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

by Nicholas Shaxson

  This question of “competition” is one of the main arguments that tax havens deploy to justify their existence, and it is well worth exploring. Mitchell articulates these arguments as well as anybody.

  “International bureaucracies and politicians from high-tax nations are launching a co-ordinated attack against these jurisdictions. The high-tax nations of the world want to set up something equivalent to OPEC,” he thundered, flashing up pictures of sinister-looking men in Arab headdresses. “It is an effort by high-tax nations to form a cartel that will enable the politicians to put in place worse tax policies.”7

  “Say you only had one gas station in a town,” he continued in a recent presentation.8 “That one gas station could charge high prices, it could maintain inconvenient hours; it could offer shoddy service. But if you have five gas stations in a town, all of a sudden those gas stations need to compete with each other: They have to lower prices, they have to be attentive to the needs of consumers. We see the same thing internationally, with governments.”

  He went further. “Imagine you are a governor of Massachusetts. You’d love to shut down New Hampshire—because it’s competition. Obama and the rest of the collectivists on the left hate tax havens because they are outposts of freedom. Because of globalization, labor and capital are a lot more mobile than they used to be. If governments are trying to impose high tax rates, [people] actually have options to move either themselves, or their money, across borders. Just like if you have one monopoly gas station in town, and all of a sudden new gas stations open up, you can decide, ‘I’m no longer going to shop at that gas station that was ripping me off; I can shop at the gas station that is actually giving me a better deal for my money.’” In other words, the argument goes, tax competition is beneficial, and you can’t fight it anyway.

  At first glance, these arguments seem reasonable. But look closer, and they collapse in a puff of nonsense. Here’s why.

  Competition between companies in a market is absolutely nothing like competition between jurisdictions on tax. Think about it like this: If a company cannot compete it may fail and be replaced by another that provides better and cheaper goods or services. This “creative destruction” is painful, but it is also a source of capitalism’s dynamism. But what happens when a country cannot “compete?” A failed state? That is a very different prospect. Nobody would, or could, as Mitchell put it, “shut down New Hampshire.” What does it actually mean for a country to be “competitive”? Governments obviously do not “compete” in any meaningful way to police their streets. They do, perhaps, compete to educate their citizens better, but this kind of “competition” points to higher taxes to pay for better education.

  The Geneva-based World Economic Forum (WEF) provides a more comprehensive answer, defining competitiveness as “the set of institutions, policies and factors that determine the level of productivity of a country.” It uses 12 competitiveness “pillars,” including infrastructure, institutions, macroeconomic stability, education, and efficiency of goods markets. One could quibble with the categorizations, but taken together they form a sensible enough selection. Most of them require raising appropriate levels of tax.

  It turns out, in fact, that the most “competitive” countries on the WEF’s measure are the higher-tax countries. There is plenty of variation, of course: Sweden, Finland, and Denmark, the world’s three highest-taxed countries, were ranked fourth, fifth, and sixth most competitive in the 2009–10 index, while the United States, with lower (but still not very low by world standards) taxes, is second. But the really low-tax economies like Afghanistan and Guatemala are the least competitive.

  Dig further into the data, and other interesting facts emerge. Countries that spend a lot on social needs—something Mitchell opposes—score best on the competitiveness scale.”9 Higher taxes help countries spend more on education, health, and other things that help their workers “compete.”

  What applies to tax applies to laws and regulation too. What does it mean for a jurisdiction to have a “competitive advantage” in being a heroin smuggling entrepôt or offering lax enforcement on child sex tourism? It may bring in revenue, but in the sense that countries do “compete” with others, it can clearly bring great harm.

