Tax Havens Make US and Europe Look Poorer than They Are, Exaggerate Size of “Global Imbalances”

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.

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  1. The Dork of Cork

    Its important to understand that taxes role in the symbiotic nation / banking state is to pay for the depreciation of capital overproduction by the very same credit banks.

    Surely the best way to rebalance the system must be to produce physical currency without the production of bonds which can therefore be used by the residents of each state to further internalize trade and cooperation without a manic drive for pointless growth (capital goods overproduction) so as to pay interest to a few.

    Thus the offshore tax havens will have diluted claims on the wealth base of former countries and will soon no longer be able to afford to fly back and forth to these claim islands.

    The solution is not to increase taxes.
    The solution is to print money and not credit.

  2. allcoppedout

    Zucman makes a meal of things. Yves’ summary is better than the original. So there is a black economy might just hit the nail on the head. Throw in an equation from a spreadsheet cell, some cut and paste references and you enter the realm of meaningless precision. This paper is typical of economists who have been taught to do sums. Yes, we have no transparency. The paper, like hundreds of others, works in forced detachment from reality.

  3. j gibbs

    Wealthy individuals hiding dough in tax havens? This is relatively unimportant if you’re talking about American citizens. They are more likely to have the money stolen by the local lawyers and the creeps operating the shell banks and shell corporations.

    The real purpose of tax havens is diverting corporate profits from the US tax collector. US multinationals use transfer pricing to shift profits to no tax jurisdictions, and a little paper shuffling easily saves any big bank one billion dollars in an average year. I was told by a person who should know that it is all done by moving liabilities rather than assets, because it is very hard for the tax haven operators to steal liabilities.

    And as for Delaware, everything must be done out in the open using federal tax id numbers on all financial accounts, so I would like to hear someone explain how this makes Delaware a tax haven.

  4. Michael Hudson

    Yves, the probem is NOT mainly “errors and omissions.” We should talk.
    Offshore earnings in tax-avoidance enclaves are in the last line, “International” in the balance-of-payments statistics.
    Back in 1965, I asked the Teasurer of Standard Oil what this meant when he told me where his company earned the money. It meant “International shipping” — flags of convenience in Panama and Liberia, which use the US dollar!. SO sold its oil cheap to the “int’l” from the producing countries, and charged a high price to Europe and American consumers. The profit was taken in a zero-tax enclave.
    It was the oil and mining companies that created the offshore havens — until the CIA came to the New York banks in the 1960s and asked to make the economy “safe” for drug dealers to do their bit to finance the Vietnam War.
    I thought Nik Shakson explained this when he was writing his book.

  5. Banger

    I have read about estimates that the world’s shadow economy is around 22% with the criminal economy somewhere around 15% of global GDP. But really these are rough ballpark figures that may be way off. I know through procurement tricks and accounting fraud (which is routine in the U.S.) that a lot of money find itself disappearing in fact but not on the balance sheets.

    There are ideas here about what to do and so on–for me the answer is there is really not much to do. In the United States income tax is a sad, cruel joke and it should be eliminated today and replaced by a combination of other taxes. But that’s not my point–the system is broken and reform, in the U.S., is not possible only a gradual process of creative destruction and the emergence of informal networks of entrepreneurs and customers which can eventually become more formal as formal structures break down. Any reform, at this point, will be written by a faction of the oligarchy who will profit from it–Obamacare a case and point. Legislation written to limit offshore accounts will be written by cliques that will profit from that and those that don’t will find accounting tricks to move around money into dummy corporations that will be constructed in such a way to de-dummify magically through the usual shyster tricks.

  6. Jim Haygood

    ‘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.’

    Ah yes … if the welfare/warfare state could just suck in more taxes, it could (like a fat grey tick) get even bigger.

    On the other hand, if the U.S. gave up its fantasy of global domination, it could easily live within its existing means.

  7. JEHR

    I may be thick, but I do not understand why governments need the income obtained by taxes if taxes just ensure the legitimacy of the currency. As I have also read elsewhere what we should be doing is just forgetting the mendacious wealthy 1% and looking after the needs of the rest of the population by, for example, job creation, higher minimum wages, etc. I would really like to just ignore the whole lot of the 1%!

    1. EconCCX

      @JEHR I may be thick, but I do not understand why governments need the income obtained by taxes if taxes just ensure the legitimacy of the currency.

      The problem with financing government by spending money into existence is that the purchasing power of money you’ve already spent overwhelms that of what you now spend. Government and Finance are in a bidding war for resources. Government spends newly created money just once; whereas Finance accrues an ever-growing piece of it per time period, via interest, and every time it changes hands, via fees.

      1. Schofield

        “The problem with financing government by spending money into existence is that the purchasing power of money you’ve already spent overwhelms that of what you now spend.”

        What do you mean by the word “overwhelms” please?

        1. EconCCX

          @Schofield What do you mean by the word “overwhelms” please?

