The advantage of political protests and uprisings is that they provide quick headlines. They can focus attention on a singular, isolated problem [a dictator, a war, a certain law], but they do not need to address—or agree upon—the solutions to the world’s complex problems. Now, after the uprisings and after the rulers have been deposed, Arab Spring countries have to put together the pieces. They have to confront those complexities. But over a year later, those pieces continue to be very disjointed and those complexities remain unsolved. Food riots have continued, inflation and unemployment have reached new peaks, and freedoms continue to be repressed.

Of course, dozens, even hundreds, of scholars have already addressed the whats and the whys of these challenges. But most have ignored the pressing problem of illicit financial flows, particularly in how their flows are both caused by and contribute to these challenges. Here’s my attempt to begin to fill that gap.

These challenges are not one size fits all. It’s difficult to make blanket-statements, even across somewhat analogous nations. For example, unlike other Arab Spring countries, Tunisia has achieved sustained growth since 1960 and has largely satisfied the requirements of a structural economic transformation from and agricultural-based economy to a more diverse one based on manufacturing and services. Libya, on the other hand, has a relatively high GDP as a result of oil revenues, but is overly dependent on revenues from oil exports.

But we can make some generalizations. For example, while of invaluable political consequence, the Arab Spring itself has in part imposed costly economic and financial challenges on Middle Eastern nations. Political uncertainty has driven down the numbers of investments and tourists and driven up the affected nations’ cost of borrowing on the international financial market.

In a region already marred by economic and financial challenges, these developments pose an unwanted additional trials. All of the Arab Spring nations need to diversify their economies and strengthen their private sectors. Malik and Awadallah (2011) have posited the singular failure of Arab countries is that they have been “unable to develop a private sector that is independent, competitive, and integrated with global markets.” And an overwhelming portion of the Middle East’s population is composed of young adults under 30, many of whom are unemployed. In fact, in order to reach full employment, MENA nations must create an astonishing estimated 100 million jobs. The root of many of these structural problems lies in these countries underdeveloped financial sector—also a side effect of illicit financial flows.

Of course the Arab Spring itself occurred in large part occurred as a result of corruption, income inequality, and greed by the political elite. Those are the very forces that drive illicit financial flows. They are some of the core reasons that between 2000 and 2008, Egypt lost US$6 billion per year to IFFs, Tunisia hemorrhaged US$1.16 billion, and the family of former dictator of Libya, Moammar Ghadhafi’s held an estimated $33 to $60 billion, in what are likely the proceeds of corruption, in financial centers around the world.

But, paradoxically, while ousting these dictators was necessary, it is not sufficient to stem the flows of illicit money. In fact, in the short run, removing them from power actually may increase these nations’ loss of capital. To some extent, we’ve already seen evidence of this phenomenon. Last week, the Money Laundering Reporting Office Switzerland reported the number of reports on suspicious money transactions in Switzerland increased some 40 percent in connection with Arab Spring countries last year.

The reasons for this are simple. Without the political and financial reform necessary to stem the flows of illicit capital, they will continue unhindered. It is the underlying macroeconomic conditions, the laws, the culture, and the greed of a wealthy elite that drive these flows. And while a country’s leader is critical to setting these conditions, he or she is not the absolute.

So now that Ben Ali of Tunisia, Mubarak of Egypt, and Qaddafi of Libya are officially gone, we must address the underlying drivers of illicit financial flows. If they do not, we may well see an increase of these flows in these countries post-Arab Spring. Otherwise, although the headlines will not reflect it, nothing will be solved. The citizens of these countries will continue to be wanting in their need for bread, for freedom, and for social justice.

Firms urge delay in IRS offshore tax dodger rules
Reuters, May 15, 2012

Tax havens: a low cost place in the sun
The Bureau of Investigative Journalism, May 15, 2012

Bishops want tougher regulations to end tax dodging
Christian Today, May 16, 2012

Swiss Bank Whistle-Blowers Said to Have Handed Over Data to U.K.
Bloomberg, May 15, 2012

Has the Guardian exploited tax loopholes to save millions?
The Bureau of Investigative Journalism, May 16, 2012

Luxembourg, Austria Veto EU Effort to Open Savings Tax Talks
Bloomberg, May 15, 2012

