Did blacklisting hurt the tax havens?

Author:Robert Thomas Kudrle
Position:Hubert Humphrey Institute of Public Affairs and the Law School, University of Minnesota, Minneapolis, Minnesota, USA

Purpose – The purpose of this paper is to test the widely-held assumption that blacklisting, such as that practiced by the Organization for Economic Cooperation and Development (OECD) and the Financial Action Task Force (FATF), affects the volume of financial activity associated with a tax haven. Design/methodology/approach – ARIMA (autoregressive integrated moving average) analysis ... (see full summary)


[…] if a haven develops too unsavory a reputation as a home for “dirty money” or a haunt of organized crime and drug traffickers, then not only will legitimate money go elsewhere as respectable companies move their business to avoiding their reputations but so too will more sophisticated criminals who want to avoid any taint by association ( Blum et al., 1998, p. 36 cited in Sharman, 2006, p. 108 ).

Many observers have placed “reputation” high on the list of the attributes of successful tax havens, a set of jurisdictions that focus public policy on providing enticement to foreign investors through low taxes or transactional opacity. The importance of reputation has strong intuitive appeal: reputation is clearly regarded as closely bound to “trust,” and those investing in the havens are typically making a very large bet that they will get their money back.

The thinking reflected in the opening quotation appears to have motivated an approach to the tax havens taken by the Financial Action Task Force (FATF) in the 1990s and into the new century. A major element of its program was to “name and shame” jurisdictions that were deemed insufficiently cooperative in the drive by major high-income countries to combat money laundering and, increasingly, terrorist finance. The Organization for Economic Cooperation and Development (OECD) “Harmful Tax Competition” (after 2000, “Harmful Tax Practices”) project, which issued its first report in 1998 aimed at tax avoidance and evasion, employed the same technique. While both rich country initiatives also threatened further measures, the blacklists themselves were widely regarded as directly important. As one prominent commentator put it at the time, “… clearly in a practical and legal sense, the issuance of blacklists are (sic) not merely ‘naming and shaming,’ but the imposition of economic sanctions” ( Zagaris, 2001, p. 524 cited in Sharman, 2006, p. 116 ). Abundant evidence suggests that many tax haven officials concurred in this assessment and feared that their attractiveness to investors would be significantly diminished1.

The following examination takes this line of reasoning seriously and explores the extent to which attacks on reputation alone appear to have had any impact on the total banking investment in the affected jurisdictions.

1 Variety among the tax havens

Discussing tax havens as a group presents a challenge because writers differ widely over what the term is supposed to capture. At one extreme, some commentators refer to the USA as the world's largest tax haven for a number of reasons including the fact that certain state practices, notably those of Delaware, allow for a high degree of secrecy about the true ownership of foreign assets held there ( Langer, 2000 ). Usually, however, the term refers to jurisdictions in which suspect activity looms large relative to the total economy and that gear their national policies towards one or more of the following types of activity: production havens use discriminatorily low-tax rates to attract real activity from abroad2. Sham havens serve as switching stations for corporations that want to keep their funds out of the immediate tax reach of their shareholders' states. Secrecy havens gain competitive advantage by allowing investors to disguise their ownership of offshore assets ( Kudrle and Eden, 2003 ). Many havens combine two or all three of these functions3.

The reputational fear captured by the opening quotation presumably applies both to secrecy haven activity because it typically involves tax evasion and money laundering and also to tax avoidance of the kind routinely practiced by large, traded US multinational corporations. These firms can defer the payment of what would otherwise be tax due – when foreign tax rates are below those of the USA – by employing a haven to redirect foreign earnings to other business locations abroad. The latter activity is overwhelming performed in a handful of high-income tax havens such as the Cayman Islands. But, the same tax havens that host massive amounts of legitimate financial investment of this kind are also believed to host the largest part of funds placed abroad for illegal purposes ( Sullivan, 2007a ).

