Tax Avoidance and Tax Havens; Undermining Democracy

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  • by Anup Shah
  • This Page Last Updated Monday, January 07, 2013

This print version has been auto-generated from http://www.globalissues.org/article/54/tax-avoidance-and-havens-undermining-democracy

We might not like the idea of paying taxes, but without it, democracies will struggle to function, and will be unable to provide public services. This affects both rich and poor nations, alike.

Individuals and companies all have to pay taxes. But some of the world’s wealthiest individuals and multinational companies, able to afford ingenious lawyers and accountants, have figured out ways to avoid paying enormous amounts of taxes. While we can get into serious trouble for evading payment of taxes, even facing jail in some countries, some companies seem to be able to get away with it. In addition, if governments need to, they tax the population further to try and make up for the lost revenues from businesses that have evaded the tax man (or woman).

Why would companies do this, especially when some of them portray themselves as champions of the consumer? The reasons are many, as this article will explore. In summary, companies look for ways to maximize shareholder value. Multinational companies are in particular well-placed to exploit tax havens and hide true profits thereby avoiding tax. Poor countries barely have resources to address these — many have smaller budgets than the multinationals they are trying to deal with.

Yet, companies and influential individuals also pour lots of money into shaping a global system that they will hope to benefit from. If the right balance can’t be achieved, not only will attempts to avoid taxation and other measures undermine capitalism (which they claim they support) they will also undermine democracy (for even responsible governments may find it hard to meet the needs of their population).

Corporate Welfare

Corporations and corporate-funded think tanks, media and other institutions are often the ones that loudly cry at the shame of welfare and the sin of living off the government and how various social programs should be cut back due to their costs. What is less discussed though is the amount of welfare that corporations receive.

Corporate welfare is the break that corporations get both legally and illegally through things like subsidies, government (i.e. public) bailouts, tax incentives and so on. Corporations can influence various governments to foster a more favorable environment for them to invest in. Often, under the threat of moving elsewhere, poorer countries are forced to lower or even nearly eliminate certain corporate taxes to these large foreign investors.

This distorts markets in favor of the big players. As such influence spreads globally, it contributes to a form of globalization that seems less like true free market capitalism that they talk of, but more like a modern form of the unequal mercantilism that prevailed during colonial and imperial times.

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Corporate Crime

When we talk about crime, we think of the violations of law caused by individuals, some of which are horrendous. However, almost rarely talked about (especially in corporate-owned media) is the level of crime caused by corporations. Such crime includes evasion of taxes, fraud, ignoring environmental regulations, violating labor rights, supporting military and other oppressive regimes to prevent dissent from workers, including violent crime against workers, and so on.

In the US, for example, back in the mid-1990s it was estimated that corporate crime cost the country about $200 billion a year1.

Side Note

Since writing the above two paragraphs originally when this page was created, the issue of corporate crime, in the U.S. particularly has taken on a whole new dimension. Events after September 11, 2001, have highlighted massive corporate failures and controversies all the way up to the President. While for now it is beyond the scope of this page to discuss all those issues (though some points are made below, as well as additional links), Benjamin Barber, professor of Political Philosophy is worth quoting, as he highlights an important issues:

But business malfeasance … arises from a failure of the instruments of democracy, which have been weakened by three decades of market fundamentalism, privatization ideology and resentment of government.… The truth is that runaway capitalists, environmental know-nothings, irresponsible accountants, amoral drug runners and antimodern terrorists all flourish because we have diminished the power of the public sphere. By privatizing government functions and refusing to help create democratic institutions of global governance, America has relinquished its authority to control these forces.

Benjamin R. Barber, A Failure of Democracy, Not Capitalism2, New York Times, July 29, 2002

Barber is highlighting that even in the most freest of societies, the United States, corporate influences have been so strong as to undermine fundamental democratic principles.

Before and since September 11, various companies and ordinary employees, shareholders and others have suffered because of accounting irregularities being highlighted, that showed that inflated stocks and other estimates of the company’s status were seriously wrong. More than just a few “rotten apples” that various economists and business elite tried to describe as the cause, is the system itself3. As the previous link also points out, the systemic problems had long contributed to inequality and other problems, but now that even other aspects are being affected, it is now highlighting the deeper problems even more:

The crisis is not the result of a few bad apples. The entire barrel is rotten. In this case, the barrel is the framework of rules and regulations for business. Not every executive is a fraud or cheat, but if the system permits cooking the books, defrauding investors, overcompensating executives, rigging prices, polluting the environment, breaking unions and abusing workers, then it puts pressure on every business to move in those directions. The failures of the much-vaunted U.S. model of deregulated cowboy capitalism were already evident in growing inequality and insecurity and a declining quality of life. Now even much of the positive side - growth, profits, new businesses, productivity, soaring stock markets - has been called into question as an accounting chimera. It’s time to question the whole model - lock, stock and barrel.

David Moberg, 10 Lessons from the Corporate Collapse4, In These Times, August 16, 2002

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Tax Avoidance

Tax avoidance is sometimes differentiated from tax evasion. Avoidance often applies to legal means (such as loopholes and clever accounting techniques) to avoid paying the full amount of tax, whereas evasion is often applied to more criminal forms of not paying tax.

As tax expert Richard Murphy notes5, tax evasion and tax avoidance can happen on the same transaction for different taxes in different places and often involve elaborate trails involving more than one person, company or organization.

Side Note

In reality it can be more complicated. For example, some regimes (legitimate or not) may try to extract taxes for questionable purposes and some people may object (often unsuccessfully) to their money being used for such purposes. History suggests that if a population is pushed too far, revolts can be violent. Many empires in the past have used taxes as one of many ways to extract wealth away from those they have subjugated to either enrich themselves or fund other projects, such as wars, in other parts of the world. In these cases, tax issues takes on additional dimensions.

This article, however, does not go into those aspects; instead, it looks at issues of corporations and others avoiding paying taxes that they would normally be expected to pay because everyone else in that society does. This can be through clever mechanisms and loopholes in the law, or through the use of tax havens, shell companies, and more.

