John Christensen and Mark P Hampton
The 1999 tourism campaign for Jersey, largest of the British Channel Islands, proclaims this tiny island as 'A World Apart'. Photographs of craggy inlets and empty beaches reinforce the image of an island disconnected in time and space from its neighbouring mainland European states. Seen from the Metropolitan viewpoint, however, the notion of 'A World Apart' has acquired an altogether less attractive image. Accompanied by a host of other micro-states which are predominantly tax havens and offshore finance centres, the Channel Islands have been identified by a variety of agencies, including the United Nations Office for Drug Control and Crime Prevention, the European Union, and the Organisation for Economic Co-operation and Development, as global problems, sufficiently threatenin in the estimation of the OECD to merit inclusion on a hit list of 'islands in the sun.' What has happened to bring these obscure statelets under the scrutiny of the international community?
Geographically the offshore world sits alongside the Metropolitan centres of the global economy, physically dwarfed and constitutionally separated, but institutionally connected and closely linked through telecommunications systems. Many of the older offshore finance centres (OFCs) are located within or on the periphery of the European Union, including the Channel Islands, Isle of Man, Liechtenstein, Luxembourg, Gibraltar, Malta, Cyprus, and Dublin's International Financial Services Centre. The Americas are serviced by Caribbean and Central American havens such as the Cayman Islands and The Bahamas, and the Pacific Rim area has Hong Kong, Singapore, Labuan in Malaysia, and a variety of Pacific islands, including Vanuatu, the Cook Islands, and Western Samoa. Over forty jurisdictions currently offer facilities for tax avoidance and evasion - recently termed "tax escape" - and in some cases offshore finance is the dominant industry. Jersey, for example, is over ninety per cent dependent upon the revenues derived from its finance sector.
Despite its relative obscurity, the global offshore finance economy is not trivial. Recent estimates suggest that between thirty to fifty per cent of global wealth is held in tax havens, and that up to one half of the value of internationally traded goods and services is transacted via the offshore circuit. The global tax revenue loss is unknown but undoubtedly substantial. Germany alone loses about £10 billion tax revenue annually to undeclared personal savings held in offshore bank accounts. Estimates of capital flight from Russia suggest that for every dollar of inward investment over the past decade, between ten to twenty dollars flies out to offshore accounts, with Cyprus providing the first step in a laundering process which typically directs the funds towards New York and the City of London.
THE MONEY LAUNDERING CIRCUIT
The use of OFCs for money laundering is one of the principal causes of international interest in these micro-states. The managing director of the International Monetary Fund, Michael Camdessus, recently told the OECD sponsored Financial Action Task Force (FATF) that money laundering represents between two and five per cent of global gross domestic product, or approximately one trillion US dollars, a large part of which is laundered via the offshore circuits. For decades organised crime has used this circuit to launder criminal assets with relative impunity, secure in the knowledge that lax application of basic safeguards such as the 'know your customer' requirement, combined with strict application of banking secrecy, provides a secrecy space that will typically thwart investigation by external law enforcement agencies. Furthermore, sophisticated cross-border crime, such as the recent case of the Antigua-based European Union Bank (EUB), whose officials disappeared along with the deposits from an Internet based offshore banking facility, highlights significant problems in determining the jurisdiction in which a crime has been committed. In testimony to the United States Congress it was noted in the context of the EUB that "the computer server was in Washington DC. The man who operated both the bank and the server was in Canada. And under Antiguan law, in effect, the theft of the bank's assets was not illegal. So now the problem is, where is the crime committed, who committed it, whois going to investigate it, and will anyone ever go to jail?"
