One of the first things to understand about offshore business is that it is, at heart, about artificially manipulating paper trails of money across borders. To get an idea of how artificial it can be, consider the banana.
A bunch of bananas typically takes two routes into your home: a real route and an artificial offshore paper trail. On the first route a Honduran worker, say, is employed by Big Banana, a U.S. multinational I’ve just invented, to pick the bananas, which are then packaged and shipped to Britain, sold to a supermarket, and sold on to a customer.
The second route—the accountants’ paper trail—is different. When a banana is picked in Honduras and shipped to Britain and sold, where are the final profits generated? In Honduras? In the British supermarket? In the multinational’s U.S. head office? And how do you work this out? How much do the corporation’s management expertise, or the brand name, or the insurance, or the accounting business, contribute to profits and costs? Which country ought to tax each component of the final profit? Nobody can say for sure, so the accountants can, up to a point, decide for themselves.
Here, in simple form, is what they might do. They advise Big Banana to run its purchasing network from, say, the Cayman Islands, and put a financial services subsidiary in Luxembourg. The Big Banana brand might be parked in Ireland; its shipping subsidiary in the Isle of Man; it might locate certain parts of its “management expertise” in Jersey, and its insurance arm in Bermuda. All are tax havens.
Next, each part of this multinational charges the other parts for the services they provide. So Big Banana’s Luxembourg finance subsidiary might lend money to Big Banana Honduras, then charge that Latin American subsidiary $10 million per year in interest payments for that loan. The Honduran subsidiary will deduct this $10 million from its local profits, cutting or wiping out its local profits (and consequently its tax bill) there. The Luxembourg finance subsidiary, however, will record this $10 million as income—but because Luxembourg is a tax haven, it pays no taxes on this. With a wave of an accountant’s wand, a hefty tax bill has disappeared. Who is to say that the $10 million charged by Big Banana Luxembourg is the real going rate—or just an accountant’s invention? Quite often it is hard to tell, although sometimes these prices are adjusted so aggressively that they lose all sense of reality: A kilo of toilet paper from China has been sold for $4,121.81, a liter of apple juice has been sold out of Israel at $2,052, and a ballpoint pen has been recorded leaving Trinidad valued at $8,500.
Though most examples are far less blatant than this, the cumulative total of these shenanigans is vast. About two-thirds of global cross-border world trade happens inside multinational corporations. And it is poor countries in particular, with their underpaid tax officials, that always lose out to multinationals’ aggressive, highly paid accountants.
What Big Banana has done here is transfer pricing (or mispricing), a common offshore trick that U.S. Senator Carl Levin calls “the corporate equivalent of the secret offshore accounts of individual tax dodgers.” The general idea is that by adjusting its internal prices a multinational can shift profits offshore, where they pay little or no tax, and shift the costs onshore, where they are deducted against tax. In the banana example, tax revenue has been drained out of a poor country and into a tax haven and funneled through to the wealthy owners of a multinational corporation. In October 2010 a Bloomberg reporter explained how Google Inc. cut its taxes by $3.1 billion in the previous three years through transfer pricing games known by names such as the “Double Irish” and “Dutch Sandwich,” ending up with an overseas tax rate of 2.4 percent.7 The problem is getting worse. Microsoft’s tax bill has been falling sharply, for similar reasons. Cisco is at it.8 They are all at it. Transfer pricing alone cost the United States an estimated $60 billion a year9—and that is just one form of the offshore tax game.
Worldly readers may still shrug and tell themselves that this is just part of the ugly flipside of living in a rich nation. If they do, in their reluctantly cynical way, they are suckers—for they are victims, too. The tax bill is cut not only in Honduras but in Britain and America too. The annual report of a real banana company listed in New York notes: “The company currently does not generate U.S. federal taxable income. The company’s taxable earnings are substantially from foreign operations being taxed in jurisdictions at a net effective rate lower than the U.S. statutory rate.”10 (Rough translation: We don’t currently pay U.S. taxes because we use tax havens.)
