Tag Archives: Tax evasion

Tax Evasion and Wealth Inequality

The Economist reports about a study by Annette Alstadsæter, Niels Johannesen and Gabriel Zucman who matched leaked information from Swiss banks and Panamanian shell companies with Scandinavian wealth records. Their findings:

  • Tax evasion is progressive. The average / top 1% / top 0.01% Scandinavian household paid 3% / 10% / 30% fewer taxes than it should.
  • Accordingly, estimates of wealth inequality (based on tax data) likely underestimate the degree of inequality.

Tax Evasion in Hong Kong and the US

The Economist reports about new strategies to evade taxes. One is based on an occupational retirement scheme (ORS) in Hong Kong:

A German or Australian with money to hide can set up a Hong Kong shell company, appoint himself as its director, with a local employment contract, and sign up with a trust company that provides an ORS. He can throw in cash, property or other assets, oversee the account himself, retire as soon or as far in the future as he likes, and then take out as much or as little as he chooses, whenever he wants. An ORS, in short, is like a flexible bank account.

The arrangement falls outside the CRS [Common Reporting Standard] and FATCA because the Hong Kong authorities classify ORS as “low risk” from a tax-evasion standpoint, meaning those running them are “non-reporting financial institutions” under both standards. Not surprisingly, some financial firms are hawking them enthusiastically to foreigners.

Another strategy exploits the secrecy provided by the United States:

It gets all the information it needs from other countries through its heavy-handed application of FATCA, and therefore sees no need to sign up to the CRS. So it is in the unique position of being able to take a lot, give little, and continue getting away with it. Not surprisingly, lots of tainted foreign cash is believed to have flowed into American banks, trusts and shell companies in recent years.

Tax Evasion in a (the) New World

In the FT, Vanessa Houlder reports about the tax evasion business. The new regulatory environment has led to portfolio adjustments and new types of behavior, and it exposes vast differences in enforcement across countries:

  • Diamonds in vaults rather than financial assets.
  • Trusts in South Dakota rather than anonymous bank accounts.
  • Moving to a different country rather than just shifting assets.
  • FATCA versus the Common Reporting Standard.

The article also links to an article by Kara Scannell and Vanessa Houlder earlier in the year entitled “US tax havens: The new Switzerland.” That article includes the following quotes:

I think the US is already the world’s largest offshore centre. It has done a real good job disabling competition from Swiss banks.

In a world where it’s very hard to hide ownership or hide assets sometimes the easiest place [is one] no one would normally think of, which is the US.

India’s Fight Against Shady Cash Holdings

India follows suggestions to fight tax evasion by taking high denomination notes out of circulation … and introducing new ones. Until the end of the year, Indians may exchange the old banknotes against new ones, at banks or post offices, by identifying themselves. On his blog, J P Koning discusses earlier demonetization episodes in Iraq and Sweden.

India’s move does not exactly follow the well publicized suggestions currently debated. But it might work.

The Demand for Cash

On his blog, J P Koning discusses Kenneth Rogoff’s proposal to abolish high denomination notes (discussed earlier). Koning concludes:

I agree with Rogoff’s general point that it makes sense to burden cash users with ever more work since this burden disproportionately falls on heavy users like criminals. But Rogoff hasn’t yet convinced me that the status quo policy of gradually increasing the workload involved in cash usage (via inflation) needs to be sped up by a sudden removal of every bill above the $10. After all, the Swedes are setting an example of how a policy of gradualism can be twinned with tax policy in order to get some of the very effects that Rogoff advocates, namely pulling people out of the underground economy into the legal economy.

Koning refers to Martin Enlund’s post on the Nordea blog; Enlund suggests that decreased cash demand in Sweden may partly be due to policy reforms that rendered tax evasion less attractive.

Figure from Enlund blog:


FATCA in Reverse?

The Greens/EFA group in the European Parliament wants the European Union to exert more pressure on the United States: the US should no longer serve as a “tax haven” for European tax dodgers. Proposed measures include blacklisting and a FATCA-type 30% withholding tax on EU-sourced payments.

