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Book Review - Les Paradis Fiscaux

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Cross-posted from The Global Sociology Blog.

Paradis Fiscaux Christian Chavagneux and Ronen Palan's Les Paradis Fiscaux is a great (and mercifully short) introduction to tax heavens, banking secrecy and the offshore financial world. And it's in French. For my non-French readers, not to worry, hopefully, my review will give enough substantial information... or, y'all could learn French! However, I have preserved what I think are the best quotes in the original language so as to preserve their value.

The book's central thesis is that the development of offshore financial centers since the 1960s is an integral part of the dynamics of contemporary globalization, both in the financial and productive sectors. Tax heavens are now a pillar without which contemporary economic globalization could not function.

And surprisingly, they have not been studied to the extent that they should have been. For orthodox economic literature, tax heavens are a product of overtaxation in industrialized countries or a simple manifestation of informal economies. Both views are faulty according to Chavagneux and Palan.

What are Offshore Financial Centers?

The first difficulty with this topic, as usual, is that of definition as there is no official consensus on criteria and lists of tax heavens. Chavagneux and Palan have settled on ten criteria for territories to be considered tax heavens (currently, roughly 80 territories):

  1. Weak or nonexistent taxation on non-residents. Very few tax heavens have no taxation at all. More likely, they have a very complex system that minimizes taxation on international transactions and they make money off of commissions.
  2. Strong banking secrecy. Financial operations are strictly confidential. By law, offshore banking centers are required to protect all information regarding their clients and the origins and nature of the funds they receive.
  3. Extensive professional confidentiality. All lawyers, accountants and employees to strict rules regarding preserving confidentiality of their clients and their operations, even (especially?) when they violate the laws of other countries.
  4. Lax registration procedures. Businesses and corporations can open operations there with minimum information and the possibility of hiding the identities of the real owners.
  5. Complete freedom on the circulation of international capital.
  6. Speed of implementation of registration and transactions. Companies can be created and be operational within 24 hours. A local resident will be paid to be name on all paperwork.
  7. Support from large financial centers. Money does not stay for very long in offshore centers. It usually circulates back into the world's major financial centers.
  8. Political and economic stability.
  9. A good reputation and image. The name of a particular offshore center must not be associated with too much corruption or criminal money laundering.
  10. A network of bilateral agreements mostly with rich countries to avoid double taxation.

It is difficult to estimate how much money circulates through offshore financial centers but it is clear that we are talking about between hundreds of billions to trillions of dollars, both clean and dirty money. Different organizations have tried to derive estimates using a variety of indicators. Sometimes, figures will emerge as a result of investigations. So, what do we know?

Half of international loans come from banks located in these territories. Half of international deposits are directed to banks located there as well. Whichever measure is used, offshore centers are divided in three categories: London (yes, London, with 40% of all offshore activities), other rich countries (such as Luxembourg, Switzerland, Austria or Ireland, with 30%) and exotic locations (Bahamas, Bermudas, etc., with 30%). London is indeed, without discussion, the world's largest offshore center. This is a different image than the one conveyed usually by the media as offshore centers located in the Caribbeans or other non-Western locations. London and a few rich countries constitute the largest share of offshore financial activities.

History

Next, Chavagneux and Palan devote a chapter to the history of tax heavens and it is quite fascinating. As I always tell my students, nothing ever happens by chance [thanks, Gob] in social matters and offshore financial centers are no exception.

Interestingly, the early United States played a part in the development of offshore financial centers: Alexander Hamilton promoted attracting foreign investment through fiscal goodies.

More generally, offshore financial centers are a product of both the Westphalian order and of the period of globalization that developed in the 19th century. Isn't this contradictory?

"Or ces deux evolutions, l'une politique et l'autre economique, sont contradictoires. En effet, comment affirmer fortement sa souverainete nationale au moment ou des acteurs economiques prives se mettent a sauter allegrement les frontieres? Des tensions se manifestent de plus en plus qui portent sur la protection des investisseurs etrangers." (29)

So, two principles conflict: national sovereignty and the support offered by industrial nations to their businesses as their internationalize their production. Four solutions were found to resolve this tension.

  • The creation of a whole body of international law dealing with international trade and economic affairs, contract signed outside of the country of origin of companies.
  • The proliferation of bilateral treaties to harmonize laws pertaining to foreign investments.
  • The development of lex mercatoria, the law of the merchants, which meant, in reality, let private businesses deal with the problems related to their international implantations.
  • The creation of an offshore economy which is then a space where laws do not apply or would apply less, in all legality.