U.S. citizens’ bank accounts in Lebanon laid bare
The Daily Star (Lebanon), May 16, 2012

Bharti Airtel faces money laundering investigation
India Today, May 16, 2012

Lawmakers sign integrity pledge
The Korea Times, May 14, 2012

Why Corporate America Shrugged at the Wal-Mart Bribery Scandal
The New Republic, May 16, 2012

flickr / James & Villja

An anonymous shell company is a corporation where it is impossible to know who the beneficial owners are. Beneficial owners are those people who ultimately benefit from, and are responsible for, the operations of the company. The result is a new corporate entity that can open bank accounts, sign contracts, receive payments, and perform all sorts of business without anyone knowing who they are actually doing business with.

Corporations serve a very important role in the economy. They allow multiple parties to work together without individually being liable for the potential failure of the joint venture. However, anonymous shell corporations are not formed to limit liability. They are formed one purpose and only one purpose: to hide the identity of the real people responsible for an action. This is a historical accident, not something that society would ever have a reason to intend.

There is no good reason to allow corporations hide the identities of the real people doing business. We see tremendous negative consequences as a result of anonymous shell corporations. Some recent cases include:

• A man in Miami used a shell company to commit $4.5 million in Medicare fraud.
• The SEC froze trading with 379 shell companies which were accused of creating shady ‘pump and dump’ schemes to manipulate the stock market.
• A shell company called W Spann LLC donated $1 million to Mitt Romney’s Super PAC, then immediately dissolved.
• The Central Bank of Iran used a shell company called Assa to own a 36-story Manhattan skyscraper near Rockefeller Square despite sanctions, funneling millions in rent back to Iran which may have been used to help fun their nuclear program.
• Arms dealer Viktor Bout, the real-life subject of the 2005 Nicholas Cage movie Lord of War, used 12 U.S. shell companies to launder the proceeds of illegal weapons trafficking.
• Teodorin Obiang, son of the kleptocrat dictator of Equatorial Guinea, used shell corporations to funnel as much as $70 million of corrupt money into the United States.
• Swiss bank Wegelins used shell companies to help their high-end clients hide their identities and evade taxes.

These are just a few of the individual cases of shell company abuse that we know about. The hard work of investigators in civil society, government, and the media have uncovered a few potent examples. But in all liklihoods, many more cases lurk beneath the surface, covered by the easy anonymous cover that our broken incorporation system offers.

We make it very easy to incorporate in the United States. Costs vary by state, but the median feee is just $95, and registration can be completed in as little as five minutes. While some states require you to list shareholders, managers, trustees, or board members as part of the registration, it is easy to assign ‘nominee’ shareholders to those positions who stand in for the real owner without any connection to the company’s operation. In many states, the incorporation will even fill those shoes themselves, for a fee. While some states create a more secretive incorporation system than others, such as Nevada or Delaware, no U.S. state has a real beneficial ownership standard.

We can change this. It not technically difficult, and imposes no significant burdens on law-abiding citizens doing legitimate business. U.S. law enforcement considers it so important that the Departments of Treasury and Justice have offered their closely-guarded asset forfeiture funds to pay for implementation – a rare move for agencies under constant budget constraints. We can require that beneficial ownership information be collected, which is physically not more difficult than adding a few lines to a form, and publish online in public databases. At minimal cost, we can remove an incredibly important tool from the criminal’s toolbox.

We can get there by passing the Incorporation Transparency and Law Enforcement Assistance Act. The bill would require states to collect beneficial ownership information, publish it online in databases, and hold incorporation agents accountable in the case of misconduct. It is fully paid for from the above mentioned Treasury and Justice funds.

Today, 41 civil society organizations, including Task Force members Global Financial Integrity and Global Witness, sent a letter to Congress to press for action on the bill to,

Curb corruption and tax evasion, promote an equitable market economy, reduce the opacity of corporate campaign contributions, help ensure a fair and level playing field for small- and medium-sized businesses, foster global development and enhance national security.

Congress needs to act on the Incorporation Transparency and Law Enforcement Assistance Act today. Every day we wait, we allow more criminals to abuse our system for their own personal gain.

