10 Jan How DO tax havens work?
A key implication of a globalised economy is that establishing fair tax systems is an increasingly international affair.
As Europe improves its commercial cohesion, we suffer terrible losses of public revenue to the tax planning of our continent’s most aggressive international players.
Every year, EU countries lose €170 billion due to cross border tax evasion. €60 billion of this is accounted for by large corporations’ profit shifting across EU borders €46 billion is accounted for by wealthy individuals. A proportion of the loss is also illegal — €64 billion being lost to cross-border VAT fraud.
These losses are mostly caused by large multinationals with the motivation and means to take advantage of the various loopholes (intentional or not), that exist between jurisdictions.
In total, 10% of the entire GDP of the EU is held in offshore financial centres, of which about 75% is not reported to the tax authorities at all.
As nations compete with one another to lower commercial tax rates (Europe saw an average 10% decrease in the first decade of the millennium), private individuals must pick up the shortfall. While six EU states have managed to benefit from the international disparity in Europe’s commercial tax rate (Belgium, Cyprus, Ireland, Luxembourg, Malta and the Netherlands), the average tax burden of the individual in relation to GDP is now at a record high. A continued failure of the Union to stem these practices will undermine trust and solidarity between nations whose common goal is peace and a means for private citizens to compete on a level playing field.
It is perfectly legal for multinational corporations to shift their profits from the country in which they operate to lower-tax jurisdictions within the EU. In 2016, the worst affected nations were: Germany (€18 billion), France (€11 billion), and the United Kingdom (€14 billion).
Over the past decades, the EU has witnessed a “race to the bottom” as regards tax rates on capital, and in particular on corporate profits: in effect we have gone from an average standard corporate income tax of 34-35% in ‘95-99, to 24% in 2009 and then to 22% in 2019. Not even the global financial crisis was able to stop this international tax competition which benefits primarily large corporations and costs society since it results in a fall of corporate contributions to public goods. To put this into numbers, the corporate income tax represented 10% of total tax revenue in EU countries in 2007: over the following decade, this fell by two percentage points to 8%.
The race to the bottom has not only benefited the corporate world: it has also benefited the richest. Top income tax rates have fallen in the EU from 47% in 1995 to 38% in 2008 and have remained roughly stable since. From 1995 to today, a total of 22 EU countries reduced their top income tax rates.
Whilst corporations, multinationals and the very richest have benefitted, the tax burden has shifted onto the rest of society, ie, those with medium and low wages. This is likely a driving factor not only of rising inequalities, but also of rising discontent and sense of injustice felt by European citizens.
Much of the tax evasion through corporate tax is technically legal. Multinationals use the very means to prevent tax evasion – such as double taxation agreements – to gain tax-neutral dividend payments and avoid withholding tax on interest. By manipulating their declarations of profit into specialised tax categories (such as copyright, utility models and trademark), they can also separate the transfer of tangible assets from the country in which the contract is held to take place. Multinational firms may also distort the prices of assets moved within their companies – which can be hard to determine where the firms holds a monopoly or near monopoly on the type of good or service provided.
Special Purpose Entities are often set up by cynical multinationals in order to create the necessary economic and legal noise to excuse the shifting of large sums of money or assets from one tax jurisdiction to another. These Entities are proliferating in Europe and now account for 80% of Foreign Direct Investment in Luxembourg and 90% of FDI in the Netherlands.
It is important to note that EU tax havens are mostly treated as intermediate destinations, used to further transfer profits to other, more traditional tax havens such as the Cayman Islands or Panama.
A fair tax system is a challenge for the EU as a whole: from loss of revenue due to profit shifting, wealthy individuals evacuating funds to international financial centres to VAT fraud, all in all, these practices are costing the EU an eye watering 150 bn euros annually. The losses from corporations and wealthy individuals are mitigated by raising the tax burden on us, the rest of society. Over time, this will lead to ever greater inequality, civil discontent and a sense of injustice.
Several countries in the EU, specifically the Netherlands, Belgium, Luxembourg, Cyprus, Malta and Ireland, deepen the problem through their legislation which benefits them, but deteriorates EU cohesion and degrades the very idea of EU solidarity.
There are some ways of fixing the current issues and proposed solutions include screening EU member states for the European Union Tax haven blacklist (the EU list of non-cooperative tax jurisdictions), giving the European Commission the power to impose sanctions on countries classified as tax havens, eliminating low corporate tax rates by setting an EU wide minimum corporate tax rate and introducing EU wide solution and a cohesive and mutual front against tax evasion.