Treasure Islands: Dirty Money, Tax Havens and the Men Who Stole Your Cash

by Nicholas Shaxson

  Perhaps the saddest part of all this is that it should have been obvious to anybody who gave it a moment’s thought.

  The stories in this chapter have been mostly about illicit financial flows drained from developing countries and into tax havens, undermining incentives for local elites to strive for better government by allowing them to remove themselves from the problems of their home countries, building safe offshore stashes that insulate and protect them against the turmoil and poverty that surrounds them. There is one more element to consider that is related to, but not the same as, the illicit offshore money. That element is tax.

  Tax is the most sustainable, the most important, and the most beneficial form of finance for development. It is not just a question of revenue: Tax makes rulers accountable to their citizens, not to donors. As Kenya revenue commissioner Michael Waweru put it: “Pay your taxes, and set your country free.” Tax helps countries build good government in two broad ways. First, as citizens bargain with their rulers over tax, a social contract develops between them, helping foster representative democracy. Second, the imperative to raise tax revenue stimulates the building of institutions to do so. It strengthens state capacity.

  This “no taxation without representation” formula is never perfect or even close to perfect, but historians recognize it as a cornerstone, over the very long term, of the development of democracy and representative government in the developed world. Until very recently, almost nobody spent time wondering whether this formula might work in developing countries too. The answer, instead, has been to send foreign aid.

  Developing countries, by and large, have very low tax revenues, and the dynamics of tax and state-building have often been weak. Where tax revenues are high, it is often because the country is a mineral producer: These kinds of revenues make rulers accountable more to oil companies than to their citizens and fail to build accountability. Yet Africans today increasingly understand the importance of tax in their developing countries. “I have made revenue collection a frontline institution because it is the one which can emancipate us from begging,” said Yoweri Museveni, the president of Uganda, which collects taxes worth only about 11 percent of GDP. “If we can get about 22 percent of GDP we should not need to disturb anybody by asking for aid; instead of coming here to bother you, give me this, give me this, I shall come here to greet you, to trade with you.”35

  Tax havens, of course, overturn the healthy dynamics by providing escape routes for their elites. It is worth briefly exploring some of the ways in which poor countries are drained of tax money through operations that, even when of questionable legality, are rarely challenged. This brings us back to the story about how countries allocate taxing rights between them.

  Since the 1920s, when the League of Nations tried to get countries to agree how they would divide up the tax revenues on incomes from the various operations of multinationals, a big question has been at play. Do most of the taxing rights go to the “source” country that hosts inward investment from a multinational based in another country, which is the source of the income in question? Or do they go to the “residence” country—the multinational’s home country, where it is resident?

  Capital-rich countries like Britain that hosted a lot of multinationals investing overseas wanted rules giving most taxing rights to “residence” countries, while the “source” countries receiving inward investment—often poorer countries—wanted to tax the investors’ income locally, at the source. The agreements were eventually laid out in bilateral tax treaties between countries, but these treaties were heavily influenced by the prevailing models. The rich countries, led by the OECD today, have pushed for a model skewed in favor of themselves, while the United Nations favors a model that shifts taxing rights toward “source” countries, typically poorer ones.

  No prizes for guessing which model has come to dominate the field of international tax. When the United Nations produced a draft model tax treaty in 1980 that was supposed to shift the balance back in favor of “source” taxation and developing countries, the OECD intervened aggressively to stop this: not only by ensuring that its own model treaty benefiting rich countries remained the preferred standard, but also by interfering at the United Nations to weaken its model. John Christensen, a former economic adviser to the British Crown Dependency of Jersey, remembers a meeting of the United Nations Tax Committee in Geneva in 2008 when Britain’s representative suddenly stood up and began speaking, in what looked like an intervention coordinated with the representative from Liechtenstein. “He kept on interrupting,” Christensen said. “It was a general assault on developing countries being better able to represent their interests, about providing more resources to the UN Tax Committee. He was the cheerleader. Twice the chair had to tell him ‘please let us speak.’ People there were really angry with him: we could all see he was blocking progress to protect the UK’s and the United States’ interests.”