From the executive summary of the report commissioned by the group:

Two global transparency initiatives are underway that could help tackle financial crimes including tax evasion, money laundering and corruption: registration of beneficial ownership for companies (to identify the real persons owning or controlling such companies) and automatic exchange of bank account information between tax administrations. The European Union has made progress in both respects, with the adoption of a 4th anti-money laundering Directive (in May 2015) and by committing to implement the OECD’s common reporting standard for automatic exchange of financial account information. The United States (U.S.), in contrast, has done neither so far.

On May 5th, 2016 the U.S. announced new measures to improve its financial transparency, although not all the texts of the proposed regulations were provided. The U.S. Treasury announced three new measures: … In any case, not only would some of these new rules require Congress approval, but even the U.S. Treasury final proposals on beneficial ownership collection by financial institutions are not enough to solve all the problems nor to bring the U.S. into line with the OECD’s standard for automatic exchange of information. …

Two main issues in the U.S. affect the global progress towards transparency: … Company registration is regulated by each of the 50 states’ law. In 14 states, companies may be created identifying neither shareholders nor managers. At the federal level, tax rules require filing some information to obtain an Employer Identification Number (EIN). However, not all companies require an EIN and, even if they do, the ‘beneficial owners’ (the actual natural persons owning or controlling the company) are not necessarily among the information to be provided. Companies only have to identify one ‘responsible party’, who may be a nominee director. In order to (partially) address this, the White House 2017 budget proposal and the new measures proposed on May 5th, 2016 suggest requiring all companies (or according to the May 5th proposed rules, at least some foreign-owned disregarded entities, such as single-member limited liability companies) to obtain an EIN. Not only does this proposal need to become effective, but information would apparently still be about the ‘responsible party’ and not necessarily about the real physical person owning and controlling the company (the so-called beneficial owner).

… The U.S. has refused to join the trend for multilateral automatic exchange of information. Instead, it will implement its domestic law called the Foreign Account Tax Compliance Act (FATCA) and the related Inter-Governmental Agreements signed with other countries. However, these involve unequal exchanges of information: the U.S. receives more information than what it sends (for example, about beneficial ownership data). Oddly, though, the OECD did not include the U.S. among jurisdictions that did not commit to its new standard.

Even if the U.S. committed to exchange equal levels of information in the future, the current U.S. legal framework does not allow its financial institutions to collect beneficial ownership information for all relevant cases covered by the OECD’s global automatic exchange of information standard. U.S. financial institutions are currently only required to obtain information on beneficial owners for correspondent banking (i.e. accounts held for foreign financial institutions) and for private banking of non-U.S. clients (accounts holding more than USD 1 million).

Final rules to address these limitations have been announced on May 5th, 2016 although financial institutions must comply with them only by May 11th, 2018. However, the final rules still have the same problems that the IMF identified regarding the 2014 version of the rules so they will not fix all the problems. Remaining shortcomings include: some entities will still not be covered (i.e. insurance companies), the definition of ‘beneficial owner’ is incomplete (it does not include the ‘control through other means’ test, meaning that if you cannot identify at least one person owning 25% or more of the shares, financial institutions should try to find someone who controls the company through other means, before identifying only someone with a managerial position-who may be a nominee director), the verification of information would rely mainly on customer’s own certification, information on beneficial owners would be required for new accounts only (not for existing ones) and it will not need to be updated after the first time of collection, unless the financial institution becomes aware of changes as part of monitoring for risks. In addition, trusts will not be required to provide beneficial ownership information unless they own enough equity in an entity, such as a company, required to provide this information.

