Offshore tax havens, traditionally masters of the very discreet low profile, have found themselves pitched center stage under the glare of bright lights and uncomfortably intense scrutiny.
Politicians in the U.S. and Europe, themselves squirming beneath the burden of sagging economies and disgruntled voters, have rallied popular support by declaring open season on tax shelters, branding them as yet one more example of corporate malfeasance and loosely linking them with the departure of American jobs to other countries.
At stake is the tax revenue from an estimated $13 trillion of untaxed wealth squirreled away in offshore accounts by countless companies and corporations, plus well-heeled and well-connected individuals.
The U.S. Government Accountability Office says 83 of the nation's 100 largest publicly traded corporations (by 2007 revenue) reported subsidiaries in tax havens or financial privacy jurisdictions; so too did 63 of the 100 largest federal contractors.
Adding a little extra political wattage to the debate, corporate giants like Citigroup, Bank of America and Morgan Stanley — all recipients of taxpayer-funded bailout money — have scores of offshore subsidiaries.
President Obama, railing against the apparent unfairness and abuse of a system that enables huge earnings to escape almost tax-free, has announced plans that would claw back something like $210 billion in lost taxes over the next 10 years.
"In certain cases," the White House explained in announcing the program, "companies are taking advantage of currently legal loopholes to avoid paying taxes by shifting their profits to tax havens. In other cases, Americans break the law by hiding their income in hidden overseas accounts, and these tax havens refuse to provide the information the IRS needs to enforce U.S. law. Either way, these tax havens make our tax system less fair and harm the U.S. economy."
And in May, while introducing the Stop Tax Haven Abuse Act with lead sponsor Rep. Lloyd Doggett, a Texas Democrat and longtime foe of tax havens, the president said, "Now understand, one of the strengths of our economy is the global reach of our businesses, and I want to see our companies remain the most competitive in the world, but the way to make sure that happens is not to reward our companies for moving jobs off our shores, or transferring profits to overseas tax havens."
Obama has drawn a steely bead on one of the handiest havens for corporate America, the Cayman Islands, while in Europe, French President Nicolas Sarkozy and German Chancellor Angela Merkel are leading the charge against shelters like Switzerland and the tiny principality of Liechtenstein. Meanwhile, seeing which way the wind is blowing, multinationals are seeking new havens, such as Ireland, or renewing relationships with old ones, Switzerland, as BusinessWeek has reported.
Sweetening the advantages of enforcement still more, reining in tax havens is touted as tamping down illegal global money laundering and choking off illicit funding for terrorist groups.
However, just as pitchforks and flaming torches are being readied, other voices — not surprisingly mostly from the business community — are warning of potential downsides. The collateral damage they predict ranges from denting the competiveness of American companies trading overseas to fomenting social unrest in tiny states whose economies have grown dependent on their role as tax havens. (And they object to being lumped in with "tax cheats.")
Business Roundtable — an association of company chief executives representing combined revenue of more than $5 trillion and almost 10 million employees — and the U.S. Chamber of Commerce have both criticized Obama's proposals.
The Obama administration believes that closing international tax loopholes may shrivel the incentive for U.S. companies to ship operations and jobs overseas. But John Castellani, president of Business Roundtable, foresees the opposite effect.
He called it "the wrong idea at the wrong time for the wrong reasons" and predicted it would hinder U.S. companies in foreign markets, cost jobs and "cripple economic growth" at home.
"It couldn't come at a worse time," he added. "The facts clearly demonstrate that expansion by U.S. business abroad leads to more and better paying jobs in America."
The U.S. Chamber of Commerce, representing 3 million businesses, takes a similar view. Eric Wohlschlegel, executive director of communications, said the proposed tax changes will also erode the value of U.S. companies, making them buy-out targets for foreign competitors.
He said the proposed changes were born out of the pressure to find ways of paying for record levels of government spending. "The concern of the business community is that these are short-term solutions with long-term consequences that will do more harm to the economy."
Wohlschlegel said U.S. multinationals are taxed twice — by the countries where they operate and by the United States. Regulations allowing the U.S. portion to be delayed or deferred, until the money is brought back to this country, simply put American companies on "more of an equal footing" with competitors.
Tax-deferred offshore earnings — working a little like tax-free personal pension plans — are regarded as important investment streams since they enable companies to plow unpaid taxes back into their businesses rather than handing it over to Uncle Sam.
"They have this money to invest if they don't pay current tax now," says Michael Vinson, assistant professor of taxation and director of the international tax certificate program at Golden Gate University in San Francisco.
