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Offshore Pirate Banks & Tax Havens – Tools of the Super-Rich

By Michael Lewis

offshore banksAccording to Forbes Magazine, an estimated $15 to $20 trillion is sitting in the “pirate” banking system today, a complex, interwoven collection of financial institutions domiciled in tax havens around the world. Nearly one-half of the funds are owned by less than 100,000 people, who comprise 0.0001% of the world’s population. These funds, shrouded in secrecy and protected by layers of anonymous owners, are immune from any government oversight and invulnerable to taxation, maintained by and for the super-rich, as well as multinational corporations.

A 2012 Tax Justice Network report defines the system as “nominal, hyper-portable, multi-jurisdictional, often temporary locations of networks of legal and quasi-legal entities and arrangements that manage and control private wealth – always in the interest of those who manage it, supposedly in the interest of the beneficial owners, and often in indifference or outright defiance of the interests and laws of multiple nation states.” More than one-half of the world’s money passes through pirate banks, otherwise known as “financial black holes,” shrouded in layers of complicated protection schemes. No one knows who buys, who sells, or who benefits.

The wealthy and governments representing the rest of a country’s population have been engaged in a war over taxation since the first taxes were levied. No one likes paying taxes, but taxes, simply put, are the way we share the costs of our common interests, such as defense, highways, airports, and social programs; compliance is based upon the principle of equity – everybody pays their fair share. Unfortunately, according to Nicholas Shaxson, reporter and author of “Treasure Island,” there are “one set of rules for the rich and powerful, and another set of rules and laws for the rest of us – and this applies to citizens of rich and poor countries alike.” The rules and practices of the super-rich are to pay no or as little taxes as possible with collection of even the smallest amounts being difficult or impossible due to the complex firewalls erected by offshore banks to maintain absolute secrecy.

Description & History of the Offshore Banking System

The international financial system was initially crafted more than 50 years ago in the Bretton Woods Conference of 1944 by the British John Maynard Keynes and American Harry Dexter White for the purpose of controlling international finance. Both economists believed that controlling capital flows across country borders, and limiting trade in currencies through exchange controls would give governments more room to pursue their objectives without the influence of international speculators.

Keynes wrote at the time, “Let goods be homespun whenever it is reasonably and conveniently possible. Above all, let finance be primarily national.” While funds flowing to a capital-starved country after the war was desirable, the authors recognized that capital flowing out of a country could be disastrous for the country suffering the loss. Therefore, they consequently proposed a provision in the Bretton Woods Agreement that receiving countries of capital would share information with the countries losing capital. Wall Street bankers, fearing the provision would crimp their business, emasculated the provision ensuring that secrecy, not transparency, in capital transfers would be the result.

In 1947 alone, according to a U.S. government analysis, more than $4.3 billion in private assets was transferred from Europe to the United States, much greater than the American postwar loans to war-torn Europe that year. In fact, America’s entire postwar aid through 1953 was smaller than the capital flowing into this country from the countries that received aid.

Tax havens exist, despite the token opposition of national governments, due to the political power of the world’s largest banks, such as the Bank of England and J.P. Morgan Chase, and their role in the continuing economic competition between countries. The major financial institutions are intimately and necessarily involved in the offshore system, either through wholly-owned subsidiaries and international banking facilities (IBFs), long-standing business arrangements, and/or personal relationships , allowing funds to be easily transferred from a tax haven into one of the major banks, being cleansed and made anonymous along the journey. Over the past 50 years, numerous regulations to eliminate the more pernicious effects of the offshore banking system have been instituted, only to be ignored or diluted by financiers in London and New York.

pirate bank

Elements of Pirate Banks

Like the buccaneers for whom they are named, one country’s pirate is another’s privateer. The pirate bank, the country in which the institution is located, and the country where the hidden funds are ultimately deposited receive enormous financial benefit (capital inflow) versus cost (capital outflow).

The United States and Great Britain have been the primary beneficiaries of the flows since World War II, accepting trillions of dollars in deposits from Third World and emerging economic powers without questioning proper ownership or the source of funds. For example, according to an article in the July 8, 2012 issue of Pittsburgh’s Tribune-Review, the Chinese hid $4 offshore for every $1 invested in 2012, a significant amount of which was invested in U.S. Government debt.

The offshore banking system requires three elements to be successful:

Foreign Domicile

The Organisation for Economic Co-operation and Development (OECD), an international organization to facilitate countries’ efforts to solve common problems, identified 41 tax havens in 2000, of which 38 remained active in its latest report. The list of havens include the Bahamas, British Virgin Islands, Cayman Islands, Hong Kong, Singapore, Isle of Man, Jersey, Malta, and Mauritius.

