To what extent does sovereignty enable offshore financial centres?

Do Sovereign states and offshore financial centres have an enabling relationship?

INTRODUCTION

            Offshore financial centres (OFC) can be regarded as a jurisdiction or a country that provides important financial services to various non-residential persons, especially on a scale, which does not commensurate the financing and the size of the domestic market (Palan et al. 2010). OFC is not usually not concerned with the actual location but rather on the number of non-residents who prefer using the financial centres (Palan et al. 2016b). Tax havens, on the other hand, refers to a country or a jurisdiction that paves the way for businesses and individuals to enjoy no or limited liability in an economically, as well as a politically static environment (Harrington 2016). According to Palan (2006), tax havens rarely share any meaningful information concerning the financial status of an individual or a person with other foreign taxing bodies. The significant difference between OFCs and a tax haven is the existence of politics and the need to hide crucial financial information to protect the involved party. However, one of the most common things is that the issue of sovereignty can never be ignored considering the thriving of OFCs takes place within the country or on a certain jurisdiction (Post et al. 2002). Therefore, the misdeed cannot occur within an independent jurisdiction or state as Hay & Beaverstock (2016) observe such occurrences will always be subjected to the international monetary laws (Zucman et al. 2016).  Therefore, this study aims at determining the extent to which sovereignty enables OFCs to thrive. It is also aimed at determining whether OFCs and sovereign states have an enabling relationship with the City of London used as the case study.

ANALYTICAL FRAMEWORK

            Palan et al. (2010) state that both tax havens and OFCs exist in different jurisdictions around the world. One is likely to benefits from such heinous financial misconducts when engaging with the monetary systems of countries such as Liechtenstein Principality and Cayman Islands (Palan et al. 2010). The same activities are also deemed to be highly common in some of the United States regions such as the Delaware State (Palan et al. 2010). The financial and banking agencies in such jurisdiction are likely to keep on offering a low level of taxes while in unison assuring the concerned corporations and individuals of a high level of secrecy (Palan 2006). Apart from that, they are also likely to apply less stringent enforcement, as well as regulations (Post et al. 2002). Despite the numerous remedial action carried out by various government regulators, the issue of noncompliance among the major tax havens has failed to end (Zucman et al. 2016). Numerous efforts aimed at diverting the concerned capita to taxable views have been met with a lot of resistance leading to the eventual prevalence of uncontrolled financial activities.

            According to Palan et al. (2010), tax havens may go unnoticed as the amount of wealth hidden by a single entity may be deemed insignificant. Nonetheless, the collective figure demonstrates the vice as one that has a far-reaching adverse impact to the global economy considering that the current cumulative of personal wealth in tax havens is estimated to be $13 trillion (Palan et al. 2010). Palan et al. (2016) consider the continued thriving of heinous activities in tax havens to be highly detrimental for the development of any world economy considering that the amount of wealth held by tax heavens can be equivalent to that of the 50% of multinational lending banks. Furthermore, the continued stashing of resources in tax havens and OFCs has led to the skewed distribution of resources, further, impoverishing the developing countries (Hay & Beaverstock 2016). Palan (2006) states that most of the OFCs are found in developing countries, thus meaning that there exists a capital flight with resources moving from developing to developed economies.

            Palan (2006) notes that tax havens, as well as OFCs can be many governments do not have sufficient knowledge concerning the number of registered companies operating stashing their finances in tax havens. This is because the tax havens are fond of charge low or no taxes to such companies and non-residential, which makes it hard to reveal their identity. The tax havens are part of the mainstream structure of the world economy and its operation as they play an integral role in determining its operation. Furthermore, they are no longer deemed as mere conduits for aiding in tax evasion or avoidance. Instead, they developed strong roots that make them be considered as part of the broader financial world (Post et al. 2002). They are regarded highly as they are not only simple tools for managing the financial and monetary resources of corporations and individuals but are also important ingredients for strengthening the financial systems of different countries (Palan 2006). The upsetting reality is that they act as a powerful globalisation force that perpetuates the continued existence of economic instability (Dharmapala 2006). As a result, this has made the continued demonstration of OFCs an important political issue in the contemporary world.