This may be quite legal—but when it happens, small businesses and ordinary folk must step in to pay the taxes that multinationals have escaped. “Small businesses are the lifeblood of local economies,” said Frank Knapp, member of a new group formed in 2010 called Business and Investors Against Tax Haven Abuse. “We pay our fair share of taxes, shop locally, support our schools, and actually generate most of the new jobs. So why do we have to subsidize multinationals that use offshore tax havens to avoid paying taxes?”
Multinationals, it has to be said, find it hard to cut their taxes to zero because governments take countermeasures. But it is a battle the governments are losing. The U.S. Government Accountability Office reported in 2008 that two-thirds of American and foreign companies doing business in the United States avoided income tax obligations to the federal government in the years 1998–2005, despite corporate sales totaling $2.5 trillion.11 Not only this, but the corporate transfer pricing abuses that I have just described are just one of several forms of tax abuse. Subsequent studies suggest the problem is getting worse.12
Transfer mispricing is one of the most important reasons that multinationals are multinationals and why they usually grow faster than smaller competitors. Anyone worried about the power of global multinationals should pay attention to tax havens.
It is not just your bananas, of course. Much of the food you eat will most likely have taken a similarly twisted route into your home. The water in your tap may have traveled on a similarly ghostly paper pathway en route to your bathtub. Your television, its component parts, and many of the programs it shows also likely took offshore routes into your living room. The offshore world envelops us.
All these offshore games make markets profoundly inefficient. Wealth has been transferred from poor taxpayers to rich shareholders—but nobody has produced a better or cheaper banana here. These are untargeted government subsidies for multinationals, courtesy of the tax havens, and they don’t make multinationals more productive. When corporate managers focus on tax dodging they take their eyes off what they do best—making better goods and delivering them more cheaply to market. Add to that the time and billions wasted paying expensive accountants and lawyers to conjure up these schemes. And then there is the secrecy. A fundamental building block of modern economic theory is transparency: Markets work best when two sides to a contract have access to equal information. Treasure Islands explores a system that works directly and aggressively against transparency. Offshore secrecy shifts control over information and the power that flows from it toward the insiders, helping them take the cream and use the system to shift the costs and risks onto the rest of society.
David Ricardo’s theory of comparative advantage elegantly describes principles that lead different jurisdictions to specialize in certain things: fine wines from France, cheap manufactures from China, and computers from the United States. But when we find that the British Virgin Islands, with fewer than twenty-five thousand inhabitants, hosts over eight hundred thousand companies, or that more than 40 percent of foreign direct investment into India comes from Mauritius, Ricardo’s theory loses its traction. Companies and capital migrate not to where they are most productive but to where they can get the best tax break. There is nothing “efficient” about any of this.
The world contains about 60 secrecy jurisdictions, or tax havens, which can be divided roughly into four groups: a set of continental European havens, a British zone of influence centered on the City of London and loosely shaped around parts of Britain’s former empire, a zone of influen
ce focused on the United States, and a fourth category holding unclassified oddities like Somalia and Uruguay.
The European havens got going properly from the First World War, as governments raised taxes to pay for their war costs. Switzerland’s famous secrecy law, making violation of banking secrecy a criminal offense for the first time, was enacted in 1934 in response to a French tax evasion scandal, though Geneva bankers had sheltered the secret money of European elites since at least the eighteenth century.13 Picturesque, little-known Luxembourg, specializing since 1929 in certain kinds of offshore corporations,14 is among the world’s biggest tax havens today: Well over $2.5 trillion is parked offshore in Luxembourg.15 In March 2010 South Korean intelligence officials indicated that North Korea’s “Dear Leader” Kim Jong-Il had stashed some $4 billion in Europe—profit from the sale of nuclear technology and drugs, insurance fraud, counterfeiting, and projects using forced labor; Luxembourg, they said, is a favored destination for the money.16
The Netherlands is another major European tax haven. In 2006, while the Irish musician Bono browbeat Western taxpayers to boost aid to Africa, his band, U2, shifted its financial empire to the Netherlands to cut its own tax bills. Austria and Belgium are also important European havens of banking secrecy, though Belgium softened its laws in 2009. A couple of other small European micro-state havens are worth noting, including Monaco and Andorra, with occasional cameo roles from odd places like the Portuguese Islands of Madeira, which was central to a major Nigerian bribery scandal involving the U.S. oil service company Halliburton17 that resulted in the second largest fine ever paid in a prosecution under the Foreign Corrupt Practices Act.