 Some rights reserved by James & Vilija

Legislation Enjoys Support of Law Enforcement, Obama Administration; Would Clean-Up American Financial System

WASHINGTON, DC – Today, 41 business and civil society groups sent a letter to every member of the U.S. House of Representatives and U.S. Senate urging them to co-sponsor the Incorporation Transparency and Law Enforcement Assistance Act (S. 1483/ H.R. 3416). This bipartisan bill, which is endorsed by the Obama Administration, would require companies to disclose their ultimate owners at the time of incorporation, making it much harder for corrupt politicians, tax dodgers, terrorists and other criminals to form and hide behind anonymous U.S. shell companies.

The signatories¹, who include, among others, American Sustainable Business Council, Calvert Investments, Citizens for Responsibility and Ethics in Washington, Citizens for Tax Justice, Financial Accountability and Corporate Transparency Coalition, CtW Investment Group, Domini Social Investments LLC, Friends of the Earth – US, Global Financial Integrity, Global Witness, Human Rights Watch, Jubilee USA Network, Main Street Alliance, Oxfam America, Project On Government Oversight, Revenue Watch Institute, Sunlight Foundation and U.S. Public Interest Research Group, are concerned that it is legal to form companies in the United States with hidden ownership.

The letter states:

Increased corporate transparency would curb corruption and tax evasion, promote an equitable market economy, reduce the opacity of corporate campaign contributions, help ensure a fair and level playing field for small- and medium-sized businesses, foster global development and enhance national security…

Investigations continue to reveal that American and foreign terrorists, narco-traffickers, arms dealers, corrupt foreign officials, tax evaders, individuals targeted for financial sanctions and other criminals easily and regularly set up U.S. shell companies, without providing any information about who owns or controls such companies…This enables criminals to disguise their identities behind the anonymity provided to U.S. corporations and launder dirty money through the U.S. financial system.

The full letter can be read here.

Corporate secrecy fundamentally undermines U.S. laws to combat money laundering and tax evasion, as well as U.S. efforts to tackle global corruption. A recent World Bank report found that the U.S. was a favorite destination of corrupt politicians trying to set up shell companies to access the financial system. Once corrupt and other illicit funds have been moved through an anonymous corporate vehicle into the financial system, it is much harder to track them down. Shining a light on the ultimate owners of companies, would make it easier for law enforcement to do its job. To date, eight law enforcement organizations, including the Fraternal Order of Police and Federal Law Enforcement Officers Association, have endorsed the legislation.

The Obama Administration also views corporate secrecy as a threat to national security. Through the U.S. Open Government Partnership Action Plan and the Strategy to Combat Transnational Organized Crime, the Administration has committed to work with Congress and advocate for legislation that would require meaningful disclosure of the ultimate (beneficial) ownership information of companies at the time they are set up.

“The President’s commitment to transparency must extend to working with Congress to prioritize ending hidden company ownership in the U.S.,” said Stefanie Ostfeld, Global Witness policy advisor. “The U.S. can no longer allow foreign corrupt dictators and other criminals to disguise their identities behind American shell companies in order to launder dirty money through the U.S. financial system.”

“Anonymous shell companies make the U.S. financial system a playground for both foreign and domestic corrupt, criminal, and tax evading money,” added Tom Cardamone, managing director at Global Financial Integrity.  “It is absolutely critical from a law enforcement, national security and governance perspective that we enact this piece of legislation.”

“It’s important that the U.S. government demonstrate leadership when it comes to dealing with financial secrecy,” commented Nicole Tichon, founding member of the Financial Accountability and Corporate Transparency (FACT) Coalition.  “As we seek cooperation from foreign jurisdictions in cracking down on terrorist financing, money laundering and tax evasion, we must ensure that the U.S. is not facilitating financial crime in our own backyard.”

