Economic analysis

Tax havens aren’t the problem, the lack of transparency is

Many commentators are calling for the “banning of tax havens.” Although well intentioned, it misses the bigger problem.
David S. Lesperance
Yachts are seen during sunset in Panama City
Yachts are seen during sunset in Panama City, Panama April 7, 2016. REUTERS/Carlos Jasso - RTSE3HG

David S. Lesperance is an international tax and immigration lawyer and co-author of The Flight of the Golden Geese: Why the 1% Matter to the 99%.

The release of the Panama Papers by the International Consortium of Investigative Journalists is causing a public firestorm. It has unleashed a torrent of real anger against some of the world’s elite engaging in tax evasion and hiding the proceeds of crime and corruption. Can this outrage be productively channelled to end these global financial scourges?

Many commentators are calling for the “banning of tax havens.” Although well intentioned, it is misguided. The label “tax haven” or “international financial centre” (IFC) could be applied to every country which has both an international banking infrastructure and which has laws and regulations which make it attractive to do business there in comparison to other jurisdictions. Along with small Caribbean islands, the list of IFCs includes Canada, the U.S. and all the G20 countries.

The resulting tax competition between IFCs is never going to be replaced by a global-level tax-playing field because of a gaming theory called the Prisoner Dilemma. For example on the personal tax front, Canadian politicians are not going to bring in gift, estate or wealth taxes that hurt Canadian voters, but which would level the tax-playing field with countries like the U.S. and France. As a result of tax competition, IFCs will always be with us. Along with the ongoing reality of tax competition, our global economy actually requires this international financial system to facilitate payments, foreign investment and exchange, and preserve intellectual and other property rights. IFCs are essential to the existence and operation of every nation’s trade.

The current problem with this international financial system is that it can also be used for tax evasion or hiding the proceeds of crime or corruption. The trick is how to actually make universally acceptable changes that reduce these illegal activities without strangling international commerce. The answer lies in increasing transparency.

Tax evasion and hiding the proceeds of crime or corruption rely completely upon secrecy. It is the ability not to be discovered that allows it to be done successfully. As a result, these illicit behaviours are difficult, if not almost impossible, in a world of proper financial transparency. In the beginning, the international financial system was completely opaque. Not only did Country X not share information with Country Y, the relevant financial information was not even collected. Over the years, with computerization and various industry changes and international initiatives, the key data began to be gathered within most IFCs. However, it has been efforts such as the U.S. Qualified Intermediary and FATCA regimes, and the signing of information-exchange treaties that have caused this information to begin to be shared. Even more critically, it is whistleblowers such as the person behind the Panama Papers who have really blown a hole in the veil of secrecy.

While the heat generated by the Panama Papers will never eliminate tax competition, it could be used to bring us closer to the proper level of transparency to eliminate illegal activity. This would require IFCs to ensure that their legal, accounting, corporate services and financial institutions effectively and efficiently collect the international standard of financial information such as the true beneficial ownership and control over companies and accounts. Elimination of secrecy tools such as bearer shares, which grant ownership to whoever holds the physical stock certificate, and nominee beneficiaries, who are used to shield the true ownership of an asset, are also required to ensure transparency. Once collected, the key information can then be shared.

The next step forward is for governments to agree upon an international standard of proper financial transparency. This standard can then be enforced and maintained across all IFCs by using a number of techniques including:

1. Setting examples. Countries like the U.S., Canada, and the U.K. could unilaterally establish the agreed standard for transparency within their realms of control;

2. Direct incentives to smaller countries. For example, the U.K., the Dutch and the French could provide incentives to their dependent territories to follow their lead on transparency;

3. Penalties. Those IFCs that do not meet the new international standard should be put on an international and/or domestic blacklist. Blacklists have the effect of increasing the chance of an audit in the taxpayer’s home jurisdiction and possibly denying domestic tax benefits. This will decrease the recalcitrant IFC’s potential market share significantly. Further extreme pressure can be applied by having the IFC’s financial institutions denied access to the international financial network. If secrecy is no longer a viable business strategy for an IFC, it will be quickly abandoned;

4. Incentivize whistleblowers. With computerization, all financial information within a bank, accounting firm, or law firm is centralized and available to anyone within or outside who has the right passwords. If the information passed onto authorities is related to legal activity, then that authority should already know about it. If the information relates to illegal activity, its disclosure should be encouraged and rewarded. As international standards of transparency become well established, you will see whistleblowing naturally tapering off, as there will be less illegal behaviour to uncover. However, having this wild card in play does discourage those contemplating bad behaviour and encourages those who are currently offside to come in out of the cold;

5. Set up effective voluntary disclosure programs. In the last few years, as whistleblowers have sent a chill through the hearts of those engaging in illegal behaviour, there has been an increasing number of taxpayers who wanted to come clean before they were uncovered. While the idea of amnesty is distasteful to much of the general public, it is actually in their long-term best interest. Having a former tax evader come clean means that the jurisdiction does not have to spend additional resources in finding and prosecuting the person. Furthermore, it results in an immediate boost in tax receipts and the addition of a full taxpayer in the future. The key is to make the program attractive enough to want to join, while also making the penalties for staying offside prohibitive;

6. Make tax agencies efficient and effective. All the information in the world about financial wrongdoing is useless, unless the tax authority has the ability to do something with the information. As the government’s sole revenue source, voters should demand that their country’s tax agency be technologically modernized, best practices and priorities put in place, properly funded and adequately staffed. Not only will this ensure that tax cheats are caught, it will also increase trust in the system for those taxpayers who have not engaged in improper behaviour.

If the white heat anger generated by the Panama Papers is properly channelled, the use of international financial centres to hide illegal behaviour may be significantly curtailed. However if it only results in talking heads and placards calling for the banning of tax havens, it will be a golden opportunity lost.