Regarding this last solution, it occurred in three phases:

1. The late 1800 in the US, where lawyers advice certain states strapped for cash (like New Jersey) to make themselves attractive to investment with a tax cap. Delaware follows suit. According to the authors, still to this day, half of US companies listed on the stock market have headquarters in Delaware.

"Ces Etats Americains on ainsi bati le premier pilier des paradis fiscaux, la possibilite d'attirer des entreprises uniquement pour des motifs fiscaux. Un mouvement d'entreprise purement fictif, les firmes enregistrant leur siege social sans changer physiquement de lieu."

2. The second phase takes place in England in the 1920s when a British judge decides that British multinational should pay their taxes where the organization of their operations. A multinational where all is decided is London even though most operations are elsewhere should pay its taxes to England. It's bad news for British companies who start then opening shell companies in foreign countries. As long as management is done there, no taxes will be paid in England and this is applicable to the entire British Empire. Thus London became a tax heaven.

3. In 1934, Switzerland passes a major banking secrecy law whereby confidentiality becomes protected by criminal law. The account of the French scandal through which this came about is absolutely fascinating.

So, we have now the three pillars of offshore financial activities: low taxation for foreign residents and profits, shell companies, and banking secrecy. Different countries and territories will combine one or two or all three of these policies.

And there are two additional pieces to the puzzle: in 1957, the Bank of England allows for financial transactions conducted in England between two non-residents in currencies other than the Sterling pound to be exempt from taxation. This is why London is the primary place where offshore capital circulates practically without any controls or regulations. This move to allow England's declining international status (with the progressive dismantling of the Empire) to regain a major place in the emerging global order.

Finally, the rise of offshore financial centers accompanies the slow death of the Fordist model which culminates with Reaganomics where US companies look for exit strategies to reduce their American workforce and their participation to the common interest in the form of taxation, with the encouragement of the Reagan administration.

What Financial Tools?

The different tools (and they can be extremely complex) offered by tax heavens have different functions: change the residence of an individual or company, change the origins of their revenues, create a veil of secrecy almost impossible to penetrate. This can all be done thanks to

  • International Business Corporations, which can be created for $100 and are exempt of most taxation on profits and capital gains. Residents are prohibited from creating them. They are only for foreign investors.
  • Foundations have no owners or shareholders. They are created to manage assets with a specific purpose. Private foundations are exempt from taxation in certain tax heavens.
  • Trust funds... these are fairly well-known but they are often used to hide assets from a former spouse since there are no registration procedures and therefore no registry of trusts.
  • Anstalt: a specialty from Liechtenstein, it is a hybrid between a foundation and a trust, perfect to avoid all inheritance taxes.

Who Uses Offshore Financial Centers?

The Rich: they want to avoid paying taxes on income, inheritance, and investments. They want to avoid alimony. In politically unstable countries, the wealthy elite wants to protect their assets and they want an exit strategy to withdraw their capital in case the economy turns bad (think Argentina 2000/2001).

Multinational Corporations: here as well, the goal is to avoid taxation but also regulations, hide debts and present healthy and highly profitable balance sheets to auditors and regulators (think Enron).

Financiers: Banks (remember than most major corporate financial scandals of the past years have involved major international banks), insurance companies, and hedge funds all seek to avoid taxation and regulations.

Lawyers and accountants can make enormous amounts of money in commissions and fees they charge for help the other categories above get settled. They usually charge between 8 and 30% of avoided taxation.

Organized criminal networks: of course, money laundering is a major activity, but also as a way to progressively rejoin the legitimate economy for the next generations.

Large countries: the secret services of core countries, such as the CIA or the French DGSE have used offshore centers for their covert operations to create shell companies through which capital would be funneled to fund a variety of operations. The KGB used to hide enormous anounts of money in offshore centers in Cyprus.

Tax heavens: think of this as a development strategy and as a resource curse as the same time. Certain territories may not have natural resources and have found themselves short of cash and in debt after their independence. Becoming a tax heaven is a great way to attract foreign investments. This is a double-edged sword though since these territories become dependent upon foreign capital and competition is pretty stiff in the global context.

What has been done to fight Offshore Financial Centers?

Not much. Because of the different actors who use them. Basically, the powerful have the political clout to prevent any significant change that would promote more openness. Rich countries, of course, are reluctant to do much since they are major players in this field. The rich also have the power to stall significant legislation.

Moreover, any significant change would have to be implemented by most countries acting together. So far, only the European Union has tried to significantly force more openness on these matters.

However, there have been new players in this game: the global civil society association, especially ATTAC and the Tax Justice Network. The alter-globalization movement has been at the forefront of the fight against offshore centers. These group do so through the name and shame strategy and are pushing the concept of corporate social responsibility.