  The rich countries’ model is dominant today. Not only has this problem of double nontaxation of multinational corporations been allowed to happen, but billions of dollars in tax that would in a fairer world be paid in poor countries is paid in rich countries instead, quite legally.

  It is worth briefly examining another role played by tax havens in the weird and wonderful world of international tax that enables companies to knock out their tax bills. Let’s say a German bank or company invests in Tanzania. Under a tax treaty between Germany and Tanzania, the African country may well agree not to tax the company’s local earnings for fear that otherwise German companies will simply invest elsewhere. But now even with this treaty in place, the German corporation has not solved its problem yet. The treaty may have knocked out the Tanzanian tax charge on the company’s earnings, but if it sends these untaxed earnings straight back to Germany they will still be taxed there. So it sends the earnings to a so-called conduit or treaty haven, which will have a wide network of treaties, including one with Tanzania. The treaty haven also agrees not to tax these untaxed earnings: What has happened here is that the haven serves as a stepping-stone for these profits to emerge, along carefully constructed tax-free pathways, out from Tanzania and into the wider world, often via yet another haven where the income will not be taxed at all.

  “Like two closely marked football players passing the ball to a third one who is unmarked,” explains Professor Sol Picciotto, a tax haven expert, a conduit haven “can create major gaps in the defenses of tax authorities.” In this case both Tanzania and Germany are deprived of tax revenues, courtesy of offshore. And this is quite legal. Many tens, and potentially hundreds, of billions of dollars of tax revenue are at stake in this game, vastly increasing the hunger for foreign aid among the world’s poorer nations. South Africa’s finance minister Trevor Manuel put the problem neatly. “It is a contradiction to support increased development assistance yet turn a blind eye to actions by multinationals and others that undermine the tax base of a developing country.”36

  Over twenty-five hundred tax treaties are in place around the world—an extensive but very poorly understood counterpart of the global trading and investment regime.

  The Netherlands, with a wide network of tax treaties, is a good example of a treaty haven. The two biggest sources of foreign investment into China in 2007 were not Japan or the United States or South Korea but Hong Kong and the British Virgin Islands.37 Similarly, as of 2009 the biggest source of foreign investment into India, at over 43 percent of the total, is not the United States or Britain or China but the treaty haven of Mauritius, a rising star of the offshore system.38 And here lies another odd tale.

  Mauritius illustrates how the British spiderweb is no imperial relic but a modern and self-renewing system. Although French-speaking, the country has a long history of British colonial involvement.39 Mauritius set up its offshore center in 1989 under the tutelage of experts mostly from the City of London, Jersey, and the Isle of Man. Rudolf Elmer, who worked as a senior offshore practitioner in Mauritius from 2006 to 2008 for Stand
ard Bank, says he trained in Jersey and the Isle of Man before being sent to Mauritius. “There is a lot of British influence,” he said. “Major banks like Barclays and HSBC have built up major operations and multistory buildings in Cyber City south of Port Louis [the capital]. Six years ago there were only five. Today, I estimate about 40. It is a hot spot: it will become very prominent.”40

  Though formally independent, Mauritius is a member of Britain’s Commonwealth, and its final appeal court is the Privy Council in London. Having gotten over a shaky period in the 1980s, Mauritius is now politically stable and boasts a cheap, well-educated, and multilingual labor force, and it is in the perfect time zone to serve Europe, Asia, and Africa. With over 40 tax treaties with countries in those three continents, Mauritius is a fast-growing conduit haven for investment into India and for investment into Africa from China and the City of London.

  Mauritius also specializes in “round-tripping.” In this practice a wealthy Indian, say, will send his money to Mauritius, where it is dressed up in a secrecy structure in order to disguise it as foreign investment before it is returned to India. Because of the treaty, the wealthy Indian can avoid Indian withholding taxes on local earnings and use the secrecy to do nefarious things—such as constructing a local market monopoly by disguising the fact that a seemingly diverse and unrelated array of competitors in a market is in fact controlled by the same interests. The construction of secret monopolies via offshore secrecy seems pervasive in certain sectors and goes some way toward explaining why, for example, mobile phone charges are so high in some developing countries.