The scale of tax avoidance

Through offshore tax havens and fraud, and through transfer pricing, billions of dollars go untaxed. Estimates range from $50 billion to $200 billion of revenue losses.

For example, in 2000, Oxfam made a conservative estimate that tax havens had contributed to revenue losses for developing countries of at least US$50 billion a year6. Side NoteAnd they stress that this is a conservative estimate as it did “not take into account outright tax evasion, corporate practices such as transfer pricing, or the use of havens to under-report profit.”

Tax rules are bananas7. Christian Aid explains why. April 24, 2009

In 2008, Christian Aid, estimated that the developing world loses US $160bn a year in tax revenue8 from just two forms of tax evasion — mispricing transfers and false invoicing.

This is a lot more than official foreign aid9.

Such estimates are conservative, given they are only able to use a handful of measures, because of the very nature of what they are trying to fathom; secretive tax avoidance.

Such large numbers may sound small compared to the amounts some governments are able to find (miraculously quickly) when it comes to bailing out large financial institutions as seen in the current global financial crisis10, but the effects are, as Christian Aid puts it, life threatening and “urgent”:

We predict that illegal, trade-related tax evasion alone will be responsible for some 5.6 million deaths of young children in the developing world between 2000 and 2015. That is almost 1,000 a day. Half are already dead.

Death and taxes11, Christian Aid, May 2008, p.2 (Emphasis is original)

In early 2012 tax expert, campaigner and founder of the Tax Justice Network, Richard Murphy, produced a report noting that tax evasion and tax avoidance might cost the governments of the European Union Member States €1 trillion a year 12 ($1.3 trillion). This down as approximately €860 billion a year being lost through tax evasion, and €150 billion a year being lost in tax avoidance.

Murphy notes that this amount is

  • More than the total health care spending in EU countries
  • 4 times higher than the amount spent on education, on average
  • Equivalent to paying off total EU public debt in under 9 years

Murphy also lists data suggesting there is no clear relation between the level of taxes and the level of tax evasion in the European Union Member States, implying that often argued notion of higher taxation causing more tax evasion may not be a warranted concern.

Murphy also said that using similar estimation techniques for the US would suggest a “tax gap” (the non-filing, under-reporting and underpayment of taxes) of US$337 billion. The Inland Revenue Service itself estimated that the tax gap in the US was $385 billion for 200613 ($376 billion of which was under-reporting).

The developing world lost nearly one trillion dollars in 2010 as a result of corruption, tax evasion, and other financial crimes not involving cash transactions 14, according to a report by the Global Financial Integrity (GFI).

The Tax Justice Network also estimates that in offshore tax havens alone, by 2010 some $21 to $32 trillion dollars were hidden away by the super elite 15, and aided by many of the big banks that citizens of many nations bailed out (and those same citizens were typically rewarded with austerity measures by their governments). It is also estimated that less than 100,000 people worldwide own about $9.8tn of the wealth held offshore.

Based on $21 trillion dollars, it is estimated that this unrecorded wealth might have generated tax revenues of $189 billion per year (p.42).

These figures are described as very conservative and do not include various things such as assets and land, etc.

In essence, the world is awash with wealth; it is just that those who have the means have tried to hide it so that even their fair share of taxes are not paid for, thus avoiding any contribution back to societies they have benefited from (while at the same time being able to influence government policy).

Individuals too have been involved in huge amounts of capital diversions. For example, former dictator of Nigeria, Sani Abacha, and his associates are said to have diverted over $55 billion to private accounts in foreign banks — Nigeria at one point after that suffered a $31 billion external debt burden.

Why is tax revenue important?

Some may wonder why taxation is important. One perspective is that less tax paid to the government means more for individuals, who are best placed to make appropriate use of it, and thus contribute to the economy. That may work well for rich nations and wealthier segments of society. But for poor countries, they have another situation to deal with: the political pressures from rich countries:

Tax is an obvious source from which countries can generate cash to fund human development. It is also one of the means by which they can begin to free themselves from dependence on handouts and the punitive conditions often attached to aid. Tax can help countries determine their own route out of poverty.

The Shirts Off Their Backs; How tax policies fleece the poor 16, Christian Aid, September 2005, p. 6

Why don’t poor countries raise sufficient tax revenues?

It is not by accident that poor countries have been unable to increase the amount of revenue they raise through taxation. There are three specific tax strategies that have hindered them:

  1. Tax competition between countries means poorer nations have been forced to lower corporate tax rates, often dramatically, in order to attract foreign investment.
  2. Trade liberalisation has deprived poorer countries of taxes on imports. In some cases, these had yielded up to one-third of their tax revenue.
  3. Tolerance of tax havens has helped wealthy individuals and multinational companies (as well as criminals, corrupt leaders and terrorists) move their wealth and profits offshore to avoid paying tax.

… As taxes on the profits of business, on the earnings of wealthy individuals and on trade have diminished, VAT [Value-Added Tax, also known as sales tax, or goods and services tax] has increased. This is regressive and shifts more of the burden of taxation onto the shoulders of poorer people. Moreover, VAT has not replenished tax revenue lost elsewhere. According to the International Monetary Fund (IMF), in low-income countries, for every US$1 lost in trade taxes, only 30 US cents has been recovered in sales and consumption taxes.

The Shirts Off Their Backs; How tax policies fleece the poor 17, Christian Aid, September 2005, pp. 4, 5

What are the impacts of tax havens on poor countries?

There are a number of impacts of tax havens on developing countries 18 as Tax Justice Network reports:

  • Secret bank accounts and offshore trusts encourage wealthy individuals and companies to escape paying taxes
  • The ability of transnational corporations to structure their trade and investment flows through paper subsidiaries in tax havens provides them with a significant tax advantage over their nationally based competitors. In practice this biased tax treatment favors the large business over the small one, the international business over the national one, and the long-established business over the start-up. It follows, simply because most businesses in the developing world are smaller and newer than those in the developed world and typically more domestically focused, that this inbuilt bias in the tax system generally favors multinational businesses from the North over their domestic competitors in the developing countries.
  • Banking secrecy and trust services provided by global financial institutions operating offshore provide a secure cover for laundering the proceeds of political corruption, fraud, embezzlement, illicit arms trading, and the global drug trade.
  • The offshore economy has contributed to the rising incidence of financial market instability that can destroy livelihoods in poor countries. Offshore financial centers (OFCs) are used as conduits for rapid transfers of portfolio capital in to and out of national economies which can have a highly destabilizing effect on financial market operations.

