Not on my watch, please
Many people, including a number of readers of this blog, will not have read the last edition of our newsletter, Tax Justice Focus. It focused strongly, but not entirely, on the links between tax havens and the current international financial crisis. With apologies to those who did read the editorial for that edition, here it is again, very slightly modified for blogging purposes.
Not on my watch, please
We are living through a period of consequences. At the time of writing, the U.S. government is working to stave off the collapse of the mortgage giants Freddie Mac and Fannie Mae, which own or guarantee over five trillion dollars’ worth of loans. Financial excesses over the past 15 years are unwinding. The billionaire investor George Soros says the world is now seeing “the most serious financial crisis of our lifetime.”
This is an appropriate moment to consider transparency and accountability, the theme of a research workshop that TJN co-hosted at Essex University on July 3–4. Papers from that workshop (click here to see them) provide the basis for this edition of Tax Justice Focus.
Lack of transparency is at the root of the current financial crisis, which is now becoming a full-blown global economic crisis. This will affect us all deeply: through our pensions, our taxes, our public services, and much more.
Astonishingly, as Jim Stewart notes in our lead article focusing on the International Financial Services Centre in Dublin, almost nothing has been written about the role that tax havens have played in this crisis. This edition of Tax Justice Focus will be among the first to address this issue seriously.
In June, TJN made a long and detailed submission to the UK Treasury Committee, (written substantially by senior adviser Richard Murphy), which launched an inquiry into the role of offshore finance centres. As we said in our submission:
“The offshore world is designed to make things appear other than they are, and by and large succeeds in doing so. This, in a nutshell, is the threat that they pose to the world.”
Financial innovation and regulatory competition For years a process of financial “innovation” has been underway, centred around New York and the City of London and their satellite havens, triggering an explosion of lending and credit, especially (though not exclusively) in Britain and the United States. In many cases, borrowing has grown to levels (relative to their safety cushions of capital) that far exceed what would be tolerated under traditional banking rules.
The high tide is receding, and we are now starting to see who has been swimming naked. To a very large degree, the innovation has been all about circumventing regulation. Regulation exists for very good reasons. It is especially important in finance: the effects of a collapse of a manufacturing company are bad enough, but a bank failure can damage a whole economy, and even cause systemic damage on a global scale. Numerous banks are now seriously at risk.
What has driven this regulatory degradation? Competition between jurisdictions on tax
and regulation, driven by tax havens, are at the root of all this. These places are a menace:
they hide risk, promote instability, distort markets, foster crime, and contribute to insecurity and widening wealth gaps. Jim Stewart’s article highlights how the rot has spread from places like the Cayman Islands, offering regulatory vacuums for financial wizards to exploit, to places like Luxembourg and Ireland. Regulators in each place have come under tremendous pressure to relax their standards. The launch earlier this year in the tax haven of Jersey of unregulated hedge funds illustrates the point.
In boom times, central bankers and the main international financial institutions, loath to regulate complex structures, have been happy to avoid taking responsibility. The responses TJN has encountered in discussions with UK regulatory authorities can be summed up as “let’s pray that nothing bad happens on my watch.”
Complexity is the enemy of transparency. Lax offshore regulation has created a systemic contagion, poisoning onshore regulation. “The creation of the Delaware Special Purpose Vehicle (SPV) that houses $30 billion worth of the most toxic waste from the Bear Stearns balance sheet,” Professor Willem Buiter of the London School of Economics wrote recently in the Financial Times, “is the clearest example of quasi-fiscal obfuscation I have come across in an advanced industrial country.” Delaware, it should be noted, is a state within the United States that aggressively plays the tax competition game against other states, and where almost anything goes. “At every juncture Delaware has underbid its competitors,” one analyst wrote in 2002. “Who needs the Cayman Islands when there’s a tiny, secretive corporate haven on U.S. soil?”
Which brings us to the next way in which tax havens have contributed to the crisis. Sam
Golden, a former ombudsman for the U.S. Office of the Comptroller of the Currency (now in private practice) was quoted recently as saying, in the context of huge potential hidden losses at Citigroup: “The banks will say that it was disclosed. Investors are saying, ‘Yeah, but it was cryptic. We really didn’t know what you were telling us.’ ”
Complexity is, let us repeat, the enemy of transparency. Warren Buffett, another billionaire investor who has been critical of abusive tax practices, says he never buys a stock he does not understand. Tax havens are masters at generating complexity. First, they distort real investment by re-directing it to where it achieves the largest tax break or the least regulation. Complex structures are artificially sliced and diced between multiple jurisdictions, adding to the mess. Regulators claim it is not their problem and they shift it “elsewhere” – which ultimately means nowhere.
Combine lax regulation and complexity with tax haven secrecy – and how could anyone possibly know where the risks and liabilities are parked, or how big they are? Worse still, the complexity and secrecy fostered and enabled by tax havens also provides ample cover for downright fraud, as happened with Enron, which held nearly seven hundred subsidiaries in the Cayman Islands alone.