###

Contact:

Stefanie Ostfeld
sostfeld@globalwitness.org
+1 202-621-6674

Clark Gascoigne
cgascoigne@gfintegrity.org
+1 202-293-0740 ext.222

Nicole Tichon
nicole@tjn-usa.org
+1 202-758-9552

Notes to Editors:

1. Accountability Counsel, ActionAid USA, American Sustainable Business Council, Asia Initiatives, Business for Shared Prosperity, Calvert Investments, Campaign for America’s Future, Citizens for Responsibility and Ethics in Washington (CREW), Citizens for Tax Justice, CtW Investment Group, Domini Social Investments LLC, EarthRights International , EG Justice, Financial Accountability and Corporate Transparency (FACT) Coalition, Foreign Policy in Focus, Friends of the Earth – US, Fund for Constitutional Government, Global Financial Integrity, Global Witness, Government Accountability Project, Human Rights Watch, International Corporate Accountability Roundtable, Jubilee USA Network, Just Foreign Policy, Main Street Alliance, Maryknoll Office for Global Concerns, Mine Safety and Health News, New Rules for Global Finance Coalition, OMB Watch, OpenCorporates, Open Society Policy Center, Oxfam America, p.h. balanced films, Project On Government Oversight, Revenue Watch Institute, Sunlight Foundation, Tax Justice Network-USA, Union of Concerned Scientists, United to End Genocide, U.S. PIRG and Wealth for the Common Good
2. On August 2, 2011, Senators Carl Levin (D-MI) and Charles Grassley (R-IA) introduced the bipartisan Incorporation Transparency and Law Enforcement Assistance Act (S. 1483). Representatives Carolyn B. Maloney (D-NY), Stephen F. Lynch (D-MA) and Barney Frank (D-MA) introduced a companion bill (H.R. 3416) on November 14, 2011. These bills would require companies to disclose information about the real people who own or control them (often called the “beneficial owners”) at the time they are created.
3. The U.S. Department of Justice, the Department of the Treasury and the Department of Homeland Security have all endorsed the legislation.  The Department of Justice and the Department of Treasury have offered $30 million in forfeiture funds to offset the cost of implementing the law in the states.
4. Multiple law enforcement organizations, including the Fraternal Order of Police, Federal Law Enforcement Officers Association and Society of Former Special Agents of the Federal Bureau of Investigation, Inc., have endorsed the bill.
5. The Obama Administration, through the U.S. Open Government Partnership Action Plan and its Strategy to Combat Transnational Organized Crime, also supports legislation to stop states from allowing secretive shell companies to be set up.
6. CNBC Documentary “Filthy Rich” (Watch Here)
7. Reuters series: “Shell Games: Articles in this series explore the extent and impact of corporate secrecy in the United States,” Jun – Dec 2011.
8. World Bank / UNODC report, “Puppet Masters: How the Corrupt Use Legal Structures to Hide Stolen Assets and What to Do About It,” Oct 24, 2011
9. The Economist endorses banning anonymous shell companies: “Corporate Anonymity: Light and Wrong,” Jan 21, 2012
10. The FACT campaign published this exampleof an American anonymous shell company facilitating the evasion of U.S. sanctions: Iranian ownership of a skyscraper in the middle of Manhattan was hidden by the use of anonymous companies and partnerships, in violation of U.S. economic sanctions. The building was owned by a partnership, the 650 Fifth Avenue Company, formed between the Alavi Foundation and Assa Corporation.  Assa Corporation is an anonymous company that was incorporated in New York, but wholly owned by another anonymous company, Assa Company Limited, which is an entity incorporated in Jersey, an offshore secrecy jurisdiction.  After a lengthy and expensive investigation, it was uncovered that Assa Company Limited is owned by Iranian citizens that represent the interests of Bank Melli, which is a bank wholly owned and controlled by the Government of Iran. Anonymous companies enabled Iranian ownership of a building in New York and through that ownership, the use of the U.S. financial system to illegally funnel U.S. dollars to Iran, evading U.S. sanctions.
11. CNN Op-Ed by Stefanie Ostfeld of Global Witness: “Shell game: Hidden owners and motives,” Oct 26, 2011

ExxonMobil vs. Dodd-Frank
Businessweek, May 10, 2012

Forecasting the Future of FCPA Enforcement
Law.com (blog), May 9, 2012

Analysis: Nigeria president unlikely to risk oil graft crackdown
Reuters, May 13, 2012

Nigeria: Oil Subsidy Report – President Jonathan’s Litmus Test on Fight Corruption
Vanguard (Nigeria), May 12, 2012

What can Slovenia learn from New Orleans?
Transparency International, May 11, 2012

KKR boosts anti-corruption credentials
Financial News, May 15, 2012

Study Praises Netherlands Integrity System
The Wall Street Journal (blog), May 14, 2012

More bribery behind sharp increase in suspect money flows
GenevaLunch, May 15, 2012

Italy May Ban Eni From Kazakhstan Over Kickbacks
RIA Novosti, May 10, 2012

flickr / Pablo Manriquez

What do you do when your eldest son, already well-known for his reckless spending and extravagant lifestyle, becomes the focus of a corruption investigation in France?

