To expedite the process, when the administration is certain that hidden money did not come from illegal activities and is not an active form of tax evasion (for example, in the case of inherited accounts), it might offer to ignore the exact amount of evaded tax, not publicize the identities of the defrauders, but in exchange tax the undeclared assets at 100%. If most cases were settled in this way, France could recover around €300 billion—15% of GDP—immediately. In the current context, it seems appropriate that the government would decide to allocate all of the sums collected in this way to reducing the public debt. The immediate benefit would be doubled, since interest expense on the debt would also be reduced. The economic models we currently have suggest that the private wealth taxed away by the state would ultimately be re-created (thanks to savings), thereby generating supplemental capital-income tax and inheritance tax revenue in the future, which could serve to lower other taxes, such as the tax on the income of the middle classes or the VAT.
THREE
Mistakes
There are concrete solutions to putting an end to offshore personal tax evasion. But before we explore these, we should discover the lessons of past attempts. Up to now, such attempts have all resulted in failure for two main reasons: a lack of constraints and a lack of verification. Some recent initiatives—such as the Foreign Account Tax Compliance Act in the United States and similar laws abroad—are very promising, but unless we learn from the past, these initiatives will fail to change things.
And Automatic Exchange Was Born . . .
The first policies to fight against tax havens go back to the belle époque, at the beginning of the twentieth century, when the modern social state and progressive taxation began to develop. For reformers, the question of progress and that of the fight against fraud were one and the same. When tax evasion is possible for the wealthy, there can be no consent for taxes. And without taxes, there are no resources to finance schools, hospitals, and roads; nor to redistribute wealth, even slightly, to ensure the equality of opportunities.
One hundred years ago, there was no one in France who understood this better than Joseph Caillaux. In 1908, when he was minister of finance, he waged two battles of great modernity on the front lines: the battle for the creation of a unified and progressive tax on income, on the one hand (it would come to pass in 1914), and that against tax havens, on the other.
The atmosphere was electric. A few years earlier, in 1901, France had made the inheritance tax that had existed since the Revolution progressive. The rates of the new tax were modest: a maximum of 5% for the largest inheritances from parents to children, as opposed to 1% regardless of the amount inherited that had existed up to then. But the reform provoked an outcry among the conservatives, for whom taxing inherited wealth at 5% was a violation of private property. They went to great lengths to contain what Paul Leroy-Beaulieu called the “virus of progression.” Their argument? Not only did the progressive taxation of people threaten the foundations of society, but it would give new life to an impulse for fraud. Although it is impossible to know if that concern was legitimate, the fear of tax evasion delayed the adoption of the income tax, encouraging reformers to look for new ways to secure tax compliance.
The law of 1901 introduced a first, revolutionary anti-fraud mechanism: the automatic exchange of information between banks and the tax authorities. Up until then, in order to take possession of an account after the death of its owner, an individual had only to present a statement from his notary designating him as the rightful owner. Heirs, of course, had to pay inheritance tax, but there were no controls over this. By virtue of the new law, banks were henceforth obligated to inform the administration of all inheritances of which they were aware. The law thus asserted that banking secrecy did not apply to questions of taxation. And, what was more important, cooperation between the banks and the public authorities was to be automatic and not upon the request of the authorities.
The automatic exchange of information that was codified at the time did, however, have limits: it was only national. Only French banks were implicated. And for decades some of the wealthiest people in France were already using private English, Dutch, or Swiss banks to manage their assets. In these offshore institutions, inheritances could still be transferred without being taxed.
Caillaux quickly tackled the problem. On March 12, 1908, he submitted a “proposed law intended to prevent fraud in matters of inheritance tax,” aimed at tax evasion through foreign banks.21 The proposed law stated that henceforth banks would be obligated to ensure that their clients indeed paid their inheritance tax by automatically including a statement on notary documents. Defrauders were subject to a fine equal to 25% of the hidden funds.
The law, however, was not passed. Conservatives, who were in the majority in the Sénat, despised Caillaux—it was a hatred, moreover, that would push his wife, Henriette, in 1914 to assassinate the director of the right-wing newspaper Le Figaro following a final press campaign. Without having the majority in Parliament, Caillaux sent his emissaries to negotiate accords of fiscal cooperation directly with the great European powers. A treaty was quickly signed with England. It functioned as follows: in the United Kingdom, the estate of every deceased person is conferred to trustees, and the heirs can take possession of their inheritance only after a hearing in front of a special probate court. By virtue of the Franco-English agreement, that court could henceforth not rule until it had informed the French administration of the amount inherited by a French taxpayer. In front of the deputies, Caillaux expressed pride in this accord, of which he said he had already “experienced the impact” (unfortunately, he didn’t provide any figures).
That was in 1908, and the first international treaty for an automatic exchange of information was born.
The Masquerade of On-Demand Exchanges
A century later, we must mourn the time that has been lost. In 2009, mandated by the G20 countries to fight against international tax fraud, the OECD instituted a particularly weak form of mutual help, an on-demand exchange of information.
