One of the most important books published in 2011 was Nicholas Shaxson’s Treasure Islands. Shaxson, a veteran Financial Times reporter, gave some dimension and color to the inherently difficult-to-cover tax haven business, or what he called “offshore”. While it’s most famously associated with secret Swiss bank accounts and shady Caymans Islands corporations, the US and the City of London are at the apex of the offshore business, with Delaware corporations and Wyoming limited liability companies playing a significant role in the tax avoidance/secrecy game.
It was understandably hard for Shaxson to put hard overall numbers on the extent of tax haven activity and its macroeconomic implications. Peculiarly, despite the importance of this topic, a pathbreaking paper published in 2013 by Gabriel Zucman of the Paris School of Economics, The Missing Wealth of Nations: Are Europe and the U.S. Net Debtors or Net Creditors? (hat tip Dikaios Logos) has received perilous little attention. Perhaps that’s because, among other things, it undercuts the Bernanke-flattering claim that “global imbalances” were a major driver of the financial crisis.
The article works back from a long-established, well-known anomaly: international fund flow statistics don’t even remotely add up. Global statistics say, impossibly, that there are a lot more liabilities than assets, and in parallel, that more investment income is paid out than is credited.
Zucman looks into the notion that tax haven holdings by wealthy households explain this behavior. He uses a unique Swiss dataset and examines the way that various countries’ investment positions fail to reconcile. From his abstract:
I find that around 8% of the global financial wealth of households is held in tax havens, three-quarters of which goes unrecorded. On the basis of plausible assumptions, accounting for unrecorded assets turns the eurozone, officially the world’s second largest net debtor, into a net creditor. It also reduces the U.S. net debt significantly. The results shed new light on global imbalances and challenge the widespread view that, after a decade of poor-to-rich capital flows, external assets are now in poor countries and debts in rich countries.
Now think about that. With all the shift of wealth to the top 1% (now at around 40% in the US), 6% hidden away from the tax man is large in an absolute sense, and a significant percentage in the population wealthy enough to avail itself of these boltholes.
Here is the longer-form statement of Zucman’s thesis:
…the rich world now appears to be a sizeable net debtor in the official data, dragged down by the U.S. and Europe. While the literature has put forward possible explanations for the U.S. net debt and the rise in China’s assets, the negative net positions of Europe and the overall rich world remain largely unexplained. Despite this, many observers have grown accustomed to the view that external assets are now in poor countries and debts in rich countries. In the public debate, the view that “China owns the world” has become particularly popular. Should it be correct, the implications for policymaking and open-economy modeling would be far-reaching.
My paper challenges this view. The negative net foreign asset position of the rich world, I argue, is an illusion caused by tax havens. International statistics fail to capture most of the assets held by households through tax havens: they overlook the portfolios of equities, bonds, and mutual fund shares that households own via banks in Switzerland and other countries with strict bank secrecy rules. This coverage gap explains many of the long-standing anomalies in global data. My computations find that around 8% of households’ financial wealth is held through tax havens, three-quarters of which goes unrecorded. This stock of unrecorded assets is double the recorded net debt of the rich world (Figure I). Since a body of evidence suggests that most of the wealth in tax havens belongs to residents of rich countries, accounting for it turns the rich world into a net creditor. Despite a decade of global imbalances, therefore, external wealth is still probably in rich countries overall: China does not own the world yet. Back in the 1980s-1990s the rich world had a large positive net position; over the last decade it has eaten some of its claims away; but today poor countries are still repaying their debts to advanced economies.
The implications are significant. It means the Europe as a whole is a net creditor, the US is less of a net debtor, and the level of global rebalancing needed is less than is pretty much universally assumed in macroeconomic circles.
And as Zucman points out, the magnitude of this dark matter means economists are probably looking in the wrong place for answers to pressing economic matters. It means income inequality is even worse than indicated by the already-grim analyses of experts like Thomas Piketty and Edmund Saez; they don’t attempt to allow for tax haven income and assets. The idea that governments can’t afford to pay for services is even more obviously the result of the inability of governments to access income that is shipped under the radar to secrecy destinations.
I sanity-checked the paper with an internationally-recongnized tax expert, who wrote back pronto:
IMF accounts have a black hole for that sort of thing; it’s the errors and omissions file for the depositor countries. It’s not like they don’t know about it, because the banking/tax havens do tell the BIS they have assets, they just don’t say whose.
There’s an iron law of tax havens that individuals have to bank nearby, so Europeans use Switzerland.
8% of wealth sounds about right. But what are those countries gonna do, claw it back? It doesn’t appear to be available to balance their budgets even if their citizens hold it, eg Italy, where you can spit and hit Switzerland.
However, there a way to considerably constrain this type of investing, although there’s no political will to make it happen:
A considerable amount of wealth is held unrecorded in Swiss accounts, and contrary to popular belief, this wealth mostly belongs to residents of rich countries….The many datasets used in this paper all paint the same picture: households own a large amount of mutual fund shares through unrecorded accounts in tax havens.
End all variants of investing in street name (as in registering the ownership in the name of the bank or fund custodian) and require full identification of the ultimate owners (individuals) and beneficiaries of any trusts or corporations that make investments (save for public corporations or other entities where the ownership structure is accessible to tax authorities). The global wealthy have too much to keep all their loot in portable form, like diamonds or gold, and even if they can find a way to tiptoe past the taxman to buy London flats or flashy yachts, they don’t want too much of their wealth tied up in illiquid form that is hard to sell in a pinch. If you require adequate disclosure as a condition of allowing individuals to own and trade securities and mutual funds, you could choke off much of the air supply of tax havens. But it would take international agreement among the major financial centers (ie, firm pressure from the relevant central banks, who do ultimately control the payment infrastructure) and international coordination on any banking-related matter has been very hard to achieve, much the less execute. So sadly, the rich tax cheats have very little to worry about.
I strongly suggest you read the paper in full. It has a lengthy section on robustness checks and also goes much further than the brief discussion above indicates in terms of how much the tax haven dark matter explains reconciliation failures in various cross-border statistics.