Why have tax havens in the first place and who benefits?

A number of reasons including the following:

  • The main appeal of tax havens come from their inherently secretive nature;
  • Tax havens imply low- or no-taxes to be paid;
  • This makes it easier to avoid paying tax.

Christian Aid is also worth quoting:

Tax havens have allowed multinational companies, rich individuals, corrupt leaders, criminals and terrorists to keep their wealth away from the prying eyes of national tax authorities. In the words of one tax expert, “I have never come across any reason for people to set up an offshore trust [in a tax haven] other than to avoid tax.”

The Shirts Off Their Backs; How tax policies fleece the poor 19, Christian Aid, September 2005, p. 10

In a later report they also note it is a systemic problem:

For more than a century there has been an inherent contradiction in the attitude of Western legislators towards tax havens. Despite their much-vaunted regard for the rule of law (and more recent concern for human rights plus the desire to help the developing world) they have allowed a financial system to develop that is wide open to abuse.

Death and taxes20, Christian Aid, May 2008, p.19

As noted by the Tax Justice Network (an organization working for international tax co-operation and against tax evasion and tax competition) in a report titled Tax us if you can 21, just “one per cent of the world’s population who hold more than 57 per cent of total global wealth use these havens to escape taxation.”

How much money is held in offshore tax havens?

As noted earlier, the Tax Justice Network estimated that in offshore tax havens alone, by 2010 some $21 to $32 trillion dollars were hidden away by the super elite 22.

How much potential tax revenue is lost through off-shoring?

Tax Justice Network reports that because tax authorities continue to be mainly limited to powers within their own countries, the result has been a massive loss of tax revenue. As a result, based on the $11.5 trillion above, they estimate that $255 billion is lost each year to governments around the world because of the no or low taxation of funds in offshore centers 23. Importantly, they reiterate, this estimate does not include tax losses arising from tax competition or corporate profit-laundering.

The Tax Justice Network’s 2005 estimates were based on estimating $11.5 trillion being held offshore earning about 7.5% which should then be taxed at around 30% if they were paying up.

When they revised their estimates in 2012, they came up with $21 – £32 trillion being held offshore as noted earlier. This time, they assumed just 3% returns, taxed at 30% giving $189 billion in tax per year24.

As these practices have been going on for years, during better economic times, these potential revenues would be even higher.

What is profit laundering?

Profit laundering is the moving of profit from the countries in which it was earned and where it would incur tax, into tax havens. It is only possible to do this if there is secrecy to avoid the tax authorities noticing it.

Interestingly, Christian Aid notes that:

The UK government estimates that between 50 and 60 per cent of world trade is accounted for by transactions between different parts of the same company, creating ample scope for mispricing and, as a result, the laundering of profits.

The Shirts Off Their Backs; How tax policies fleece the poor 25, Christian Aid, September 2005, p. 14

Not only is globalization not really “global”, but a large chunk of world trade may include laundering of profits.

This is one reason you may occasionally hear of mispricing. Some examples Christian Aid noted included how:

  • Some TV antennas from China could be under priced at US$0.04;
  • Rocket launchers from Bolivia could be under priced at US$40; and
  • US bulldozers could be under priced at US$528

But other items could also be over-priced, for example:

  • German hacksaw blades priced at US$5,485 each;
  • Japanese tweezers at US$4,896; and
  • French wrenches at US$1,089.

How much profit laundering is there?

Christian Aid reported in 2005 that the total estimated dirty money flowing into the global banking system is $1 trillion 26. Breaking that down:

Amount siphoned from the developing world
$500 billion
Amount of profit laundered by multinational companies
$200 billion
Amount of profit laundered by individuals and criminals
$250 billion
Amount lost through corruption
$50 billion

In another report, Christian Aid tried to estimate the amount of capital flows through mispriced trade alone, from just non-EU countries to the EU, US, UK and Republic of Ireland (ROI), between 2005 and 2007

In sum, it estimated (conservatively) that $1.1 trillion flowed into the EU and US from mispricing from non-EU countries alone27. This would amount to $365 billion in lost tax for developing countries (or almost $122 billion a year).

What is Tax competition and why is it bad?

In short, tax competition is about countries out-competing each other to offer the lowest taxes possible to attract foreign investment.

Tax Justice Network describes the negative impact that Tax Competition has on developing countries:

Faced with the pressures of the globalisation of capital movements and the threat that companies will relocate unless given concessions on lower regulation and lower taxes, governments have responded by engaging in tax competition to attract and retain investment capital. Some states with limited economic options have made tax competition a central part of their development strategy. This inevitably undermines the growth prospects of other countries, as they attract investments away from them, and has stimulated a race to the bottom.... a recent empirically based study in the United States has found:

There is little evidence that state and local tax cuts – when paid for by reducing public services – stimulate economic activity or create jobs. There is evidence, however, that increases in taxes, when used to expand the quantity and quality of public services, can promote economic development and employment growth.

If this conclusion applies to a relatively high tax economy like the United States, it is even more applicable to economies in south Asia and sub-Saharan Africa, where social and economic development is held back by under-investment in infrastructure, education and health services. Proponents of tax competition have never answered the crucial question of how far it should be allowed to go before it compromises the functioning of a viable and equitable tax regime. Taken to its logical extreme, unregulated tax competition will inevitably lead to a race to the bottom, meaning that governments will be forced to cut tax rates on corporate profits to zero and subsidise those companies choosing to invest in their countries. This is already happening in some jurisdictions. The implications of this for tax regimes and democratic forms of government around the world are dire.

