scandals, as the publication of the Panama Papers did. But a more radical approach to offshore havens is needed.

The work of University of California, Berkeley economist Gabriel Zucman -- who estimates that the equivalent of about 10 percent of global gross domestic product is held as offshore wealth -- explains it best. The core problem is twofold: Multinationals use offshore jurisdictions to hide profits from taxation, and the corrupt elites of developing countries outsource justice and property rights there, plundering their home countries and ruining incentives to reform.

In a recent presentation, Zucman and two collaborators from the University of Copenhagen estimated that 16.9 percent of global corporate profits are recorded by multinational companies; 45 percent of multinationals' profits -- 600 billion euros ($696 billion) in 2015 alone -- are shifted to tax havens. In the coming days, the analysis of the Paradise Papers will provide more facts about how this works for the likes of Apple and Nike.

That translates into a global corporate tax revenue loss of 200 billion euros; the European Union, for example, loses 20 percent of the revenue to which it would be entitled had tax havens not existed. The roughly $108 billion the U.S. undercollects every year is nothing to sneeze at either. 

The Biggest Offshore Leak

Tax loss as a share of the current corporate tax income

Source: Torslov, Wier, Zucman (2017)

These are only theoretical revenues; one could argue these countries could never collect them, especially in this age of globalization. But the path of least resistance offered by the tax havens is the greatest obstacle for tax reforms in wealthy nations. If the companies that currently use Bermuda and Luxembourg to minimize taxes were deprived of this opportunity, they would be more likely to invest their massive resources into pushing for change at home, leveling the playing field for smaller businesses, which cannot afford to build international avoidance schemes in the process.

Zucman's proposed solution: Apportion global profits according to the geographic breakdown of sales. It would make profit-shifting pointless; it would also work as a unilateral solution for any of the world's big economies.

It wouldn't, however, solve the other problem -- that of the developing world. In a September 2017 National Bureau of Economic Research working paper, Zucman and collaborators estimated that while Scandinavian countries only send the equivalent of about 5 percent of their economic output to offshore centers, and the share only goes up to 15 percent for continental European countries, it increases to more than 50 percent for Russia, Persian Gulf and Latin American nations. 

This is not about taxes so much as about the way these countries are governed. Unreliable, easily corruptible courts; the selective enforcement of property rights; rulers' sudden expropriatory impulses and power struggles disguised as anti-corruption campaigns, exemplified by last weekend's royal purge in Saudi Arabia -- all of these endemic problems make it prudent for the developing world's rich to keep their wealth in jurisdictions with good legal systems and traditions of secrecy. No matter how much more open offshore centers have become in the last decade, one can still construct layers of ownership, often across several countries, that make wealth hard to attribute.

The Paradise Papers show how this works in Ukraine, where President Petro Poroshenko constructed various offshore schemes to safeguard his confectionery business assets and an official taking part in reforming the country's energy sector set up a structure that could have been used to avoid the nation's capital restrictions. Ukraine would be better off if they'd worked harder to fix its regulatory and legal environment.

Regimes such as Vladimir Putin's in Russia have also availed themselves of offshore entities to obscure the origin of the money they've invested in Western markets. That's reportedly what happened with some early Russian investments in Facebook and Twitter, some of which, it has now been revealed, came from state-owned sources. 

These problems require a more radical solution than the tax issue. In response to the Paradise Papers, Transparency International, the global anti-corruption organization, has suggested increasing the due diligence requirements for lawyers and luxury merchants and establishing national registers of beneficial owners. But these measures would be difficult to enforce, and corrupt regimes would have little incentive to be serious about owner registers.

The owner register should be maintained by an international body, perhaps under the auspices of the G-20. It would also be useful to adopt international rules that would ban residents of a country from owning assets in it through other jurisdictions. Along with anti-tax-evasion measures, it would create a tougher regulatory framework for offshore jurisdictions and stimulate institutional change in economies that now send hundreds of billions of dollars offshore. There's no need for more scandals to start the process.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

    To contact the author of this story:
    Leonid Bershidsky at lbershidsky@bloomberg.net

    To contact the editor responsible for this story:
    Therese Raphael at traphael4@bloomberg.net

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