by Alec Ross
The companies and individuals who can afford to take advantage of the global financial system might benefit, but most of us do not. Many small countries have “mostly given up” trying to bring in taxes from multinationals, according to University of Chicago economist Austan Goolsbee.
Today, governments around the world rely more on sales and individual income taxes than corporate taxes to fund their programs. The result, Goolsbee said, is that the burden of funding the government has shifted from big companies to everyday people. Government policy enables concentrated power in markets to avoid contributing to society, and as a result that burden is borne by citizens even as their public benefits are constrained by a drop in tax revenue. When countries are forced to compete on tax, their citizens lose the ability to determine the size of their government programs, the strength of their safety net, and the distribution of their wealth. The power and potential of good governance evaporate.
Nowhere is this cost greater than in the developing world.
ANGOLA
As we turn to the developing world, it’s worth remembering the distinction between corporate tax avoidance, which does not blatantly violate the law (albeit contortedly), and tax evasion, which does. Both tax evasion and tax avoidance rely on the same basic strategy: use the laws of an offshore jurisdiction to get around the rules of your home country. While companies use the offshore system to lower profits in high-tax countries and raise profits in low-tax countries, many of the ultra-wealthy use it to make their wealth disappear from view altogether.
When it comes to tax evasion, the name of the game is secrecy. The more cash, stocks, bonds, and other assets you can hide from the government, the less income you declare on that wealth, and the less you pay in taxes. By obscuring the paper trails that can tie them to their assets, some of the wealthiest individuals in the world can make it seem like they make a lot less money than they do.
Certain jurisdictions specialize in these disappearing acts. The funds that reinvest this hidden wealth are located mostly in Luxembourg, Ireland, and the Cayman Islands. The anonymous shell companies, trusts, and foundations where elites deposit their money are concentrated in the Caymans, Panama, Singapore, Hong Kong, and the British Virgin Islands. The United States is also becoming a top destination for non-Americans looking to set up anonymous companies. This secretive banking industry traces its roots to the early 20th century, when wealthy families flocked to Switzerland to avoid the new taxes European governments imposed after the First World War. Because Swiss banks did not communicate with other countries’ tax authorities, foreigners could earn interest and dividends on their assets without tipping off anyone back home.
The secrecy of Swiss banks also attracted less savory clients from across the pond. After federal authorities locked up Chicago gangster Al Capone on tax evasion charges, mobsters found themselves in desperate need of a place to stash their ill-gotten money. They found refuge in Switzerland. Beginning in the 1930s, mobsters started moving their assets through anonymous companies into Swiss banks, often in suitcases stuffed with cash, diamonds, and cashier’s checks. They then took out loans from the same banks and wrote the interest payments off their taxable business income.
The effort was orchestrated by Meyer Lansky, a Russian-born mob financier who inspired the character Hyman Roth in the Godfather movies. Lansky would later spearhead the mob’s expansion into Cuba and, after Fidel Castro came to power, the Bahamas. His gambling and banking operations brought so much money to the Bahamas that the territory’s British officials were willing to turn a blind eye to his criminal ties. In the 1960s, Finance Minister Stafford Sands, who had previously taken a $1.8 million bribe from Lansky, pushed for legislation that made it a criminal offense to disclose the owners of bank accounts and other financial information. The measure passed with the tacit approval of London, making the Bahamas one of the first Caribbean tax havens.
The secretive banking system created for mobsters in the Bahamas would later expand to the Cayman Islands, the British Virgin Islands, and beyond. It also started attracting new clients. By the 1980s, Latin American drug traffickers, African dictators, and American entrepreneurs were using the offshore system to invest their fortunes in the global market, invisible to tax authorities and law enforcement. The banks that provided these services were (and still are) mostly regional offshoots of larger institutions in London, Zurich, and New York City. While it still caters to organized crime, the offshore system now serves the whole array of global elites, and the scale of the tax evasion is massive.
Gabriel Zucman, an economist at the University of California, Berkeley, estimated in 2015 that about $7.6 trillion in private assets is hidden in global tax havens. That means about 8 percent of the planet’s personal financial wealth is invisible to tax authorities. If it were taxed, this hidden wealth would generate an extra $200 billion in revenue for governments worldwide, every single year. And this is a conservative estimate. Researchers at the Organisation for Economic Co-operation and Development uncovered more than €10 trillion ($11.4 trillion) in personal wealth stashed offshore. Economist James Henry places the figure in the range of $24 trillion to $32 trillion. One estimate holds that if the wealthiest 1 percent paid just 0.5 percent in extra tax each year over the next ten years, it would equal the investment necessary to create 117 million new jobs.
But not every country feels the impact of tax evasion in the same way. According to Zucman’s estimates, Europeans have the most money stashed offshore—$2.6 trillion—but that represents only about 10 percent of the total financial wealth on the continent. In the United States and Asia, only 4 percent of financial wealth is located offshore. Make no mistake: personal tax evasion still costs these governments tens of billions in revenue. But wealthy nations can weather the loss of revenue more easily.