To fix this situation and promote equal levels of transparency, this paper provides a series of recommendations. For example, the European Union should consider including the U.S. in the upcoming list of tax havens, unless it effectively ensures registration of beneficial ownership information for companies and commits to equal levels of automatic exchange of information with European Union countries. Ideally, all financial centres should effectively implement the OECD standard for automatic exchange of information (by becoming a party to the OECD Amended Multilateral Tax Convention, signing the Multilateral Competent Authority Agreement and agreeing to exchange information with all other cosignatories). The European Union could thus consider imposing a sanction (such as a 30% withholding tax on all EU-sourced payments) against any financial institution that refuses to automatically exchange information about EU residents holding accounts abroad. In a second stage, sanctions could also be used to ensure that financial institutions from financial centres will also provide information to developing countries with which the European Union is already exchanging information.

Reports by René Höltschi in the NZZ as well as Markus Fruehauf und Winand von Petersdorff in the FAZ.

Nevada Shell Companies, Elliott and Argentina—Some Unforeseen Consequences

In an earlier post (April 2015) I wrote:

The Economist reports about Nevada shell companies. In its eternal struggle against the Republic of Argentina, Elliott Management is inquiring about several shell companies in the state. They are suspected to own funds that might have been stolen from the Republic. The hedge fund reasons that it is entitled to those funds because they belong to Argentina, and Argentina owes 2 billion dollars to Elliott according to earlier court rulings. Elliott sued in Nevada for information on the shell companies and has been partially successful.

Now, The Economist reports about some unforeseen consequences of the earlier ruling and the “Panama Papers affair”:

Until now, getting information on clients of law firms in Panama has been [difficult]. … But sleuths may soon find it a lot easier, thanks to a court ruling in, of all places, Las Vegas.

In 2014 Elliott, a fund that owned debt on which Argentina had defaulted, sued in Nevada to compel Mossack’s local affiliate to provide information on shell companies, in the hope of discovering Argentine assets to seize. The affiliate, MF Nevada, claimed—implausibly—that it was independent of Mossack. …

A judge in Las Vegas ruled in March 2015 that Mossack and MF Nevada were one and the same. That put a crack in the wall of secrecy around American shell companies. But its full significance is only now becoming apparent: it means that, under an American law about assisting with foreign legal proceedings, any investigator anywhere in the world can subpoena Mossack, through the Nevada subsidiary, for information that could be relevant to cases in any country. …

Faced with the power of American subpoenas, Mossack’s head office will find it much harder to stonewall foreign requests for information. Ignoring them could mean being found in contempt of court. That would leave it open to penalties designed to compel it to comply, including asset seizures, in other countries where it operates.


EU Tax Blacklist

The Economist reports (somewhat belated) about a blacklist put together by the European Union. The EU list aggregates lists of member states which applied different criteria and in parts were outdated. The Economist writes:

As pressure has mounted, however, Brussels has backtracked. At a meeting with the 30 ostracised states last month, it agreed to make clearer reference to efforts that some of them have made to adhere to new tax-transparency standards—though it is not clear if it will ditch the “non-co-operative” label.

“Leben ohne Bargeld (Life without Cash),” SRF, 2015

SRF, Echo der Zeit, May 18, 2015. AUDIO, HTML.

  • The availability of cash has costs: It eases tax evasion and money laundering and obstructs monetary policy at the zero lower bound.
  • But it also has benefits.
  • And the zero lower bound constraint can be relaxed otherwise, using taxes or an exchange rate.

Removing the Zero Lower Bound on Interest Rates

Imperial College London (the business school’s Brevan Howard Centre), CEPR and the Swiss National Bank organized a conference on this topic in London.

Most of the speakers agreed that giving central banks the option to move interest rates much further into negative territory would be valuable; and that deposit rates lower than minus half a percent p.a. are difficult to sustain without triggering major cash withdrawals. There was less agreement on how to avoid such withdrawals. Some favored phasing out cash, as this would also render tax evasion and money laundering more difficult; others were unwilling to sacrifice the privacy benefits of cash. But many speakers emphasized that there are other possibilities to achieve the same objective. (See my earlier blog post.)

