The weakest link
Writing in another period of social and economic crisis, Marx and Engels observed how financiers are "like the sorcerer who is no longer able to control the powers of the nether world whom he has called up by his spells."
De-regulation of the financial markets from the 1970s onwards unleashed the powers of the nether world, and we are now struggling to contain the consequences of those spells. In their frantic efforts to maximise profits, financiers have created innovative instruments of devilish complexity; they have played a fiendish game of pass the parcel involving sliced, diced and re-packaged debts with unknown risks attached to them; they have created a shadow banking system designed to operate beyond regulatory control; they have perpetrated massive frauds and looted on an awesome scale; they have become accomplices to criminal activity, including insider dealing, money laundering and tax evasion.
With patience and stealth they have created a shadow economy from which they can operate beyond democratic accountability and regulation. Few people know about this shadow economy. You will not learn about it at universities, or read about it in political economic texts. But it is real nonetheless. Over half of world trade is transacted - on paper - through this shadow economy. Almost all cross-border investment flows are routed through it. At least one-third of global wealth is managed from the shadow economy. But despite the immense scale of its operations, next to nothing is known about how this economy actually works.
Does the shadow economy have a name? Can we find it on a map? The answer to both of these questions is yes. The shadow economy is widely called "offshore", and it is located in the 72 tax havens (we sometimes prefer the term secrecy jurisdictions) dotted across the face of the Earth.
Tax havens have played a major part in the current crisis. They have been used for a variety of purposes, including:
- to create complex securitised instruments (mostly collateralised debt obligations) to mix packages of risk that have been marketed indiscriminately around the world;
- to register'off-balance sheet' entities that have been used to withhold materially sensitive information from investors, regulators, rating agencies, journalists and others;
- to degrade the regulatory regimes of other nation states;
- to create complex and opaque structures criss-crossing multiples of jurisdictions in order to confuse investigation and fragment regulatory effort;
- to evade and avoid tax on an industrial scale.
In other words, these tax havens have become engines of chaos in the financial markets, serving the dual purposes of helping financiers to 'get-out-of taxation-free' and also 'get-out-of regulation-free.'
Tax havens have been the means by which rich people and powerful companies have thrown off the chains of democratic accountability and social solidarity. It is not at all surprising to find that their principal cheerleaders include the most extreme of the organisations of the libertarian far-right, including the Heritage Foundation and its offspring, the Center for Freedom and Prosperity.
In a world of global banks and 24 hour financial markets, regulation is only as effective as the weakest link in the chain: tax havens are the weakest link. This explains why so much of the 'financial innovation' of the past two decades can be traced back to these places. The majority of hedge funds are located in London, the Cayman Islands and the British Channel Islands. Ditto the private equity industry; the issuance of securitised debt; the re-insurance industry, and the structured investment vehicles at the heart of the shadow banking system.
The current crisis does not result from some accident de parcours: it arose because financiers have created a shadow economy that is so opaque in its operations, so complex in its structure, and so blatantly corrupt in its attitude towards democracy, regulation and taxation, that no one can and should trust any of its activities.
Tax havens are relatively new political economic phenomena. Although Marx and Engels visited my home island of Jersey on several occasions, the island was not a tax haven in the 19th century, and only developed this role as a result of conscious decisions taken in the 1960s. Delaware started out down this route in the 1890s, but tax havens really emerged as a significant feature of contempary capitalism after the expansion of the London-based Eurodollar market in the late 1950s. The 'Big-Bang' de-regulation of London in 1986 accelerated the process.
De-regulation of financial markets opened the door for tax and regulatory competition. Tax competition has been used to increase returns to capital, and by lowering government revenues, to force privatisation of strategic assets. De-regulation has greatly increased profitability, but at massive cost to workers, consumers and the environment. Tax havens have been used as mechanisms for catalysing both processes, acting as termites which have hollowed out the structures we have put in place to protect ourselves from predatory practices.
To all intents and purposes, tax havens represent a financial world without rules, where criminality can prosper. My own experiences of working within a tax havens suggest that the secrecy they provide facilitates not just tax evasion, but also insider dealing, market rigging, payment of illicit political donations, non-disclosure of conflicts of interest, facilitation of bribery, and all sorts of other corrupt practices. And this happens day in day out on an industrial scale.
In a few weeks the G-20 leaders will convene in London for an emergency summit. UK Prime Minister "Crash" Gordon Brown wants a return to business as usual as fast as possible. His interest lies with protecting the City of London and its infernal progeny in the Cayman Islands, the Channel Islands and elsewhere. Civil society must insist that there will be no return to business as usual. We must demand comprehensive reform which will eradicate all of the mechanisms that the financiers, lawyers, accountants and their clients use to take advantage of tax havens. This will include demands for:
- comprehensive disclosure of ownership data;
- the closure of bank subsidiaries located in tax havens;
- adoption of a country-by-country reporting standard for multinational companies;
- abolition of the use of 'off-balance' sheet accounting vehicles;
- effective steps to tackle trade mispricing;
- taxation of hedge fund profits as income rather than capital gains;
- a multilateral tax information exchange treaty based on automatic exchange;
Taken as a package, these measures will severely restrict the use and abuse of tax havens. Many can be expected to collapse and might need transitional support to restructure their economies. These measures will reduce the amount of grand corruption. They will restore the ability of democratically elected governments to tax on a progressive basis. And they will start the process of re-balancing a system that has created wild inequality of wealth and income distribution.
When the G-20 leaders meet in London in April, we will be insisting that these reforms are included in any proposal for a new financial architecture.