The Hidden Wealth of Nations

by Gabriel Zucman

  Third, we need to rethink the taxation of companies. The fixes recently proposed by the Organisation for Economic Co-operation and Development (OECD) are unlikely to enable much progress. Looking forward, the taxation of multinational firms should derive from their worldwide consolidated profits, and not, as is true today, from their country-by-country profits, because those are routinely manipulated by armies of accountants. A tax on consolidated profits would increase corporate tax revenue by about 20%; this would essentially benefit the large countries of Europe as well as the United States, where the kings of tax dodging—the Googles, Apples, and Amazons—produce and sell the most but often pay little in taxes.

  The Symbolic Power of Finance

  If we believe most of the commentators, the financial arrangements among tax havens rival one another in their complexity. In the face of such virtuosity, citizens are helpless, nation-states are powerless, even the experts are overpowered. So the general conclusion is that any approach to change is impossible.

  In reality, the arrangements made by bankers and accountants, shown in the pages that follow, are often quite simple. Some have been functioning unchanged for close to a century. There have of course been innovations, sometimes esoteric. And we can’t deny that there are still aspects of the functioning of tax havens that no one really understands. But, as this book will show, we know more than enough to be able to act against the fraud they perpetuate.

  Economists share some of the responsibility for the sense of mystery that still surrounds tax havens. Academics have for too long shown little interest in the subject, with some notable exceptions. But progress has been made within the past ten years, and we may rightfully hope for important advances in the near future. The fact remains that most of the progress in understanding tax havens achieved up to now—remarkable progress in many respects—can be credited not to economists, but to a certain number of pioneering nongovernmental organizations, journalists, political scientists, historians, jurists, and sociologists.

  The approach I adopt in this book differs from these earlier ones; it complements them and in no way claims to eclipse them. The originality of my approach is that it is based foremost on statistics. I do not look at individual cases. Though they are indispensable in raising awareness, even scandal, individual case studies are of little help in guiding action. You will not find either oligarchs or African dictators, venal bankers or great money-changers of the city of London here, except in the numbers. This work focuses on an analysis of data and their implications, while respecting their historical context, distinctiveness, and limits.1

  ONE

  A Century of Offshore Finance

  Of all the countries involved in offshore wealth management, one has been active longer than any other, and it is still the number-one offshore center today. If we take a close look at this country’s banking history, we’ll reveal the intricate mechanisms of dissimulation that, starting from its center, have spread out all over the world, and the ingenuity of some bankers in safeguarding financial secrecy and fraud. And while tax havens rarely publish instructive statistics, this country is actually the exception to the rule: there is a remarkable amount of data from the country available, which have received astonishingly little attention. This country, of course, is Switzerland.

  The Birth of a Tax Haven

  The fabulous destiny of the Swiss financial center began in the 1920s when, in the aftermath of World War I, the main countries involved began to increase taxes on large fortunes. Throughout the nineteenth century, the greatest European families were able to accumulate wealth by paying little or no taxes. In France, on the eve of the war, a pretax stock dividend of 100 francs was worth 96 francs after taxes. In 1920 the world changed. Public debt exploded, and the state vowed to compensate generously those who had suffered during the war and to pay for the retirement of veterans. That year the top marginal income tax rate rose to 50%; in 1924 it reached 72%. The industry of tax evasion was born.

  The industry’s birthplaces—Geneva, Zurich, and Basel—enjoyed fundamentally favorable trends that were already in motion. At the beginning of the century, banks had formed a cartel (the Swiss Bankers Association was established in 1912) and were able to make the Swiss government pay relatively high interest rates, which made Swiss banks very profitable.2 And since 1907, they had benefited from having a last-resort lender, the Swiss National Bank, which could intervene in the event of a crisis and ensure the stability of the entire system. So by the eve of World War I, Switzerland had a financial industry with clear marching orders and a well-developed network of credit establishments. Also, since Switzerland has enjoyed the guarantee of perpetual neutrality since the Congress of Vienna in 1815, it emerged from World War I and the accompanying social upheavals relatively unscathed.

  The boom in the tax-evasion industry was also made possible by the transformation of the nature of wealth. In industrialized countries, financial wealth had, since the middle of the nineteenth century, overtaken that of land ownership. In 1920 the holdings of the richest people in the world were essentially made up of financial securities: stocks and bonds issued by public authorities or by large private companies. These securities were pieces of paper that resembled large bank notes. Like notes, most of the securities did not bear names, but instead the phrase “pay to bearer”: whoever had them in his possession was the legal owner. So there was no need to be registered in a cadastre. Unlike individual notes, stocks and bonds could have an extremely high value, as high as several million dollars today. It was possible to hold a huge fortune anonymously.

  Tax Fraud 101

  During the greater part of the twentieth century, it was possible to transport huge amounts of wealth across borders easily, by traveling with one’s “pay to bearer” securities. This is no longer true today, because securities aren’t tangible objects: they now exist only in electronic form. So to shelter one’s money, in lieu of moving suitcases filled with bank notes across borders, the common solution is electronic transfer to offshore accounts.