Tax Us If You Can 28, Tax Justice, September 5, 2005, p. 5

Where did the idea of tax competition come from?

Tax Network Justice summarizes:

Many in business and pro-business political actors argue that nations should compete with one another to attract inward investment from international business by offering:

  • Lower tax rates on profits
  • Tax holidays
  • Accelerated tax allowances for spending on capital assets
  • Subsidies
  • Relaxation of regulations
  • The absence of withholding taxes
  • Other forms of tax inducement

This process, called tax competition, has been widely adopted across the world and has become a key element in shaping world-wide investment flows. The IMF, World Bank and EU have all, in varying ways, encouraged developing countries to compete in this way for resources.

Tax Us If You Can 29, Tax Justice, September 5, 2005, p. 17

But the Network goes on to mention that this is “fundamentally flawed as a development strategy because it limits the control any country can have over taxation policies and creates harmful distortions.”

In addition to being “anti-democratic” the notion of making nations compete with other this way does not make sense for its citizenry (though it does for multinational companies who can have a “choice” of which country to invest in.)

How did tax avoidance come about in the first place and who are the main actors?

Tax Justice Network provides a decent summary in the same report mentioned above (see chapter 3). In short, the main players who promote what they call “tax injustice” are:

  • Accountants
  • Lawyers
  • Banks
  • Transnational corporations
  • Tax haven governments
  • Tax avoiders and tax evaders

In addition, the Network says that this whole idea probably started with the US and the British Empire. “The ‘offshore’ phenomenon probably began in the US when states such as New Jersey and Delaware realised that they could lure businesses from more prosperous states by offering tax advantages on condition that they register in their states.” And then, “The first real cases of international tax planning occurred in the British Empire in the early twentieth century when wealthy people started to use offshore trusts established in places like the British Channel Islands to exploit the curious British phenomenon of the separation of taxation residence and domicile.”

In the 1920s, the UK found new ways for the “internationally mobile person” to avoid tax “when a UK court ruled that a company incorporated in the UK was not subject to UK tax if its board of directors met in another country and it undertook all its business overseas. At a stroke, the concept of the separation of the place of incorporation of a company and its obligation to pay tax had been created. This concept survived in UK law until the 1990s, by which time it had become the basis for the operation of most tax haven corporations throughout the world.”

In the 1930s Switzerland offered “internationally mobile people” residency, only requiring them to pay a fixed, pre-agreed amount, each year, not varying with income, and not disclosed. “This concept has been widely copied” the Network also noted.

The Network continues by adding that “the other major Swiss contribution to tax injustice is banking secrecy, a concept which they developed at the time of the French Revolution (for the benefit of the French aristocracy) but which became enshrined in Swiss law in the 1930s. The Swiss believed at the time that it provided them with a competitive advantage as a small, land-locked state in a hostile European environment.”

This all happened not by chance, but, as the Network also notes, by plan: “They were thought up by lawyers and accountants and were exploited by them and their bankers for commercial gain.”

Tax avoidance undermines capitalism

As Christian Aid notes, tax avoidance distorts markets, undermining capitalism:

The ability of multinationals to take advantage of tax havens to avoid tax and launder profits distorts markets. It gives them an edge over nationally based competitors, which has nothing to do with the inherent quality or price of the goods and services they are selling. This undermines the basic notion of capitalism.

Even in rich countries, multinational companies are managing to avoid paying tax. Recent research suggests that at least 75 per cent of UK-quoted companies do not pay tax at the notional rate of 30 per cent that applies to them. Some pay less than half this rate. In the US, 60 per cent of corporations with at least US$250 million in assets reported no federal tax liability for any of the years between 1996 and 2000.

The Shirts Off Their Backs; How tax policies fleece the poor 30, Christian Aid, September 2005, p. 15

Tax avoidance undermines democracy

Today, of the 72 tax havens, almost half are British territories, dependencies or Commonwealth members. Britain alone loses some £100 billion (approx. US $170 billion) a year in avoided taxes. Even for a wealthy nation, this is a reasonable sum when public funds are scarce and people are reluctant to see the government spending more money on various programs.

In effect then, tax avoidance is also a threat to democracy, according to Prem Sikka, a professor of accounting at the University of Essex, UK:

The tax avoidance industry is on a collision course with civil society. Elected governments take months and years to develop tax laws, but in pursuit of private profits accountancy firms can undermine them within hours of a chancellor’s budget speech.

… The [accountancy] firms also peddle a range of avoidance schemes in the UK, which are estimated to cost the state £100bn each year in possible tax revenues.

… The government continues to award lucrative public contracts to the big accountancy firms. Their partners advise government departments on legislative design and enforcement. There has as yet been no public investigation into the tax avoidance industry.

Major casualties of the tax avoidance industry are ordinary people, who are forced to pay higher taxes while corporations and the rich avoid theirs. Individuals on the minimum wage have to pay income taxes, but some 65,000 rich individuals living in the UK are estimated to have paid little or no income tax. The top fifth of earners pay a smaller proportion of their income in tax than the bottom fifth. Corporate tax payments now account for just 2.5% of national income, the smallest share ever.

… Without adequate tax revenues no government can deliver its legislative program, provide public goods or redistribute wealth.

We can be persuaded to vote for governments that promise to invest public revenues in education, healthcare or public transport. But the tax avoidance industry exercises the final veto by shrinking the tax base and eroding tax revenues.

Prem Sikka, Accountants: a threat to democracy31, The Guardian, September 5, 2005

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Tax Shelters and Avoidance in the US

A PBS Frontline broadcast on tax shelters in the US revealed some important issues in the US alone.

The scale of the problem

Estimating how much abusive tax shelters cost the U.S. Treasury is very difficult. Some estimate the cost is in the tens of billions every year and a few deem it as high as $50 billion a year.

... Whatever the actual cost, former IRS Commissioner Rossotti says that abusive tax shelters are the “biggest single source” of a larger problem — the gap between taxes owed and taxes collected. The total uncollected tax gap, Rossotti says, is somewhere in the range of $250 to $300 billion per year — which, he says, is the equivalent of a 15 percent surtax on the honest taxpayer.