  Mitchell’s world of beneficial tax competition emerges from a sub-school in economics that clings to a 1956 paper by the economist Charles Tiebout, who explored what happens (only in theory, you understand) when markets are perfect and free citizens flee in hordes from one jurisdiction to another at the drop of a tax inspector’s hat. This is not, of course, how the world works—but libertarians and defenders of tax competition stretched Tiebout’s ideas like rubber to make their intellectual shield for the havens. Mitchell also points to lists of secrecy jurisdictions, claiming they tend to be wealthier than other jurisdictions, and takes this as evidence that offshore is a good thing. This is like an argument that points to the private jets, yachts, and palaces owned by a rich dictator and his cronies as evidence that corruption generates wealth. Well, it does, in a way, but “generating” this kind of wealth is not exactly what we should aim for.

  Yet there is one area where Mitchell is probably right. Tax rates have been tumbling for years around the world: Average corporate tax rates, for example, fell from nearly 50 percent in 1980, Mitchell says, down to just over 25 percent today. This is, in large part, the result of tax competition between jurisdictions and with tax havens as the sharp edge of the ax. “When I go in for my salary review, I always say it’s because of the great papers I write for Cato that is forcing governments all over the world [to cut taxes],” Mitchell says. “But the real story is tax competition . . . and tax havens are the most powerful instrument of this tax competition.”

  It is a hard point to prove, but it is reasonable to think that while the world has fixated on ideas and ideologies as the driving force behind global tax-cutting and financial deregulation, tax competition may have been the bigger force.

  Many economists see this as a nonstory, though. Although tax rates have fallen, tax revenues have been fairly steady. Since 1965 personal income taxes in rich-world OECD countries have remained remarkably stable at 25 to 26 percent of the total tax haul,10 and total corporation taxes have even risen slightly, from 9 to 11 percent. Some say this proves that tax competition does not matter. But look behind the numbers, and an unhappier picture emerges.

  Though rich countries have preserved their overall tax revenues, corporations and rich folk have paid much less as a share of revenues. Corporate profits, on which their tax liabilities are assessed, have increased sharply.11 Meanwhile, the rich have not only seen their wealth and income soar, but they have shifted their income out of “personal income tax” categories and into “corporation tax,” to be taxed at far lower corporate tax rates. For example, the richest four hundred Americans booked 26 percent of their income as salaries and wages in 1992 and 36 percent as capital gains. By 2007 they only recorded 6 percent as income and 66 percent as capital gains.12 The same has been happening across all high-income categories and in all OECD countries since at least the 1970s. So falling corporation taxes are being masked by rich people’s tax dodges.13 The working population has seen its personal income taxes and social security contributions rise over the last 30 years, as their wages have stagnated. Mitchell is right to say that tax competition is real, and it bites.

  Look at how tax competition smites developing countries, and a bigger story emerges.

  One of the only studies ever made was a short IMF paper in 200414 that notes how little attention has been paid to how international tax competition has been affecting developing and emerging-market economies and takes what it calls a “first look at those issues.”

  Its results are remarkable. Tax rates have fallen at least as fast as in rich countries, if not faster, and furthest of all in sub-Saharan Africa. But tax revenues fell sharply too: Just in the short 11-year period from 1990 to 2001, corporation tax revenues in low-income countries fell by a quarter
. This is especially troubling because developing countries find it much easier to tax a few big corporations than to tax millions of poor people, so corporate taxes are a bigger deal for them.

  One reason for the falling corporate tax revenues has been special tax incentives. In 1990, only a small minority of poor countries offered these incentives; by 2001 most of them did. The IMF’s first detailed study on this in July 2009 concluded15 that these tax incentives, which are supposed to attract foreign investors, slash tax revenues but do not promote growth.16

  As I have mentioned, tax, not aid, is the most sustainable source of finance for development. Tax makes governments accountable to their citizens, while aid makes governments accountable to foreign donors. Tax competition is destroying developing countries’ tax revenues and making them more dependent on aid. Brazilians talk about tax competition in terms of a guerra fiscal—a tax war—a term that reveals far better what is really happening here and echoes the words of U.S. Senator Carl Levin when he says tax havens are “engaging in economic warfare against the United States and honest, hardworking Americans.”

  Mitchell has another presentation he likes to make: what he calls “The Moral Case for Tax Havens.”17 A video from October 2008 gives a flavor.