            However, it is worth investigating the origin of OFCs and tax havens to understand their importance. According to Harrington (2016), a tax haven is a term that emerged in the early 1950s even though the terminology has lacked a precise meaning to date. Its significance, nonetheless, is validated by Hampton & Abbott (1999) findings that 50% of the global stock passes through the offshore channel. For example, Cayman-registered banks are believed to have stashed more than $1.5 trillion in terms of deposits (Hampton & Christensen 2002) ‘. Luxembourg, on the other hand, is believed to the safe home for over $2.3 trillion worth of cash and assets that have flown from mainly developing economies. The Swiss banks are deemed to have embraced tax evasion activities more than any other country as it is estimated that more than $ 4trillion are stashed there (Zucman et al., 2016). One of the most important aspects worth noting is that most of the tax havens are found in developed countries where stable financial systems are found. The demonstration of the above statistics indicates there must be some instruments the perpetrators use to encourage the malpractice. As indicated earlier, a tax haven is a perpetual misdeed conducted by companies, as well as individuals. As a result, it becomes clear that there must be special ways through which the vice is perpetuated. Both parties make use of identical techniques of ensuring that they have avoided paying taxes like in the case of the offshore organisations, as well as offshore trusts. Therefore, the avoidance of taxes can be regarded as one of the principal tools for facilitating the OFC processes. Data collected by Organisation for Economic Cooperation and Development (OECD) indicates that tax haven are likely to offer individuals, as well as organisations ‘effective’ taxation rates as a way of attracting more offshore deposits (Harrington 2016). Therefore, the taxation regime of a country can be used to evaluate whether it can be regarded as a tax haven or not. The level of its “effectiveness” can be used to evaluate whether it entices individuals from developing countries and offshore companies to deposit their assets and large amounts of liquid cash in foreign banks.

            The evolution and how the tax haven metastasised can be understood through the in-depth analysis of Palans (2006) work on “The Offshore World.” The author observes that a strong force of market sovereignty hugely maintains OFCs with the concerned states being reluctant to regulate their financial sectors. As a result, they encourage the continued thriving of nomad millionaires in virtual banking sectors. Having started and thrived after the world war one, tax havens were ‘legitimised’ as the individual states were ready to provide the necessary legal framework support despite the financial industry remaining hugely unregulated (Palan et al. 2010). The leading states were ready to support their banking sectors if they engaged in matters of international finance and e-commerce. Eventually, the trend led to the sovereignty commercialisation and the eventual casting of doubts the nation’s legitimacy and sincerity in fighting the nomadic capitalism vice. It is worth noting that the British Empire surpassed Switzerland as the archetype territory of evading. According to Palan et al. (2010), the empire still retains approximately seven areas that can be regarded as tax havens. Bermuda, Caymans Islands, Anguilla, British Virgin Islands, Montserrat, and Gibraltar are some of the famous tax havens under the United Kingdom’s administration (Palan et al. 2010). Apart from that, Hong Kong (a former British Colony) is also regarded as one of the global tax havens (Burn & University of Sussex. Centre for Global Political Economy 2006). The trend can be traced to a British-based financial management system, further, underlining that the UK could have been the major instigator of the malpractice.

