by Hala Mounib

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Introduction

The collective decision to integrate within the global economic system, like the revocation of the mercantilist Corn Laws in 1846 (Kevin O’Rourke, 1999), propelled states further into interdependency and drastically improved their economies.

With that said, one of the downsides of said economic integration is the fact that it allowed certain individuals to abuse the system by utilizing loopholes aimed at fulfilling self-serving agenda while disregarding the rest, directly contributing to a wealth-gap and hindering state progress.

One of these self-serving schemes is the avoidance of taxes through rerouting revenues into foreign nations that intentionally create regulations that favour those not residing in their geographical domains. Such places are referred to as Offshore Tax Havens.

Conceptual Framework

This segment aims at explaining some of the main concepts that are relevant to the topic of offshore tax havens, which will be recurring throughout this paper.

The U.S. Department of the Treasury defines taxation as a governmental levy that is imposed on citizens and businesses in order to collect revenue that eventually goes into funding services that are needed by society, such as research, infrastructure, and defense.

It is possible, however, to avoid taxation through associating with offshore tax havens or secrecy jurisdictions. Characterized by their low-rate interest rates that they offer (Nicholas Shaxson, 2012), the way that these entities operate is by granting beneficiaries a way to avoid or evade paying taxes in their home jurisdictions by exporting their profits and revenues into offshore shell companies with low interest rates.

Under the guise of Foreign Direct Investment, the beneficiaries register their companies in foreign countries with low tax rates (Fisher, 2014). This process, which is called corporate tax shifting, shifts profit to low-tax jurisdictions through transfer pricing and transfers of intangible assets such as patents and copyrights (Dyreng, Hanlon, and Maydew, 2008).

Impact on GDP

Tax contributes to a state’s GDP. According to a 2018 report released by the Organisation for Economic Co-operation and Development, an average of 34.2% of member countries’ GDP is generated by taxes, with the highest being France at 46.2%.

Since taxes play a significant role in a country’s GDP, it’s only natural to assume that missing taxes, especially from wealthy individuals, steeply bring down the GDP, which subsequently impacts the process of state budgeting. A 2018 study by the National Bureau of Economic Research found that in 2015 alone, over $600 billion in profits were transferred to offshore tax havens, amounting up to 40% of the profit generated by multi-national corporations (Tørsløv, Wier, and Zucman, 2018).

Forty percent of all foreign direct investment companies globally are artificial, empty shell companies with no real activity (IMF, 2018).

Because these states offer low-tax rates, companies are more likely to register their headquarters there and pay a smaller amount of tax compared to that in their home jurisdictions. The concentration of many companies into one country and the financial capital flow running through these front shell companies allow tax havens to rapidly build strong financial sectors in a relatively short period of time.

Panama Papers

In April 2016, the International Consortium of Investigative Journalists released the world’s largest financial data leak to time. Amassing over 2.6 terabytes, the investigation titled Panama Papers published more than 11.5 million documents regarding 214,000 front companies operating in 50 countries around the world, exposing 140 politicians among many others.

The ICIJ’s collaboration with Süddeutsche Zeitung, the newspaper that first received the leak, allowed them to expose the global scandals and illicit financial dealings of influential people who had abused their power for so long.

Panama Papers shed light on Mossack Fonseca, a law firm in the centre of the tax noncompliance conspiracy that was responsible for the creation of numerous shell companies. Sigmundur Gunnlaugsson, Petro Poroshenko, and Malcolm Turnbull are a few Prime Ministers that appeared in the data leak, compromising any trust their citizens had in them as country leaders, and in the case of Gunnlaugsson, leading to his resignation. Several other leaders come from the MENA region.

Policy Recommendations

If well-off world leaders find taxation inconvenient, it’s reasonable to believe that ordinary citizens do too. Going extreme lengths to participate in tax avoidance, and in some cases tax evasion, while expecting citizens to comply with tax systems is not only hypocritical, but also highly unethical. It generates inequality, disconnects the public from the elite because of the lack of transparency, and creates overall resentment.

Tax noncompliance offenses ought to be forgiven in states where leaders have utilized offshore secrecy jurisdictions to participate in tax evasion. Either taxation should be abolished as a whole, or extreme transparency should be exercised in order to do the citizens justice, as governments exist to serve the individual and to maximize his or her liberties. Otherwise, since greed is a prevalent human trait, it’s unlikely that openness will be exercised as those who are capable of avoiding paying taxes will continue to avoid them.

 

Hala Mounib is a Policy Research Fellow at the American Freedom Institute

Featured Image by Süddeutsche Zeitung

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