To obtain banking information from a tax haven, a country such as the United Kingdom must first have well-founded suspicions of fraud against one of its residents, which in practice is almost impossible to prove. In the absence of any evidence, tax havens do not have to cooperate. One hundred years earlier, no one would have envisioned tackling the problem in such a simplistic way. The OECD, however, declared that the era of banking secrecy was over; for then French president Sarkozy, it was the “end of tax havens.”
When we take stock of this policy today, it is disturbing. Tax havens have signed hundreds of treaties for the on-demand exchange of information. Yet through these treaties, countries like the United Kingdom gather only a few dozen pieces of information each year, whereas hundreds of thousands of UK residents have foreign bank accounts. In spite of the resounding declarations of progress, defrauders go about their business with almost complete impunity. The only risk they run is if the tax authorities get their hands on stolen files or happen to obtain information on undeclared accounts—for example, through clandestine reports—the only methods capable of feeding a valid demand for mutual help. The supreme irony is that a policy of on-demand exchange can thus function only by exploiting information obtained on the edge of legality.
And so it is not surprising that this strategy has had little effect on fraud. Between 2009 and early 2015, as we saw in chapter 1, the total amount of foreign wealth managed in Switzerland has increased by 18%. According to my estimates, on a global level—all tax havens combined—the increase has been even greater, on the order of 25%. There is some evidence that voluntary declarations have increased—20% of the funds held by Europeans in Switzerland are now being reported to tax authorities, against less than 10% before the financial crisis—but most of the wealth in Switzerland continues to be hidden.
Devoid of meaning, the policy of on-demand exchange in fact turned out to be counterproductive. At the April 2009 summit, the G2
0 countries had decided that tax havens should each sign at least 12 treaties to be compliant and to be removed from the blacklist of uncooperative states. Why 12 and not 27 or 143? No one knows. Because of this arbitrarily low threshold, the network of treaties in effect today is full of holes. Nothing could be easier than to send one’s money to a tax haven that is not tied by an agreement with the country in which one lives. According to the available data, the small minority of defrauders who reacted to the G20 policy did not do so by bringing back their assets to their country, but by sending them to the least cooperative places, those that signed the fewest treaties for information exchange with foreign countries.22 Between 2009 and 2013, Singapore thus gained the equivalent of 4% of the global amount of offshore banking deposits, Hong Kong, 5%; Jersey, on the other hand, lost 4%.
For the most part, such movement represents a simple shell game: most establishments domiciled in the Anglo-Norman islands and in Singapore are branches of the same multinational private wealth-management groups. The money stays inside the same banks, but it chooses the most advantageous laws (or rather, non-laws)—and those of the tax havens in Asia are today the most protective, in particular because American pressure is much weaker there than in Switzerland. Transfers are made with the click of a mouse—there is no need to carry suitcases full of bank notes across the globe. The more money that goes in, the more the strategy of the aggressive tax havens is validated. This episode teaches us an important lesson: a partial fight against tax havens is actually counterproductive because it increases the incentive of the remaining havens not to cooperate; to be effective, a fight against tax evasion has to be truly global.
Perhaps the most spectacular illustration of the pitfalls of on-demand information exchange comes from France, from what is known there as the Cahuzac affair. Jérôme Cahuzac, a member of the Socialist Party, was appointed by President François Hollande as minister of the budget in May 2012. In this respect, he was the very person in charge of fighting tax evasion at the highest level in the French administration. Yet at the end of 2012, an online investigative newspaper, Mediapart, published a recording (dating from the early 2000s) in which Cahuzac is heard mentioning his hidden account in the Swiss bank UBS. A political scandal ensued: Did Cahuzac actually possess undeclared assets? To find out, the French authorities used the cooperation agreement signed with Switzerland in 2009. The response of the Swiss authorities was negative. The on-demand exchange treaty, in other words, laundered the launderer. An independent judicial inquiry a few weeks later would discover that in fact the hidden account had been transferred to Singapore, leading to the minister’s resignation.
Foreign Account Tax Compliance Act
Fortunately, at the time the OECD went for on-demand information exchange, the United States started exploring an alternative, more meaningful strategy. In 2010 Congress passed and President Obama signed into law the Foreign Account Tax Compliance Act. FATCA imposes an automatic exchange of data between foreign banks and the Internal Revenue Service. Financial institutions throughout the world must identify who, among their clients, are American citizens and inform the IRS what each person holds in his or her account and the income earned on it. There is no requirement for prior suspicion: the exchange of data has to be automatic, every year, just like US banks automatically send information to the IRS to ensure that taxes on interest income, dividends, and capital gains are properly paid.
The Foreign Account Tax Compliance Act has been criticized on a number of grounds. FATCA, some argue, asserts US government power over foreign-based financial firms; it invades privacy; and the US government does not require reciprocal reporting to other countries regarding assets held by foreign households in US banks. Above all, it creates difficulties for ordinary Americans overseas because foreign banks may choose simply not to offer or to sharply limit accounts to Americans rather than deal with the FATCA requirements. Some of these issues have merits. In particular, there is a real risk that FATCA will impose substantial administrative burdens on many law-abiding US taxpayers and the financial institutions that serve them, while at the same time failing to catch the most aggressive tax dodgers. Notwithstanding, FATCA has been the starting point toward changing the ground rules that previously governed offshore banking.