  Let’s look at a fictitious example. Michael is CEO of the US company Michael & Co., a firm with 800 employees of which he is the single stockholder. To send, say, $10 million to Switzerland, Michael proceeds in three stages. First, he creates an anonymous shell company incorporated, for example, in the Cayman Islands, where regulations on disclosure of company owners are very limited.1 He then opens an account in Geneva under the shell company’s name, which takes all of a few hours. Finally, Michael & Co. buys fictitious services from the Cayman shell company (consulting, for example), and, to pay for these services, sends money to the shell company’s Swiss account. The transaction generates a paper trail that appears legitimate, and in some cases it actually is. Because companies carry out millions of transfers to Switzerland and other large offshore centers every day—and it is impossible to identify in real time those that are legal (for example, sums paid to true exporters) and those that are not (money evading taxes)—the transaction from Michael & Co. to the shell company’s Swiss bank account is unlikely to trigger any money-laundering alarms at the banks.

  And Michael wins twice. By paying for fictitious consulting, he first reduces the taxable profits of Michael & Co., and thus the amount of corporate income tax he must pay in the United States. Then, once the money has arrived in Switzerland, it is invested in global financial markets and generates income—dividends, interest, capital gains. The IRS can tax that income only if Michael self-reports it or if the Swiss bank informs the US authorities. Otherwise, Michael can evade US federal income tax as well.

  If Michael wants to use the money, he has two possibilities. For small amounts, he can simply go to an ATM. But for large amounts, he has to be more clever. The most popular technique is what’s called “Lombard credit”: Michael takes out a loan with the US branch of his Swiss bank, using the money held in Geneva as collateral. So the money stays in Switzerland, still invested in stocks and bonds, while it is also spent in the United Sta
tes, to buy, for example, a painting by a famous artist or a condominium in Florida.

  In sum, the IRS is cheated out of millions—all the taxes owed over time on the income generated by the wealth hidden in Geneva—and Michael can secretly spend his hidden money however he likes.

  If you wanted to keep these paper securities at home under your mattress, you would run the risk of their being stolen, and so owners looked for safe places to keep them. In order to respond to this demand, beginning in the mid-nineteenth century European banks developed a new activity: wealth management. The basic service consisted of providing a secure vault in which depositors could place their stocks and bonds. The bank then took responsibility for collecting the dividends and interest generated by these securities. Once reserved for the richest individuals, in the interwar period these services became accessible to any aspiring capitalist. Swiss banks were present in this marketplace. But—an essential point—they offered an additional service: the possibility of committing tax fraud. The depositors who entrusted their assets to them could avoid declaring the interest and dividends they earned without the risk of being caught, because there was no communication between the Swiss establishments and other countries.

  Looking for Lost Securities

  Up until the end of the 1990s, the amount of wealth held in Swiss banks was one of the best kept secrets in the world. Archives were kept under lock and key, and banks were under no obligation to publish the details of the assets they were managing. It is important to understand, in fact, that securities deposited by customers have never been included in banks’ balance sheets, even now, for a simple reason: those securities don’t belong to the banks. Since the financial crisis of 2008–9, the term “off-balance sheet” has acquired a nasty connotation, notably referring to the sometimes complex arrangements that were carried out to remove American mortgage loans from bank books. But one of the off-balance-sheet activities par excellence—coincidentally the oldest and still today one of the most common—is actually of childlike simplicity: holding financial securities for someone else.

  If today we are able to know the amount of wealth held in Switzerland during the twentieth century, it is thanks to two international commissions appointed in the second half of the 1990s. The mission of the first—presided over by Paul Volcker, former chairman of the US Federal Reserve—was to identify the dormant accounts belonging to victims of Nazi persecutions and the victims’ heirs. For three years, hundreds of experts from large international auditing firms explored the archives of the 254 Swiss banks that had been involved in managing wealth during World War II, producing masses of never-before-seen information—notably, the sum of assets held by each establishment in 1945. The goal of the second commission was to better understand the role played by Switzerland during the war. Presided over by the historian Jean-François Bergier, it also had extensive access to the archives of Swiss banks, which enabled it to establish the sum of securities deposited in the seven largest Swiss establishments during the twentieth century, which, from buyouts to mergers, became the UBS and Credit Suisse of today.

  The statistics produced by the two commissions have limitations. Part of the archives had been destroyed; others were kept beyond their reach. But the information gathered by Volcker, Bergier, and their teams is by far the best we have for studying the history of offshore finance. In particular, the data on the assets under custody are of high quality, because, without publishing them, the banks internally kept a detailed accounting of their wealth-management activities, precisely recording the value of the securities that had been entrusted to them, stocks at their market value, and bonds at their face value.

  In spite of all this, up to now that information had never been compared to the overall level of European income and wealth in the interwar period, notably due to a lack of statistics on national capital stocks. This is the first contribution of this book: to bring everything together—and the results deserve our attention, for they challenge many of the myths that surround the birth of Switzerland as a tax haven.

