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Overseas Tax Havens Under the Microscope as Governments Call for Tighter Regulations

The much-vaunted secrecy of tax havens the world over is in danger as bailouts, outrage over low or no taxes paid by hugely profitable corporations, and precarious economies—such as that of Cyprus—make headlines.

Leaders from the EU to the U.S. are calling for greater transparency, tighter regulations and an end to tax evasion by multinational corporations and the high-net-worth. While the jury is still out on whether, and how much, change will come, one thing is certain: tax havens have become a much more open secret. That in itself could bring change in many areas—from taxation to earnings to business practices and even politics.

In 50 to 60 such locations in the world, corporations and individuals have sheltered what is estimated to be $8 trillion to $20 trillion; since there is such a shroud of secrecy over who owns how much, the actual amount is unknown. The EU estimated this April that it loses as much as a trillion euros per year to tax evasion. That by itself is enough to fund the complete bailouts of Greece, Ireland, Portugal and Cyprus twice over, and still have 200 billion euros left. Or, to put it another way, 1 trillion euros is equal to Spain’s annual economic output.

Dr. Eric Toder, co-director of the Urban Institute-Brookings Institution Tax Policy Center, said that there were two kinds of secrecy at issue in the current climate: “One conceals tax avoidance is a big concern about people who might be using secret accounts to conceal drug dealings or other [illicit activities],” he said.

With businesses trying to book their income in countries with the lowest tax rates and most advantageous laws, there is “public disquiet” about the effects of such activities as governments look for ways to bring in additional income to offset losses from the global economic slowdown.

That disquiet is making itself known in a number of ways, including a movement to rein in tax havens. An online petition launched in Europe seeks a “truth commission” to investigate corruption and tax evasion in Switzerland, as well as criminal action against officials and politicians who have salted money away in tax havens. The EU is discussing calls from various member states for those absent tax euros to help finance economies hurting in the wake of the financial crisis. And the U.S. has already taken action, both through investigations of financial misdeeds and the Foreign Account Tax Compliance Act (FATCA).

However, with corporations—and many politicians on both sides of the world—firmly on the other side of the issue, just how much can be done remains to be seen. The U.S., though, in March asked Liechtenstein for information on Americans with financial ties there, and it has already brought Switzerland to heel through its pursuit of American tax evaders. Switzerland’s oldest bank, Wegelin, ended a 272-year history earlier in the year when it succumbed to that pursuit. Now Switzerland is working to negotiate a settlement with the U.S. for the rest of its banks, but that’s not the only issue for the Swiss. A distaste has developed for some of the companies that use Switzerland as a means of evading higher taxes in other jurisdictions.

Commodities traders that use Switzerland as the site of their trades have made their own headlines, such as Trafigura, which dumped toxic waste in Ivory Coast, and Glencore, which recently reveled in the boost to its business a severe U.S. drought would pose. This is not the image Switzerland wants—the home of traders who focus on profits to the exclusion of human costs—and the country’s finance, economy, and foreign ministries are jointly carrying out an investigation of trading companies that benefit from the country’s long-entrenched confidentiality and low taxes.

Between the Swiss investigation and actions by other governments to bring home taxes on sheltered income, businesses may be in for a rude awakening. “That’s the risk you take when you build a business essentially built on bilking other countries’ treasuries Switzerland is in the middle of Europe,” Toder said. It’s no doubt worried about its reputation.” However, he added, “Island [tax haven] jurisdictions are not that worried. I think they’re attractive to the people they want to be attractive to.” Other companies faced boycotts when their tax bills (or lack thereof) were revealed.

The heavy reliance of a tax haven’s government on its financial sector is also a cause for concern. Cyprus’s recent fall from grace resulted in large depositors falling prey to the costs of its bailout, with chatter that a similar fate may await other large depositors in other economically troubled countries. But subsequent headlines have suggested that problems could also lie ahead for Luxembourg, the EU’s wealthiest country, because of the size of its banking sector: 22 times the country’s annual economic output. In contrast, Cyprus’s financial sector was only eight times its annual output. Luxembourg denies there is even a hint of trouble, but EU officials are concerned about countries where the financial sector tail wags the national economy dog.

Malta, too, has voiced its own central bank’s concern about the state of its economy; its financial sector is also eight times its annual output. Josef Bonnici, the central bank governor, suggested that Maltese banks should better diversify their lending portfolios in the long term.

Fallout from ties to tax havens is heavy and growing heavier. News that former U.S. presidential candidate Mitt Romney had accounts in the Cayman Islands did not help his campaign, but in March, a member of French President Francois Hollande’s government resigned after news broke that he’d owned a secret Swiss account. Former Budget Minister Jerome Cahuzac had been leading a government crackdown on, of all things, tax evasion, and repeatedly denied a December report by a French news outlet that he’d had the Swiss account until the beginning of 2010. When he was tied to the account by a voice recording, he resigned.

Still, change is unlikely to come quickly. Although Luxembourg has announced that it will lift its secrecy rules for EU citizens with accounts there, Austria still defends its own secrecy policies, which are written into its constitution. Maria Fekter, the country’s finance minister, declared that she would “fight like a lion” to preserve Austria’s banking secrecy. She also pointed the finger at Britain for its tax havens, including the Cayman Islands, the Channel Islands, the Virgin Islands, and Gibraltar. Britain has said it will make tax evasion the top priority at the G8 this year, during its term of presidency.

While “how all this squeezes out is hard to say. It’s a difficult problem because it really requires international cooperation. Even without cooperation, there are going to be some unilateral moves—by the U.S., to keep some minimum tax on the foreign income of its companies, and there’s talk about changes in other places. Japan has a minimum tax on income that its companies receive from low-tax countries. It’s not that countries are doing nothing; it’s that you need to get away from a race to the bottom, and whether that’s with coordinating activities [or singly], countries are doing that,” according to Toder.

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