Well, if you’re the world’s longest-ruling leader, President Teodoro Obiang Nguema of Equatorial Guinea, you brazenly attempt to thwart justice and the rule of law by appointing him to a position at UNESCO, a position that comes with a convenient perk: diplomatic immunity.

One doesn’t survive in power for 33 years without having a few tricks up the sleeve.

Over the past year, French authorities have become rather fond of President Obiang’s eldest son, Teodoro Nguema Obiang Mangue (commonly referred to as “Teodorín”). During that time, they have twice stopped by the six-story, $100 million mansion where he stays in Paris. In September 2011 they seized 11 of his luxury cars, valued at more than $5 million. On February 14, 2012 they revisited the mansion and stayed for ten days, eventually hauling away three truckloads of valuable artwork, furniture, and antiquities reportedly valued at more than 40 million Euros. In April 2012, a French prosecutor approved an international arrest warrant for Teodorín on charges of money-laundering. The case is part of a broader corruption investigation into the alleged ill-gotten gains of three African Heads-of-State, including President Obiang.

Just two weeks after the September raid and seizure, President Obiang appointed Teodorín as the country’s Permanent Deputy Delegate to UNESCO via a presidential decree that explicitly stated that the move was “In response to the circumstances of Teodoro Obiang Mangue.”  

Given the Obiang regime’s poor record on corruption, human rights abuses, and democracy, this disregard for the rule of law is, unfortunately, not unique in the annals of Equatoguinean history. The move is surprising, however, in its blatant disrespect for international law and the French judicial process.

There is no guarantee that President Obiang’s attempt to misuse UNESCO to shield his son from justice will actually succeed. The French Foreign Ministry must first issue a diplomatic visa to Teodorín before he can claim diplomatic immunity. A significant number of international civil society organizations are mounting a campaign to urge that body to deny the visa and allow the French corruption investigation to proceed unhindered. In addition to an open letter to the Foreign Ministry signed by 16 human rights and anti-corruption organizations, including a coalition that represents 314 groups, a petition has been launched that calls on the Foreign Ministry to repudiate President Obiang’s calculated effort to obstruct the rule of law and justice.

The French government should deny the visa and send a strong message to corrupt African leaders that impunity will not be tolerated.

Image:  Some rights reserved by Pablo Manriquez

flickr / Nir Nussbaum

When we talk about economic growth and corruption, it is often in one direction: corruption hurts economic growth. One of the major reasons for this is that corruption increases risk and uncertainty for businesses and investors and provides a distinct disincentive for their investments. Lower investment levels lead to less economic growth.

Less frequently, we say economic growth is an antidote to corruption. But this is also almost certainly true. The reasoning is somewhat complex and indirect, though. Economic growth does not directly ameliorate corruption. Rather, economic growth leads to better access to education, awareness of rights, empowerment of citizens, and then sometimes leads to improvements in human development indicators and therefore less corruption.

There may also be one other direct link. In a recent paper studying the relationship between economic growth and corruption in India, Bhattacharyya and Jha (2011) argue “economic growth creates additional resources which allow a country or a state to fight corruption effectively.”[1]

So what if economic growth is not coupled with an effective anti-corruption government policy and without an improvement in human development? Could it actually worsen corruption since it increases the amount of funds available for venal officials to steal?

We unequivocally see this is the case with oil wealth (which is not synonymous with economic growth, although it can result in growth of GDP). Oil wealth is certainly both a product and a driver of corruption. U4 explains corruption in resource-rich countries is “political and bureaucratic…involving both abuse of office on the part of key decision-makers and corrupt acts among lower level officials tasked with policy implementation.”

It is clear natural resource wealth is fundamentally different from other, healthier, forms of economic growth. But we also know some countries with certain kinds of governance structures are more susceptible to corruption. While even democracies with strong human rights records can fall victim, corruption has a particular stranglehold on countries with limited transparency, free press, and human rights. When those types of countries experience economic growth and do not try to rein in corruption, does the level of corruption increase or decrease?