Frequently Asked Questions; Tax Me If You Can32, Frontline, PBS, February 19, 2004

In an introduction to the tax shelter report33, Frontline notes that “The General Accounting Office estimates that illegitimate tax shelters cost the government more than $85 billion in recent years.” (It would seem that this number is a conservative estimate, if, as per further above, some deem a cost of $50 billion per year.)

Why a rise in tax shelters in the 1990s?

Bogus tax shelters in the 1970s and 1980s were shut down by the US government. In the 1990s, however, they started to proliferate. How did this happen? There seems to be two major reasons:

  1. Economic boom of late 1990s
  2. Effective marketing of tax shelters

The economic boom put pressure on companies to increase profits and keep stock prices up. As Frontline also noted, “One favored means was to drive down the tax line of their corporate returns. According to Harold Handler, former chair of the Tax Section of the New York State Bar, ‘What changed in the '90s was that the tax line of the financial statement became a profit center for many corporations.’”

The effective marketing was a major issue. Harold Handler also added that, Businesses started to do artificial transactions for the purpose of reducing tax only34. Quoted at further length:

The other big change was in how tax shelters were marketed. Tax firms that previously responded to client needs, (i.e., reviewing business transactions to help minimize the tax implications) turned to pushing tax products that had no connection with the client’s business needs. “That’s bothersome,” says Handler, “because it changes the dynamic of what you’re doing. You’re no longer doing real things, but you’re doing artificial transactions for the purpose of reducing tax only.” Buck Chapoton, a treasury official in the Reagan administration, says many of the shelters of the 1990s were “sham transactions.... They simply were financial mechanisms for creating tax losses.”

Frequently Asked Questions; Tax Me If You Can35, Frontline, PBS, February 19, 2004

Corporations manage to reduce their tax burden

But these tax shelters were being promoted by powerful and wealthy institutions36. “So-called ‘legitimate’ firms — accounting firms, law firms, tax investment firms — were the engine of these deceptions. They were the promoters, the designers [of] the marketing that went into them.”

Looking at just the top 250 US corporations between 1996 and 1998 only, the Institute on Taxation and Economic Policy discovered that “companies are paying less than half of what they’re supposed to”, roughly 15 to 20% of tax, compared to the corporate tax rate of 35%. Much of this was believed to be due to tax code loopholes, and shelters.

Former US Treasury Secretary, Lawrence Summers, noted in 2000 that while corporate profits rose 20%, tax revenue fell by 2%37. The gap between what was reported to Wall Street and what was reported to the IRS widened. As Summers added, “The income to shareholders went up rapidly. The taxable income reported to the IRS stayed the same, and in some years, actually declined. It was pretty obvious that the reason had to be more shelter[s] and activity of various kinds.”

Some mega corporations were actually paying zero taxes or even getting refunds38.

Powerful interests minimize Congress’s chance of tough action

Frontline looked into the challenges of doing something about this problem, as ordinary US citizens are the ones affected. The following highlights well the challenges involved:

[Asking former US Treasury Secretary, Lawrence Summers:] What was the chief obstacle? What was the sticking point? What was the obstacle to getting your proposals passed in Congress?

[Answer from Summers:] There’s a concentrated focused constituency for the tax shelter — the person who doesn’t have to write a check to the government, and the people whose livelihood depend on marketing those tax shelters in the accounting profession in particular. They were a strong constituency for tax shelters.

On the other side, you have a general national interest — and that’s always the challenge in Washington. [A] specific interest that’s prepared to invest a lot of money in a particular political issue will often beat the broader national interest, and that was our challenge. [Emphasis Added]

Is Sweeping Reform Necessary?39, Tax Me If You Can, Frontline, PBS, February 19, 2004

Sheer amount of money involved implies problem will remain

Frontline notes that some people argue that in the aftermath of Enron and other corporate scandals, companies will be less likely to use devices such as tax shelters to pump up their bottom line. Others maintain that the current lull in shelter activity is due to the current economic downturn and that the widespread use of tax shelters will flourish when the economy rebounds.

One question, however, is whether it is even a lull period at this time. Senator Charles Grassley, (Republican for Iowa) provides an answer when interviewed:

[Question:] Do we face another surge of tax shelters as soon as the economy goes back to booming again?

[Answer:] “All of the evidence we have from the hearings before my committee indicates that it’s just as big of a problem now as it’s ever been. The point being that you would think that with the exposures from Enron and WorldCom and all those other companies that have done such illegal, unethical things, that it would slow down the tax shelter business to some extent. Every indication we’ve had through our hearings is that it hasn’t slowed it down whatsoever.”

[Question:] Why not?

Big money. This industry of writing tax shelters produces big money, much bigger money than these accounting firms get from the usual auditing. That’s why it’s going to be very difficult to slow them down.

Will the Shelter Problem Return?40, Tax Me If You Can, Frontline, PBS, February 19, 2004

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Transfer Pricing — Intercepting Wealth

Transfer pricing provides a multinational corporations' tax-avoiding dream. It allows the ability to set up offshore accounts and paper companies through which most transactions occur, without having to pay as much taxes. Internal accounting and costing is therefore adjusted to minimize the costs and maximize the profits.

Much needed revenue for social needs in a country is therefore lost this way.

The following quotes summarize this quite well:

The post-Second World War period witnessed not merely a rise in TNCs’ control of world trade, but also growth of trade within related enterprises of a given corporation, or “intra-company” trade. While intra-company trade in natural resource products has been a feature of TNCs since before 1914, such trade in intermediate products and services is mainly a phenomenon of recent decades. By the 1960s, an estimated one-third of world trade was intra-company in nature, a proportion which has remained steady to the present day. The absolute level and value of intra-company trade has increased considerably since that time, however. Moreover, 80 per cent of international payments for technology royalties and fees are made on an intra-company basis.

A Brief History of TNCs41, CorpWatch.org

(Note in the above quote at the sheer amount of intra-company trade as a percentage of world trade. Bear this in mind the next time corporate-media talk about the growing trade and prosperity for all.)