          The financialization of agriculture, medicine, education, intellectual property. The bidding up of bottleneck assets so that an ever-increasing share of your earnings, your employer’s earnings, your merchant’s earnings and your government’s earnings are required to pay the rentier.

          Funding by bond or coin creates a bond or reserve that is eternal but immobile, a tertiary form of money that can be used by banks to clear payments and accrue more assets, but one that is impractical as a daily medium of exchange for nonbanks. You and I use bank debt for that purpose, and it vanishes quickly, per transaction, because of compound interests and fees and the need to service prior debt. M1 is extinguished with each payment from a deposit account to a bank.

          Money creation may seem like a populist approach to funding public needs, but it’s actually an engine of hyper-inequality. We’d have better results with a transaction tax that was automatic and effortless (just as banks collect a portion with each card swipe) and a money system that did not have the debt deflation characteristic, where paying down a debt to a bank extinguishes the medium of exchange. Coins don’t work that way; deposits do, so it’s not an inherent characteristic of money.

          1. rob

            What would be good would be to enact a monetary system , that uses “permanent” money, like that espoused by lord adair turner,with his “overt permanent money”.One that is not created as a debt.As a former head of the british financial services commission,he is someone who knows how money works and how it doesn’t.
            In this country, it was the “NEED ACT”.HR 2990 112th congress,that has “put on the table” ,a “VIABLE” option.This has been modeled by the IMF chief of modeling Kumhof,which has shown it would “help” stabilize our monetary system.
            The pies in the skies need to be abandoned and people need to be taught that there is a real way forward.It is the dissolution of the federal reserve and the money creation being handled by the treasury with permanent money that is created as fiat with no debt associated with it.
            The American monetary institute has plenty of information on this subject.People need to look,before worrying about strawmen and hyperbole.
            There is a history of money,and the reality is today in America,our money is created as a debt,which is the original sin and in itself creates wealth disparity.This banker’s monetary system we adopted in 1913, sucks for most.If people want to create a monetary system that makes our gov’t “the monetary sovereign”, we need to adopt the Kucinich bill.”National Emergency Employment Defense act”.HR 2990,112th congress.Right now, the gov’t is not “the monetary sovereign”. We “contract out”, that responsibility to a private consortium of banking intrests.which make the whole of the government and everyone who uses “the US federal reserve note/US Dollar” participate in their three ring circus of intrest rate theatre and bond sales with intrest being owed in perpetuity.

    2. j gibbs

      The purpose of income taxes is to keep the workers poor and the rich rich. The US internal revenue code is 7000 pages long. One page is a tax rate schedule. Ninety-five percent of the remaining pages are loopholes for corporations and those achieving capital gains, the effect of which is to pretty much eliminate any theoretical tax burden. I haven’t looked at this in several years, but there used to be a 70% exclusion for dividends received from publicly held domestic corporations. The “theory” was that the corporation previously paid a tax on the “earnings” from which those dividends were paid. Oh, really? Anyone can tell you the effective US income tax rate on world wide earnings of large US corporations is less than seven percent. The entire income tax law is just another swindle, essentially no different from banking.

      Many years ago, while I was underemployed in a large corporation, I took an advanced degree in Income Tax Law. I didn’t have any particular purpose in mind. The company paid for such extracurricular activities, and I thought I might learn a useful skill. When I finished, I realized the only purpose of the training was assisting large companies in tax evasion. I didn’t need money that badly, so I just limited myself to doing my own tax returns. I figure it saved me $25 a year since 1976. Not much of a return on the tuition. Good thing I didn’t have to borrow the dough!

    3. jrs

      If taxes ensure the legitimacy of the currency, why can’t we have state currencies? (at least in states with an income tax). Maybe less beholden to the banksters and the corptocracy. Riddle me that, take your time …

  8. TheCatSaid

    Wonderful post, Yves, on an important topic.

    Combining what j gibbs and Banger observed, the most substantial hidden assets are probably corporate profits and criminal economy (with significant overlap).

    As you suggest, the only way to start tackling this is by bringing in transparency. Any new requirement for transparency will be a step in the right direction.

  9. Ignacio

    An associate problem is that tax heavens serve also as financial umbrellas for governmental black operations, political parties illegal financing, and illegal trade of human beings, drugs or weapons. I bet many of those undisclosed assets originate in drug deals and help a lot to explain the assets-liabilities imbalance in rich countries. Hernández and Saviano have just published a new book in which they measure the size of the illegal drug industry in monetary terms. Not surprisingly they reach the conclusion that this is the largest economic sector in Italy and Mexico.

    Thus, those tax heavens, besides helping to create holes in state accounts, have other negative externalities like helping to maintain parasitic bussiness.