            Eden & Kudrle (2005) avers that there is a strong correlation between politics and the existence of tax havens. As indicated earlier, they are more likely to be witnessed in developed countries rather than in the developing ones. Even though the origin of tax havens cannot be clearly indicated, some of the earliest cases were recorded in developed countries such as the British foreign departments. Dharmapala (2006) observes that tax havens have now become part of the economic and financial globalisation system. Nevertheless, they have led to the manifestation of uneven impact in different nations. According to Desai (2004), most of the banking sectors in developed countries offer zero or low rate in terms of taxation, especially to the nonresidential individuals, as well as businesses. The trend is likely to be observed in developed than in developing economies, thus, encouraging a pattern of capital flight to developed countries (Desai 2004). Despite countries such as the US, Germany, and France being on the frontline in the fight against OFCs toward the end of the 20th century, minimal substantial results were achieved. Burn (1999) observed that the trend led to the shifting of these havens from the foreign departments of the powerful nations to other regions such as countries in the Caribbean Islands. The continued shifting of grounds and lack of political goodwill from key players have far left the fight from being won. Sad enough, most of the companies that seek such services are classified as multinational corporations with their parental roots in the developed countries, further, making it hard to fights the vice. This is a clear demonstration that there exists a strong correlation between global politics and the existence of tax havens. The political factions seem not to be ready to end the vice to date as they collaborate with organisations opposed to any move that may end tax havens.

Case Study

            The City of London has been marred with many cases of being accused of enabling several non-residential individuals and multinational companies evade heavy taxation (Johns 2013). Monbiot (2011) states that the city has a unique governance structure, which emanated from its distinctive political status. The City of London has for long been highly regarded as a global financial hub as it currently harbours major global banks. Some of the unscrupulous key players in the financial sector have taken advantage of the government’s reluctance to adopt international ethical financial laws.  The successive British regimes have shown laxity in adopt the international financial principles, thus, demonstrating the tax evasion as a vice sustained by the country’s sovereignty (Doggart &Economist Intelligence Unit (Great Britain) 1997). As the global financial hub, the political classes have declined to take stern action against banks facilitating tax evasion. The move has made a huge number of non-residential to avoid heavy taxes from the countries (Monbiot 2011). The trend can be demonstrated through the famous documentary called “The Spider Web: Britain’s Second Empire.”

    The in-depth nature of its financial sector has made it a constant rival of Manhattan, in New York, which demonstrates its potential to engage in offshore tax evasion activities. Today, London City is regarded as the hub for banking, as well as insurance institutions in the world. Famous organisations such as Lloyd’s of London, Bank of England, and the London Stock Exchange have their headquarters in London (Johns 2013). Additionally, many more banks (estimated to be more than 500) are also located in London (Doggart &Economist Intelligence Unit (Great Britain) 1997). As a result, this has transformed the city of London to become a leader in trading in matters related to Eurobonds, global insurance activities, energy futures, as well as in foreign exchange issues. It also acts as the substitute investment market, especially where smaller firms can carry our equity trade (Nachrichten 2017). The current scenario portrays the City of London as a potential tax haven as many individuals, as well as foreign companies, are likely to seek banking services with the aim of evading taxes. As Doggart & Economist Intelligence Unit (Great Britain) (1997) put it, tax havens are especially affiliated to the political system. This is the case with London, which means that the government is likely to turn blind on any malpractices performed by the banking sector in London.

            According to Picciotto (1992), London plays a significant role as a vital and pre-eminent tax haven in the world. The Brexit issue issues is deemed by many as a gateway to the rolling back of gains made on the elimination of tax haven in London. The wealthy are likely to benefit because of the special privileges London banks have. The city banks are also well connected with other banks in its former colonies, as well as in the foreign departments (Monbiot, 2011). Therefore, this means that multinational companies operating in such jurisdictions are likely to find their ways into one of the banks in the city. It is worth pointing out that this takes place despite the existing strong inter-governmental financial regulations. Thus, this demonstrates the existence of enormous laxity among the influential political leaders to curb the menace.

