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Tax Havens: Stunting Latin American Development

Bethan Rafferty, November 21, 2010

Benjamin Franklin once said, "In this world nothing can be said to be certain, except death and taxes." However, with battalions of highly paid "tax professionals" searching for ways around tax legislation for multi-national corporations (MNCs) and wealthy individuals, taxes are not as inevitable as Franklin envisaged. In Latin America, taxation-related problems are rampant, especially in the Caribbean, where many islands are considered offshore financial centers (OFCs) by the International Monetary Fund. Along with facilitating tax evasion and money laundering, the use of tax havens for legal tax avoidance is contributing to poverty in much of Latin America.

Tax havens are in many ways a legacy of the British Empire. The use of tax competition as a method of attracting foreign investment and promoting local development started in the 1960s when a number of countries, including many in the Caribbean, gained their independence from European powers. These newly independent nations were in search of development strategies that would be viable in tiny island states with few resources; they were led to believe that promoting "tax competition" would bring wealth to the islands. However, "tax management" schemes have often been intimately related to the crippling inequality and injustice that has characterized the region. Ultimately, finance salesmen, along with social elites and multi-national corporations, are the only real beneficiaries of "tax competition."

Tax Havens

According to the Organisation for Economic Co-operation Development (OECD), the criteria that define a jurisdiction as a tax haven include: minimal or no taxation, lack of transparency, and the existence of laws that prevent the exchange of information between governments. In Latin America, well-known tax havens include Panama, Belize, Costa Rica, and Uruguay. In addition, in the Caribbean, the Cayman Islands, the U.S. Virgin Islands, and the British Virgin Islands are among the most notorious tax havens in the world. Due to its close proximity to the United States, the Caribbean's OFCs are particularly popular with U.S. corporations. The existence of tax havens in Latin America is a serious impediment to the development of stable societies in the region for a number of reasons.

One major threat posed by tax havens is that they enable criminal networks to operate under the pretense of legitimate enterprise. Secrecy and anonymity are inherently linked to tax avoidance, making these regions particularly susceptible to illegal activity. When addressing criminal activities and tax havens, it is important to bear in mind that this includes not only the implantation of professional criminals, but also corrupt officials who work in tandem with them. According to the global corruption watchdog Transparency International, "Corruption in Latin America remains part of serious structural problems that not only adversely affect the region's economic and democratic development, but also place a direct burden on the population." Indeed, tax havens give criminal networks, including drug-trafficking organizations, a safe place to hold the billions of dollars in profit they earn each year. This is demonstrated in the infamous case of Panamanian General Manuel Noriega's complicity with the Colombian drug lord Pablo Escobar, who laundered money in the Bahamas and Panama.

Drug trafficking in Latin America is dependent on a network of corrupt officials. Tax havens offer a way for individuals to violate their domestic laws and abuse power without consequences. According to Transparency International, malfeasant Latin American officials have used tax havens across the world; ex-President of Haiti Jean Claude "Baby Doc" Duvalier, ex-President of Peru Alberto Fujimori, and ex-President of Nicaragua Arnoldo Alemán were all guilty of embezzlement facilitated by tax havens. A U.S. Senate report found that the U.S.-based Riggs Bank assisted the notorious Chilean dictator Augusto Pinochet in setting up secret offshore accounts in the Bahamas.

Many states with "tax haven" status are motivated by promises of rapid development and a higher standard of living for their citizens. However, as the United Nations Office on Drugs and Crime points out, countries trafficking "dirty money" actually find it more difficult to attract long-term foreign investment because investors prefer settings with "stable conditions and good governance." Consequently, becoming an OFC is, more often than not, a misguided development strategy. It is rarely the case that a country's GDP vastly improves as a result of becoming a tax haven. Indeed, the process often leads to increased inequality, with the majority of the wealth that enters the country remaining in the hands of rich foreigners. Panama, for example, has a Gini index rating (a measure of inequality) of 56.1, which is roughly double the level of Japan or Germany. Some try to justify the loss of tax revenue by arguing that significant income will be generated from a growing housing market to cater to foreign nationals attracted by lucrative tax conditions. However, rising house prices can lead to locals being priced out of the real estate market, forcing them, in many cases, to migrate.