Nevada Shell Companies, Elliott and Argentina

The Economist reports about Nevada shell companies. In its eternal struggle against the Republic of Argentina, Elliott Management is inquiring about several shell companies in the state. They are suspected to own funds that might have been stolen from the Republic. The hedge fund reasons that it is entitled to those funds because they belong to Argentina, and Argentina owes 2 billion dollars to Elliott according to earlier court rulings. Elliott sued in Nevada for information on the shell companies and has been partially successful.

Bleak Prospects for Greece

My colleague Harris Dellas argues in swissinfo.ch that it is too easy to blame a tax dodging elite for the Greek malaise; tax evasion is much more prevalent, not least because a large share of the population is self employed, and institutionally ingrained. He doubts that the current government is better equipped to address the problem than earlier ones. And he fears that Grexit could turn Greece into a failed state.

Also, an open letter (in Greek and German, PDF) by Greek academics (mostly living abroad I presume). They doubt that the current Greek government actually helps to restore the country’s dignity as intended.

“Notenbankgeld für Alle? (Reserves for Everyone?),” NZZ, 2015

Neue Zürcher Zeitung, February 20, 2015. PDF, HTML. Ökonomenstimme, February 24, 2015. HTML.

  • Allowing the general public to hold reserves at the central bank could help reduce the risk of bank runs and the negative consequences of deposit insurance.
  • It would end the need to accept bank deposits as means of payment although they are not legal tender; this need arises due to prohibitions on cash payments, for tax reasons.
  • But it could also have negative consequences: Money and credit creation by banks would be undermined, with social costs and benefits.
  • Price stability and financial stability could be threatened during the transition period.
  • More technical questions would have to be addressed as well: They concern the payment system or the conduct of monetary policy.
  • Proposals to go further and to abolish cash are not convincing. One suggested benefit—more leeway for monetary policy makers—is over estimated: Negative rates can also be engineered (effectively) through fiscal policy, and they can fully be implemented with a flexible exchange rate between reserves and cash.
  • Another suggested benefit—better monitoring of tax dodgers and criminals—is also overrated; the fixed cost to circumvent the measure would deter minor illegal activity but not major one.
  • But abolishing cash would have severe negative consequences for privacy and could negatively affect financial literacy.
  • Enforcing an abolishment of cash would be difficult. In a free society, any reform to the monetary system is constrained by the requirement that money must remain attractive for its users.

Swiss Leaks

The International Consortium of Investigative Journalists published a report that seems to suggest that HSBC’s Swiss branch violated Swiss laws; helped customers to hide assets; and assisted in money laundering activities. The report is based on information that Hervé Falciani, a former HSBC employee-turned-whistleblower, handed over to French authorities in 2008.

The small print (in the footer of the “Swiss Leaks” website) reads:

There are legitimate uses for Swiss bank accounts and trusts. We do not intend to suggest or imply that any persons, companies or other entities included in the ICIJ Swiss Leaks interactive application have broken the law or otherwise acted improperly.

Additional reporting in The Guardian, FTNZZ, Süddeutsche Zeitung.

“Reserves For Everyone—Towards a New Monetary Regime?,” VoxEU, 2015

VoxEU, January 21, 2015. HTML.

New proposals to phase out cash are set to revive an old debate. Contributions to this debate focus on two related but independent issues: granting the general public access to central bank reserves; and phasing out cash.

Abolishing cash is neither necessary nor sufficient. But allowing the public to hold reserves at the central bank could have substantial benefits. Technical questions need careful consideration.

Phasing out Cash

In the first and third of his Munich Lectures in Economics, Kenneth Rogoff argued in favour of phasing out cash, at least high denominations and in some developed economies. (His second lecture covered financial crises, see my post.)

Rogoff is well aware that cash preserves privacy and he acknowledges that one should have very good reasons to advocate phasing it out. He believes that there are two: Tax evasion and the black economy on the one hand, and the zero lower bound on nominal interest rates on the other.