Global Flows
How big is this problem? Philip Sarre’s informative mapping of global financial flows on page 6 provides some (extremely large-scale) answers. But he makes another important point in this context. Countries like China and the oil-exporting nations have accumulated large surpluses of savings, which they needed to export. Sarre notes that the two countries that are regarded as being at the forefront of financial innovation – the United States and the United Kingdom – have been among the largest debtors, accommodating these surpluses. Their financial “innovation,” it seems, enabled these foreign surpluses to be channelled into the shadow banking systems free from regulatory constraints, where dangerously large and unbalanced borrowings have been allowed to build up.
History and mechanics of the system
Jurisdictions “compete” with each other not only on regulation, but also on tax, which we have warned about for years. Countries engaged in a race to the bottom on tax slash their taxes on capital, while boosting it on labour, consumption and other factors. The net effect is widening inequality. Thomas Rixen’s important article In need of a Fix looks at the history of tax competition, and reveals the current international web of tax treaties as a central aspect of the whole problem. This is nicely complemented on page 15 by Professor Sol Picciotto’s review of Reuven Avi-Yonah’s book International Tax as International Law which looks at other aspects of the mechanics of the international system and its history, and how multinational corporations and others grew to structure themselves to minmise their taxes. Both Rixen’s and Picciotto’s articles offer strong pointers for reform.
This issue, among many others, was discussed in an event held by TJN-Netherlands in Amsterdam on May 21, involving Dutch Finance ministry officials, tax practitioners, and non-governmental organisations. Attiya Waris describes this on page 14.
And more
Again and again, in the context of the current crisis, we see language distorted by the practitioners of offshore. Financial “innovation,” as they called it, was really about escaping regulation. “Light-touch” regulation replaces the real term: lax regulation. And so on. John Christensen’s article, The language of offshore, on page 16 probes the issues, and provides a light-hearted table for translating what they say into what they really mean. This is then complemented by Silke Ötsch’s article (on page 17) announcing a photo exhibition that aims to deconstruct the positive imagery of tax havens based on palm-fringed beaches and conspicuous consumption, which is an important step towards raising public awareness about what tax havens are really about.
On a separate tack, Olivia McDonald’s feature article Making the link: Tax, governance
and civil society looks at what Christian Aid is finding out on the ground about the links
between tax and accountable government. This is a large and expanding area for new
research, and her organisation is at the forefront of non-governmental groups now
starting to probe this crucial question.
Not on my watch, please
We are living through a period of consequences. At the time of writing, the U.S. government is working to stave off the collapse of the mortgage giants Freddie Mac and Fannie Mae, which own or guarantee over five trillion dollars’ worth of loans. Financial excesses over the past 15 years are unwinding. The billionaire investor George Soros says the world is now seeing “the most serious financial crisis of our lifetime.”
This is an appropriate moment to consider transparency and accountability, the theme of a research workshop that TJN co-hosted at Essex University on July 3–4. Papers from that workshop (click here to see them) provide the basis for this edition of Tax Justice Focus.
Lack of transparency is at the root of the current financial crisis, which is now becoming a full-blown global economic crisis. This will affect us all deeply: through our pensions, our taxes, our public services, and much more.
Astonishingly, as Jim Stewart notes in our lead article focusing on the International Financial Services Centre in Dublin, almost nothing has been written about the role that tax havens have played in this crisis. This edition of Tax Justice Focus will be among the first to address this issue seriously.
In June, TJN made a long and detailed submission to the UK Treasury Committee, (written substantially by senior adviser Richard Murphy), which launched an inquiry into the role of offshore finance centres. As we said in our submission:
“The offshore world is designed to make things appear other than they are, and by and large succeeds in doing so. This, in a nutshell, is the threat that they pose to the world.”
Financial innovation and regulatory competition For years a process of financial “innovation” has been underway, centred around New York and the City of London and their satellite havens, triggering an explosion of lending and credit, especially (though not exclusively) in Britain and the United States. In many cases, borrowing has grown to levels (relative to their safety cushions of capital) that far exceed what would be tolerated under traditional banking rules.
The high tide is receding, and we are now starting to see who has been swimming naked. To a very large degree, the innovation has been all about circumventing regulation. Regulation exists for very good reasons. It is especially important in finance: the effects of a collapse of a manufacturing company are bad enough, but a bank failure can damage a whole economy, and even cause systemic damage on a global scale. Numerous banks are now seriously at risk.
What has driven this regulatory degradation? Competition between jurisdictions on tax
and regulation, driven by tax havens, are at the root of all this. These places are a menace:
they hide risk, promote instability, distort markets, foster crime, and contribute to insecurity and widening wealth gaps. Jim Stewart’s article highlights how the rot has spread from places like the Cayman Islands, offering regulatory vacuums for financial wizards to exploit, to places like Luxembourg and Ireland. Regulators in each place have come under tremendous pressure to relax their standards. The launch earlier this year in the tax haven of Jersey of unregulated hedge funds illustrates the point.