Legal tax evasion

A further damaging characteristic of OFCs is the legal tax evasion encouraged by tax havens seeking the investment of MNCs and wealthy individuals. According to Tax Justice Network, an NGO fighting for ethical taxation practices throughout the world, "Assets held offshore, beyond the reach of effective taxation, are equal to about a third of total global assets." MNCs actively avoid paying taxes both in the countries where their raw materials originate and in the countries where they make most of their sales and profits. The most common way of doing this is through "transfer mispricing," which involves one branch of an MNC over- or under-charging another branch for the use of goods and services, thereby putting the profit of the company in an artificial low-tax jurisdiction. While many companies claim to practice "corporate social responsibility," the widespread use of this practice suggests otherwise.

The Guardian points out that many corporations have green policies and charitable foundations, but few of those corporations address their use of OFCs and tax havens. Good examples of this are the Chiquita, Delmonte, and Dole fruit companies, all of which source bananas from plantations in Latin America and West Africa. From 2002 to 2007 these companies paid an effective tax rate of 14 percent despite having headquarters in the United States, where the corporate tax rate was 35 percent. Indeed, the preference for pseudo-philanthropy regarding taxes is so widespread that it affects whole regions. According to Oxfam, an NGO that focuses on world poverty, developing countries lose more than $50 billion each year to tax havens, which is about the same amount given in aid to developing countries each year by wealthy nations. From this, it can be concluded that to maximize development in poorer countries, tax avoidance must be addressed. According to the Tax Justice Network, "Tax is the most important, the most beneficial, and the most sustainable source of finance for development. The long-term goal of poor countries must be to replace foreign aid dependency with tax self-reliance."

Personal taxation

One of the most salient taxation issues in Latin America is the under-taxation of its wealthiest citizens. Latin America has the highest levels of inequality in the world. One of the more reliable ways to ensure the progress of Latin American countries would be to fund social development programs, such as education and healthcare, with tax money. However, this process is hampered by the great lengths to which Latin American elites will go to avoid paying taxes. According to fiscal expert John Christensen, "More than 50 percent of the total holdings in cash and listed securities of rich individuals in Latin America is held offshore." If Latin American governments invested in creating efficient, competent, institutionalized tax systems with repercussions for tax avoidance, there would be a sizeable increase in financial resources for development in the region. Secretary of State Hillary Clinton addressed the theme of under-taxation in Latin America in a recent speech in Quito, Ecuador: "In many places, it is also a simple fact that the wealthy do not pay their fair share. We can't mince words about this. Levels of tax evasion are unacceptably high—as much as or more than 50 percent in some of the region's economies when it comes to personal income tax."

What else can be done?

The fact that some forms of tax avoidance are legal needs to be further addressed in the international arena. The United Nations has the potential to be one of the most powerful forces against tax evasion and tax avoidance. The United Nations is currently working on the Stolen Asset Recovery Initiative (StAR) with the World Bank Group, which aims to recover assets stolen by corrupt leaders. Although the StAR initiative, along with the U.N. Convention Against Corruption, tries to tackle the problem of tax havens, it must go further and combat those attempting to evade tax laws, and address the legal loopholes involved.

Another powerful tool that can be used to address the issue of tax avoidance is public awareness. If pressure groups demonstrated that this was a crucial issue to the public, organizations such as the G20 would have no choice but to confront the problem. If voters were aware of the fact that "each year the U.S. may lose a total of about $100 billion in potential taxes, France about $50 billion, Germany $30 billion, the U.K. between $20 billion and $80 billion, and the developing world loses up to $800 billion in stolen capital," a more aggressive opposition to tax avoidance might emerge. President Obama acknowledged this problem during his presidential campaign and has since announced initiatives aimed at U.S. corporations' use of OFCs. If Obama's stance is any indication of future political action, tax avoidance may become a deservedly more important issue in the international political arena, with tangible implications for the future prospects of development in and outside of Latin America.

This article was originally published by the Council on Hemispheric Affairs: www.coha.org/. Bethan Rafferty is a COHA research associate.

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