A foreign presence is essential so that the haven is subject to its own laws, not the laws of the depositor’s nation. A bank account in Switzerland, for example, is subject to Swiss laws, not those of any other country, and, unless there is a treaty requiring cooperation between the country of the depositor and the country of the bank, the Swiss Government is under no obligation to either enforce U.S. laws or identify its U.S. depositors.

Two states of the United States – Delaware and Nevada – are considered tax havens by many foreign governments due to the secrecy provided under each state’s incorporation regulations.

Secrecy

The country in which the pirate bank is located must guarantee the confidentiality of account holders – whether they are depositors, trustees, beneficiaries, or shareholders – to foreign governments. Switzerland, perhaps the most notorious of the tax havens and the preferred recipient of Nazi Germans hiding stolen Jewish wealth, made revealing a client’s identity a criminal offense in 1934.

Secrecy is further enhanced by the use of asset-protection trusts and the practice of “laddering,” where corporations of anonymous shareholders and directors in one tax haven are owned by other corporations of anonymous shareholders in another tax haven. Many havens do not require agents of incorporators or depositors to verify identities, the source of deposits, or the beneficiaries of any funds.

No or Low Taxes

Like water flowing to a lower level, wealth flows to jurisdictions that provide the lowest level of taxation. It would be illogical to move from one locale with a tax rate of 25% to another at the same level, all other factors being equal. However, it makes imminent sense to move from the 25% tax locale to one offering 20% or lower. This economic fact results in a race to the bottom where each country repeatedly lowers its taxes in order to defend its economy and keep wealth within its borders, the circumstance that Keynes and White intended to avoid with capital controls in the Bretton Woods Agreement.

The difference in tax rates allows the wealthy and multinational corporations to manipulate their books and manage earnings and taxes between countries. A company domiciled in a zero-tax country sells services to a related company in a high-tax area at an inflated price, effectively moving profits from one country (high-tax) to the second (no-tax).

For example, Multinational, an electronics manufacturer, has a Cayman Islands subsidiary that owns all of its patents. Multinational has U.S. profits of $5 million subject to U.S. tax. Multinational subsequently pays a $5 million licensing fee for the patents to the subsidiary, reducing its profits in the United States to zero ($0) while showing  a $5 million profit in the Cayman Islands subsidiary. There is no tax in the Cayman Islands, so no tax is paid on the $5 million.

While this example is simple to explain how the system works, multinational companies have layers of subsidiaries in different countries as part of a tax avoidance scheme. This practice is known in accounting as “transfer pricing,” and is integral to stripping and moving profits that would be taxable in one location to a location where no tax is due. The world’s largest companies including Apple, Microsoft, and Walmart actively and necessarily participate in transfer pricing, the intent or legality of which is difficult or impossible to know.

offshore banking

Beneficiaries of Pirate Banks

1. Criminals, Despots, and Dictators 
Meyer Lansky’s use of a Swiss bank account to pay off Huey Long for allowing slot machines in New Orleans, as well as the transfer of pallets of plastic-wrapped dollar bills into the Cayman Islands by Columbian Medellin drug king Carlos Lehder, have been well-publicized, as have the activities of Bernard Cornfield and Robert Vesco and their Investor Overseas Services. The $500 billion annual drug revenues would be a cottage industry if not for the participation of the major money centers, as illustrated by the Wachovia/Casa de Cambios Puebla arrangement, in which Wachovia laundered more than $378 billion for a Mexican drug cartel.

Idi Amin of Uganda, Saddam Hussein of Iraq, Robert Mugabe of Zimbabwe, and Muammar Gaddafi are just a few of hundreds of Third World country dictators who have robbed their countries of billions of dollars and hidden the proceeds in the offshore banking system, generally with the knowledge of the countries and corporations that benefited from their reigns. Rulers in North Korea, Iran, and other less-developed countries continue to use the system to amass great wealth and preserve power today at great cost to those countries’ citizens.

2. Super-Wealthy Individuals and Families
Tax havens are a boon to the super-rich, and are essential for their maintenance of wealth over generations. The mobility of wealth and its power to influence government policy has forced their home countries to either reduce taxes on the wealthy or risk the flight of their capital. The threat to move is not idle, as more than 8,000 Americans are expected to give up their citizenship in exchange for lower taxes in another country. Recently, Facebook co-founder Eduardo Saverin moved to Singapore, following such public figures as William Browder, founder of Heritage Capital Management, and John Templeton, one of the most successful stock fund managers in the 20th century. And it is not just America that faces the threat of capital flight – Irish musician Bono of U2 moved from one tax haven (Ireland) to another (Netherlands) for lower rates.

The threats to move have been effective. For example, in 1992 the richest 400 Americans booked 26% of their income as salaries and wages, and 36% as capital gains. By 2007 they only recorded 6% as income and 66% as capital gains for a much lower tax bite.

