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Tax justice now

John Christensen on the cancer at the heart of the financial system

In April the G-20 committed itself to tackling tax havens. In the intervening months the Organisation for Economic Cooperation and Development claims to have made more progress in the battle against banking secrecy and tax evasion than in the preceding decade. This is good news. But in the run-up to the G-20 finance ministers meeting in Saint Andrews, Scotland, in early November we need a much more ambitious agenda for tackling secrecy jurisdictions (a term we prefer to tax havens). Above all the finance ministers must recognise that secrecy jurisdictions are integral components of what many people call the Anglo-Saxon model of financial capitalism.

Over the past fifty years a shadow economy has been created that works in parallel to the mainstream economy. US government research, and research by the Tax Justice Network, reveals that around three quarters of the top American businesses use secrecy jurisdictions, and almost 100 per cent of the top European businesses do the same.

Over 80 per cent of international loans are routed through secrecy jurisdictions. More than half of world trade passes on paper through secrecy jurisdictions. Over half of the private wealth of Latin America and Africa sits in secrecy jurisdictions. $11.5 trillion of private assets are held in offshore structures to evade tax. Most hedge funds operate through secrecy jurisdictions. Most private equity firms are based in secrecy jurisdictions. To my knowledge the entire shadow banking system is located in secrecy jurisdictions. Day by day we accumulate more evidence that secrecy jurisdictions have become a central and totally destructive feature of the globalised economy.

In every national survey to date, banks top the lists of secrecy jurisdictions users – by far. Acting with stealth they have created a shadow banking system of inter-related structures spanning different secrecy jurisdictions, often using SIVs (Structured Investment Vehicles) and SPVs (Special Purpose Vehicles) to hold assets and liabilities off their balance sheets.

This explains why secrecy jurisdictions have been a major contributory factor to the current crisis. The trend for financiers to structure complex financial instruments through secrecy jurisdictions is largely a response to favourable tax treatment of capital gains and profits-shifting to low tax areas. Similarly, favourable tax treatment has encouraged the use of debt securitisation and other devices (e.g. by reducing the cost of sub-prime financing), and the combination of opacity and complexity inherent to CDOs (Collateralised Debt Obligations) has significantly contributed to the failure to identify hidden risks. Yet it was those hidden risks that eventually brought the global economy to its knees.

Much of what journalists call financial innovation is driven by nothing more than opportunities for tax or regulatory arbitrage. The need to hide this arbitrage behind complex structures has put huge obstacles in the way of regulators, auditors, credit rating agency analysts, financial journalists and others with a legitimate interest in analysing financial market risk.

Opportunities to use secrecy jurisdictions for tax evasion and avoidance have played a major part in shaping the globalised financial markets. Anxious to protect the interests of financiers in London and New York, and to attract much needed capital to balance their chronic current account deficits, both the UK and USA have provided tax concessions which distort the global capital markets.

The growth of hedge funds is a prime example of these distortions. Tax authorities have treated hedge funds with enormous lenience, allowing them to operate in London and New York, but treating them for tax purposes as though they were resident in the Channel and Cayman Islands and therefore not taxable on profits or capital gains. Furthermore, their distributions to investors are not subject to withholding tax and their location in secretive locations has provided investors with a tailor-made opportunity for tax evasion.

Favourable regulation and tax avoidance opportunities have encouraged investors to accumulate capital in secrecy jurisdictions. This has fuelled excess liquidity which has been channelled into hedge funds, other derivative markets and private equity funds, all of which are largely engaged in speculative financial transactions rather than genuine business activity.

The International Monetary Fund has now recognised that tax biases have encouraged the excessive leveraging of debt and other distortions at the root of the crisis. The IMF agrees with us that these distortions have had damaging macroeconomic consequences, leading to over-reliance on debt rather than equity financing, and subsidising borrowing. This issue must now be explored more thoroughly and we recommend that both the IMF and the European Parliament's Economic and Monetary Affairs Committee should give priority to research into how the tax and judicial regimes of secrecy jurisdictions impact on other countries and on the global financial markets.