As previously stated, it is the developing world that suffers the most from tax evasion. In Latin America, about 22 percent of personal financial wealth is kept in tax havens, and in Africa the figure is 30 percent. In both Russia and the Gulf states, more than half of all financial wealth is stashed abroad. Developing nations often lack the necessary resources to ensure that the tax they’re owed makes it into their coffers—especially when tax havens and even the US and UK make it so easy to move money to their shores without a trace. And in developing nations, individual tax evasion and corporate tax evasion often go hand in hand. There is a long history of companies engaging in downright abusive schemes to drain profits out of the developing world without giving a cent back. In Africa alone, a High Level Panel on illicit financial flows estimated that companies drained $50 billion from the continent annually. And while the US or EU might have the tools to investigate a Double Irish scheme or more brazen money laundering, this is much rarer in poorer nations, especially as the globe continues to race to the bottom.
Financial secrecy exacerbates poverty, government corruption, and organized crime. Over the years, journalists have uncovered countless stories of oligarchs in developing countries using the offshore system to enrich themselves at the expense of citizens. Nowhere is this more evident than in Angola, a prime example of the tax abuse woes that plague the developing world.
Angola’s geography bears some resemblance to California: it boasts rain forests in the north and desert in the south, connected by nearly a thousand miles of beautiful coastline. Like many countries in sub-Saharan Africa, the vast majority of Angola’s wealth comes from beneath the ground. Oil accounts for more than 90 percent of the country’s exports, diamonds make up another 5 percent, and the rest is coffee and other agricultural products. Despite the riches that lie beneath Angola’s soil, half of its citizens live on less than a dollar per day, and the country has one of the highest rates of infant mortality in the world. The suffering of the Angolan people is attributable to the country’s ruling class, which has spent decades funneling Angola’s wealth offshore.
Immediately after gaining independence from Portugal in 1975, Angola descended
into a twenty-seven-year civil war. By 1993, the forces loyal to President José Eduardo dos Santos were in desperate need of weapons. With his government under an international arms embargo, dos Santos and his associates set up an under-the-table deal with French officials to exchange arms for oil. In the following years, nearly $800 million in Angolan oil money was transferred out of the country through anonymous accounts in Switzerland. Subsequent investigations found that much of the money ended up in the hands of French and Angolan officials, after routing through tax havens. At the same time, the forces opposing dos Santos were smuggling diamonds into the Congo and Belgium to finance their own war effort. Though the exact figure is impossible to know, researchers estimate some $4.7 billion was smuggled out of Angola during the last decade of its civil war.
Dos Santos emerged victorious from the civil war and held on to the presidency until 2017. All the while, he and his family used Angola as their personal piggy bank.
José Filomeno dos Santos, the president’s son, served as the head of Angola’s sovereign wealth fund from 2013 to 2017. He was later accused of siphoning more than $500 million out of the fund during his tenure.
In 2020, Isabel dos Santos, the president’s daughter, was charged with embezzling some $57 million from the state-run oil company she once directed. She is also wrapped up in a scandal involving Angola’s state-sponsored diamond producer, Sodiam.
In 2012, Sodiam and dos Santos’s husband, Sindika Dokolo, agreed to buy a stake in the Swiss jeweler De Grisogono. It was intended to be a fifty-fifty partnership, but it later came out that Sodiam poured nearly $150 million into the deal while Dokolo put up virtually no money. To pay for the investment, Sodiam took out a loan from a private bank in which dos Santos herself was the largest shareholder.
As of April 2020, dos Santos was still considered the richest woman in Africa, with an estimated $2 billion in assets scattered across some four hundred companies in forty-one different countries. I spent time with Isabel dos Santos on two occasions, once in Gabon and once in Nigeria. In both cases she moved through the country like a head of state, with an absurd sense of entitlement and dripping in jewelry.
The problem of families like the dos Santoses is not unique to Angola. The offshore system has allowed corrupt officials and business leaders to plunder the continent for decades.
“Corruption continues to be a major problem in Africa,” said Johnnie Carson, a career diplomat who served as US assistant secretary of state for African affairs. “If you steal all of the major income of a country … then you’re going to have a weak and fractured society. You’re going to have endemic corruption that goes up and down, not just at the top, but through the system, and the social contract will break down.”
The Western firms that assist elites in siphoning money out of the developing world appear happy to ignore the consequences of this theft.
Before his time in the Jersey government, John Christensen worked for Touche Ross, a professional services firm that is now part of Deloitte. While there, he administered the offshore accounts of about 120 clients, none of whom resided in Jersey. Given his access, Christensen said, he quickly realized most clients were engaged in some kind of illicit activity. He voiced his misgivings on more than one occasion, but each time they were met with a shrug. Once, he remembers alerting his boss to potential fraud involving an oil company in Nigeria and a string of trust companies in Jersey and the Caribbean. He was told to drop it. “That client is a very good client—and frankly I don’t give a shit about Africa anyway,” his boss said.