I haven’t found any definitive literature either way, but my hunch is it’s the latter.

Look at China. While the People’s Republic has experienced massive economic growth over the last decade and has improved educational opportunities for its population, it has by and large not improved its record on human rights or transparency.

Meanwhile corruption has also gotten worse. A lot worse. China ranks highest in the world in illicit financial flows, illicit outflows from the People’s Republic of China have surged from an annual US$169 billion in 2000 to US$344 billion in 2008. A report from China’s own central bank estimates that “up to 18,000 corrupt officials and employees of state-owned enterprises” have absconded with 800 billion yuan, or $123 billion, of state money since the 1990s. An editorial in China’s business magazine Caixin notes: “As a rule, corruption thrives in an authoritarian regime. A leader with exceptional self-discipline may be able to stay above board. But, at this stage of its development, China offers too many temptations, and the collusion of money and power is commonplace.”

More economic development means more money for everyone: the government, businesses, and individuals. But more money also means more opportunities for venal officials to cut themselves a piece of the pie. That can be a police officer who “fines” a man with a new car who hasn’t really broken any rules, a politician who secretly skims off the top of an infrastructure project, or a customs official who charges a fee for letting an essential import through. And without effective government controls, what’s to stop them?

flickr / MREBRASIL

“If you don’t know how to fix it, please stop breaking it,” was the press headline when Severn Suzuki addressed heads of states in Rio de Janeiro in 1992. She was twelve years old, at what was then the world’s biggest-ever political gathering. In an impassioned critique of unfettered industrialism, Severn lamented the decline of the natural world, and the many injustices that man has wrought upon it. “I’m fighting for my future,” she said.

Two decades have since passed and a child could still give the same speech. Perhaps they will, in one month when world leaders will again descend on Brazil. The UN Rio+20 Conference on Sustainable Development will serve as both an appraisal of progress (or regress) made during those twenty intermittent years, and a renewed study of how best to tackle poverty and forge the transition to a green economy.

Sustainability is one of those clumsy words that is flung about but eludes most of us. At its core, it means preserving our planet so that future generations can live safely and happily on it. One of the triumphs of the 1992 UN Earth Summit was that for the first time world leaders jointly and publicly acknowledged that sustainability was not a conundrum for environmentalists alone, but required serious thought about we how develop economically and socially.

So how does Transparency International fit into all this? Corruption is the antithesis of sustainable development. It gets in the way of free education, blocking a potential ticket out of poverty. It can mean that people lack access to clean water or a toilet, or die in childbirth at home because they can’t afford hospital bribes.

As climate change proceeds along its perilous path, the cost of corruption on development is heightened not just in poorer countries but in all countries. In other words, if money intended to guard us against extreme storms, droughts, floods and freezing temperatures is lost to corruption, we’re all in serious trouble.

It’s worrisome then that corruption hasn’t yet made it onto the Rio+20 agenda. The word doesn’t appear once in the ‘Future We Want’ document that Rio+20 negotiators are currently crafting; a series of non-binding international resolutions to be published as the conference concludes. Particularly in this age of hyper-securitization, it seems untenable that a sustainable development framework might fail to address such a grave threat.

Also conspicuous in its absence from the document is any talk of climate finance. This is absurd given that by 2020 climate finance may amount to US $100 billion per year in investment, representing unprecedented quantities of developmental funding.

As negotiators meet in New York at the end of the month for a final round of informal talks before Rio+20 begins on June 13th, we’ll be pushing for these twin considerations (corruption and climate finance) to be explicitly and satisfactorily addressed.

We want all institutions that channel climate finance to commit to full transparency in decision-making processes and spending allocations. Accountability is a huge problem in climate financing. It is often unclear who (a person rather than an organisation) is responsible for choosing how and where climate money is spent, meaning people aren’t always answerable to their actions. Clear roles and responsibilities are needed, together with legal and administrative procedures to determine liability and penalties in cases of wrongdoing. Independent oversight is also integral to any anti-corruption strategy.

Oversight bodies need to be staffed by salaried, qualified professionals who can prove that they have no personal stakes in carbon markets, offset or adaptation projects or climate negotiations. Involving local communities in the planning, prioritisation and monitoring of climate projects will also help guarantee that funds ends up where they should.