The second offshore group, accounting for about half the world’s secrecy jurisdictions, is the biggest. This is a layered hub-and-spoke array of tax havens, centered on the City of London, which mostly emerged from the ashes of the British empire.18 As I will show, it is no coincidence that the City of London, once the capital of the greatest empire the world has known, is the center of the most important part of the global offshore system.
The City’s offshore network has three main layers. Its inner ring consists of Britain’s three Crown Dependencies: the nearby islands of Jersey, Guernsey, and the Isle of Man. The authoritative U.S. publication Tax Analysts estimated conservatively in 2007 that just these three havens hosted about $1 trillion of potentially tax- evading assets.19 At a reasonable annual rate of return of 7 percent and a top income tax rate of 40 percent, the tax evaded on those could be almost $30 billion per year—and income tax evasion is just one of several forms of offshore tax and financial losses. Other losses, which I will explain below, are far bigger.
The next, intermediate ring involves Britain’s 14 overseas territories, the last surviving outposts of Britain’s formal empire. With just a quarter of a million inhabitants between them, they include some of the world’s top secrecy jurisdictions: the Cayman Islands, Bermuda, the British Virgin Islands, Turks and Caicos, and Gibraltar.20 Like the Crown Dependencies, these places are partly independent from Britain—though Britain controls events behind the scenes. In the Caymans, for instance, Her Majesty the British Queen appoints His Excellency the Governor, the most powerful person on the island. He (never a she, so far) presides over a cabinet of local Caymanians who are elected locally but who have almost no power over the stuff that matters—the money. The governor handles defense, internal security, and foreign relations; he appoints the police commissioner, the complaints commissioner, the auditor general, the attorney general, the judiciary, and other top officials. The final appeal court is the Privy Council in London. MI6, Britain’s Secret Intelligence Service, is highly active here21 (as are the CIA and several other intelligence services).
The Cayman Islands is the world’s fifth largest financial center, hosting eighty thousand registered companies, over three-quarters of the world’s hedge funds, and $1.9 trillion on deposit—four times as much as in all the banks in New York City. And it has, at the time of writing, one cinema.
To indicate how murky things are here, the Cayman Islands reported in 2008 that institutions based there had $2.2 trillion in borrowings but had only lent out a third of that amount—even though these figures should match each other, more or less. The UK and Caymans authorities have not explained this $1.5 trillion discrepancy.22
The third, outer ring is a more diverse array of havens like Hong Kong and the Bahamas, which are outside Britain’s direct control but nevertheless have strong historical links to the empire and deep current links to the City of London. One authoritative account estimates that this three-layered British grouping accounts for well over a third of all international bank assets worldwide. Adding the City of London itself brings the total up to nearly a half.23
This network of offshore satellites does several things for the City of London. First, it gives it a global reach: These havens scattered around the world attract and catch mobile international capital flowing to and from nearby jurisdictions, just as a spider’s web catches passing insects. Money attracted to these jurisdictions, and much of the business of managing that money, is funneled through to London. A lot of U.S. business is attracted to the Cayman Islands, and this gives the City of London the chance to get a slice of the action. Second, the spiderweb24 lets the City get involved in business that might be forbidden in Britain, giving the financiers in London sufficient distance from wrongdoing to allow plausible deniability. By the time the money gets to London, often via several intermediary jurisdictions, it has been washed clean. The old City of London adage “Jersey or Jail” means that if you want to do a certain type of business but don’t want to get caught, you just step out into the Jersey part of the spiderweb and do it there. Sometimes, business too dirty for the Crown Dependencies is farmed out further into the spiderweb. John Christensen, formerly a Jersey financial sector professional, remembers the Overseas Territory of Gibraltar being one particular favorite. “We in Jersey regarded Gibraltar as totally subprime,” he said. “This was where you put the real monkey business.” Later, a Caymanian character who introduced himself to me only as “The Devil” will help illustrate just how dirty this business can be.