  “The vast majority of the world’s population lives in nations where governments fail to provide the basic protections of civilized society,” says Mitchell (cue pictures of Kim Jong-Il, Robert Mugabe, and Vladimir Putin, looking sinister). “Tax havens protect these people from venal and incompetent governments by providing a secure place to hide their assets.

  “One reason why Switzerland has such an admirable human rights policy of protecting financial privacy is that they strengthened their laws in the 1930s to help protect German Jews wanting to guard their assets from the Nazis.” (Cue grainy pictures of Hitler saluting from a staff car and a Gestapo officer rounding up frightened women.) “And what about the Argentine family,” he continues, “and the risks that their life savings are wiped out by devaluation?” Put it offshore, he says, and the money is safe.

  Again, his arguments are persuasive—right up to the point where you stop to think about them.

  First, the story about the origins of Swiss bank secrecy is no more than an appealing fiction. The argument about it being set up to protect Jewish money first appeared in the November 1966 Bulletin of today’s Credit Suisse. It wasn’t true. The reason bank secrecy was strengthened in 1934 was a scandal two years earlier when the Basler Handelsbank was caught in flagrante facilitating tax evasion by members of French high society, among them two bishops, several generals, and the owners of Le Figaro and Le Matin newspapers. Before that, there was professional secrecy (such as exists between doctors and their patients), and violation of this secrecy was a civil offense, not a criminal one as it is today.18 The law had nothing to do with protecting Jewish secrets.

  Next, if a country is misruled, why should it only be the wealthy elites who get to protect their money by going offshore? If a country has unjust laws, then providing an offshore escape route for its wealthiest and most powerful citizens is the best way to take the pressure off the only constituency with real influence for reform. Keep their money bottled up at home, and pressure for change would come fast. Even then, there is no need for offshore secrecy to protect your money. If I am a Tanzanian with a million dollars in London earning 5 percent, and I ought to pay tax on that income at 40 percent, then I owe my government twenty thousand dollars in taxes for that year. I should pay that. Britain could tell my government all about my money, but that would give Tanzania no power under any international agreement to “confiscate” my million dollars. An Argentine family can protect its money from hyperinflation by shifting it to Miami—but secrecy plays no part in this protection. Put it in a normal bank account, exchange the information on the income, and pay tax on it. The principal remains quite safe.

  On the question of people needing to protect their cash from tyrants, Mitchell might like to answer this. Who uses secrecy jurisdictions to protect their money and bolster their positions? The human rights activist, screaming in the torturers’ dungeons? The brave investigative journalist? The street protester? Or the brutal, corrupt, kleptocratic tyrant oppressing them all? We all instinctively know the answer.

  Ah, but, Mitchell then retorts. “Your personal data may be sold to kidnappers who then grab one of your kids.” Transparency threatens homosexuals in Saudi Arabia and Jews in France “victimized by corrupt and/or despotic governments. Without the ability to protect their assets in so-called tax havens, these people would be at even greater danger.” The answer, he says, is to “place your money in a bank in Miami, since America is a tax haven.”19

  This one carries a shading of truth—but no more. Kidnappers don’t need tax data to know that someone has money. And the very wealthy have bodyguards and are relatively rarely kidnapped: The lower and middle classes are usually the victims. More importantly, though, good tax systems promote better governance (and hence less kidnapping), as all the research indicates. By helping elites loot their countries, secrecy jurisdictions are causing exactly the problems Mitchell says he is worried about.

  And then we get to the question of freedom. Mitchell is quite clear about his views. The high-tax welfare state, he says, is “a prison for the human soul. It’s making pets out of all of us. It’s going to put us in a little cage, control our freedom, control our lives—that’s what we need to fight against.” Tax is bad, and tax havens are the answer.

  In this worldview personal property is inviolable, and tax is theft. “It makes sense,” Mitchell says, “to protect your family’s interest by putting your money someplace like Hong Kong, where the politicians from your country can’t find out about it. And if they can’t find out about it, they can’t steal it.”