  Local elites lobby for these treaties despite the harm they can cause. “The India treaty with Mauritius is a pure treaty-shopping treaty,” said David Rosenbloom, a U.S. tax expert. “Why do the Indians tolerate it? We, the United States, have a treaty with Bermuda, which is ridiculous: Bermuda doesn’t even have a tax system. Countries do bizarre things. A lot of it is political. It defies rational thought.”41

  8

  RESISTANCE

  In Combat with the Ideological Warriors of Offshore

  IN APRIL 1998 THE ORGANISATION FOR ECONOMIC Co-operation and Development, a club of rich countries that includes the world’s most important secrecy jurisdictions, made an astonishing admission: Tax havens cause great harm. Tax havens and associated offshore activities, an OECD report acknowledged, “erode the tax bases of other countries, distort trade and investment patterns and undermine the fairness, neutrality and broad social acceptance of tax systems generally. Such harmful tax competition diminishes global welfare and undermines taxpayer confidence in the integrity of tax systems.”1

  Offshore is not only a place, a system, and a process, but it can also be considered as a collection of intellectual arguments. Through the OECD’s new project—the first serious and sustained intellectual assault on the secrecy jurisdictions in world history2—I will explore the main arguments made by the defenders of the offshore system.

  At the time the OECD project got under way, worldwide protests were rampant against the obvious failures of globalization. Yet campaigners, who focused many of their arguments on trade, all but ignored the offshore system. The OECD’s new initiative, which contained a lot of baffling discussion about international tax, hardly registered on the protesters’ agendas.

  The new report was allowed to emerge for several reasons. First, the evidence had become impossible to ignore: The use of tax havens was “large, and expanding at an exponential rate,” as the report put it. Second, the report was aimed mostly at small Caribbean islands that were not OECD members, and it glossed over the role of OECD countries in offshore.3 Also, several OECD countries that were not tax havens pushed the report hard inside the OECD. But there is another important reason why the OECD report got through: Tax havens are so steeped in indifference to big inter-governmental bodies that although the OECD had flagged the report for two years, almost nobody offshore had paid it enough attention to mount a serious effort to stop it from emerging.

  John Christensen was in Jersey when the 1998 report came out. “Virtually nobody there took it seriously except me,” he said. “Bankers were saying ‘OECD who? Isn’t that some sort of customs organization?’” Daniel J. Mitchell of the right-wing Heritage Foundation, in Washington, D.C., one of the secrecy jurisdictions’ most vocal supporters, had a similar reaction to the Paris-based OECD. “I thought ‘Ah, just a bunch of crazy European socialists.’”4

  Still, Mitchell decided to write a couple of things on it for the Heritage Foundation and began to see that this mattered. And the OECD’s follow-up report in 2000 contained a primed bomb: a blacklist of 35 secrecy jurisdictions, and a threat of “defensive measures” against havens that did not shape up. More alarming for Mitchell, it was not only the “European collectivists” who backed the OECD, but the Clinton administration too.

  “Our side was caught with our pants down,” Mitchell said in an interview in Washington, D.C. “Heritage, a big full-service think tank, doesn’t focus on just one thing. I thought we ought to have a group to have a go at this.” So he got together with Andrew Quinlan, a friend from college, and Veronique de Rugy, a Paris- educated libertarian academic, to create a small outfit called the Center for Freedom and Prosperity (CF&P) with a subgroup, the Coalition for Tax Competition, whose aim was to protect “the cause of tax competition.” They lodged it at the Cato Institute, a well-funded free-market think tank in Washington.

