Offshore finance: for better and worse
The beginning of November saw a data leak of 13.4 million confidential electronic documents, dubbed the ‘Paradise Papers’, illuminating the world of offshore finance. The Paradise Papers has raised many of the same questions around tax avoidance and transparency as did the release of the Panama Papers in 2015. The documents show the financial affairs of people and companies connected to offshore law firm Appleby. Some of those implicated include companies such as Facebook, Apple, Nike, Glencore, alongside high profile individuals such as heads of states including Queen Elizabeth II, Prince Charles, Justin Trudeau’s chief fundraiser and Lord Ashcroft.
As a practice, offshore finance is not illegal. A company or individual may legally move offshore for the purpose of tax avoidance or to gain from looser regulations. The practice is also nothing new; for instance, the documents in question here date back to 1950. What role does offshore finance play in the global economy? As it stands, is the practice as parasitic as it comes across on the surface, or is there some benefit to this flexibility around the law?
The general press coverage of these documents has a strong sense of implied guilt, with a particular emphasis on the possibility of wrongdoing. While the activities highlighted here are bridled with a guise of secrecy, and the activities themselves are not considered as respectable or right, no lawful wrongdoing has been established so far. These activities come with a particular blow of hypocrisy and distrust when conducted government officials. In the its press release, Appleby has stated “we are an offshore law firm who advises clients on legitimate and lawful ways to conduct their business. We do not tolerate illegal behaviour”. Taking a conspiratorial view, when the law comprises of loopholes, open to exploitation benefiting the wealthy and amongst those the lawmakers, global governance and financial regulation comes into question as it did during the 2008 financial crisis. Set against the backdrop of austerity and last Wednesday’s budget, the governing powers seem at best impotent and at worst malign .
Legal tax avoidance by companies and individuals, I believe, is for the most part immoral and unfair, on par with illegal tax avoidance. Related to this, a Treasury statement says "since 2010, the Government has secured an additional £160 billion, more than the annual UK NHS budget, for our vital public services by tackling tax avoidance, evasion and non-compliance … This includes more than £2.8 billion from those trying to hide money abroad to avoid paying what they owe”. The statement went on to say “A fair tax system is a critical and key part of our plan to build a fairer society, and we are clear that everyone must pay what is due, at the right time". In spite of clear evidence of tax avoidance, Theresa May refuses to commit to a public register of the ownership of offshore companies and trusts. Interestingly, in the announcement by the UK treasury increasing air passenger duty for business and first class passengers in the autumn budget, chancellor Philip Hammond described the cost of travel as “an important factor for families and businesses.” He followed this with “Sorry Lewis,” referencing Lewis Hamilton’s VAT duty avoidance of £3.3 million on the purchase of a private jet as exposed by these papers.
So what benefit could offshore finance possibly carry for the global economy as a whole? One can argue that it eases cross-border investment by providing individuals from different countries a “tax-neutral” venue to make pooled investments. Research by Professor Andrew Rose of the University of California, and Dr Mark Spiegel of Stanphyl Capital, a small New York hedge fund reaches the conclusion that for neighbouring economies the benefits of offshore financial centres outweigh the costs. Using the example of France, by being close to Andorra and Monaco, France has a more competitive banking system, which provides more credit at lower interest rate spreads. These indirect competitive benefits of offshore financial centres more than offset their costs. This was studied through a theoretical model where offshore financial centres have the benign effect of encouraging competition in the domestic banking sector. They then take the predictions of the model to the data, and examine the impact of offshore financial centres’ proximity on banking sector competitiveness and financial depth. This benign impact on local banking conditions tends to mitigate the adverse effects of offshore financial centres on tax evasion and illegal activity.
Furthermore, offshore financial centres provide a legitimate financial “neutral” zone or refuge for people from countries in turmoil. Those people need not only be of war-ravaged regions. For example, in Cyprus in 2013 expats were blocked from making transactions. For these people banking offshore means removing their wealth from the threat of appropriation.
All in all, the Paradise Papers have brought to light an abundance of shady and questionable practices. It is important to note that offshore centres have got little credit for cleanups over the past decade. On some measures of tax and corporate transparency and combating money laundering, Jersey, the Cayman Islands and some other havens score better than many rich countries. In the case of Vanuatu, one could fault the past governments for failing to stay current with global anti-money-laundering laws. The international reaction of regulation could see such nations as victims of richer governments trampling the smaller players. Singling out a nation like Vanuatu for grey listing (money laundering standards of the Financial Action Task Force) would pose grave economic consequences. According to Prime Minister Charlot Salwai, “its effect will be felt on imported food, such as rice, and fuel”. It is important to remember that really the strongest players in opaque financial matters are those in ‘onshore’ financial centres.