"If a corporation doesn't pay U.S. tax for 10 or 15 years, they have the use of the money all that time," said Vinson, who spent two decades in international tax planning for companies like Apple and Hyperion Solutions, which is now part of Oracle.
Anthony Travers, chairman of the Cayman Islands Stock Exchange and the Cayman Islands Financial Services Association, accuses Obama of political posturing and has written an open letter to the president trying to set the record straight.
He takes issue with Obama on two key points: He says the Caymans are not a tax haven and the so-called loopholes that Obama wants closed are a result of U. S. domestic tax law, easily addressed without what he calls this "appalling rhetoric."
Travers said the Caymans have 27 tax transparency treaties with Europe and one with the U.S., meaning the islands cannot be considered tax havens in the same, secretive way as some others he mentioned — Switzerland, Dubai, Hong Kong, Liechtenstein, Andorra, Monaco.
They are among an estimated 40 to 50 tax shelters worldwide. Exact numbers depend on how they're defined though characteristics may include no or very low taxes, sketchy financial regulation, secrecy, lack of transparency and a reluctance to share tax information with other countries.
Many so-called tax havens also promote themselves as offshore financial centers, touting for foreign businesses to set up subsidiaries and holding companies. Corporate America uses such shelters around the world though places closer to home, such as the Caymans, Bermuda and the Bahamas, are preferred.
Travers also raised the key distinction between tax avoidance and tax evasion. The former seeks to minimize the amount of tax paid through legal use of tax regulations; the latter is illegal.
However, this is such a notoriously gray area that former English Chancellor of the Exchequer Denis Healey once famously described the difference between evasion and avoidance as the "thickness of a prison wall."
Google was recently criticized in the U.K. for spinning British earnings through the Irish tax system, paying 12.5 percent corporation tax instead of 28 percent in Britain. However, Travers sees this simply as a legal, logical and inevitable response to an international landscape littered with different national tax rates.
The Tax Foundation, which describes itself as a nonpartisan research group based in Washington, D.C., and is the nation's oldest nonprofit think tank, reached a similar conclusion in its special report titled, "Bank Secrecy, Tax Havens and International Tax Competition."
The report suggests the U.S. has been caught flat-footed by leaving corporate tax largely unchanged over the past two decades while other nations have been lowering rates. Today the combined U.S. federal and state corporate tax of 39.25 percent is second only to Japan among the 30 countries in the Organization for Economic Cooperation and Development.
"Lawmakers," the report reads, echoing Travers, "need to be careful not to confuse the act of wrongful tax evasion with the effects of global tax competition. U.S.-based firms are already at a competitive tax disadvantage compared to firms based in other major trading nations. Confusing tax evasion with tax competition could lead to policy changes that put the U.S. economy at an even greater competitive disadvantage."
Travers said what Obama is getting upset about are not "tax loopholes" but "perfectly clear provisions of U.S. tax law" that were included for specific tax-deferral purposes and are being used as such by U.S. companies.
The Tax Foundation echoes these concerns, labeling Obama's proposed changes "misdirected" and suggesting it "might be wise for the administration to proceed carefully, lest the 'law of unintended consequences' apply."
Still, Vinson believes there's an even bigger driver behind the use of offshore financial centers — the accounting benefits. He says a company's balance sheet shows the tax rate on worldwide income: the lower the tax, the higher the earnings-per-share and, usually, the higher the stock price.
According to Travers, the Cayman Islands, a British overseas territory totaling just 100 square miles, are home to around 80,000 companies, about 7,000 mutual funds, close to 1,000 insurance companies and around 270 banks.
A study of the economic benefits of banking, insurance, legal services, accountancy, fund administration and other financial services found that in 2007 they accounted for over half the gross domestic product and directly employed more than 5,700 people.
In the wake of Obama's comments, Travers describes the mood among the roughly 50,000 residents as "outrage tinged with concern" though he said the latest proposed tax law changes will have "marginal to no effect" on the Caymans.
However, he is much more worried about proposed future legislation — the Stop Tax Haven Abuse Act — that he describes as potentially "the equivalent of carpet-bombing the Cayman Islands from 30,000 feet."
Such arguments carry little weight with dyed-in-the-wool opponents like the Tax Justice Network. "Supporters of tax havens point to the wealth enjoyed by such tax havens as Switzerland or the Cayman Islands to bolster their arguments," the network's Web site notes under the heading "We oppose tax havens and offshore finance."
"This is like pointing to the wealth of a corrupt politician and arguing that corruption is therefore a good thing: Tax havens effectively appropriate other countries' taxes for themselves."
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