The key provision of FATCA is that foreign banks refusing to disclose accounts held by US taxpayers face clearly defined economic sanctions: a 30% tax on all dividends and interest income paid to them by the United States. That threat has proven effective in securing the (formal) cooperation of most of the world’s tax havens and financial institutions (whether real cooperation will ensue is less clear, as we shall see). Some large countries were initially skeptical—the Chinese authorities publicly criticized the American law, before halfheartedly praising automatic exchanges in the summer of 2013. And there are still today some cracks in the edifice: in places like Lebanon and Uruguay, one can still have accounts in banks that are not registered as FATCA compliant. But by and large, the 30% withholding tax has acted as a powerful-enough deterrent. This episode teaches us a second important lesson: apparently, tax havens can be forced to cooperate if threatened with large-enough penalties.
Toward the Global Automatic Exchange of Information
The upshot of the American support in imposing FATCA is that it helped to strike a decisive blow against the flawed on-demand exchange policy. In 2013 the OECD recognized that the goal to be reached is an automatic exchange of data. The main high-income countries are now emulating the United States, and the automatic sharing of bank information is set to become the global standard by the end of this decade. Key havens—including Switzerland, Singapore, and Luxembourg—have already indicated that they would participate. In 2008 the vast majority of tax experts deemed such worldwide cooperation utopian. This huge step forward is a reason for optimism, and it teaches us a third lesson: new forms of cooperation, deemed impossible by many, can materialize in relatively short periods of time.
Despite all the progress made in curbing banking secrecy in recent years, we are still, in the spring of 2015, at the beginning—or almost—of the struggle against tax havens. The automatic exchange of bank information that is starting to be implemented comes up against three fundamental stumbling blocks.
First, outside of the United States, there has been no clear strategy presented to force tax havens to abandon financial secrecy. It is not enough to politely ask tax havens to cooperate. A number of them derive a large fraction of their income from illegal activities; if they have nothing to lose by continuing to attract tax dodgers, it is likely at least some will persist in this lucrative business. Yet no country, not even the European Union, has been able at this stage to articulate clear penalties like the United States has. Through diplomacy, the OECD has convinced many offshore centers to share bank information automatically. But the more havens that agree to cooperate, the bigger the incentives for the remaining ones not to do so. To believe that they will spontaneously give up managing the fortunes of the world’s tax dodgers, without the threat of concrete sanctions, is to be guilty of extreme naïveté.
Even the penalties in FATCA in some ways do not go far enough. Banks who don’t follow FATCA will suffer a 30% withholding tax on the interest and dividends they receive from the United States. Now, America might well be the largest economy on the planet, but defrauders can easily decide not to invest there. It is conceivable that in order to attract American clientele, some banks will voluntarily choose not to follow the FATCA law and invest, for themselves and for their clients, only in Europe or Asia. In those cases, they will incur no sanctions.
The second problem is that automatic information exchange is likely to come up against financial opacity. If you ask Swiss bankers if they have US, UK, or French clients, their response is always the same: “Very few,” “fewer and fewer,” and “soon, none at all.” The overwhelming majority of accounts in tax havens are held through shell corporations, trusts, or foundations, all of which fulfill th
e same objective: to disconnect money from its true owners. The tricks (legal and illegal) that allow the wealthiest to claim they have abandoned control over their wealth—while conserving it in practice—are legion. What are the consequences of this? If ambitious measures are not taken to fight against this form of dissimulation, automatic information exchange may only involve a minority of taxpayers—those who do not have access to empty shells in which to hide their assets. All the while claiming that they are upholding their obligations, banks will be able to transmit only a relatively small fraction of their data to foreign countries every year—and may continue to protect the most aggressive defrauders.
Is this idle fancy? It is, however, this type of dissimulation that led the ancestor of FATCA—a US program called “qualified intermediary”—to fail. This program was in fact quite similar to the new law; at the time it was put into place at the beginning of the 2000s, many observers actually believed it would lead to the end of banking secrecy, since it already involved an automatic exchange of information. The main difference was that the banks were to provide the data only if their clients held American securities, whereas now they must cooperate regardless of the investments made by those clients. The fact remains that FATCA’s predecessor was not enormously successful. Credit Suisse was thus one of the “qualified intermediaries” that was supposed to collaborate with the IRS. We know what happened, since in 2014 the Swiss bank pleaded guilty to criminal conspiracy to defraud the IRS and was sentenced to pay a fine of $2.6 billion for having actively solicited Americans and for having sold them services of tax evasion—notably by hiding their assets behind shell corporations. And Credit Suisse is far from being an isolated case: UBS, HSBC, and smaller establishments like Wegelin and BSI have been indicted by US authorities, have had to pay fines, or both; many others may have to in the near future.
The Hidden Wealth of Nations Page 6