            An in-depth look into the London economy demonstrates that better times are yet to come any time soon. Instead of being structured on productive and manufacturing sectors, the London economy is built around the financial industry (Picciotto 1992). Therefore, former regimes found it hard to regulate and mitigate tax evasion activities considering that such a move could lead to the overall malfunctioning of the economy. Finance is the backbone of the London economy, meaning that any move aimed at regularising its operations would lead to its death (Johns 2013). London banks provide various financial services to the empire, as well as the former colonies, thus, enabling make financial gains in the form of low-interest rates they charge (Nachrichten 2017). It is worth highlighting that the city metastasised into a tax haven the early 1920s soon after the banks started experiencing the limited capability to make profits because of strict laws (Monbiot 2011). The dire situation prompted the key financial players to create their own rules to safeguard their interests. They, initially, aimed at protecting companies and individuals from paying corporate and personal taxes to Britain and its colonies (Johns 2013). The tendency attracted long chains of offshore companies, as well as the trust to stash vast sums of money in London banks. By 1950, these banks had already established an unregulated financial arena that also enabled them to engage with other international banks to advancing the fraudulence (Monbiot 2011). The turning of a blind eye on the menace by the success the British government has become one of the most significant aspects. According to Picciotto (1992), the British success regimes end up supporting rather than condemning the activities of these banks by continuously frustrating international bodies attempting to end tax evasion activities. British legislature had consistently and unanimously voted against any attempt aimed at introducing a global organisation that will streamline the banking sector in London City to demanding its corporation (Picciotto 1992). The British government has also gone against any regulatory attempts aimed at creating a common taxation approach for international corporations by the EU (Monbiot 2011). It is the overreliance on matters of international trade that pushed the British government to remain adamant on any regulatory attempts on the London financial sector. One of the current agenda on Brexit to bolster London’s role as a key global financial hub. The move may have the potential of increasing tax evasion activities as the British government is likely to become non-committal to the international ethical financial laws. Cutting ties with the rest of the European countries would translate to less exertion of international pressure to regulate the sector.

DISCUSSION

Sovereignty is the Number one Ingredient for Facilitating Tax Evasion Activities    

            It is evident that the Palan et al. (2010) assertions on the government as a party to the tax evasion schemes is true. According to Palan et al. (2010), government representatives are likely to keep on enabling the governments of the respective jurisdiction where the tax evasions and related activities occur are expected to turn a blind eye to their banking sectors. The issues have been observed such as the case of Hong Kong and American’s Manhattan governments’ laxity to regulate the banking sectors (Avi-Yonah 2000). The problems are more evident from the closer analysis of the continued frustration on international financial governing bodies to regulate London banks and their activities. The British legislature has turned a blind and even thwarted such attempts by offering support to these banks (Nachrichten 2017). The trend reflects lack of willingness by the governments, especially in counties classified as tax Haven. The British government has continuously gone against any EU recommendations that aim at introducing a standard taxation scheme for multination companies. Its strong opposition despite London being listed as one of the tax havens in the world indicates OFCs are not ready to submit to any regulatory laws. The case study of the British government on the continuous refusal to establish a global body that can work in conjunction with it to end the vice also indicated that tax havens are not ready to stop aiding individuals, as well as international companies evading taxes. According to Picciotto (1992), tax havens offer wealthy individuals, as well as multinational companies an appropriate avenue for evading corporate and personal taxes.

            However, the governments are fully aware of the vice yet they turn a blind eye. The simple example of the formal British colonies and the foreign departments as such as the British Virgin Island engaging in tax evasion activities. The move portrays the existence of the government-tax evaders’ cooperation. Obviously, the respective governments are fully aware of the thriving of the unregulated banking sector but are afraid to monitor it because of the immense financial benefits they derive (Cassard n.d.).  A sizeable amount of the funds hidden in the banks located in the former British colonies and its foreign departments end up in the city’s banks where they benefit few individuals (Palan et al. 2010). Therefore, this translates into the continued thriving and augmenting of the city’s economy. The continued thriving of the unregulated banking industry also means that the respective government officials gain from the backdoor remittances made to them in the form of loyalties (Cassard n.d.). It is also worth indicating that most of the tax havens are primarily supported by the banking or financial sectors (Avi-Yonah 2000). This might translate into the collapsing of the economy if they were to regularise the banking sectors and their respective activities. The same case applies to the City of London. It emerged that the financial sector is the major backbone of the city as it remits more revenues compared to the other productive industries such as the manufacturing sector (Nachrichten 2017). London is the economic hub of Britain as it contributes to about 2.5% of the overall GDP (Nachrichten 2017). As a result, it has become tough for the successive governments to regulate the industry despite the continuous exertion of pressure from international bodies such as the EU. The recent Brexit agenda also translates to the provision of more protection to the London banks as Britain aims at cutting ties with the EU. Therefore, the trend portrays that sovereignty is an enabling environment for the continuous manifestation of tax evasions. The established government policies are the major stumbling block to the fight against tax evasion by the multination companies.

