Tax Evasion Paradise No More: The U.S. and Caribbean Nations Crack Down on Hidden Offshore Accounts
DEVELOPMENTS
For decades, Americans have hidden their assets in a number of offshore accounts with the goal of avoiding paying more taxes. When President Obama signed into law the Hiring Incentives to Restore Employment Act in March of this year, these Americans - who have for years hidden their taxable incomes in foreign banks and other investment schemes in the Caribbean and elsewhere - will now have this money potentially taxed by the U.S. government. Besides banks, the new law also addresses securities houses, derivatives dealers, hedge funds, private equity firms and commodity traders.
While any place that wealthy Americans have squirreled away their income will invariably be subject to a close inspection by the Internal Revenue Service under the new law, the impact of the new law will be felt especially in the Caribbean, where several island nations have developed reputations as off-shore tax havens after emerging as regional financial centers in recent years. In the Cayman Islands alone, more than 93,000 companies were registered as of 2008, including almost 300 banks, 800 insurers, and 10,000 mutual funds.
The U.S. efforts parallel recent efforts by Caribbean nations themselves to crack down on those who are seeking to use the Caribbean islands as ways of evading tax laws in their home countries. This is particularly reflected in the rapid rapid spread of Tax Information Exchange Agreements, widely known as TIEAS, across the Caribbean region. Together, these efforts will make the Caribbean a much less appealing place for tax evaders to hide their assets, which in turn will help several Caribbean nations in their ongoing efforts to confront and change their international reputations as foreign tax havens.
BACKGROUND
The new U.S. law contains two mechanisms which give the U.S. federal government added enforcement power to collect taxes that had previously escaped the detection of the I.R.S. Financial institutions that have investments in the U.S. will have their assets taxed by an additional 30% if they do not disclose, or refuse to disclose, the nature of investments held by Americans. The law also eliminates a strategy that investors had used to avoid taxes on derivatives.
Specifically, the tax targets foreign holding companies that are hiding accounts for tax dodgers. These accounts are assessed based on any earnings that have accrued from stocks, securities, bonds, debt and equity in American companies based in the United States.
The federal government has estimated that the IRS and other government agencies have been unable to acquire nearly $1 trillion USD from these accounts because of the loopholes in U.S. tax laws. Out of this $1 trillion USD, these tax dodgers have avoided paying nearly $70 billion USD a year in taxes on these assets and concurrently have cost the U.S. Treasury $30 billion USD a year in lost revenue. Tax specialist Lee Sheppard recently observed in a widely-publicized editorial that the “bill is a huge step in the right direction" because it meant that the U.S. was "getting serious about tax enforcement on cross-border investment flows in a way that we never have before.”
While several countries prove to be lucrative tax havens, (among them Switzerland, Austria, Panama, Liechtenstein and Turks and Caicos) it is the Cayman Islands which often proves to be the most desirable tax havens for Americans. More than 93,000 companies were registered in the Cayman Islands as of 2008, including almost 300 banks, 800 insurers, and 10,000 mutual funds.
While the new law is generally considered a positive step towards enabling the U.S. to retrieve much-needed tax dollars, it does pose a problem for those Caribbean islands where international finance has become a cornerstone of their local economies. For instance, financial services represent some 40% of the Cayman Island's GDP. These governments have long cautioned that financial reform must be done in such a way that does not devastate their economies or cause widespread unemployment.
The U.S. efforts parallel similar efforts being made by Caribbean countries themselves to crack down on their nations' financial systems being used as a global destination for financial criminal activity such as tax evasion. One of the most preferred methods of achieving this goal among the Caribbean nations themselves has been through Tax Information Exchange Agreements, more widely known as TIEAs. TIEAs are described by the Organisation for Economic Co-Operation and Development as a way “to promote international co-operation in tax matters through exchange of information. It was developed by the OECD Global Forum Working Group on Effective Exchange of Information (“the Working Group”). The purpose of a TIEA is to exchange information between two signatories, in this case states. The goal of a TIEA is to close tax loopholes between two countries, with the purpose of shoring up lost revenue due to lost taxes from wealthy individuals who flee from a medium- to heavily-taxed state, to one that has lax tax laws.