In this continuing battle over the world’s wealth, “transfer pricing” becomes a crucial aspect in the interception of the wealth of both Third World and First World countries. The multinationals either manufacture in a low-wage country or purchase cheaply from a local producer. The product, is then, theoretically, routed to an offshore corporation and invoiced (billed) at that low price. There the export invoice is increased to just under the selling price of local producers. However, the offshore company is nothing more than a mailing address and a plaque on the door. No products touch that offshore entity; even the paperwork is done in corporate home offices.

In 1980, there were eleven thousand such corporations registered in the Cayman Islands alone, which has a population of only ten thousand. [Many of these funnel a lot of money out of Central and South America] ... These corporations are doubly insulated from accountability. ...

These secret maneuvers of multinationals, and the huge blocks of uncontrolled international finance capital, make many of the statistics on world trade questionable. “If the sales of offshore American production facilities had been treated as exports, the 1986 American trade deficit of $144 billion would have become a trade surplus of $57 billion.” (Emphasis Added)

J.W. Smith, The World’s Wasted Wealth 2, (Institute for Economic Democracy, 1994), p. 138.

And the above-mentioned PBS Frontline report also notes the importance of Cayman Island as a tax haven42: “45 of the world’s top 50 banks have subsidiary or branch operations in Cayman, and in 2003 alone $415 billion in deposits flowed through this sandy resort.”

As an example of corporate evasion, the following is about Rupert Murdoch’s News Corporation:

In March 1999, the Economist reported that in the four years to 30 June of the previous year, News Corporation and its subsidiaries paid an effective tax rate of only around 6 per cent. This compared with 31 per cent paid by Disney. The Economist notes that “basic corporate-tax rates in Australia, America and Britain, the three main countries in which News Corporation operates, are 36%, 35% and 30% respectively”.

The article points to the difficulties of finding out about the specifics of News Corporations’ tax affairs because of the company’s complex corporate structure. “In its latest accounts, the group lists roughly 800 subsidiaries, including some 60 incorporated in such tax havens as the Cayman Islands, Bermuda, the Netherlands Antilles and the British Virgin Islands, where the secrecy laws are as attractive as the climate”.

The article continues, “This structure, dictated by Mr Murdoch’s elaborate tax planning has some bizarre consequences. The most profitable of News Corporation’s British operations in the 1990s was not the Sunday Times, or its successful satellite television business, BSkyB. It was News Publishers, a company incorporated in Bermuda. News Publishers has, in the seven years to June 30th 1996, made around £1.6 billion in net profit. This is a remarkable feat for a company that seems not to have employees, nor any obvious source of income from outside Mr Murdoch’s companies.”

Tax Havens; Releasing the hidden billions for poverty eradication43, Oxfam, June 2000

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Privatizing profits, socializing costs

One of the quotes above, is from J.W. Smith. There he describes the cost of transfer-pricing. He goes on to explain quite well the effects and points out that both high-wage and low-wage countries lose out as the wealth is siphoned to offshore accounts to avoid taxes. This is “historical mercantilism to perfection” by intercepting both the foreign country’s wealth and one’s own.

However, as he goes on to point out, there is a difference in that today’s corporations don’t have any loyalty to any nation, due to greed.

The last 20 years has seen the wealth of the United States reduced as corporations seek out44 cheaper and cheaper places where wages are less and environmental, safety and other regulatory measures are less or non-existent. (This has the effect of depressing wages and labor rights in industrialized as well as developing countries and therefore affects the wealth of those countries.)

Disparities between the wealthy and poor continue to rise, in the most powerful nation as well as all other countries. As Smith continues to point out,

Looking only at their bottom line, and listening to their own rhetoric, the managers of capital are unaware they are moving society back towards the wealth discrepancies of the early Industrial Revolution; this return to quasi-aristocratic privileges is a recipe for eventual contraction of commerce and destruction of their own wealth along with that of labor.

J.W. Smith, The World’s Wasted Wealth 2, (Institute for Economic Democracy, 1994), pp. 164-165.

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Tackling the problem, or pretending to do so?

While Smith wrote the earlier piece in 1994, it is applicable today as well, with wave of news about “corporate crime” around the start of 2000 and fascination of some CEOs and other executives as some major American companies have faced bankruptcy or have collapsed.

Yet, the media, while offering an outpouring of news and analysis have by and large concentrated on individual characters and looked for scapegoats (CEOs being the current flavor!). The impacts of the underlying system itself has been less discussed and when it has, often been described as basically ok, but just affected by a few “bad apples.” As media critic Norman Solomon describes,

On the surface, media outlets are filled with condemnations of avarice. The July 15 edition of Newsweek features a story headlined “Going After Greed,” complete with a full-page picture of George W. Bush’s anguished face. But after multibillion-dollar debacles from Enron to WorldCom, the usual media messages are actually quite equivocal — wailing about greedy CEOs while piping in a kind of hallelujah chorus to affirm the sanctity of the economic system that empowered them.

...Corporate theology about “the free enterprise system” readily acknowledges bad apples while steadfastly denying that the barrels are rotten. ... (“Let’s hold people responsible — not institutions,” a recent Wall Street Journal column urged.)

...Basic questions about wealth and poverty — about economic relations that are glorious for a few, adequate for some and injurious for countless others — remain outside the professional focus of American journalism. In our society, prevalent inequities are largely the results of corporate function, not corporate dysfunction. But we’re encouraged to believe that faith in the current system of corporate capitalism will be redemptive.

Norman Solomon, Renouncing Sins Against the Corporate Faith45, Media Beat, Fairness and Accuracy In Reporting, July 11, 2002

In some countries, the business community shouts a lot about government interference (in their profits) and recommends that the government be reduced in bureaucracy. While many governments are plagued with inefficiency, some is due to the powerplay of groups including various industries.