  The Swiss Big Bang

  The first thing we learn is how extraordinary the rise of Swiss banking at the end of World War I was. Between 1920 and 1938, offshore wealth—meaning that belonging to non-Swiss residents—managed by Swiss banks increased more than tenfold in real terms (that is, after adjusting for inflation): it went from around 10 billion in today’s Swiss francs to 125 billion on the eve of World War II. This growth contrasts vividly with the stagnation of European wealth in general: due to a whole series of economic, social, and political phenomena, the private wealth of the large European countries was approximately the same in 1938 as it was in 1920.3 Consequently, the percentage of the total financial wealth that households on the Continent were hiding in Switzerland, fairly negligible before World War I (on the order of 0.5%), increased greatly to reach close to 2.5%.

  Who owned all of this wealth? A tenacious legend, maintained since the end of World War II by Zurich bankers, claimed that Swiss banking owed its rise to depositors who were fleeing totalitarian regimes. For proponents of this thesis, the banking secrecy law that was enacted in 1935 had a “humanitarian” aim: it was meant to protect Jews fleeing financial ruin. And so in 1996 the Economist wrote that “many Swiss are proud of their banking secrecy law, because it . . . has admirable origins (it was passed in the 1930s to help persecuted Jews protect their savings).”4

  This myth has been debunked by a great deal of historical research.5 The Volcker commission identified more than 2.2 million accounts opened by non-Swiss individuals between 1933 and 1945. Out of that total number, around 30,000 (or 1.5%) have been linked, with varying degrees of certainty, to victims of the Holocaust. The data established by Bergier and his team show that it was in the 1920s—and not the 1930s—that the Swiss “big bang” occurred. From 1920 to 1929, assets under custody grew at a yearly rate of 14% on average. From 1930 to 1939, they grew only 1% per year. The two most rapid phases of growth were the years 1921–22 and 1925–27, which immediately followed the years when France began to increase its top tax rates. Swiss banking secrecy laws followed the first massive influx of wealth, and not the reverse.

  What does it matter if reality belies the propaganda put out by the bankers? The legend hasn’t died—at the very most it has metamorphosed. These days, as is constantly repeated, most customers are fiscally irreproachable and deposit their money in Switzerland only to flee the instability or oppression of their home country. But, as we will see, more than half of the wealth managed by Swiss establishments still today belongs to residents of the European Union (although the share held by developing countries is rising fast), thus making this assertion as fallacious as the preceding one, unless we consider the EU to be a dictatorship.

  In the interwar period, the customers of Swiss banks for the most part were French. For example, at Credit Suisse, at that time the largest bank involved in wealth management, 43% of the foreign-owned assets belonged to French residents, only 8% to Spanish or Italian savers, and 4% to Germans.6 The geographical percentages are imperfect, because the depositors did not always give their true address (instead, some gave that of a Swiss hotel, in which case the funds were recorded as belonging to Swiss residents), but all the other data collected within the framework of the Bergier commission confirm that the highest percentage of capital came from France. On the eve of World War II, the available data suggest that 5% of all the financial wealth of French residents was deposited in Switzerland.

  What did hidden wealth look like? For the most part, it was made up of foreign securities: stocks of German industrial companies or American railroads, bonds issued by the French or English government, and so on. Swiss securities occupied a very secondary place, for two reasons: the local capital market was much too small to absorb on its own the mass of wealth that took refuge in Switzerland, and the returns on foreign investments were more attractive—on the order of 5% for securities from North America versus 3% for those from Switzerland. Af
ter financial securities, the balance was made up of liquidity (bank deposits such as saving accounts, which appear in banks’ balance sheets) and a bit of gold, but foreign stocks and bonds dominated by far. The same is true today, and it is essential to emphasize this point, because it is a source of recurring misunderstanding: for the most part, non-Swiss residents who have accounts in Switzerland do not invest in Switzerland—not today, and not in the past. They use their accounts to invest elsewhere, in the United States, Germany, or France; Swiss banks only play the role of intermediary. This is why it is absurd to think that Swiss offshore banking owes its success to the strength of the Swiss franc, to the traditionally low inflation rate prevailing in Switzerland, or to political stability, as its apologists continue to claim. Through their accounts in Zurich or Berne, bank customers from other countries make the same investments as from Paris or Rome: they buy securities denominated in Euros, dollars, or pounds sterling, whose values go up and down depending on devaluations, defaults, bankruptcies, or wars. Whether these bits of paper are held in Switzerland or elsewhere doesn’t change anything.

  For a customer, the main reason to deposit securities in a Swiss bank is and always has been for tax evasion. A taxpayer who lives in the United States must pay taxes on all his income and all his wealth, regardless of where his securities are deposited; but as long as Swiss banks don’t communicate comprehensive and truthful information to foreign governments, he can defraud tax authorities by reporting nothing on his tax return.

  The First Threats to Berne