But again, offshore financial centers are so central to the global economy that dismantling them would have an enormous political impact. More than that:

"Il est impossible de juger de leur impact quantitatif sur l'economie et la croissance mondiales, non seulement parce qu'ils sont createurs d'opacite, mais egalement parce qu'apres un siecle de pratiques, individus, firmes et Etat souverains ont integre leur existence et adapte, internalise leur comportement en consequence. Ainsi, l'ampleur croissante du phenomene exerce-t-elle une pression a la baisse sur les niveaux d'imposition et de reglementation des Etats. Certes, tous n'ont pas adopte une strategie de developpement des pratiques offshore comme le Royaume-Uni, l'Irlande ou une multitude de petites iles, mais chacun d'eux doit tenir compte dans la definition de sa politique fiscale de la necessite de ne pas trop demander a l'impot, surtout pour la taxation des agents economique les plus mobiles." (109)

In other words, they have won. States have to decide on fiscal policy under the constant threat that should they tax the rich, the corporations, the investors, etc. too much, these would simply pack up and go offshore, depriving states of increasingly needed revenues.

This is already happening: the African Union estimated in 2007 that Africa loses $150 billion a year in tax fraud (how many African dictators, like former Nigerian strongman Sani Abacha, got to plunder their countries and hide their assets in Switzerland or elsewhere? Abacha was able to extract $4 billion), and the numbers for Western countries are even higher.

In this context, private elites get to more or less dictate economic policies to their government with the threat of capital flight (which might happen anyway). Even before he got elected, Lula, of Brazil, got warnings that his proposed economic policies (largely involving redistribution) would trigger a rush for the exits from the upper classes.

The book is not pessimistic but cautious: there can be no unilateral strategy to fight offshore financial centers, they are too much part of globalization. The only strategy that can work is a global one, involving many countries and civil society groups.

It is a great book, short but incredibly informative. I learned a lot reading it. But be warned: this is not a book about organized crime or money laundering. It does not go for the sensationalist accounts of Mafia families, mostly because these do not represent the majority of the capital that transits through offshore centers.

But, I am more pessimistic, like Ian Welsh: there was a class war. The rich won it.

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Submitted by lambert on

Unlike us poor shlubs, who have "nowhere to go."

So, this would be why Halliburton moved to Dubai?

[ ] Very tepidly voting for Obama [ ] ?????. [ ] Any mullah-sucking billionaire-teabagging torture-loving pus-encrusted spawn of Cthulhu, bless his (R) heart.

First they ignore you, then they ridicule you, then they fight you, then you win. -- Mahatma Gandhi

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Submitted by FrenchDoc on

That's why a lot of people (including organized criminals) go there and invest in these extravagant real estate projects as a way of laundering their money. The Sheiks there don't look too closely at the origin of these investments.

Submitted by gob on

This is the kind of post that really makes blogging great, because it brings me knowledge I didn't know I wanted. It's a little scary commenting on something like this because I share Paul's feeling that one may sound stupid in the presence of those who've thought long and hard about the issues under discussion. But I hate to see good writing go unacknowledged, and surely the highest bloggy acknowledgment is a comment, so here goes.

Two points piqued my interest:

Whoa, that was some excellent post of Ian Welsh's that you linked. Not that the charts or the 30-year class war story are new, but there's a lot more context and detail on the mechanisms. But taking the longer view, yes, there "was" a class war and the rich "won", on the scale of my lifetime, but in fact there's been class war as far as I can tell since before history started to be written. The rich, by definition, always are winning and at times there's a sense of finality, like scary now. The non-rich can be made to "forget" to fight, up to a point, but the war is never over. And never will be, in my opinion (not a Marxist).

The other thing is more abstract and potentially boring I guess, having to do with contingency. You wrote, nothing ever happens by chan[c]e in social matters and offshore financial centers are no exception. You go on to support this by showing how the "three pillars" were deliberately created for various reasons by the U.S., the U.K., and Switzerland. But it's the "various reasons" that grabbed my interest--because the system that resulted was not designed, rather emerged as a result of the interaction of the three pillars, if I understand aright. The variety of the reasons spans the distance from the fiscal opportunism of certain states in the U.S. to an "absolutely fascinating" French scandal. The latter sounds like a "chance" happening, that is, not determined by the larger economic forces? Is it right to think, though, that in the absence of this particular scandal the vast pressures created by the contradiction you cite between national sovereignty and globalization would have found some outlet anyhow, through some other "chance" happening? That such happenings are like cracks in a dam, where the particular pattern of cracks is unimportant since the dam will fail no matter what?

