Magazine issues » Autumn 2012

INTERVIEW: A big black hole

Black-holeThis year may see major political transitions in China and the United States – that could influence regulation around tax havens. Stefanie Eschenbacher talks to James Henry of the Tax Justice Network.

As much as $32 trillion of hidden financial assets may be held offshore by high-net-worth individuals, according to the Tax Justice Network (TJN).

Its latest report, entitled The Price of Offshore Revisited, states that at least $21 trillion of unreported private financial wealth was owned by wealthy individuals via tax havens at the end of 2010.

James Henry, a former McKinsey & Co chief economist who completed the research, says this is a “rather conservative” estimate and the number may be as high as $32 trillion.

This year will see critical political transitions and their outcome will most likely influence the degree of regulation around tax havens.

The Communist Party in China is preparing to change its leaders for the first time in a generation, although it is unclear how much will actually change as a result.

Perhaps more significant for wealth management will be the outcome of the forthcoming US presidential election.

The presumptive nominee of the Republican Party, Mitt Romney, challenges president Barack Obama.

“It is hard to believe that a Romney administration would crack down on offshore tax havens,” Henry says. “Under Obama, progress towards greater transparency for secrecy jurisdictions has been slow, but the US Treasury has at least been making some progress.”

Henry has calculated that the world’s top 50 leading banks in international private banking collectively serviced more than $12.1 trillion in cross-border bank deposits, assets under management and brokerage assets for private clients at the end of 2010.

To put this into perspective, the total value of the world’s financial stock stood at $212 trillion at the end of 2010, according to the McKinsey Global Institute. This number comprises equity market capitalisation and outstanding bonds and loans.

Using Henry’s estimates, up to 15% of the world’s financial wealth could be held in offshore accounts.

Since 2005, the wealth serviced by the top 50 international private banks has grown at an average annual rate of 9.8%.  The top ten banks alone managed over half of the top 50 banks’ assets. And they appear to have increased their market share.

The TJN has made these calculations using the total client assets of private banks, which many of the banks release with their financial statements, but deducting domestic financial assets. A major challenge, though, was that reporting practices and definitions differ among institutions. “We had confidence that these numbers are in the ballpark,” Henry says.  

He adds that he used three independent methods of estimation: a model of total portfolio wealth based on Bank of International Settlements data on cross-border deposits; detailed models of unrecorded capital flows for 139 key source countries; and the detailed estimates for 50 individual banks.

Although average growth rates were maintained even throughout the financial crisis, according to Henry’s data, it may have slowed since 2010 because of the developments in Europe.

Overall, these findings suggest that inequality may be worse than previously thought.

“On balance, the offshore haven industry is having several very negative impacts on global economic development,” Henry says. “It is boosting inequality and poverty, undermining financial regulation, accelerating capital flight from poor countries, and promoting corruption and organised crime all over world.”

Widening gaps
Even among the rich, there are significant variances.

The number of the global super-rich who accumulated a total of at least  $21 trillion offshore fortune is fewer than ten million, Henry adds. Of these, less than 120,000 people worldwide own at least $6.5 to $9.8 trillion of wealth offshore.

The TJN calculates that if all this unreported wealth earned a modest rate of return of 3%, and that income was taxed at 30%, this would have generated income tax revenues of up to $280 billion. Taxes on inheritances and capital gains would increase this.

Henry says the lost tax revenues are enough to make a significant difference to the finances of many developing countries. “Once we take these hidden offshore assets and the earnings they produce into account, many so-called debtor countries are in fact revealed to be quite wealthy,” he says.

“The real problem is not necessarily their debts, but the fact that so much of their wealth is located offshore, in the hands of their own elites and their private bankers.”

The offshore system is like a “black hole” in the international economy, he says, and the challenge is to figure out ways to tax it or get it to return home.

One solution, according to Henry, could be an annual withholding tax of 0.5% on anonymous capital.

Tax haven critera
The Organisation for Economic Co-Operation and Development uses four key factors to determine whether a jurisdiction is a tax haven.

The first is that the jurisdiction imposes no or only nominal taxes. But it acknowledges that this criteria is not sufficient.

It takes three other factors into consideration: whether there is a lack of transparency; whether there are laws or administrative practices that prevent the effective exchange of information for tax purposes with other governments on taxpayers benefiting form the no or nominal taxation; and whether there is an absence of a requirement that the activity be substantial.

The TJN highlights that offshore finance is not only based in islands and small states, but that it has become an “insidious growth within the entire global system of finance”.

The largest financial centres of London and New York, as well as countries like Switzerland and Singapore, offer secrecy and other special advantages to attract foreign capital flows.

Asian wealth hub Singapore, for example, is not typically considered a tax haven. Although both jurisdictions were not studied in-depth, Henry says there is anecdotal evidence that money is flowing into Singapore and to Hong Kong.

The TJN’s calculations do not consider other categories of non-financial offshore wealth, liek real estate, art collections, ships and intellectual property. So, even after all these calculations that have already been made, there is another big black hole when it comes to non-financial wealth.

©2012 funds global

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