Each year, tax evasion costs African governments $14 billion in revenue. When you factor in the money African leaders directly siphon out of their governments, the total losses are much greater. Among economists, this outflow of national wealth through tax avoidance, tax evasion, and other means is known as capital flight.
A dollar invested abroad is a dollar that does not support local businesses and entrepreneurs. Researchers at the University of Massachusetts Amherst found that between 1970 and 2015, Africa lost more money to capital flight than it received in foreign aid. That makes the continent a “net creditor” to the rest of the world.
“A major constraint to economic development in Africa is the lack of adequate financial resources in the face of immense needs in public investment in infrastructure and social services,” researchers wrote. “Capital flight undermines efforts to alleviate that constraint.”
You cannot stop wealthy Africans from investing abroad. But by reforming tax havens and the secretive banks that they empower, you can ensure that a piece of their returns gets injected back into the local economy. Increased tax revenue would also enable governments in developing countries to more effectively investigate tax evasion and avoidance, creating a virtuous cycle. We have already seen that a small increase in resources can go a long way. In 2015, the Organisation for Economic Co-operation and Development (OECD), an organization comprising thirty-seven of the largest economies, and the United Nations launched Tax Inspectors Without Borders, an initiative that supports developing countries’ tax authorities with outside expertise. By 2019, the program had helped participating nations collect almost $500 million in additional tax revenue. Every dollar invested in the program returned $100 in extra taxes, which is then reinvested in citizens and the economy. These results show that strengthening tax authorities may be among the most cost-effective ways to improve governance and expand social services in developing countries. According to John Christensen, countries participating in the program see multinational companies adopting “far less aggressive” tax structures than they had previously.
Much of the money flowing out of developing countries is flowing illegally. It is not companies cleverly navigating the rules of different jurisdictions to lower their tax bills; it is often individuals using financial secrecy laws to hide their wealth entirely, or shady companies keeping illicit deals off the books and absconding with the money.
In these cases, “we’re not talking about tax competition, but of theft pure and simple,” said Gabriel Zucman, the economist and author of The Hidden Wealth of Nations. “Luxembourg or the Cayman Islands offer some taxpayers who wish to do so the possibility of stealing from their governments. It is their choice, but there is no reason that the United States, Europe, or developing countries should pay the price for it.”
That’s the reality right now. That’s what happens when nations like the US talk about cracking down on tax havens while welcoming anonymous foreign money.
HOW DO WE START TO FIX THIS MESS?
So how do we start to fix this mess?
The world we know today is not the world our tax system was built for. When financial activity and wealth traverses national borders, the tax system must do the same. Right now, it does not.
When it comes to tax, a multinational corporation is treated not as a single entity but rather as a loosely affiliated group of subsidiaries distributed around the globe. As such, countries can tax only the subsidiaries that fall under their jurisdiction. The government of Italy can levy taxes on Google Italy s.r.l. (the search giant’s Italian arm), but Google Ireland Limited, Google Netherlands Holdings B.V., and the dozens of other subsidiaries under the Google umbrella are out of its reach. So too is Alphabet Inc., Google’s parent company.
If you think of multinational companies as a forest that spans the globe, national governments today can levy taxes only on the tree trunks within their borders. But the companies can ensure the fruit falls well beyond those borders. When the bulk of the harvest is funneled to low-tax jurisdictions, it is easy to see how other regions will starve.
Given this complexity of international tax law, some people think countries would be better off shifting away from corporate taxation altogether.
“I think some legitimate mutual gain that can be had by continuing to creep towards clamping down on some of the more egregious corporate tax structures, but it’s not going to solve the issue around corporate tax becaus
e it’s just unsolvable,” said a former top official with the UK chancellor of the exchequer. “The coordination problem is too hard—there’s too many jurisdictions willing to be the low tax jurisdiction. If you’re actually really serious about using the tax system more effectively to be redistributive … corporate taxation is not where it’s at.”
However, some economists think they have already figured out a system that prevents countries from falling victim to multinationals’ profit shifting. It is an elegant solution with an unwieldy name: unitary taxation with formulary apportionment.
The system is actually a combination of two separate but related policies: unitary taxation and formulary apportionment.
Under unitary taxation, governments treat a multinational corporation not as a collection of affiliates but as a single organization. Instead of looking at the profits of each individual subsidiary, a unitary tax system focuses on the profits of the company as a whole. In Google’s case, that means it does not matter if profits come from Google Ireland Limited, Google Ireland Holdings, or Google Netherlands Holdings B.V. Tax collectors consider only the profits for Alphabet Inc. In other words, you acknowledge the trees but tax the forest.
That said, countries would be able to tax only their fair share of the forest. This is where formulary apportionment comes in. The process can get quite complex, but at its core, formulary apportionment is a way to determine where a multinational’s revenues and costs were generated geographically. The calculation can be based on different metrics—the simplest formula considers only sales, but others factor in payroll and property. After crunching these numbers, governments can figure out what percentage of the company’s total profit was generated within their borders, and thus what they have the right to tax.