Yet this raises a major problem: until now tax policy has largely been treated as an issue of national sovereignty. Since the time of the League of Nations in the 1920s, the majority of international tax cooperation effort has focused on avoiding double taxation of corporate profits. Little or no effort has been expended on ensuring that profits avoid taxation altogether. The result is that the current financial architecture is a tax avoider's paradise. And there is no effective institutional framework for moving ahead with programmes for enhanced international cooperation: the OECD wants to take the lead but its agenda is timid and the organisation cannot claim to represent the interests of developing countries. Worse, the UN Tax Committee lacks political authority and adequate resourcing. We must push for this Committee to be given a new political status and sufficient resources to move ahead with a new, pro-poor tax agenda.

After years of relying on the financial markets to set their own rules, and then to self-regulate within a framework of rules which favour the interests only of wealthy elites, we now require a financial architecture that emphasises international cooperation, democratic accountability and operational transparency.

As a starting point we must restore the ability of elected governments to tax capital and to tax on a progressive basis. To do this, we need enhanced international cooperation to combat tax evasion and the abusive activities of secrecy jurisdictions.

In April G-20 leaders called for measures to tackle secrecy jurisdictions, and asked the Organisation for Economic Cooperation & Development to take steps in that direction. But the OECD's standards for tackling tax evasion rely on complex, time-consuming and ineffective bilateral treaties for tax information ‘upon request'. G-20 finance ministers must seize the current political opportunity to push for a more ambitious multilateral treaty process based on automatic information exchange on the model currently being used within the European Union.

Some claim that automatic information exchange is too complex and detailed to provide the basis for a global standard for information exchange. We disagree. One statistic alone demonstrates the weakness of the OECD ‘upon request' standard: in the past three years the British Crown Dependencies of Guernsey, Isle of Man and Jersey have cooperated with only 17 exchanges of information across their entire network of treaty partners. That's fewer than two exchanges a year for each jurisdiction. No wonder the tax evasion industry prefers the OECD exchange model to the European standard. If anyone doubts the effectiveness of the European model they should note that a prominent British lawyer - an adviser to secrecy jurisdictions, no less - has urged these jurisdictions to cooperate with the OECD processes in order to resist pressure for the alternative automatic exchange process. The tax avoidance industry knows that automatic exchange works. It is what the tax avoidance industry is afraid of, and with good reason.

In addition, we call for General Anti-Avoidance Provisions, enshrined in national laws, which will de-legitimise the harmful but highly profitable activities of the global tax dodging industry. Again, such laws work. Australia, which has operated such laws for a number of years, is proof.

And we go further. The current framework of international financial reporting standards, promulgated by the International Accounting Standards Board, a private company based in London and registered in the secrecy jurisdiction of Delaware in the United States, has patently failed to protect public interest. Too much of what happens within and between subsidiaries of multinational companies is not disclosed in their published accounts, creating opportunities for profits shifting to secrecy jurisdictions and thereby enabling massive tax avoidance.

We propose a new reporting standard for country-by-country reporting, which would require publication of accounts for all subsidiaries in the countries where they operate. This information is material to a wide range of stakeholders, not least tax authorities. Having this information would be a major stepping stone towards tackling trade mispricing and tax fraud, but also ensuring that developing nations have a fair chance of holding onto their own sovereign tax revenues, instead of losing $250billion to secrecy jurisdictions every year as they currently do.

And whilst we're about it, the International Accounting Standards Board, which has demonstrated its lack of willingness to promote public interest, should be replaced by a democratically accountable body constituted of a far wider stakeholder community, including civil society. It is wrong that this unaccountable, unelected so-called regulatory body of chums regulating chums is our only recourse to international accounting justice, when accountancy is at the heart of the global tax scam.

The need to tackle the secrecy jurisdictions is urgent. They lie at the root of massive wealth inequalities in, and between, most countries. They shift the tax burden from capital to labour and consumers, which causes huge macroeconomic distortions and fundamentally alters the balance of power within societies. They reduce job creation, encourage speculation, and facilitate corruption. They make the world of finance a more risky and dangerous place, and threaten all our economic livelihoods in the process.

That is why we must tackle secrecy jurisdictions, and why we must tackle them now. Britain is better placed than most to take on this issue: London is the largest secrecy jurisdiction of them all, and half of the small island secrecy jurisdictions are Crown Dependencies, British Overseas Territories or Commonwealth members. Tackling this cancer in the system must now go to the top of the political agenda.