The existence of Economic Interests Give Rise to Tax Havens

            The case study of the City London clearly demonstrates that the government majorly contributes to the existence of tax haven. British government understands the important role the financial sector plays such as in the creation of employment opportunities and growth of the economy (Picciotto 1992). It understands that the financial sector is the backbone of London’s economy, which means that any slight interference with its functioning may lead to the slowing down of the city, as well as the country’s economy. A similar situation is also experienced in other jurisdiction classified as tax havens. Country’s such as Monaco and Hong Kong economies largely depend on the financial efficiency of their banks (Avi-Yonah, 2000). As a result, their respective governments remain non-committal to any international regulations aimed at controlling their banks (Hampton & Abbott 1999). They understand that in-depth scrutiny of the highly unregulated sector would lead to the automatic fall or create dormancy of the economy. They even end up protecting their financial sectors from the ‘external interference.’ Even though the largely unregulated sector benefits a few individuals as Teltscher (2002) finds out, the tax havens and their respective governments find it hard assimilating the proposed international financial regulatory laws. They are perceived as the genesis of loss of employment and the eventual underperformance of the economy. Therefore, the increased tendency of experiencing capital flight from developing economies such as Sub-Saharan Africa, Middle East, India, and China has made the respective governments more adamant (Johns 2013). They are less likely to continue exerting pressure on their banks, yet they see a significant opportunity for having an influx of more financial resources from non-residential and multinational companies into the local economies. However, it is worth indicating that the need to protect the economic interests also boils down to the exertion of sovereignty powers to protect tax havens.

Recommendation

Proper Planning for Industrial Diversifications

            It is evident that the major tax havens have been identified to be hugely dependent on the financial sector. The case study of the City of London, for example, portrays London a fragile region where the implementation of standard financial regulatory policies is applied. The economic contribution of the financial industry far outstrips that of the other sectors meaning that it is a key player in the economic growth of the city. The same case applies to other tax havens such as Hong Kong, which makes the fight against the vice difficult. The respective governments are reluctant as they usually use their sovereignty to protect their highly unregulated banking sectors. According to Hampton & Abbott (1999), they remain adamant about implementing such changes as they are not ready to risk their fiscal and financial sustainability. Therefore, diversification of the whole industrial sector is deemed the most appropriate as it will erase such doubts. It will also enable the respective governments to fight the vice with more zeal as they will not stand to lose anything.

Conclusion

            It is evident that sovereignty of a state or jurisdiction is an important enabler of tax evasion. The respective governments are usually aware of fraudulent activities taking place in their banking industry but turn a blind eye. Furthermore, they are also not ready to exert any pressure to the sector as they are aware that doing so will prove detrimental. The continuous refusal by the British government to regulate the banking industry or to adopt international ethical financial laws is a clear indication that sovereignty plays a significant role in maintaining tax havens. However, since it has been identified that the economic interests play a part in the continued establishment of tax havens, such governments should adopt a more stable industrial diversification formula. The move will erase fears on the shaking of fiscal sustainability even as these governments prepare to fight and thwart tax evasions activities.

References

Indicative Reading

Palan, R., Murphy, R., and Christian, C. (2010). Tax Havens: How Globalization Really Works. Cornell University Press.

Palan. R (2006). The Offshore World: Cornell University Press.

Secondary Readings

Avi-Yonah, R. S. (2000) ‘Globalization, Tax Competition, and the Fiscal Crisis of the Welfare State’, Harvard Law Review, 113(7). doi: 10.2307/1342445.