  10. Chauncey Gardiner

    Thank you for the post, Yves. Besides the issues identified by Ignacio and others above, the issue of massive underreporting of “wealth” socked away in “safe havens” in various forms and locations plays into one of the tactics of the 0.1 Percent: ignoring or intentionally hiding Distribution of income and wealth. In this vein, Reuters reported this morning that U.S. household wealth rose above $80 trillion at year-end 2013 on rising real estate and stock prices:

    Along with “tax/safe havens” for the wealthy, the Reuters article completely overlooks the most salient feature of the current policy set, Wealth Distribution, and instead trumpets the “success” of the Fed’s and Treasury’s monetary policies in raising asset prices in an Bernaysian effort to reframe perceptions.

    For those interested in a reality based analysis, there is information like this:

    Thank you for the link to Nicholas Shaxson’s book.

  11. allcoppedout

    Some research on Delaware as a tax haven here –
    Even the tax havens with palm trees claim they are not.
    ‘Firms likely to be using Delaware-based state tax avoidance strategies have state effective tax rates (State ETRs) between 0.7 and 1.1 percentage points lower than other firms, on average. The reduction in State ETRs translates into a decrease in state income tax payments of 15% to 24%. In aggregate, we estimate a range of total state tax savings of $6.6 to $9.5 billion over the sample period.’

    It’s often been said that money has no smell. Much as we could imagine underwear labels containing information like ‘likely to be made in a sweat shop where women on dismal wages are beaten and at severe risk from fire’ or a ‘quality of work life’ certification, electronic money could be tagged with a historic trace. Indeed, it often is and the tags are often removed manually in banks or by other money-launderers.

    I suppose Zucman deserves some credit for stating that the institutional facts of economics aren’t. I’d like to see some thoroughgoing work on the historic smell of money (stuff like where money from slaving, war profiteering, the Nazis etc. is now, criminal money flows and so on) and how something like MMT might work with everyone doing it, in a system where Gresham’s Law and dirty-hands excuses did not rule.

    Tax havens are like viruses. Once you allow one, they are going to spread. Soon, you can barely stop to take a coffee on the high street without using one. Even simple products like a latte are designed with royalty payments in them that account through low tax havens like Delaware and Amsterdam. Revenue tags don’t stop this.

    I’d like to drink coffee and pay tax to the country I drink it in, not sit in a Bolton Starbucks with ‘double-Dutch-Irish’ accounting. At the same time, I work with Swedes, Norwegians and Finns who like the odd alcohol binge. Money doesn’t go far in Nordic bars because of tax. We hire a little retreat and stock up from a Latvian smuggler. I have double-standards on tax. Quite a few bars have the illegal stuff up on optic, stealing what tax we do pay. Tax havens and offshore have origins in smuggling. The presence of bought-and-paid-for lawyers and accountants does not make these arrangements morally legal, just legal.

    Thinking on the origin of money leads me into the disgusting practices of slavery, blood debts and piracy. Slave raids on Russian Slavs by Tartars and Africans by such as the Dahomey tribe must have been worse than waiting for two inevitable 9/11s year on year on year. 12 million Africans, 2 million Slavs – whatever the numbers on can see a mechanism of money made in one place and lost in another – there are estimates that the harvesting of the Russian Steppes alone translates into the loss of 120 small towns not built. We should open up the definition of money to include these ‘smells’ and their track to current exploitation. This is not a simple matter of history. There are 30 million slaves today. And questions as to whether 1% claims to ‘working smarter’ have any basis in truth at all.

  12. John Yard

    Another very informative article. During the Clinton administration, the Cayman Islands ( pop. 50k ) was home to several million US credit card accounts. We are finally beginning to see – after glacial inaction – some action taken against these abuses. Excellent work.

  13. rps

    A considerable amount of wealth is held unrecorded in Swiss accounts…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…..

    I think we need to think not in terms of physical wealth such as paper currency stashed away on some island. Of course there are wealthy individuals holding gold bullion, art, precious metals etc.. But physical wealth is bulky and cumbersome, and simply too much trouble to transport to hide away from government eyes. However, digitized wealth, that is electronic 1’s and 0’s on a screen are accessible and transferable without physical movement or island hopping.

    What we have learned from Snowden is the enormous amount of government spying on us via our electronic devices with the cooperation of google, apple, and cell phone carriers. Simply any electronic device is under surveillance by NSA including bank accounts that are nothing more than electronic 1’s and 0’s. There’s no need for governments to physically invade tax havens to find hidden wealth, its available on NSA’s massive mainframes where the data is stored. The question is why haven’t they?

    1. rob

      I guess the obvious answer is the NSA has no intention on raining on the tax haven parade,BECAUSE that is WHO they work for.

  14. kimsarah

    Tax dodgers argue that they pay more in dollars (not percentages) than everyone else.
    If they paid their taxes, then the burden on all of us would be that much less.
    It’s like pissing on us and saying, what are you going to do about it?
    How about putting in a few lawmakers with spine to actually require them to do so.
    And absolutely NO to any tax repatriation holiday, which was last proposed by Sens. Hagan and McCain. Watch for that to creep up again.

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