Even though recent presidential candidate Mitt Romney pays income tax at a 14.1% rate – an equivalent to someone making about $200,000 a year – he has been actively involved in the offshore banking system, having at least 12 accounts in the Cayman Islands, according to the New York Post. His former company, Bain Capital, became so effective at using the offshore banking system that one strategy became popularly known as the “Double Irish with a Dutch Sandwich.” This is a scheme with transfer payments between a U.S. parent company, two Ireland subsidiaries (one of which is not taxed and the second of which is subject to low Irish taxes), and a Netherlands subsidiary to eliminate the taxes on the second Irish company. Apparently, low tax rates are not enough for the super-rich – they seek to pay no taxes.

3. Multinational Corporations
According to a Citizens for Tax Justice report, 285 of America’s Fortune 500 companies – including many of the country’s largest banks, manufacturing companies, and high-tech firms – had almost $1.6 trillion in unrepatriated foreign income at the end of 2011, with the top 20 companies accounting for more than $794 billion. In other words, this money is theoretically kept outside the country so it will not be taxed.

An analysis of the public information available from the companies indicates that no income taxes to the United States or any other country has been paid, and suggests that the income is likely U.S. profits shifted overseas by transfer payments, most likely by making the U.S. operations a subsidiary of a foreign parent company domiciled in the tax haven.

4. Governments
The operation known as the Iran-Contra affair during the Reagan presidential term was possible only through the secrecy and deniability of the offshore bank system, even though the activity was approved at the highest levels of the United States Government. Similar clandestine activities occur in other countries with the approval of top government officials outside public and traceable channels.

Without the secrecy and the funding ability afforded by the offshore banking system, “black ops” and other covert government activities could not occur. It is impossible to know the extent to which any of the world’s governments have been or are actively engaged in offshore hidden accounts, but it is most likely significant.

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Impact of Pirate Banks

According to a September 2010 report of the Congressional Research Service, the United States loses annual tax revenues of $100 billion a year due to tax havens and the activities undertaken by corporations and individuals to evade taxation. This will amount to more than $1 trillion over the next decade, or about the amount of funds needed to repair the nation’s transportation network. The $100 billion annual loss is equal to about 10% of the projected deficit this year and must be recovered by either collecting higher taxes from those who do pay taxes, or adding the amount to the national debt to be repaid by our children and grandchildren.

Aside from the annual tax revenue drain, utilization of the offshore banking system by the super-rich weakens the integrity of our government system, allowing some to be above the law. Transparency is a fundamental principle upon which democracy and civilization are based. Our Founding Fathers believed in no taxation without representation, yet offshore tax havens epitomize representation with no taxation.

Final Word

Despite the Libertarian belief that personal property is inviolable and tax is theft, communities need government, and governments need funds. A fair and equitable tax system should be the goal of every American. While offshore banks are necessary in today’s shrinking world, the extreme secrecy and ability to hide financial transactions from public view needs amendment.

The Bank Secrecy Act of 1970 has long required citizens with a financial interest in or signature authority over a foreign bank account to report annually to the IRS. In 2013, the Foreign Account Tax Compliance Act, requiring identified tax havens to agree to information-sharing or be subject to withholding of any funds sourced through the U.S., goes into effect. Let us hope these laws will reduce the current abuses of the pirate bank system.

Do you think taxes are justified? How much is too much? Should anyone be exempted?

Michael Lewis
Michael R. Lewis is a retired corporate executive and entrepreneur. During his 40+ year career, Lewis created and sold ten different companies ranging from oil exploration to healthcare software. He has also been a Registered Investment Adviser with the SEC, a Principal of one of the larger management consulting firms in the country, and a Senior Vice President of the largest not-for-profit health insurer in the United States. Mike's articles on personal investments, business management, and the economy are available on several online publications. He's a father and grandfather, who also writes non-fiction and biographical pieces about growing up in the plains of West Texas - including The Storm.

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  • Mzvon88

    Don’t get me started! Yet again a perfect reminder of how WE everyday working folk with average or low level incomes get screwed each year, while Republicans fight over their rich corporate pals paying their fair share in taxes!!

    • Mlewis

      It seems that we sometime have a break in communications between those who govern and those who are governed. I don’t think most people detest the wealthy or don’t want to become wealthy, they just want them to pay their fair share. I’m not hopeful that the playing ground will be leveled in the future; it is more likely that the gap between the the Super-rich and average Americans will expand.

      Thanks for writing.

  • Ramonthom

    A very very well written article on a complex topic. I read every word, and understood it perfectly.

    Thank you, and well done!

    • Mlewis

      Thanks for your kind words, I’m glad you enjoy my articles. Are there other economic subjects that interest you?

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