Why do I care about this second point? Because I think it's necessary to understand how these big social and economic forces act without resorting to conspiracy theories. And conspiracy theories thrive on simplistic notions of causality. So I'm trying to understand how to think and speak accurately about causality.

We will push and push and push until some larger force makes us stop.

Submitted by lambert on

1. Shystee's notion of emergent conspiracy

2. Gould's notion of "spandrels"

I think plenty that happens is contingent, but also there are some who, primarily through wealth, are better placed to exploit/arbitrage the contingent into the "inevitable" and from there to the unexamined.

[ ] Very tepidly voting for Obama [ ] ?????. [ ] Any mullah-sucking billionaire-teabagging torture-loving pus-encrusted spawn of Cthulhu, bless his (R) heart.

First they ignore you, then they ridicule you, then they fight you, then you win. -- Mahatma Gandhi

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Submitted by FrenchDoc on

if you believe that things happen contingently because then, you don't bother to look at the mechanisms of power that bring about certain states of affairs, like economic recessions or mortgages crises or high gas prices, you name it.

The more you believe in the Tom Friedman "no one controls globalization" school of thought, the more you'll leave powerful decision makers and institutions off the hook and therefore free to keep on keepin' on.

Submitted by lambert on

And we humans are all part of the evolutionary process.

Therefore...

[ ] Very tepidly voting for Obama [ ] ?????. [ ] Any mullah-sucking billionaire-teabagging torture-loving pus-encrusted spawn of Cthulhu, bless his (R) heart.

First they ignore you, then they ridicule you, then they fight you, then you win. -- Mahatma Gandhi

FrenchDoc's picture
Submitted by FrenchDoc on

First, I would dispute somewhat the use of the word "contingent" if by that you mean an element of randomness. In a sense, evolution is the opposite of that, especially in the case of natural selection.

Second, yes, we're a product of evolution but we're the only species that is able to actively change its environmental conditions, generate culture. Cultural evolution changes a lot faster than biological evolution. So do the social formations (social, political and economic arrangements) that are both causes and consequences of such changes.

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Submitted by admin on

However, evolution is contingent in the sense that it can only work from what has previously evolved. Nothing is ever "from scratch." Not so with culture, I agree, always, but still true with culture sometimes.

I don't believe the science of history stuff. I think that mindset did a lot of harm.

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Submitted by FrenchDoc on

And definitely not dumb at all.

On your first point, I think that yes, class warfare has been a major dynamic of human history. The rich tend to prevail but not always and not systematically (look at contemporary Scandinavia, or, in a more extreme fashion, the USSR).

Or even in the US, there seem to be cycles between eras of unbridled capitalism, then, of course, big scandals, then a more regulatory era.

On your second point, yes, the French scandal precipitated the 1934 Swiss law, but it was in the non-random context of the French 3rd Republic, which had these cycles of savage capitalism, scandals, regulation.

Swiss already had a weaker banking secrecy statute, but after the scandal, bankers freaked out and got what they wanted with the 1934 law.

So, when I say "things never happen by chance", I am not thinking in terms of simple A->B causality. I have in mind a multiplicity of factors that converge to precipitate certain events or social trends... which makes my life miserable but then, the big job is figure out all these factors... :-(

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Submitted by badger on

Without being able to really prove anything, I'd guess that the history of financial mechanisms that the wealthy can exploit follows a evolutionary path.

For example, somebody like Carnegie sets up foundations to (mostly) do good things with his vast wealth. Later on, Henry Ford finds that he can transfer control of his enterprise to his spawn while avoiding taxation by forming the Ford Foundation. Others, like the Morgans, Rockefellers, John D and Catherine T MacArthur and all those other names you hear for every PBS show need a similar tool. If the tool doesn't work well enough, they can refine it because they own the legislature and/or the executive (something that in itself probably evolved out of some initial use by some individual).

So initially someone does a design that fixes one specific problem, and lots of people who have the same or similar needs exploit it as well. It doesn't arise out of conspiracy, but the commonality of interests it supports acts the same as a conspiracy to perpetuate and enhance it. For example, junk bonds, derivitives, hedge funds, etc.

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Submitted by FrenchDoc on

These things have also a cyclical quality to them.

But I agree with everything else you say in your comments.

But the specific "evolutionary" path that a trend follows is a function of "environmental" factors, here, economic and political decisions.

Think of the evolution of the 401k in the tax code and as part of society.

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Submitted by Truth Partisan on

"The more you believe in the Tom Friedman “no one controls globalization” school of thought, the more you’ll leave powerful decision makers and institutions off the hook and therefore free to keep on keepin’ on."

WE must keep on saying and criticizing and pushing for the good.

Thanks so much for this book review work you do!