In boom times, central bankers and the main international financial institutions, loath to regulate complex structures, have been happy to avoid taking responsibility. The responses TJN has encountered in discussions with UK regulatory authorities can be summed up as “let’s pray that nothing bad happens on my watch.”
Complexity is the enemy of transparency. Lax offshore regulation has created a systemic contagion, poisoning onshore regulation. “The creation of the Delaware Special Purpose Vehicle (SPV) that houses $30 billion worth of the most toxic waste from the Bear Stearns balance sheet,” Professor Willem Buiter of the London School of Economics wrote recently in the Financial Times, “is the clearest example of quasi-fiscal obfuscation I have come across in an advanced industrial country.” Delaware, it should be noted, is a state within the United States that aggressively plays the tax competition game against other states, and where almost anything goes. “At every juncture Delaware has underbid its competitors,” one analyst wrote in 2002. “Who needs the Cayman Islands when there’s a tiny, secretive corporate haven on U.S. soil?”
Which brings us to the next way in which tax havens have contributed to the crisis. Sam
Golden, a former ombudsman for the U.S. Office of the Comptroller of the Currency (now in private practice) was quoted recently as saying, in the context of huge potential hidden losses at Citigroup: “The banks will say that it was disclosed. Investors are saying, ‘Yeah, but it was cryptic. We really didn’t know what you were telling us.’ ”
Complexity is, let us repeat, the enemy of transparency. Warren Buffett, another billionaire investor who has been critical of abusive tax practices, says he never buys a stock he does not understand. Tax havens are masters at generating complexity. First, they distort real investment by re-directing it to where it achieves the largest tax break or the least regulation. Complex structures are artificially sliced and diced between multiple jurisdictions, adding to the mess. Regulators claim it is not their problem and they shift it “elsewhere” – which ultimately means nowhere.
Combine lax regulation and complexity with tax haven secrecy – and how could anyone possibly know where the risks and liabilities are parked, or how big they are? Worse still, the complexity and secrecy fostered and enabled by tax havens also provides ample cover for downright fraud, as happened with Enron, which held nearly seven hundred subsidiaries in the Cayman Islands alone.
Global Flows
How big is this problem? Philip Sarre’s informative mapping of global financial flows on page 6 provides some (extremely large-scale) answers. But he makes another important point in this context. Countries like China and the oil-exporting nations have accumulated large surpluses of savings, which they needed to export. Sarre notes that the two countries that are regarded as being at the forefront of financial innovation – the United States and the United Kingdom – have been among the largest debtors, accommodating these surpluses. Their financial “innovation,” it seems, enabled these foreign surpluses to be channelled into the shadow banking systems free from regulatory constraints, where dangerously large and unbalanced borrowings have been allowed to build up.
History and mechanics of the system
Jurisdictions “compete” with each other not only on regulation, but also on tax, which we have warned about for years. Countries engaged in a race to the bottom on tax slash their taxes on capital, while boosting it on labour, consumption and other factors. The net effect is widening inequality. Thomas Rixen’s important article In need of a Fix looks at the history of tax competition, and reveals the current international web of tax treaties as a central aspect of the whole problem. This is nicely complemented on page 15 by Professor Sol Picciotto’s review of Reuven Avi-Yonah’s book International Tax as International Law which looks at other aspects of the mechanics of the international system and its history, and how multinational corporations and others grew to structure themselves to minmise their taxes. Both Rixen’s and Picciotto’s articles offer strong pointers for reform.
This issue, among many others, was discussed in an event held by TJN-Netherlands in Amsterdam on May 21, involving Dutch Finance ministry officials, tax practitioners, and non-governmental organisations. Attiya Waris describes this on page 14.
And more
Again and again, in the context of the current crisis, we see language distorted by the practitioners of offshore. Financial “innovation,” as they called it, was really about escaping regulation. “Light-touch” regulation replaces the real term: lax regulation. And so on. John Christensen’s article, The language of offshore, on page 16 probes the issues, and provides a light-hearted table for translating what they say into what they really mean. This is then complemented by Silke Ötsch’s article (on page 17) announcing a photo exhibition that aims to deconstruct the positive imagery of tax havens based on palm-fringed beaches and conspicuous consumption, which is an important step towards raising public awareness about what tax havens are really about.
On a separate tack, Olivia McDonald’s feature article Making the link: Tax, governance
and civil society looks at what Christian Aid is finding out on the ground about the links
between tax and accountable government. This is a large and expanding area for new
research, and her organisation is at the forefront of non-governmental groups now
starting to probe this crucial question.
posted by TJN at 7:34 am
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