However, without the various governments, entire industries and market economies wouldn’t have got started in the first place. In the US, for example:

  • The pharmaceutical industry received research and development funds from the US government.
  • The Internet was created with public funds, but is now handed to corporations to profit from.
  • Most major industries receive some support or bailout, including:
    • Energy industries
    • Agriculture
    • Biotechnology
    • Information Technology
    • Telecommunications
    • Weapons/arms/military industrial complex
    • and so on.

While the private companies profit, any costs, such as social problems resulting from environmental degradation, resulting social degradation and so on, are all socialized. “Privatizing profits, socializing costs” is a common phrase heard in critical circles.

Some argue that minimizing tax is one of the various parts of a company’s responsibility to maximize shareholder value. As such, tax is seen as a “cost” to be minimized. However,

… tax is not a cost for a business but rather a distribution of profit and, as such, should have no impact on the economic efficiency of firms. But it will affect the dividends a shareholder receives. Therein lies the crux of the problem. Company directors have a legal responsibility to maximize what shareholders receive.

They can therefore argue that in fact they have a legal responsibility to ensure tax liabilities are as low as possible. If other competing companies are using offshore secrecy or trade mispricing to avoid tax, the pressures on a company director or accountant to advise doing the same will be considerable.

Death and taxes46, Christian Aid, May 2008, p.28

And politics has gotten even murkier since the aftermath of the September 11, 2001 terrorist attacks on the U.S. Some industries have used the September 11th incident to say that has led to loss of business and to try and ask for government assistance as a result. While it has surely had an effect, for example, in the airline industry, as the UK’s BBC 24 news program on September 27, 2001 at about 8:30pm in an interview, said that before the tragic terrorist attacks some of the airline companies such as British Airways were already suffering quite badly, and this tragedy provided an excuse to get out of it.

Of course, this doesn’t mean all companies were using the excuse, but it does highlight the difficulty of addressing these issues during highly emotional times. Companies are understandably going to try and use this to their advantage, if possible.

Economist and professor at MIT, Paul Krugman highlights this with the case of the highly publicized Enron collapse, in a piece that appeared in the New York Times, quoting here at length:

Enron’s illusion of profitability rested largely on “mark to market” accounting. The company entered into contracts that would yield profits, if at all, only over a number of years. But Enron jumped the gun: it treated the capitalized value of those hypothetical future gains as a current profit, which could then be used to justify high stock prices, big bonuses for executives, and so on.

...the Bush administration has turned to the political equivalent of another increasingly common accounting trick: the “one-time charge.”

According to Investopedia.com, one-time charges are “used to bury unfavorable expenses or investments that went wrong.” That is, instead of admitting that it has been doing a bad job, management claims that bad results are caused by extraordinary, unpredictable events: “We’re making lots of money, but we had $1 billion in special expenses associated with our takeover of XYZ Corporation.” And of course extraordinary events do happen; the trick is to make the most of them, as a way of evading responsibility. (Some companies, such as Cisco, have a habit of incurring “one-time charges” over and over again.)

The events of Sept. 11 shocked and horrified the nation; they also presented the Bush administration with a golden opportunity to bury its previous misdeeds. Has more than $4 trillion of projected surplus suddenly evaporated into thin air? Pay no attention to the tax cut: it’s all because of the war on terrorism.

Paul Krugman, Bush’s Aggressive Accounting47, New York Times, February 5, 2002

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Rich country governments finally acting because it now affects them?

For many years, various organizations have attempted to highlight these problems and its effects on poor countries.

If anyone can help sort this out, it would be rich country governments as they would have the clout to do something. Poor countries simply don’t have the resources to deal with this.

However, as shown throughout history (and throughout this web site) how much they care about the effects these things have on poor countries is questionable.

When it is for their own strategic or self-interest then rich nations will act. (To some extent, this is understandable; in the murky world of politics, “might makes right” and “realism” triumphs (or, at least is the excuse!)

And it is at such a time that we see some rich countries potentially pressuring tax havens to become more transparent.

The current global financial crisis48 has hit nations like the US and UK very hard. As such, one of the causes of the problem, tax havens, has come into the fore.

Countries such as the US (with its Stop Tax Haven Abuse Act), the UK, France and Germany, are all showing signs of acting by demanding more transparency, for example. The Pope is even to call for the closure of all tax havens.

The UK, for example, has made Jersey recently sign an agreement to increase transparency, as Channel 4 news reports:

Channel 4 news item on tax justice in Jersey, March 2009 (via IFIWatch.tv49)

Some tax havens, such as Monaco, have tried to suggest that they are victims because others are “jealous” of their “success”:

Monaco defends its tax haven status50, Al Jazeera, June 21, 2009

If individual nations such as UK or US try to deal with this alone, they might find their companies looking for other ways around any new measures and regulations by going elsewhere, or that companies will fight hard to resist measures by saying other countries are not doing it and they will therefore be at a competitive disadvantage.

As Christian Aid therefore says, the solution needs to be global, not unilateral:

The Big Tax Return, Part 2 of 251, Christian Aid, April 24, 2009

It’s too early to tell at time of writing whether or not these measures will have any meaningful effect or if they will just give the appearance of toughness while the financial crisis takes hold. Unfortunately, signs are not good.

A recent agreement for more exchange of tax information by multinational companies52, though welcome, is feared to be quite weak, for example.

In the April 2009 G20 Summit to address the global financial crisis, there was much hope (and fanfare) about dealing with tax havens. Some leaders claimed the “the era of banking secrecy is over.” Unfortunately, the reality was less definitive, as Bretton Woods Project summarized:

The G20 decided to endorse the OECD approach of exchanging information about companies and individuals suspected of evading taxes on request, rather than the more stringent automatic exchange of information called for by the Tax Justice Network and others. There was no mention of measures that could help developing countries crack down on corporate tax abuse: country-by-country financial reporting or requiring transparency of all information on beneficial ownership in all jurisdictions.

The fanfare surrounding a supposed “blacklist” of non-cooperative countries published on the day of the summit by the OECD went silent when it emerged that only four countries were on the list … none of them well known tax havens. Further confusion followed when even these four were removed, leaving no countries in the OECD's worst category.