In a bid to help ensure this, a number of our national chapters have sent letters and policy recommendations to their Rio+20 delegations, together with the changes we want to see made to their outcome document. Why don’t you send them to yours?  By tackling the problem as part of the solution we can help make sure that sustainable development and the means of financing it are better cushioned against corruption. It’s our future we’re fighting for after all.

 Some rights reserved by MREBRASIL

David Shankbone/Flickr*

On Sunday, The New York Times published an op-ed by Robert Morgenthau, the legendary former Manhattan District Attorney, who oversaw law-enforcement in the world’s financial capital for more than three decades.  Mr. Morgenthau, who retired from public life in late-2009, highlights the systemic risks posed by tax haven secrecy around the world.

Tax havens, with little to no taxes, of course, facilitate tax avoidance and tax evasion in countries like the U.S., but it is the secrecy they provide that is the real problem.  As Mr. Morgenthau, a member of Global Financial Integrity’s Advisory Board, explains:

The favorable tax rates encourage corporations to avoid paying American taxes by structuring complicated international transactions, like Apple’s “Double Irish With a Dutch Sandwich,” recently described by The New York Times. But it’s not just the low tax rates that make these jurisdictions attractive to those following the rules. The secrecy of offshore jurisdictions allows some individuals and corporations to engage in outright tax fraud, costing America at least $40 billion each year.

And that secrecy makes offshore tax fraud almost impossible for law enforcement to detect. When I was the Manhattan district attorney, we learned of offshore accounts only through whistle-blowers, cooperators and serendipity.

And this secrecy is not just about tax fraud.  Indeed, as Morgenthau puts it:

The secrecy laws in these tax havens are at the root of serious crimes: fraud, money laundering and international terrorism.

He points out that nearly every big financial scandal can be connected to the secrecy provided in tax havens. Offshore secrecy jurisdictions were critical to the frauds conducted by notorious Ponzi-schemers Bernie Madoff and Allen Stanford.  Meanwhile, the fraudulent accounting techniques which brought down Enron were substantially based on opaque offshore accounting.  According to Mr. Morgenthau:

How much havoc can these offshore schemes wreak? Where there is no transparency, there can be no oversight. Abuses grow literally without limit. Huge bankruptcies like Enron and Parmalat have resulted when corporations faked their balance sheets using offshore secrecy jurisdictions.

Of course, the problems posed by tax haven secrecy do not stop with financial scams.  They facilitate drug trafficking, criminal networks and terrorist financing.  Morgenthau writes:

Offshore secrecy jurisdictions provide the perfect cover to funnel money and arms to rogue states and nonstate actors. On April 5, the arms dealer Viktor Bout, the so-called Merchant of Death, was sentenced to 25 years by a federal judge for conspiring to sell antiaircraft missiles to agents posing as foreign revolutionaries. Published reports have linked him to arms sales to Al Qaeda and the Taliban.

Aren’t there international sanctions to prevent the sale of arms to terrorists? Of course there are. That’s why the Merchant of Death found a Bulgarian weapons supplier — based on the offshore haven of Gibraltar.

But it’s not just shadowy fellows like Viktor Bout who evade sanctions to do business with rogue states or terrorists. Many American corporations, including Halliburton, have done business with Iran through their offshore tax haven subsidiaries.

Putting the significance of this in stark terms, he adds (emphasis my own):

When companies use secrecy jurisdictions to commit fraud or to evade sanctions, legal remedies may come as cold comfort. Once world financial institutions begin to fail, or a rogue regime acquires unconventional weapons, it will be too late for law enforcement to prevent disaster.

Additionally, as Global Financial Integrity points out, the secrecy in these tax havens is not just a problem for the United States; it has serious implications for poor countries.  GFI estimates that tax haven secrecy costs the developing world an estimated $1 trillion per year, which could otherwise be used to invest locally in healthcare, infrastructure, and education, among other things.  Moreover, the tax avoidance and evasion facilitated by these jurisdictions has undermined the European economy, the U.S.’s biggest trading partner, and brought the single currency’s continued existence into doubt.

