I
t
is ironic that one of the key features of modern globalized capitalism,
offshore banking, was invented by some obscure comrades in charge
of managing the foreign reserves of the old Soviet Union. During
the early Cold War years, they were apprehensive about depositing
their accidental dollar holdings in U.S. banks where they risked
being frozen if a political confrontation arose. The solution the
comrades came up with was to deposit the dollars in London. While
they were at it, why not open their own bank in what was still the
banking center of the world? In this way, the Russians ended up
having a bank in London, mainly dealing in “red” dollar
deposits and lending.
For
big U.S. corporations a dollar is always green, no matter where
it comes from. They quickly saw the advantage of having access to
dollars outside of the U.S. where the banking system at the time
was strictly regulated. Nor did it take long for British banks to
realize that the Russian comrades in their midst had hit on a significant
financial innovation. They hurriedly followed in their footsteps
and started to open departments specializing in unregulated dollar
deposits and lending. Offshore banking as a wider phenomenon was
born.
In
the early days, tax considerations weren’t an important facet
of offshore banking. It started out mostly catering to corporate
customers that were interested in the lower rates and quick decisions
available to customers with the right corporate credentials. In
the early period, this new market for eurodollars (as it came to
be called) was mostly used for U.S. corporate expansion in post-war
Europe. But it didn’t take long for wealthy individuals to
realize that the low level of regulations was also beneficial for
what today is euphemistically termed “tax planning.”
In
London, while regulations for foreign accounts were low, there was
still a demand for a paper trail documenting all transfers. Therefore,
when the focus started to shift towards deposits, for which the
main objective was tax evasion and even money laundering of criminal
income, offshore banking activities started to move to new destinations.
The preferred choice became small jurisdictions with no prior international
banking activities and thus no laws covering them. Most importantly,
many of these small jurisdictions saw the luring of these deposits
to their shores as a potential bonanza for moribund and underdeveloped
economies and were thus ready to protect the deposits by refusing
to engage in information sharing with authorities in the depositors’
home countries.
In
recent decades, another prominent feature of the ongoing globalization
has been the outsourcing of manufacturing to developing economies
where labor costs are much lower. However, the question of labor
cost is not as simple as it appears. The direct labor cost going
into a product can be as low as 1 percent of its final sales price,
as recent revelations regarding manufacturing conditions for Nike
products have shown. It is also worth noting that products, when
they are brand names, as Nike’s are, have higher price inelasticities,
which translate into higher abilities to absorb labor costs. Thus,
seen only from a price consideration, much of the outsourced production
could probably—using normal profit standards—be kept in
the U.S. by accessing the growing pool of workers within its borders
forced to accept whatever minimum wage work they can get. Clearly,
it appears that there are other factors behind the trend of offshore
outsourcing of corporate production.
Here
tax havens come back into the picture. Offshore production in a
global economy creates new possibilities for reducing tax liabilities,
that don’t exist if a company both produces and sells within
its home country. To take advantage of this, when moving production
offshore, it is typically accompanied by the establishment of a
subsidiary in a tax haven to which ownership of the so-called soft
assets, such as patent rights, brand names, and company logos, are
transferred. The tax haven subsidiary will thereupon invoice the
offshore manufacturer for the “right” to use these soft
assets.
This
transforms the soft assets from balance sheet items into costs embedded
in the products when they return to the home country. Since the
tax haven subsidiary is fully owned and operationally controlled,
the cost structure of the whole process can be geared up and down
so that profits in the home country disappear no matter what sales
prices can be fetched in the home market. Sometimes the process
is refined by moving the main company—either as an empty shell
registration or as a skeleton corporate headquarter—to the
tax haven. This leaves a subsidiary with all the rest of normal
corporate functions, such as design, marketing, distributing, and
the majority of the corporate executive staff, in the original home
country.
A
key aspect of the process is that it is tailored to corporate elites’
interests at the expense of ordinary shareholders. For example,
the corporate elite can have part of their remuneration hidden as
“consulting” fees paid to shell companies and bank accounts
the executives have set up in the tax haven, with the money coming
from the revenue accruing to the subsidiary that holds the soft
assets.
Interpolating
from a sample of credit card transaction records, the IRS concluded
that upwards of two million U.S. citizens access funds held in tax
haven bank accounts by credit cards, while tax returns only reported
170,000 accounts. In the Cayman Islands alone, deposits totaled
more than $800 billion, which equals one-fifth of all deposits within
the U.S. A conservative estimate is that upwards of $70 billion
in taxes are lost every year due to the hiding of income in tax
havens. However, since the Bush administration cut the IRS’s
auditing staff drastically, the IRS has essentially been reduced
to the role of an onlooker.
The
growing problem of tax evasion occurring in tax havens spurred the
Organization for Economic Cooperation and Development (OECD) into
action in 1998, with the Clinton administration signing onto the
process. Forty- three identified offshore tax havens were notified
that they would have to comply with a certain level of information
exchange, otherwise they would be the target of countermeasures.
Despite
the fact that both the OECD demands and the contemplated countermeasures
were weak, they were too much for the Bush administration, who,
in 2001, gave the activities in tax havens another free pass, declaring
that the OECD demands were “not in line with this Administration’s
priorities.”
The
OECD initiative had brought the market extremists behind the Bush
administration out on the war path, with Tom DeLay leading the charge.
According to him, tax “planning,” as everything else,
should be left to free, unregulated market forces. Let the chips
fall where they may. That we are talking of forces exhibiting asymmetries
of almost incomparable proportions doesn’t matter. Forget about
the fact that a large, developed country burdened with upholding
a sophisticated socio-technical infrastructure must raise taxes
to pay for it.
On
the other hand, a tax haven like the Cayman Islands (with barely
40,000 inhabitants, many of them expatriates connected to tax haven
activities) has as its main responsibility keeping the golf courses
green, burdening it with no serious need for levying taxes. It is
not hard to figure out where the “market” choice for having
their taxable income show up is for everybody with a billion dollars
in income and no concept of social responsibility.
In
this case, the market extremist logic is barely a fig leaf for the
culture of free riders prevailing among the current elite. The reality
is that outsourcing profits and income to tax havens is another
nail in the coffin for the dying principles of the welfare state.
As the rock singer Perry Farrell coined it: “Your true nature
is how you treat the weak.” Using that measure, there is not
much doubt about the true nature of the crowd that took over the
White House during the Floridian coup d’état of 2000.
Dix Sandbeck
lives in Canada and his has articles have been printed in the Toronto-based
Economic Reform
and in the British magazine
Sustainable
Economics
.