  The antitax atmosphere in Washington in those days was poisonous. A Delaware senator, William Roth, had been whipping up a hate storm against the U.S. Internal Revenue Service under a declared Republican strategy to “pull the current income tax code out by its roots and throw it away so it can never grow back.”5 In an effective piece of political theater, Roth, a manic supporter of tax cuts for the wealthy, got IRS agents to testify at hearings behind screens like mobsters, with their voices electronically distorted. His people regaled the hearings with stories about IRS agents in flak jackets storming houses and forcing teenage girls to change clothes at gunpoint—and the IRS had no right of reply. No matter that most of these claims were untrue.6

  Mitchell began to bombard politicians with emails about the OECD reports, to write scary op-eds in national newspapers with headlines such as “Global Tax Police,” and to insult the OECD publicly. Hostilities had begun in the offshore world’s first big battle of ideas.

  To understand the intellectual underpinnings of offshore finance, it seems appropriate to start with Mitchell, one of the secrecy jurisdictions’ noisiest and most active defenders.

  He is a man of striking warmth and great personal charm. In his blog “International Liberty: Restraining Government in America and around the World,” he declares, “I’m a passionate Georgia Bulldog,” in reference to the mascot of the University of Georgia’s gridiron team, “so much so that I would have trouble choosing between a low-rate flat tax for America and a national title for the Dawgs. I’m not kidding.” In his blog he notes that Britain’s left-of-center Observer newspaper called him a “high priest of light tax, small state libertarianism” and that this was “the nicest thing anyone’s ever said about me.”

  Mitchell began to take a serious interest in politics in the Reagan era, emerging from George Mason University fascinated by conservative economists such as James Buchanan and Vernon Smith, who explored a branch of economics known as Public Choice Theory, which rejects notions that politicians act on behalf of people or societies and instead looks at them as self-interested individuals. Its followers’ distaste for government dovetailed with Mitchell’s budding libertarian outlook and his love for Reagan. He worked with Republican Senator Bob Packwood, then for the Bush/Quayle transition team, before joining Heritage.

  His libertarian vision is of a world where government is pared back to just a few core roles, such as providing security, leaving the rest to the market. “Some people fantasize about supermodels,” he said. “I fantasize about having government at five percen
t of GDP.” (This is quite an ambition: Currently, most OECD governments take in tax revenues equivalent to 30 to 50 percent of GDP.) During our interview he retreated several times behind a personal disclaimer along these lines: “I just work with theories; I have not worked in the real world of business.”

  Mitchell’s specialty is a tone of calculated, arched-eyebrows incredulity when discussing people or ideas that he disdains, and his sound bites are carefully crafted to appear utterly reasonable. His short, peppy little Internet videos are clear, simple, and striking in their directness, and he sprinkles them with homespun wisdom, along with repeated references to freedom and liberty and digs at his adversaries—“international bureaucrats,” “intrusive governments,” and “Europeans” (especially the French, his particular bogeys)—uttered in tones of theatrical horror.

  “Let me give you some frightening numbers,” Mitchell said in a bouncy presentation to a “Freedom Conference” at the antitax Steamboat Institute in Colorado in August 2009. Citing a seventy-five-year projection that raised the specter of whopping tax increases, and reeling off statistics about the free-spending habits of George W. Bush (whom he dislikes), he predicted that “we will have a bigger government than any European welfare state—even France and Sweden…. I don’t know if that means we have to stop using deodorant and train our army to surrender if there’s a war, but we are going to be a European welfare state.”

  Before the OECD report emerged, Mitchell said he did his best to avoid international tax. “My bread and butter was fiscal policy issues: tax cuts versus tax increases; that kind of thing,” he said. “For me, international tax—transfer pricing, interest allocations, and so on—was almost as bad as excise taxes on milk in Mongolia.”

  In those days there was no real ideology for tax havenry: Few people understood how important the offshore system was becoming, and in the age of rapid globalization, almost nobody questioned it. Fortunately for Mitchell, the OECD had tried to avoid looking like it was victimizing smaller jurisdictions by couching its initiative not so much as an attack on tax havens but as an attack on harmful tax competition—the race to the bottom between states to attract footloose capital by offering zero taxes and other lures. This focus gave Mitchell an immediate advantage in Washington, letting him complain that the OECD was a big bureaucracy that opposed competition.