Tax haven secrecy, and its many ills, is one of the most pressing issues plaguing the world today.  Luckily there are some practical steps that can be taken if political will can be mustered.  As Mr. Morgenthau notes, the bi-partisan Incorporation Transparency and Law Enforcement Assistance Act would make it exceedingly more difficult for criminals, tax evaders and terrorists to utilize anonymous shell corporations within the American financial system.  Congress should move to enact that legislation before it adjourns this year.

Likewise, the CUT Loopholes Act, introduced by Sen. Carl Levin (D-MI) and Sen. Kent Conrad (D-ND) in February, would enact legislative changes to crackdown on a number of tax haven abuses.  Passing that bill would be another step in the right direction.

As Mr. Morgenthau concludes, “America needs to set an example of financial accountability and insist that the world follow.”

* Image License: Some rights reserved by david_shankbone

flickr / theamazingyen

In 2009, leaders of the world’s 20 most powerful nations gave the impression that offshore tax evasion would no longer be tolerated. The London G20 threatened tax havens with economic sanctions unless they agreed to exchange bank information. High-level international pressure forced commitments from all tax havens to cooperate. The G20 declared: “the era of bank secrecy is over.”

Three years later, bank secrecy is not over and many tax havens are thriving. In fact, the fight against offshore tax evasion has backfired. Information exchange agreements – the main policy tool that G20 countries use to curb tax evasion – have proven to be largely ineffective.

Each year, the UK’s Her Majesty’s Revenue and Customs automatically receives millions of reports from British banks about the amount their customers earnt in interest and dividends. This information makes tax evasion via UK bank accounts very hard.

Yet, despite the many tax information exchange agreements concluded in the past years with tax havens, HMRC receives at most a few hundred such reports from them. Tax havens, in fact, do not generally provide information automatically, but only “upon request”.

Under the existing UK-Swiss agreement, for instance, HMRC can request information from Swiss authorities only if they have well-documented suspicion that a UK resident is evading taxes. But this kind of information is almost impossible to come by.

Since the London G20 summit, tax havens have signed more than 700 “upon request” information exchange agreements. But it is arguable whether these arrangements have achieved anything. After all, there is roughly as much money today in tax havens as three years ago. Bank deposits held by foreigners in tax havens amounted to around $2,700 billion at the eve of the G20 London summit, according to the Bank for International Settlements. This figure has slightly increased today. So since the London G20 there has been no substantial repatriation of funds onshore.

Indeed some tax evaders have reacted to the new agreements by simply transferring their funds to tax havens that have no agreement with their home country. And since no country has agreements with all tax havens, there remains ample scope for placing assets in safe and secret location. Tax evaders, our research suggests, quite extensively exploit the loopholes in the network of information exchange agreements.

So offshore centres that have signed many agreements have experienced a significant exodus of cash. Foreign deposits in Jersey, for instance, decreased by around 60 percent between January 2008 and July 2011. But offshore centres that have signed relatively few agreements have seen a significant influx of funds. Over the same period, foreign deposits in Hong Kong increased by more than 40 percent. Overall, this has been a zero-sum game: at the global level, nothing much has changed.

There has certainly been some qualitative progress in the fight against tax evasion – before 2009, many tax havens refused to sign information exchange agreement altogether. Quantitatively speaking, however, progress is very modest – far too modest to justify any celebration of “the end of bank secrecy.”

Yet there exist simple, practical ways to significantly improve tax collection. First, G20 leaders should urge tax havens to sign treaties with all countries: a truly global agreement would prevent tax evaders from transferring their funds from haven to haven.

More fundamentally, the G20 needs to rethink its information exchange standard – and drastically strengthen it. “Upon request” information exchange does not work well. Evading taxes through offshore bank accounts remains easy. Tax specialists widely agree that automatic exchange of information is the most effective solution to curb tax evasion. It would allow tax authorities to obtain comprehensive data about income earned by domestic residents in foreign banks. Automatic reporting of bank information exists within most developed countries – as well as between most EU countries. It does not pose any great practical difficulties.

The European Union pushes for automatic exchange of information. Why doesn’t the G20 do so as well? This would undoubtedly have much larger consequences on tax revenues than the current flawed policy.

Niels Johannesen and Gabriel Zucman are academics from the University of Copenhagen and the Paris School of Economics. Their paper, The End of Bank Secrecy? An Evaluation of the G20 Tax Haven Crackdown is available here. 

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