Following the series of stories emerging from the ‘Paradise Papers’ has been like unpacking a Christmas stocking. While each individual item may be underwhelming in itself, the overall effect is designed to be thrilling.
Many have jumped to the conclusion that the Paradise Papers reveals massive tax avoidance and evasion by the rich and powerful, and complicity by offshore actors. In the UK, Margaret Hodge called an emergency debate in Parliament and argued that “the paradise papers reveals the enormity and scale of the problem”, speaking of “ill-gotten gains of tax dodging”. But it is not all that surprising that details of the assets of international businesses and celebrities are found in the files of a major offshore law firm.
Rasmus Christensen and Jeremy Cape both highlight the risk of bundling legal and illegal behaviour together and jumping to rash politically satisfying responses, rather than undertaking deliberated, effective reform where they are needed. Rasmus argues that we risk eliding the very bad with the not-so-bad. But in fact the risk is worse than this. We risk bundling the socially useful, the very bad and the not so bad.
What is socially useful about offshore finance? It is the same thing that is socially useful about other parts of the financial system; apart from when people are hoarding gold bars in a safe or mooring a yacht somewhere hot, money is generally not ‘parked’ offshore but ultimately invested in the real (onshore) economy. Investors make a return by investing in enterprises and productive assets that provide products and services to customers, and in the process also fund wages and taxes. International financial centres, both on- and offshore have specialised in enabling people and institutions to undertake investments across borders. They are used by individuals and families, corporations, private equity funds, pensions and insurance companies, universities, charities and foundations, and development finance institutions . In particular they provide a tax-neutral place to combine capital from different places, and they can provide a trusted legal environment that co-investors and lenders depend on.
There are also nefarious ways to make money; through corruption, criminal enterprise, and self-dealing, and through business that evade regulation and manipulate markets. Businesses owners that hide their assets from creditors and regulators can undertake excessive and asymmetric risks, ducking the costs that they generate and leaving unpaid wages, underfunded pensions, out of pocket customers and environmental damage in their wake. The use of offshore structures to make it impossible for law enforcement, tax collectors, regulators and legitimate creditors to connect assets to their owners is definitely harmful. This also includes tax evasion such as opportunistically ‘forgetting’ to report legitimate earnings to the revenue authority, or hiding income by making false payments to a company that is secretly owned. Also in the harmful zone we can include aggressive, artificial tax avoidance schemes such as ‘working wheels’ where individuals pretended to be engaged in a used car business.
Then there is the area of debatable practice. These are generally legal ways for private actors to reduce risks and costs or improve convenience, privacy and freedom. As Brooke Harrington describes in her book Capital Without Borders this is not only about tax but also includes for example protection against the risk of “spendthrift heirs burning through the family assets or relatives with embarrassing secrets that could make them vulnerable to blackmail.” It can include shopping between jurisdictions for inheritance purposes –fathers in Islamic law states that want to leave their daughters an equal share of the family fortune have to find an offshore alternative. Tax motivations include access to tax treaties and favourable tax rates and avoidance of capital gains tax – these can support ‘useful’ investment, but there is also the risk of abuse through treaty shopping and transfer price manipulation. I bracket these this category together as ‘debatable’ not because the practices are necessarily close to the line of illegality, but because as a society we must decide where that line should be; if the interplay of policy choices and tax rules, onshore and offshore, results in a balance of private benefits and social costs that is not deemed generally beneficial or at least tolerable we should change the laws accordingly.
Most of the stories emerging from the paradise papers seem to be in the ‘useful’ zone (the Queen) or the ‘debatable’ (St Enoch’s). Some, such as the scheme used by the Mrs Brown’s Boys actors (something similar to Jimmy Carr) seem to be definitely in the ‘harmful’ zone. In some cases it is not clear from the media coverage whether the issues raised ‘debateable’ or ‘hamful’ – for example the case of Lewis Hamilton and the corporate jet . Is the problem that the Isle of Man provides a legal way to manage the VAT liability of corporate jets which offers a cash flow advantage? Or is there evidence in the files that Hamilton and others systematically used this as a means to get away with not paying VAT on personal use of the jet?
The distinctions between the different types of behaviour matter, because different problems need different solutions. Where there are failures or weaknesses in financial regulation (the ‘harmful’ zone) they should be strongly addressed (particularly by offshore jurisdictions that want to stay in business) but blanket demands to ‘outlaw tax havens’ are misplaced.
Rushing to action, and demonising a sector which manages some 5% of global financial assets based on inflated expectations, and a bundle of poorly defined problems, risks undermining the socially useful, letting the very bad off the hook, and failing to have a coherent debate about what it is about the not-so-bad that might be problematic, and how best to address it.
A good case can be made that some specific debatable uses of offshore are not beneficial to society. This has a large part of the focus of the G20/OECD-led Base Erosion and Profit Shifting reforms. Multilateral action is not always required however. In the UK we might argue that offshore investors shouldpay tax and stamp duty on UK commercial property – this would require a change in UK tax rules. It is well known that US companies have large offshore cash reserves, on which US tax has been deferred. The ball is in the US’s court on this.
Public registers of beneficial ownership could be a useful tool in deterring opportunistic tax evaders (but we should not assume that 80% of the offshore assets of high net worth individuals currently evade tax). They might only make life slightly harder for those undertaking major organised crime and grand corruption, who are not shy about lying on government forms. And they would result in a significant loss of privacy for law-abiding tax payers. These trade-offs, and the case for jurisdictions demonstrating compliant confidentiality should be considered seriously.
A version of this blog was first published on Maya’ blog, https://hiyamaya.wordpress.com