The evils of tax havens

Elfren Sicangco Cruz

Posted on February 26, 2013

COUNTRIES ALL over the world, including the Philippines, have started to seriously take steps to combat not just tax evasion but also tax avoidance, money laundering and push for more corporate and personal income transparency. But to be successful, there is a need to increase regulation, if not eliminate the tax havens that serve as hiding places for illicit money.

There are an estimated 50 to 60 tax havens that serve as domiciles for more than two million paper companies, including a few thousands controlled by Philippine interests. In a recent issue of the Economist (Feb. 16-22, 2013), several sources were cited estimating the amount of money booked in those tax havens.

The Boston Consulting Group estimates that on paper approximately $8 trillion of private financial wealth out of a global total of $123 trillion is in these offshore accounts. However, this value does not include property, yachts and other fixed assets that may not be under the name of the real owner.

James Henry, a former chief economist at McKinsey who advises the Tax Justice Network, a pressure group, believes the amount invested in these tax free offshore havens tops $21 trillion.

Economists at Global Financial Integrity, a research group founded by Raymond Baker, an authority on financial crime, says that "developing countries suffered illicit financial outflows - defined as money that is illegally earned, transferred or used -- of at least $5.9 trillion over the past ten years."

There are two principal purposes for these tax havens. Money is laundered through them to shelter it from taxes undermining collection in the client’s home country where he or she will benefit from publicly funded services without having paid his or her way for it. According to the Nicholas Shaxson (as quoted in the Economist), one of the offshore industry’s most prominent critics, the appeal of tax havens rests on "providing rich individuals and corporations with financial bolt holes, where they can do things with their money that would not be allowed to do at home."

The second reason for using tax havens is to prevent public knowledge of the source of the money, especially if the origin is a criminal activity like drug dealing or smuggling or other forms of organized crime or corruption.

Economic statisticians and policy makers also believe that official statistics underestimate the net foreign assets of advanced economies "because they fail to capture funds stashed away in tax havens." Gabriel Zucman of the Paris School of Economics "concluded that official statistics significantly underestimate the net foreign assets of advanced economies because they fail to capture funds stashed away in tax havens." He estimates that "… 8% of all private financial wealth is held offshore with three quarters of it unrecorded." If he is correct, the euro zone, which officially a big net debtor, is actually a net creditor.

The Economist calculates that the elites of 139 low and middle income countries, including the Philippines, have parked up to $9.3 trillion of unrecorded wealth offshore. The Global Financial Integrity, an international anti-corruption group, estimated that $5.86 trillion in illicit funds were illegally moved from developing countries to these tax havens in the last ten years, 2001 to 2010.

The top 10 countries with the highest illicit financial outflows are China ($2.74 trillion ); Mexico ($476 billion); Malaysia ($285 billion); Saudi Arabia ($210 billion ); Russia ($152 billion); the Philippines ($138 billion); Nigeria ($129 billion); India ($123 billion); Indonesia ($109 billion); and the UAE ($107 billion).

The most revealing information was that the majority of these illicit cash flows, 60%-65%, were for tax avoidance and 30%-35% from criminal activities. Illicit cash flows from corruption, bribery and theft among government officials accounted for 3%-5%.

The depressing news, of course, is that the Philippines is ranked 6th in the list of developing countries in terms of illicit cash flows. Economists believe that tax havens attract as much money from poor countries as from rich nations.

The most damaging consequence of all this tax avoidance by the elites is that it deprives the countries concerned of much needed tax revenues and investments. It also gives the elites less incentives to build institutions and invest at home.

One can imagine the positive effect on the Philippine economy and the jobs that could have been created if the Filipino elites had kept the $138 billion instead of stashing them abroad. The euro zone is faced to raise taxes and reduce government spending. Tax avoidance, the gray area between compliance and tax evasion, has become one of its political priorities. Britain has put tax compliance and corporate transparency at the top of its own priorities.

There is no legitimate reason for stashing money in a tax haven. The only purposes are tax avoidance, tax evasion or hiding the criminal activity as the source of the money. If the Filipino elites truly are concerned about their country, they should bring back from these tax havens like British Virgin Island, Cayman, Switzerland, or Bermuda. If the government seriously wants to increase tax collection, it must find ways to prevent the Filipino elites from stashing their money in these places or, at the very least, expose the names of Filipino citizens with illicit cash deposits abroad.

Dr. Elfren S. Cruz is a professor of Strategic Management at the MBA Program, Ramon V. Del Rosario College of Business, De La Salle University. Please send comments or questions to elfrencruz@gmail.com