Concerns about the use of OFCs as conduits for the proceeds of crime
from Latin American narco-economies, from Russian gangsters, and from endemic
corruption and fiscal crime in many OECD states, lie behind the recent
initiatives of the UN, the EU, the G7 group of leading industrial
economies, and the FATF. Addressing the Paris Group of Experts in March 1999, French finance minister Dominique Strauss-Kahn noted that "Currently, offshore financial centres play a major role in the international movement of capital, regardless of whether its origin is legal or illegal. Some experts estimate that almost half of the global monetary stock passes through them. They are often an indispensable tool in the conclusion of corrupt deals and thus have a critical responsibility in efforts to block dirty money channels. They can no longer side-step international regulations governing the oversight of financial activities or refrain from co-operation in efforts to combat financial crimes."
In response to international pressures the Caribbean FATF has undertaken
that by the end of 1999 the UN Drug Control Programme measures for controlling
money laundering will be applied across the region. Other OFCs in
UK Overseas Territories and Crown Dependencies agreed to extend their existing
anti-money laundering programmes to encompass the proceeds of fiscal crime,
and further pressure will be applied by national tax authorities seeking
assistance with the process of countering tax evasion and avoidance.
The focus of such pressure will be upon the banking secrecy which lies
at the heart of tax haven activity, and which is the key enabler
of the money laundering process.
FISCAL AND REGULATORY DEGRADATION
Money laundering is, however, only one of a number of reasons for the international community's interest in offshore finance. Of greater political and economic significance is the contribution made by offshore to the dynamics of fiscal and regulatory degradation, or the process of undermining the tax and regulatory systems based mainly upon the classic nation state. Neo-liberalists have long argued that tax havens provide an important counter-weight to high tax and spend regimes such as those within the European Union . The more extreme apologists for the 'free market' in tax affairs, defend the rights of private individuals and trans-national corporations (TNCs) to 'optimise their tax efficiency' through the use of offshore tax vehicles, regardless of the original location of the economic activity from which the tax liability derives.
The late 1990s swing away from free market fundamentalism towards a more moderate brand of economic liberalism has challenged the view that fiscal competition is necessarily a good thing. The OECD Committee on Fiscal Affairs argues that tax competition between states can be economically harmful in a number of ways, for example by shifting the tax burden between different types of economic activity, thereby encouraging short-term speculative activity to the detriment of fixed, long-term investment, and providing TNCs with an unfair competitive advantage over their solely domestically based competitors. In addition, intense competition between tax havens, the majority of which are based in micro-states with relatively unsophisticated governments, provides an opportunity for TNCs to exert their considerable political influence to sponsor favourable tax and regulatory legislation. An example being the Limited Liability Partnership Law enacted by the States of Jersey in 1998 at the request of accounting trans-nationals Ernst & Young and PriceWaterhouseCoopers.
Pressure from the European Union, with France and Germany at the forefront, has led to the adoption of a voluntary code of conduct on business taxation, which is monitored by an inter-governmental group. Perhaps more importantly, in April 1998 the OECD adopted fifteen recommendations for combating 'harmful tax competition' by :
- identifying regimes considered to be engaged in harmful
- eliminating harmful practices within member states and their dependencies, and wherever possible persuading non-members to co-operate;
- introducing counter-measures against harmful tax competition from non-members.
THE REGULATORY BURDEN
Regulation poses particular problems for micro-state tax havens. Typically their state apparatus consists of a small civil service largely engaged in supplying the range of public services normally provided by a mainland local authority. However, the need to service an independent legislature and judiciary, albeit on a micro scale, creates demands of a type unknown at local authority level. In practice offshore regulation is constrained by the limited local pool of qualified and experienced professional regulators, and the regulatory process is hindered by the extensive laddering of transactions via networks of inter-connected offshore trusts and companies registered through nominee directors and shareholders.
The inadequacy of the regulatory structures in some tax havens is compounded by the proximity of local politicians and regulators to the marketing of the OFC. In a number of cases the same people act both as regulators and promoters of the OFC, giving rise to one regulatory authority being known as 'the three monkeys', a reputation which stems from the understandable fear that the OFCs' image would be damaged by scandal.