The tax havens are often treated as a relatively homogenous group because so many of them are small in physical size and population, and the same 30-40 or so such jurisdictions appear on multiple lists. But, this is a big mistake. They differ dramatically from each other, whether the measure chosen is foreign direct investment or banking and portfolio investment4. The Cayman Islands with a population of about 45,000 (2005) had external banking liabilities of approximately $1.66 trillion at the end of 2006 and per capita income of $43,800 (2004), while Vanuatu in the South Pacific with a population of 212,000 (2007 estimate) could claim only 292 million in external banking liabilities and had a per capita income of $3,900 – less than 10 percent of the Caymans5.

Using total external banking liabilities as a measure of tax haven activity, only five jurisdictions, the Caymans, Jersey, Singapore, the Bahamas, and Hong Kong, accounted for 83.7 percent of the total for “offshore centres” at the end of 2006, with 15 other jurisdictions accounting for the rest6. And there has been considerable stability over time. Although the role of Jersey has grown greatly in recent years, the other four jurisdictions accounted for 87 percent of total external bank liabilities in 19987.

2 The blacklists

The OECDs (1998) Harmful Tax Competition noted that tax havens could be identified by several characteristics. They:

  • impose little or no tax on relevant income (an innocuous sorting criterion) along with one or more of;
  • a lack of effective exchange of information;
  • a lack of transparency; and
  • “insubstantial” activity attached to the claim of haven location.
  • The points (2) and (3) are linked because, if no local laws compel appropriate transaction recording, there is no information for authorities to share ( OECD, 1998, pp. 22-3 ). “Coordinated responses” were threatened against those jurisdictions that resisted removing policies that met the last three tax haven criteria. Low tax regimes per se were not a problem; aspects of their application often were. Jurisdictions came under attack if they abetted tax evasion through secrecy or tax avoidance through the recognition of nominal rather than real activity.

    Harmful Tax Competition did not list offending jurisdictions. Such a list was to be prepared within a year of the first meeting of a “Forum” designed to operationalize the intentions of the report ( OECD, 1998, p. 57 ). The list was presented in June of 2000, by which time several would-be targets had committed to complying with the OECD's demands. About 35 jurisdictions appeared on this first “blacklist.” But shortly thereafter, the “insubstantial activity” criterion was first gutted and then removed completely. This largely removed the project's threat to the use of the havens by legitimate international business along with its political opposition to the project ( Kudrle, 2008a, b ). The attack on secrecy in the service of tax evasion remained.

    A parallel effort by the developed countries against organized crime took the form of the FATF established following the Paris G-7 Summit in 19898. Adopting the “name and shame” approach much favored by US Treasury Secretary Lawrence Summers ( Sharman, 2006, p. 17 ), the FATF (2000a, b) on Money Laundering published a list of 15 non-cooperative territories in June – the same month as the OECD tax haven list appeared. These territories were tagged as delinquent due to:

  • inadequate financial regulation including customer identification; the permission or mandating of excessive financial secrecy; and a lack of a suspicious transaction reporting system;
  • other regulatory problems including the failure to require adequate information on the beneficial owners of various kinds of businesses;
  • obstacles to international cooperation due to administrative and judicial constraint; and
  • inadequate anti-money laundering budgets and agency activity ( Reuter and Truman, 2004, p. 86 ).
  • The FATF added new states to its blacklist over the following 15 months while taking others off. There were six countries still on the non-cooperating list in July 2004: the Cook Islands, Myanmar, Indonesia, Nauru, Nigeria, and the Philippines ( FATF, 2002, 2004 )9.

    After 9/11, the FATF shifted its emphasis towards terrorist funding, and its prominence began to eclipse that of the OECD project. This reflected rebalanced concern in nearly every major polity towards security and away from whatever local privacy norms had prevailed previously. But local authorities found that the information gathering and sharing requirements for the two rich-country initiatives were quite similar. One observer estimated that “once jurisdictions had complied with the FATF, they had done 90 per cent of what the OECD expected of them” ( Sharman, 2004, p. 6 ).

    The two years after June, 2000 saw all but seven jurisdictions agree...

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