G20 “trillion” dollar magic trick 53, Bretton Woods Project, April 3, 2009

In addition, a coalition of some European NGOs, Counter Balance, revealed in May 2009 that key EU-funded development projects in the Global South are being carried out by companies registered in tax havens and financial off-shore centers54, potentially costing developing countries tens of millions in tax revenues and leading to corruption, capital flight and lack of transparency and accountability.

And while much of this section about the global financial crisis impact was written in mid-2009, into 2012/2013, it seems that many companies are still avoiding large sums of tax, just as individuals are being squeezed even further.

This is by no means an exhaustive list in any way, but an example of some of the ones that have made headlines in recent months:

  • The agency responsible for collecting tax in UK, HMRC, produced a list of photos on the popular photo-sharing site, flickr, showing 2012’s top tax criminals in the UK55.
  • A Swiss bank became the first foreign bank to plead guilty in the US for helping some Americans evade their taxes56, which also resulted in the bank to close.
  • Another Swiss bank, UBS, had encouraged rich Americans to store more than $20 billion in offshore Swiss bank accounts and cheat the IRS57 in the largest tax evasion scheme in U.S. history.
  • The HMRC has also targeted wealthy UK taxpayers over possible large-scale tax evasion58 based on a list of high net-worth individuals with accounts at the Swiss division of HSBC stolen by an employee and passed to the taxman by the French authorities. That same list was used by a Greek reporter who published a list of 2,000 Greeks with such HSBC accounts. He was arrested59 just at a time that the country has been going through an extremely severe set of austerity measures, thus flaming further resentment at the Greek government and the elite.
  • At the end of 2012 it was revealed that Facebook paid just $4.64 million on its entire non-US profits of $1.344 billion for 2011 60 — roughly a 0.3% tax rate below the already low Irish corporate income tax of 12.5%. This was achieved through legal means channeling funds through the Cayman Islands.
  • Bloomberg reported that Google avoided about $2 billion in worldwide income taxes in 2011 by shifting $9.8 billion in revenues into a Bermuda shell company 61, again using legal means.
  • After a number of high profile cases emerged of multinationals such as Amazon, Google and Starbucks avoiding millions in taxes in the UK, the Public Accounts Committee concluded that multinationals “do not pay their fair share” of taxes62, that the problem is “widespread” and it also affects British businesses negatively who compete on an uneven playing field because they pay the full amount of taxes.
  • It emerged that another tech giant, Microsoft, pays no UK tax on £1.7bn of online revenues63.
  • An investigation by the BBC, the Guardian newspaper and the International Consortium of Investigative Journalists identified a flourishing industry helping people evade tax64 and turn a blind eye to criminal activity through the existence of an extraordinary global network of sham company directors65.
  • In October 2012, councillors from Finland’s capital city, Helsinki, voted to sever business ties with companies operating in, or having links to, tax havens 66.

It should be noted that many of the above cases while morally outrageous or questionable at least, are often quite legal. As many have suggested, tackling this requires global cooperation such that it levels the playing field and no-one can simply play countries against each other in tax competition. However, as history has shown, where a lot of money is at stake and where there is a lot to lose, such cooperative agreements are less likely to happen.

If the economic problems start to ease, it is easy to imagine that the little attention this issue has achieved so far, will fall off the radar of the mainstream and a prolonged period of boom may encourage more tax avoidance in the future resulting in continued misery for the less well-off.

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More Information

I have not even scratched the surface of this issue here, at it is large and complex. Since the September 11 tragedy, this issue has ballooned incredibly and I have hardly discussed any of the issues arising since then. However, there are a number of organizations doing more research on this, and critics have pointed out these issues for a long time. You could start off at the following links to learn more:

  • Tax Havens; Releasing the hidden billions for poverty eradication67, Oxfam Policy Paper, June 2000.
  • Global Shell Games; How the corporations operate tax free 68, by U.S. Senator Byron Dorgan.
  • Corporate Welfare and Foreign Policy69 from Foreign Policy in Focus looks at the US roles in corporate welfare, providing statistics and a collection of articles.
  • Essential Information70 has a lot of information on all sort of issues relating to corporate accountability.
  • EnronGate71 from Alternet.org news web site is an example of many sites providing articles on Enron-related issues
  • Explosive Revalation$72, from In These Times magazine, provides a look at a banking system that secretly moves trillions of dollars around the world.
  • Tax me if you can73, from PBS Frontline provides a detailed look into the issue of tax shelters in the US, with interviews from key politicians.
  • The Shirts Off Their Backs; How tax policies fleece the poor 74 from Christian Aid, September 2005 provides details about the scale and effects of tax avoidance.
  • Tax Us If You Can 75 from Tax Justice Network, September 5, 2005 looks in depth at the role of tax havens.
  • New Internationalist’s Tax Justice issue76, October 2008 has a collection of articles on the topic.
  • The Tax Gap77 from the British Newspaper, The Guardian provides many articles on the topic, looking into numerous evasions by some of UK’s top companies, and includes a “tax database” of what the top 100 UK companies have paid, or not paid, in tax in recent years.
  • Tax Havens78 section from Bloomberg.
  • Tax Research UK79 by tax expert Richard Murphy

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Where next?

Online Sources:

(Note that listed here are only those hyperlinks to other articles from other web sites or elsewhere on this web site. Other sources such as journal, books and magazines, are mentioned above in the original text. Please also note that links to external sites are beyond my control. They might become unavailable temporarily or permanently since you read this, depending on the policies of those sites, which I cannot unfortunately do anything about.)

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Author and Page Information

  • by Anup Shah
  • Created: Monday, September 04, 2000
  • Last Updated: Monday, January 07, 2013

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Document Revision History

DateReason
January 7, 2013Added some further examples of companies and individuals avoiding large amounts of tax, legally.
July 12, 2009Added updated information on profit laundering and transfer mispricing, as well as notes about recent actions by some governments attempting to tackle the problem.
September 14, 2005Added sections on tax avoidance, havens, their impacts on poor countries, etc.
June 3, 2005Added a section on US tax shelters and the impact to the US economy.

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