Tax Justice Network

Theme 1: Financial regulation

The weakest link

Tax havens have played a major part in the current crisis. They have been used for a variety of purposes, including:

• to create complex securitised instruments (mostly collateralised debt obligations) to mix packages of risk that have been marketed indiscriminately around the world;

• to register’off-balance sheet’ entities that have been used to withhold materially sensitive information from investors, regulators, rating agencies, journalists and others;

• to degrade the regulatory regimes of other nation states;

• to create complex and opaque structures criss-crossing multiples of jurisdictions in order to confuse investigation and fragment regulatory effort;

• to evade and avoid tax on an industrial scale. In a world of global banks and 24 hour financial markets, regulation is only as effective as the weakest link in the chain: tax havens are the weakest link. This explains why so much of the ’financial innovation’ of the past two decades can be traced back to these places. The majority of hedge funds are located in London, the Cayman Islands and the British Channel Islands. Ditto the private equity industry; the issuance of securitised debt; the re-insurance industry, and the structured investment vehicles at the heart of the shadow banking system. The current crisis does not result from some accident de parcours: it arose because financiers have created a shadow economy that is so opaque in its operations, so complex in its structure, and so blatantly corrupt in its attitude towards democracy, regulation and taxation, that no one can and should trust any of its activities. Tax havens are relatively new political economic phenomena. Delaware started out down this route in the 1890s, but tax havens really emerged as a significant feature of contempary capitalism after the expansion of the London-based Eurodollar market in the late 1950s. The ’Big-Bang’ de-regulation of London in 1986 accelerated the process.

De-regulation of financial markets opened the door for tax and regulatory competition. Tax havens have been used as mechanisms for catalysing both processes, acting as termites which have hollowed out the structures we have put in place to protect ourselves from predatory practices. To all intents and purposes, tax havens represent a financial world without rules, where criminality can prosper. My own experiences of working within a tax havens suggest that the secrecy they provide facilitates not just tax evasion, but also insider dealing, market rigging, payment of illicit political donations, non-disclosure of conflicts of interest, facilitation of bribery, and all sorts of other corrupt practices. And this happens day in day out on an industrial scale.

Comprehensive reforms are needed which will eradicate all of the mechanisms that the financiers, lawyers, accountants and their clients use to take advantage of tax havens. This will include demands for:

• comprehensive disclosure of ownership data;

• the closure of bank subsidiaries located in tax havens;

• adoption of a country-by-country reporting standard for multinational companies;

• abolition of the use of ’off-balance’ sheet accounting vehicles;

• effective steps to tackle trade mispricing;

• taxation of hedge fund profits as income rather than capital gains;

• a multilateral tax information exchange treaty based on automatic exchange;

Taken as a package, these measures will severely restrict the use and abuse of tax havens. Many can be expected to collapse and might need transitional support to restructure their economies. These measures will reduce the amount of grand corruption. They will restore the ability of democratically elected governments to tax on a progressive basis. And they will start the process of re-balancing a system that has created wild inequality of wealth and income distribution.

For a more detailed analysis of how tax havens operate, and recommendations for how to regulate their activities, please read the accompanying report "Tax Havens: Creating Turmoil"