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Will G20 Crack Down On Tax Havens?

Critics charge that the public is losing large amounts of tax funds to tax havens on such tiny Carribean islands as the Caymans, or Jersey in the Channel Islands.
Critics charge that the public is losing large amounts of tax funds to tax havens on such tiny Carribean islands as the Caymans, or Jersey in the Channel Islands.
As the leaders of the Group of 20 (G20) major and developing economies gather in London on April 2 to discuss the global financial crisis, one issue they will consider is how to crack down on tax havens.

Tax havens have become an increasingly large part of the world's economy. In fact, so much money goes to them, and so much financial speculation takes place with that money, that tax havens are a major factor behind the crisis.

Tax havens have grown from just five in the 1950s to 90 today. They range from some very well-known countries -- like Luxembourg, Austria, and Singapore -- to some islands most people would find hard to locate on a map, like the Cayman Islands in the Caribbean.

Tax havens work in various ways. The simplest merely offer business the chance to pay a lower tax rate than they normally do in most big countries. Micro-states, like islands, can do that because they do not have large state budgets to support.

So, companies register in the tax haven, do business as foreign corporations in their own home countries and pay less tax according to the dual tax agreements between the two states.

But the most sophisticated tax havens offer companies much more: a cloak of secrecy. Officials do not ask -- or are unable to find out --who owns the business or how it makes its money and the haven may not have dual tax agreements with other states.

That can make it possible for companies to deliberately mislabel and hide much of their income and pay little or even no tax on it to anyone. And it can allow dictators, terrorist groups, and mafias to hide and transfer their wealth around the world.

In 1998, the year the ruble collapsed in Russia, some $70 billion in foreign currency from Russia are believed to have passed through banks in the tiny Pacific island of Nauru. The capital flight is said to have directly contributed to ordinary Russians' hardships during that time, because it left the government with very little foreign reserves to prop up the ruble.

Taking Public Money?

Proponents of tax havens say they do more good than harm. Many of the havens are former Western colonies which, after independence, had few prospects for prosperity or even survival. They designed tax rates and banking practices to attract money from abroad and flourished.

The Island of Jersey, one of Britain's historically autonomous Channel Islands, obtains some 80 percent of its government revenues from taxes and licenses on the companies operating there. Its banking sector employs many of the residents.

But critics of tax havens say the damage they do internationally far outweighs the benefits for the host countries. Raymond Baker, the director of Global Financial Integrity in Washington, D.C. and author of the 2005 book "Capitalism's Achilles Heel: Dirty Money and How to Renew the Free-Market System," says tax havens have diminished governments' ability to obtain the tax money needed to build roads, fund schools, and otherwise maintain civic life.

"The result of this [growth of tax havens] is that there has been a considerable shift, not only in the United States but in other countries, of the tax burden away from corporations and onto income, income earned by poor, middle class, and wealthy alike," Baker says.

NGOs led protests against tax havens on the Isle of Jersey last month.
The Organization for Economic Cooperation and Development says estimates of the value of assets held in tax havens range from $1.7 trillion to $11.5 trillion. That means billions of dollars in lost tax revenues.

"Some people have estimated that as much as half of global trade and capital movement passes through this shadow financial system somewhere between initiation and completion," Baker says.

In recent years, the loosely regulated or completely unregulated environments of tax havens have made them a preferred base for speculative financial practices, including ones now widely considered to have contributed to the present global economic crisis.

The Cayman Islands, for example, are home to some 10,000 hedge funds. Those are funds in which investors pool their resources to play the stock market, driving targeted companies' stocks up or down in the process. Critics say the results can be big profits for the investors but sometimes ruin for a company and its ordinary stockholders.

Why, then, does the world tolerate tax havens? Dr. Mark Hampton, a professor in the Business School at the University of Kent, England, says one reason is that many major banks have branches in tax havens.

"It has to do with the banks having these places, obviously there have been hugely profitable units down there in the Channel Islands," Hampton says. "The branches and subsidiaries of all the major players have made very very healthy profits, which then get sent back to group, so from a banks point of view it is very very helpful having these places."

And until "the recent crash in confidence," as Hampton notes, Britain's banking sector -- one of the most important in the world -- "had a huge amount of political influence on the British government, so [the government] would make all sorts of statements in public about 'we ought to be tough on these places' but the reality was a kind of linkage between the City of London [the financial center] and their branches down in the Channel Islands."

Transparency vs. Regulation

Now, as the global financial crisis brings tax havens onto the front pages of newspapers, leaders are stepping up their criticisms.

U.S. President Barack Obama recently said there is "a building in the Cayman Islands that supposedly houses 12,000 corporations. That's either the biggest building in the world or the biggest tax scam in the world."

British Prime Minister Gordon Brown has called on governments around the world "to outlaw shadow banking systems and offshore tax havens."

Hampton believes the time may finally be right for curbing the tax-haven phenomenon. And he says it would be possible for major Western countries to do so.

"The vast majority of the largest tax havens are British territories or in some sort of association with Britain through the Commonwealth and various other groupings," Hampton says. "So, should Britain decide to take this seriously and push very hard there are a lot of things that Britain could do because ultimately, in somewhere like Jersey, the responsibility for its governance lies with London although there is a high level of autonomy."

Equally, independent states can be subjected to international freezes on their assets to gain compliance. But some other observers, like Baker, are skeptical that the G20 can muster the political will to crack down hard on tax havens.

Baker notes that the communique issued after the first G20 meeting in Washington on November "placed transparency ahead of regulation in importance." But he says that in papers being circulated now, "transparency has substantially slipped from the agenda and regulation has grown. What that means is that the G20 is moving toward regulation within the shadow financial system rather than altering the shadow financial system with greater transparency."

Now, the stage is set to see how the G20 leaders respond. Will they find a way to recover the vast amounts of tax dollars -- the world's public, not private, wealth -- for the common good? Or will it largely still be business as usual?

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