Burn, G. (1999) ‘The state, the City and the Euromarkets’, Review of International Political Economy, 6(2), pp. 225–261. doi: 10.1080/096922999347290

Burn, G. and University of Sussex. Centre for Global Political Economy (2006). The re-emergence of global finance. Basingstoke: Palgrave Macmillan.

Cassard, M. (n.d.). ‘The Role of Offshore Centers in International Financial Intermediation – IMF Working Paper No. 94/107.’ Available at: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=883400.

Desai, M. A. (2004) ‘Economic Effects of Regional Tax Havens.’ Available at: http://0-www.nber.org.wam.city.ac.uk/papers/w10806.

Dharmapala, D. (2006) ‘Which Countries Become Tax Havens?’ Available at: http://0-www.nber.org.wam.city.ac.uk/papers/w12802.

Doggart, C. and Economist Intelligence Unit (Great Britain) (1997). Tax havens and their uses. 1997 ed. London: Economist Intelligence Unit.

Eden, L. and Kudrle, R. T. (2005) ‘Tax Havens: Renegade States in the International Tax Regime?’, Law & Policy, 27(1), pp. 100–127. doi: 10.1111/j.1467-9930.2004.00193.x.

Hampton, M. and Abbott, J. (1999d) Offshore finance centres and tax havens: the rise of global capital. Basingstoke: Macmillan.

Hampton, M. and Abbott, J. (1999g) Offshore finance centres and tax havens: the rise of global capital. Basingstoke: Macmillan.

Hampton, M. P. and Christensen, J. (2002) ‘Offshore Pariahs? Small Island Economies, Tax Havens, and the Re-configuration of Global Finance’, World Development, 30(9), pp. 1657–1673. doi: 10.1016/S0305-750X(02)00054-2.

Harrington, B. (2016) Capital without borders: wealth managers and the one percent. Cambridge, Massachusetts: Harvard University Press.

Hay, I. and Beaverstock, J. V. (eds) (2016) Handbook on wealth and the super-rich. Cheltenham, UK: Edward Elgar Publishing.

Johns, R. A. (2013). Tax havens and offshore finance: a study of transnational economic development. London: Bloomsbury Academic.

Monbiot, G. (2011). The medieval, unaccountable Corporation of London is ripe for protest. Retrieved from https://www.theguardian.com/commentisfree/2011/oct/31/corporation-london-city-medieval

Nachrichten, D. W. (2017). The City of London: Capital of an Invisible Empire. Retrieved from https://www.taxjustice.net/2017/09/19/city-london-capital-invisible-empire/

Palan, R. (2002a) ‘Tax Havens and the Commercialization of State Sovereignty’, International Organization, 56(1), pp. 151–176. doi: 10.1162/002081802753485160.

Palan, R. (2006b) The offshore world: sovereign markets, virtual places, and nomad millionaires. Ithaca [N.Y.]: Cornell University Press.

Palan, R., Murphy, R. and Chavagneux, C. (2010b) Tax havens: how globalization really works. Ithaca, N.Y.: Cornell University Press.

Picciotto, S. (1992). International business taxation: a study in the internationalization of business regulation. London: Weidenfeld and Nicholson.

Post, J. E., Preston, L. E. and Sachs, S. (2002) Redefining the corporation: stakeholder management and organizational wealth. Stanford, Calif: Stanford Business Books.

Teltscher, S. (2002) ‘Electronic Commerce and Development: Fiscal Implications of Digitized Goods Trading’, World Development, 30(7), pp. 1137–1158. doi: 10.1016/S0305-750X(02)00033-5.

Zucman, G., Fagan, T. L. and Piketty, T. (2016a) The hidden wealth of nations: the scourge of tax havens. Paperback edition. Chicago: The University of Chicago Press.

Zucman, G., Fagan, T. L. and Piketty, T. (2016b) The hidden wealth of nations: the scourge of tax havens. Paperback edition. Chicago: The University of Chicago Press.