So far, most TIEAs signed by Caribbean nations have involved European economies. In recent years, Aruba, Bermuda, the Cayman Islands, the Netherlands Antilles, the Seychelles and San Marino have all signed various TIEAs with a number of European states. In the past year, Germany has signed with the Bahamas, Anguilla, St. Vincent and the Grenadines; France has signed agreements with Saint Lucia, Turks and Caicos, San Marino, Uruguay, the British Virgin Islands; the United Kingdom with Grenada, Dominica, Belize, St. Kitts and Nevis, San Marino, the Bahamas, Saint Lucia, St. Vincent and the Grenadines, Antigua and Barbuda, Turks and Caicos, Anguilla and the British Virgin Islands; Denmark with St Vincent and the Grenadines, British Virgin Islands, Antigua and Barbuda, St. Kitts and Nevis and Antigua and Barbuda; and the Netherlands with St. Vincent and the Grenadines, St. Kitts and Nevis, Antigua and Barbuda, Turks and Caicos, the Cayman Islands and Bermuda.
ANALYSIS
Since all of the above-mentioned TIEAs have been signed in the past year, the ultimate impact of the legislation remains unclear. However, the sheer sweep of the European and Caribbean countries involved in the recent trend toward wider international financial disclosure, combined with the powerful new U.S. legislation, has the potential to radically alter the Caribbean's relationship with the rest of the world in the growing global effort to combat tax evasion. Moreover, these recent developments hold the potential to transform global perceptions of the Caribbean financial industry, as the region becomes an ever less attractive destination for individuals and corporations seeking to violate their own national tax laws.
There have been some concerns that U.S. and Caribbean efforts to combat tax evasion may devastate local Caribbean economies by reducing foreign financial investment in those countries. However, this is unlikely for several reasons. Those Caribbean nations that have successfully established themselves as international financial centers have largely consolidated their reputations over the course of several decades. Equally importantly, there are few international contenders with more permissive financial reporting laws that are likely to take their place anytime in the near future. The recent U.S. and Caribbean efforts to close financial loopholes merely helps bring outliers the Caribbean region to the same basic international standards accepted by the vast majority of the world.
Those remaining countries whose financial systems continue to fail to meet these basic standards are for the most part so renown for instability and corruption that they are unlikely to emerge as attracted tax haven alternatives for would-be tax evaders. For instance, both Nigeria and Niger have financial systems riddled with loopholes and inconsistencies that could in theory make them attractive destinations for foreign tax evasion. However, according to Transparency International’s Corruption Perceptions Index (CPI), Nigeria and Niger are ranked at 130 and 106 respectively in global perceptions of clean government, whereas much better-established international financial destinations in the Caribbean such as Santa Lucia and Saint Vincent and the Grenadines are ranked 22 and 31 respectively. The enormous discrepancy in international perceptions as to the trustworthiness of most Caribbean nations compared to that of the large majority of the world's few remaining financial transparency renegades means that the Caribbean is unlikely to see its international financial holdings disappear anytime soon.
In the final analysis, there are likely to be several winners to emerge from the U.S. and Caribbean efforts to combat international tax evasion. The U.S. is likely to gain a significant windfall from taxes that it had previously lost. The vast majority of U.S. taxpayers are therefore likely to benefit, since it means that those who properly pay their taxes are not stuck having to compensate for the losses caused by the minority of individuals and corporations who have the wealth and means to funnel nearly $70 billion dollars every year into foreign offshore accounts. Addressing this injustice will become ever urgent as the U.S. government increasingly turns to its taxpayers to help it confront its growing national deficit in the years ahead.
Moreover, Caribbean countries themselves are likely to benefit as well from the improvement to their global reputations that better financial regulations and enforcement will provide. International financial investors who may now view certain Caribbean nations with suspicion as "tax havens" will increasingly see those same countries as the burgeoning international financial centers that many of them have become in recent decades. Ultimately, in those Caribbean islands where international finance already plays a central role in their national economies, it is far better for their long-term interests to be grouped with the likes of other international financial centers such as New York and London than to become associated with the world's remaining financial trouble-spots such as Niger and Nigeria.
John Lyman is a columnist for Foreign Policy Digest.
Adam Benz is the Editor in Chief of Foreign Policy Digest.