  Leaving aside the question of whether or not this is a general incitement to criminal tax evasion, it is worth asking if tax is theft.

  Property rights, as the philosopher Martin O’Neill points out, emerge from a general system of legal and political rules that includes the rules of taxation. To say tax is theft, then, is to use a system of which tax is a central part as your weapon against taxation. It is to argue in an illogical circle.

  Corporations, too, emerge from states, legally speaking. “The state is the only institution in the world that can bring a corporation to life,” explains Joel Bakan in his best-selling book The Corporation. “It alone grants corporations their essential rights, such as legal personhood and limited liability…. Without the state, the corporation is nothing. Literally nothing.”20 To say that corporation tax is theft is, again, simply illogical.

  You can find any number of other illogical eddies, ironies, and contradictions in the world of offshore. Secrecy jurisdictions routinely say their role is to promote efficiency in financial markets—but the cloak of secrecy they provide directly contradicts the idea of efficient markets, which require transparency. In an article entitled “Why Do I Have to Deal with People Like Dan Mitchell?”21 the University of California, Berkeley, economist Brad deLong points to several of Mitchell’s articles—including one praising Iceland for its tax-cutting, deregulated economic policies, just before Iceland’s economy collapsed, and one entitled “A Better Way to Chastise France,” urging the United States to eliminate withholding taxes on all dividends paid to foreigners, so as to suck tax-dodging capital out of “oppressive high-tax nations.” So Mitchell contradicts himself: Tax havenry does “chastise” other nations after all.

  Monetary policy is another case where offshore cheerleaders find themselves confused. Generally, these cheerleaders have supported the Monetarist doctrine, which argues that you tackle inflation and unemployment by managing the quantity of money. Yet it is ironic that this doctrine began its rise with a paper by Milton Friedman in 1956, the very year when the offshore Eurodollar market and the offshore system properly took off. But the offshore system directly undermined monetarism: In a world where capital fli
ts effortlessly to unregulated offshore worlds, and where banks can create money willy-nilly, governments struggle to control their money supplies. “The use of quantity of money as a target,” Friedman himself finally conceded in 2003, “has not been a success.”

  Tax avoidance is another case in point. Tax havens endlessly promote themselves as delivering “tax efficiency” to corporations—but this tax avoidance is inefficient. “If tax abuse is needed to ensure an investment is viable,” notes the accountant Richard Murphy, “it’s a misallocation of resources to do it.”

  Another offshore antitax favorite is the old claim that tax cuts actually raise revenue partly because people will be less inclined to dodge taxes. Therefore tax competition, driving down tax rates, must be a good thing. This has been bundled together in many Republican minds with another big idea embraced by the antigovernment libertarian world of offshore: It is essential to cut taxes to starve the beast of big government. Or, as the antitax zealot Grover Norquist memorably put it, government should be cut “down to the size where we can drown it in the bathtub.”22 There is a problem with all of this, of course. Many people think tax cuts boost revenue. Starve-the-Beast-ers think tax cuts are useful ways to cut revenue. They can’t both be right. Bob McIntyre of Citizens for Tax Justice explains how he thinks the two conflicting theories have thrived side by side for over a quarter of a century. “It’s simple,” he said. “On Mondays, Wednesdays and Fridays Republicans say that cutting taxes raises revenues. On Tuesdays, Thursdays and Saturdays they say cutting taxes reduces revenues so much that it forces government to cut back—to starve the beast. And on Sundays they rest.” In truth, most serious analysts don’t believe that tax rates, on their own, make all that much difference. Obviously, real businesspeople invest and hire workers where there is demand for their products, strong infrastructure, and a healthy and educated workforce. Most studies show that corporate tax rates are a relatively minor factor in business location in most areas of business. Tropicana won’t grow oranges in Alaska just because it is offered a tax break there. In the golden age of 1947–73, the U.S. economy grew at nearly 4 percent a year—while the top marginal tax rate varied from 75 to over 90 percent.23 I am not arguing that those tax rates caused that growth. But high taxes clearly don’t need to choke off growth.