Based on earlier research (Rogoff 1998) he argues that withdrawing bank notes with high denominations (e.g., USD 100 bills, EUR 500 bills etc.) would increase the cost of evading taxes or engaging in the black economy sufficiently strongly as to raise tax revenues, and that increased tax revenues would more than compensate for any loss of seignorage.

The (close to) zero lower bound on nominal interest rates and the resulting constraints for monetary policy derive from the fact that cash pays a zero nominal interest rate. Rogoff emphasised the seminal contribution of Lebow (1993 Fed working paper) in identifying the problems connected with the zero lower bound as well as possible ways to address them. Rogoff added that earlier writers (e.g., Gesell, Goodfriend, Mankiw or Buiter) who suggested to relax the constraint by subjecting cash to depreciation missed the point. Rather than forcing a negative nominal interest rate upon cash one should eliminate it altogether. He also dismissed shifting to a higher inflation target to avoid the zero lower bound problem, pointing to the huge loss of credibility that central banks would suffer as a consequence. Among factors for the trend towards lower real interest rates, Rogoff emphasised demographics and the asset pricing consequences of rare disasters; he dismissed secular stagnation. He also discussed forward guidance in the form of price level targeting.

Rogoff suggests to replace cash by universal debit cards. He does not expect significant technical difficulties in the process and proposes to subsidise debit cards for low income households.

Corporate Taxation, Profit Shifting and Cross-Border Tax Avoidance and Evasion

Matthew Klein discusses corporate and personal income tax evasion and avoidance in the FT (part 1, part 2), with reference to a JEP article by Gabriel Zucman. Klein makes several points:

  • Profit taxes were introduced as complements to income taxes, in order to make it more difficult to evade taxes by routing profits through fabricated corporate structures rather than distributing them. To avoid double taxation, capital gains and dividends typically are taxed at lower rates than labor income.
  • Whether corporate taxation should be coordinated internationally is not a new question. The League of Nations already debated it. The issue regained importance as international trade and cross-border profit flows rose.
  • Today, a third of US corporate profits are generated outside of the US. Of those, more than half are generated in Ireland, Luxembourg, the Netherlands, Singapore, Switzerland and the Carribean. Both shares have increased over recent decades (see the figure below which is taken from Zucman’s article). This might have contributed towards lowering the effective corporate tax rate of US corporations in the US.
  • If the objective is to (i) avoid double taxation and (ii) render cross-border profit shifting irrelevant, an easy way forward could be to credit a corporation’s taxes paid worldwide against the personal income taxes owed by the corporations shareholders. This would imply that higher corporate taxes abroad could lead to lower domestic income tax revenue, a difficult political sell. It would also imply that unrealised capital gains may go untaxed.
  • Based on discrepancies between national balance of payments statistics, Zucman estimates that 8% of global household financial wealth is not reported to tax authorities (see the table below which is taken from Zucman’s article).
  • He proposes to impose high tariffs on exports originating from “tax havens” to force these countries to exchange information about bank accounts and, in the medium term, to create an “international financial registry.”

The End of Bank Secrecy?

Jeevan Vasagar and Vanessa Houlder report in the FT about the pledge by 51 countries to facilitate the collection and exchange of information on bank accounts and the beneficial ownership of companies and other legal structures. The agreement was drawn up by the OECD and previously endorsed by the G20. Going forward, the countries involved seek a consensus on the treatment of intellectual property income.

Christoph Eisenring in the NZZ and the FAZ provide additional information. Liechtenstein, Luxemburg, Bermuda, the British Virgin Islands and the Cayman Islands signed the accord; Switzerland and Singapore promised to follow soon; Panama and the US didn’t. German finance minister Wolfgang Schäuble declared the end of bank secrecy. While not signing the agreement the US is credited for helping to make it possible, due to the FATCA treaties is has signed with many countries. Those treaties also stipulate an automatic exchange of tax information. However, so far the US has not produced the legal base to provide such information to foreign governments.