Britain’s understated, ambiguous, but ultimately controlling role in these nodes of the spiderweb is the bedrock that reassures flighty global capital and underpins their offshore sectors. The gesture toward local representation keeps Caymanians happy and gives Britain the chance to say “it is not our business to interfere” when something unpleasant breaks the surface, or when other countries complain of abuses being perpetrated out of there. Periodically, the charade of the overseas territories is exposed: In August 2009 Britain imposed direct rule in the Turks and Caicos Islands after corruption there spun too far out of control.25 Britain plays down these episodes, as far as is possible, to distract attention away from its real control.
The outer reaches of the British spiderweb consist of a more complex and varied set of places that are independent from Britain, but with a history of involvement with the British empire or zones of close influence, and with enduring and powerful links with the City of London. The biggest are Hong Kong, Singapore, the Bahamas, Dubai, and Ireland,26 though many others exist, like Vanuatu in the South Pacific, whose small offshore center was created by the British government in 1971, nine years before independence. New ones continue to emerge: In February 2006, for example, Ghana said it would set up offshore legislation with help from Britain’s Barclays Bank. The thought of a new African secrecy jurisdiction in the midst of a swath of legendarily corrupt African oil-producing nations—and just as Ghana takes its own first steps as a big oil producer—is almost too horrible to contemplate. Botswana, right next to South Africa, is setting up its offshore center too.
One might ask why the United States has more or less tolerated the presence of British-run places parked off its eastern and southern coastline, eroding its tax base and undermining its laws and financial regulations. The answer isn’t straightforward. U.S. o
fficials have periodically tried to crack down on offshore tax abuse, at least since 1961, when President Kennedy asked Congress for legislation to drive these tax havens “out of existence,”27 but have been thwarted each time by powerful interests on Wall Street. A U.S. Government Accountability Office (GAO) report from December 2008 provides a clue as to their power, showing that Citigroup had 427 tax haven subsidiaries, of which 290 were in the British spiderweb. The next biggest user was Morgan Stanley with 273 offshore subsidiaries (of which 220 were in the British zone), then News Corporation with 152, of which 140 were in the British zone.28
In these numbers lies another important point to understand from the outset. People have traditionally seen tax havens as marginal players used by mafiosi, drug smugglers, spies, petty criminals, and celebrity tax-dodgers. Plenty of these can be found offshore, it is true.29 But I need to stress again: The big users of the secrecy jurisdictions are the banks and other financial institutions.
I am struck by similarities between Britain’s postcolonial offshore network and what I encountered in oil-rich Gabon, the epicenter of France’s own very strange, quasi-offshore postcolonial system. Gabon fits no conventional definition of a tax haven, but it is, like the havens in the British spiderweb, a relic (or even a rebirth) of a colonial empire that is being used by elites to do things—often unpleasant ones—that would not be allowed at home. The Elf system, with its subterranean bargains with African rulers and French politicians, was a way for France to retain a great degree of control over its former colonies after independence. Britain’s spiderweb is different—most of its former colonies in Africa, India, and elsewhere really are independent. But what Britain has done instead is to retain a large degree of control of the vast flows of wealth in and out of these places, under the table. Illicit capital flight from Africa, for example, flows mostly into the modern British spiderweb, to be managed in London. In both the French and the British systems, powerful interest groups in the old colonial powers have built secret financial relationships with the local elites, creating global alliances with each other against the ordinary citizens of these poor countries—and against their own citizens too.
Treasure Islands: Dirty Money, Tax Havens and the Men Who Stole Your Cash Page 3