The quality of offshore regulation varies considerably. As a general rule the longer established OFCs have developed to the point where they are able to be highly selective when choosing new types of business and new institutions, and they are better equipped to apply prudential regulation. They nonetheless find themselves threatened by increasing pressure to more effectively regulate what Professor Sol Picciotto describes as 'the heart of the offshore phenomenon', international tax avoidance .
The huge scale of the global offshore market of unregulated, private financial flows has the potential for de-stabilising the international banking system. The interconnectedness of the global financial system, and high levels of inter-bank lending, means that an offshore banking collapse could contribute to contagion within the onshore banking system. In 1993, the Bank for International Settlements - the central bank for central banks- estimated that total offshore cash holdings amounted to some five trillion US dollars, approximately five times the sum available to the world's central banks. Arrangements to ensure the prudential supervision of offshore subsidiaries and branches of international banks are in the process of being introduced. Progress in this direction, however, has been delayed by offshore regulatory authorities' fears that any increase of regulatory functions will dilute their offshore competitive advantage.
THE CUCKOO IN THE NEST
The micro-states in which so many tax havens are located have good grounds
for fearing for their futures. Micro-states, especially of the small
island variety, are typically confronted with significant economic disadvantages,
including diseconomies of scale, dysfunctional market
structures, high transport costs, and deficiencies in the development of their professional and institutional skills base. Tax haven and offshore finance activity play to their geo-political advantages, namely fiscal autonomy, independence from onshore supervision, judicial independence, and secrecy in the political and banking spheres. Micro-state culture also plays an important part in the successful operation of a tax haven in so far as small communities are insular and inward looking, and therefore able to suppress dissent and whistle blowing.
Over the past forty years many micro-states have adopted economic development strategies based upon their ability to attract offshore financial services. The rapid growth of this activity has dramatically transformed their local economies, crowding out pre-existing industries and creating a high degree of dependence upon a single sector. Scope for diversification into new industries is tightly restricted by the high cost base that arises from the hosting of a finance centre, and by the prevalent skills shortages. This lack of effective choice is common to most micro-states. Furthermore, dependence on offshore finance creates a paradox that strikes at the very heart of tiny, insular communities:
"The dilemma of offering economic advantages to attract foreigners and
foreign capital . . is reflected in the nationalist, anti-foreign sentiment
over their presence, and the attendant effect on employment, housing, the
cost of living, and the unsettling onslaught on the traditional way of
The growth of offshore finance has been so dramatic that some micro-states run the risk that their OFCs will emerge as a 'cuckoo in the nest', not only crowding out pre-existing industries, but also exerting a dominating influence within the apparatus of the state. Once such a position has been secured the major financial institutions are able to use their influence over local politicians to secure favourable tax and regulatory advantages. This was the case with the Jersey Limited Liability Partnership Law, the introduction of which led to the island's government being branded 'a legislature for hire.'
Having managed since the 1960s to create an image of probity and stability, the world of offshore finance feels highly uncomfortable with the attention of organisations like the OECD, G7, the EU and the UN. Many residents of these economically vulnerable territories fear that tax havens might finally be meeting their Nemesis. Recognising their collective vulnerabilities, the larger tax havens and OFCs are mounting intense lobbying programmes to persuade onshore governments of the important role they play in global capital flows, and of the dangers that might arise if capital moved from comparatively reputable and well regulated centres to more obscure and completely unregulated offshore centres.
It remains to be seen whether or not such arguments will be persuasive
in the face of mounting political pressure from the world's most
powerful states. If tax havens are to survive, even in
highly modified form, they must demonstrate that their role in the
global economy actually creates added value, rather than merely acting
as vehicles for financial capital to avoid its social and economic liabilities.
The time might have arrived, however, when tax havens must face up to the
fact that all good things come to an end. If so, the international
community has a vital role to play in helping micro-states to identify
innovative and sustainable alternative development strategies.