Offshore tax havens played a central role in causing the global financial crisis. And almost nobody has noticed.
The first reason why tax havens helped cause the crisis is that they offered banks a get-out-of-regulation-free card. In short: if you can’t do it at home, go offshore and do it there.
There is much more to say here – but before going any further, I must clear up two huge, widespread misconceptions.
First, tax havens are not just about tax. They offer escape: not just from taxes, but also from financial regulation, criminal laws, democratic scrutiny, and much more. For the wealthy individuals and corporations that use them, tax havens offer an opt-out from the democratic constraints, risks and burdens that bind the rest of us.
Also understand the concept of ‘elsewhere.’ Cayman’s secrecy, or its tax or financial loopholes, are designed to attract money not from locals, but from foreigners. ‘Elsewhere:’ hence the term ‘offshore.’ Offshore lawmakers are always separated from those affected by the laws they write, so there is never proper democratic consultation when these laws are written. This is not only deliberate – it is the whole point. These are laws by insiders, for insiders, without democratic accountability: they are private law-making machines. Offshore is, almost by definition, a smoke-filled room. The implications for the last financial crisis, and for the next ones, should be quite clear.
The second big misconception concerns the true geography of offshore. Without understanding this, we will never properly understand the financial crisis, or the modern global economy. To understand it, we must first go back in time.
After the Great Depression of the 1930s and President Roosevelt’s progressive New Deal, Wall Street was tied down with regulations such as the Glass-Steagall Act, separating dangerous ‘casino’ investment banking from ‘utility’ commercial banking. The co-operative global economic order that emerged after the Second World War saw financial trading across borders tightly curbed, and high taxes on the wealthy; bankers were kept firmly in their place. “By Thursday afternoon at four,” an American banker remembered of London in the 1950s, “one of the senior partners would come across to the juniors and say, “Why are we all still here? It’s almost the weekend.”
Imagine that attitude today. The quarter century of restrained finance that followed was an era of high, broad-based growth, around the world.
Wall Street found its escape route in London. Britain hosted a new unregulated market – the so-called Euromarket – where banks could shake off all those pesky curbs. The Euromarkets spread fast to Switzerland, Caribbean tax havens; and beyond—though London remained the biggest player. From small beginnings in the 1960s, the newly unrestrained banks began a new era of explosive growth, courtesy of offshore. Banks’ return on equity, which had averaged about ten percent a year from 1920 to 1970 – roughly in line with other sectors of the economy – suddenly doubled to 20%, then rose to 30%. Courtesy of offshore, banks became too big to fail.
The havens began a race to offer ever laxer regulations, deeper secrecy and cleverer tax loopholes, to attract trillions in flighty financial capital sloshing around the globe. Supposedly onshore jurisdictions tried to keep up, becoming steadily more offshore-like, but the havens – which didn’t have to worry about irritating consultations with voters or societies –changed their laws at lightning speed and remained at the forefront. They became the battering rams of tax-cutting and financial deregulation. Thinkers like Milton Friedman, and politicians like Ronald Reagan and Margaret Thatcher, were hugely influential – but the havens may have played at least as powerful a role in forcing through deregulation, whether voters wanted it or not.
The offshore option has become a weapon for bankers. “Do not tax or regulate us or we will go to Geneva,” they cry – and tax authorities and regulators often give them what they want. Without offshore, our financial sectors could not have ‘captured’ our political leaders as they have today.
The result has been astonishing. Today half of all world trade, on some measures, passes via tax havens. When the U.S. Government Accountability Office (GAO,) the Tax Justice Network and others surveyed how multinationals use tax havens, they found that the biggest users by far are banks. Citigroup alone had 427 tax haven subsidiaries. Enron, which was a corrupted financial corporation as much as an energy utility, had 692 subsidiaries in Cayman and 119 more in Turks & Caicos. Offshore, it could engage in trading far riskier than what regulators would have allowed, based on its financial resources.
From all this, two things stand out. First, offshore is far bigger than almost anyone realises. Second, London (or the U.K. more broadly) is firmly offshore. An IMF report in 2007 confirms this, as did a new Financial Secrecy Index produced by the Tax Justice Network in 2010. That index, based on objective measures of secrecy and size, ranks the world’s six biggest havens as the United States, Luxembourg, Switzerland, Cayman, the United Kingdom, and Ireland.
Here is the true geography of offshore. The popular view of tax havens as exotic, palm-fringed islands, along with perhaps Switzerland and Monaco – is false. The world’s biggest tax havens are big rich countries. The U.S., for example, provides corporate secrecy facilities that are as hard to crack as Swiss banks, and offers tax loopholes and exemptions to foreigners. These offshore facilities were mostly put in place since the Vietnam War, to help the U.S. plug its deficits with foreign hot money, attracted to this tax-free, secret bolt-hole.
Offshore incentives such as secrecy and tax exemptions radically skew the flow of capital around the world – and have contributed massively to global economic imbalances that economists have identified as being at the root of the financial crisis. How big are these effects? Well, Washington-based Global Financial Integrity reckons that in 2008 alone almost $1.3 trillion in illicit finance flowed out of developing countries and into tax havens and rich-world economies. The net flow into deficit countries, worsening the imbalances, was huge. Much of it flowed into real estate and bonds, creating housing bubbles, further puffing up the financial sector, and feeding the deficits and the imbalances.
Tax havens contributed to the financial crisis in several other ways: by fostering dangerous complexity, secrecy and mistrust; by serving as offshore booking centres massively boosting financial liquidity, and by helping create tax incentives that led firms to load up on debt. There is no space to explore these here: for those who are interested, see this page.
Some people, faced with the size of what we are up against, are gloomy about tackling offshore finance. This pessimism is misplaced. In the past there was never much resistance to offshore, because few could even see it, let alone understand it. But an awakening is now underway. The superb ‘Uncut’ protests about corporate tax avoidance in Britain, the U.S. and elswhere are early signs that people are beginning to pay attention to the true nature of how financial globalisation really happened. My book Treasure Islands, which explores these things in detail, has been well received and is selling well – as are others. The profile of anti-offshore groups like the Tax Justice Network is rising fast. As understanding spreads, the potential for real change will grow.
Nicholas Shaxson is author of ‘Treasure Islands: Tax Havens and the Men Who Stole the World’ (http://treasureislands.org/) and writes for the Tax Justice Network.