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A top expert on tax havens explains why the Panama Papers barely scratch the surface

Panamanian Law Firm Mossack Fonseca At Center Of Massive Document Leak Involving World's Rich And Powerful Joe Raedle/Getty Images

The biggest scandal in the Panama Papers leak, which revealed that political leaders around the world were hiding money in offshore accounts, isn't about corruption or organized crime.

The 11.5 million files stolen from the Panamanian law firm Mossack Fonseca revealed just how unequal the world is.

The economist Gabriel Zucman estimated in his 2015 book, The Hidden Wealth of Nations, that worldwide more than $7.5 trillion is squirreled away in offshore tax havens — 8 percent of the world's financial wealth. While some of it is properly declared to world governments, about 80 percent, or $6 trillion, is never taxed at all.

Zucman, an assistant professor of economics at the University of California Berkeley, argues that this tax avoidance worsens the vast global gap in wealth and income between the rich and the poor. Hiding vast sums of wealth from taxation makes it easier for the rich to stay rich and avoid tax policies meant to help the poor. Offshore accounts also make it harder for everyone else to get rich, because they're paying higher taxes to make up for the tax dollars the wealthy don't pay when they shelter their assets overseas.

"If we want to deal with rising inequality seriously, then we need to make these forms of tax dodging much, much more limited," Zucman told me in an interview.

We discussed how Zucman totaled up that $8 trillion number by solving a puzzling mystery in global economics, the disturbing lessons from the Panama Papers, and the drastic steps toward transparency Zucman argues are necessary in order to stop tax evasion.

The transcript of our conversation follows, edited and rearranged for length and clarity.


Libby Nelson: You've done a tremendous amount of research on offshore tax havens, the amount of money stored in them, and their contributions to global inequality. As the Panama Papers story unfolds, what's the most important thing everyone should understand about tax havens?

Gabriel Zucman: It's been way too easy for very rich individuals to pay very little in taxes, for both legal and illegal reasons. And the implications of this for inequality down the road are potentially very important.

Tax havens are one of the prime reasons why inequality is rising and may continue to rise in the future. The inability to have a well-functioning tax system at the top end raises the risk of an ever-increasing trend of rising inequality, and that's not something we want.

If we want to deal with rising inequality and rising wealth concentration seriously, then we need to make these forms of tax dodging much, much more limited.

LN: How big is the problem of offshore assets? How much money are we talking about?

GZ: According to my estimates there's about 8 percent of the world's wealth — $7.6 trillion — in tax havens, and 80 percent evades taxes, meaning only 20 percent is duly reported.

The estimate I have for tax losses is about $200 billion per year. That's at the global level, and that's only for one specific form of tax evasion: really illegal tax evasion. So failing to report the income that you earn on your offshore accounts, the dividends, the interest income, and the capital gains that your offshore wealth generates.

That's only for this particular form of tax evasion. There are also lots of other revenue losses due to lots of things — some of which are legal. The $200 billion figure is just for the illegal stuff.

LN: How much does this vary across countries?

GZ: Eight percent is a global average that conceals significant heterogeneity. According to my estimates, the US has a bit less than 8 percent of its financial wealth offshore, maybe something like 4 percent. Europe has a bit more, something like 10 percent.

But then if you look at Latin America, more than 20 percent of Latin America's financial wealth is in offshore tax havens. In Africa, more than 30 percent; in Russia, 50 percent. For many countries in the world, in particularly developing countries, these are extremely important sums. So it means it's really meaningless to study inequality in Latin American and developing countries without considering this issue. It's really a very important phenomenon.

LN: You've also conducted some very important research on wealth inequality — including that the top 0.1 percent of Americans now hold 22 percent of the nation's wealth, nearly the same level as in 1929. What's the connection between this and tax havens?

GZ: The people who own this wealth and who benefit from these tax havens are very, very rich individuals, who are able — sometimes legally, sometimes illegally — to considerably reduce the effective tax rates they pay.

If they pay less in taxes, it has two consequences. First, it's easier for them to accumulate more wealth and remain at the top of the wealth distribution, and that tends to increase wealth inequality. It also means that it's harder for the vast majority of the population to accumulate wealth, because the taxes that are evaded at the top have to be compensated for through higher taxes for the rest of us.

And so at the end of the day this has potentially very big implications for inequality. One of the key determinants of the long-run concentration of wealth is the actual tax rate on capital, on wealth, that rich people face.

Wealth was very concentrated in Europe in the 19th century, when there was very little wealth taxation, and was very concentrated in the US in the early 20th century, when there was no federal income tax. Then there was a big decline in inequality in the first half of the 20th century that's largely related to the big increase in taxation at the top.

If all of this is reversed, there's a real risk that we might reach sustained, very high levels of wealth concentration in the US, and in many other economies. So if you want to prevent that, it's critical to have a well-functioning tax system that is fair, and that taxes the very richest people at least as much as ordinary citizens.

LN: What other problems do tax havens create surrounding income and wealth inequality?

GZ: There's also a measurement question. The way we measure inequality is by looking at tax data. If you're interested in wealth, it's critical to pay attention to what's going on at the very top, because the top 1 percent in the US owns more than 40 percent of US wealth. So you really want to pay attention to the top, and the best way to do that is to look at tax data.

The problem, of course, is that tax data only gives you information about the wealth or the income that's reported to the tax authorities. So it's very important to go beyond that and ask, Okay, what are we missing? How might this bias the levels of wealth concentration, or the trends, the cross-country comparisons?

For the US it makes a bit of difference, and for Europe a bit more. For developing countries it makes a great deal of difference. And so if you want to study global wealth inequality, it's obviously very important as a measurement question to take tax havens into account.

LN: How did you come up with the $8 trillion estimate?

GZ: When you look at the global investment data, you see that there is a big problem, which is that the world's financial assets fall short of the recorded liabilities. So there's a discrepancy.

LN: In other words, there's a lot of money missing from the balance sheets.

GZ: It's been known for quite a long time, but until recently it was a bit hard to understand the reason for that. I was able to show that the bulk of this statistical anomaly is because the wealth that people own in tax havens is not recorded as assets. It's recorded as liabilities, but not as assets, and that's a reason why you have this big imbalance in the global accounts. By using these statistical anomalies I was able to estimate that there is 8 percent of the world's financial wealth in tax havens.

LN: Are there other things this hidden money obscures about the world economy?

GZ: When you look at the official statistics and the net financial positions of nations — who's a creditor, who's a debtor — one of the world's biggest debtor is the eurozone.

And I think that's just wrong. There's growing recognition that it's wrong. This data fails to capture quite a lot of assets, and when you try to reattribute them to the countries that actually own them — to Germany, France, Italy, Greece, Spain, Portugal — this improves the net financial position of these economies. In particular, that makes Europe a net creditor rather than the world's biggest debtor. For the US, the effect is the same but it's less strong — the US is actually the world's biggest net debtor in the statistics, but this exaggerates the reality.

LN: How long have tax havens been a problem?

GZ: For Europe, the massive use of tax havens started in the 1920s, because that's when Switzerland started its offshore wealth management industry, and when Germany and France and the UK started to increase a lot the marginal income tax rates.

But from the 1920s to the 1980s, Switzerland was the only well-functioning tax haven. It was mostly used by Europeans. You can look at the fraction of all US equities that belong to offshore financial institutions and to individuals who live in tax havens — that's data collected since the 1940s by the US Treasury. From 1940s to the mid-1980s, it was very small; about 1 percent of US equities belonged to tax havens.

Then in the 1980s, lots of other tax havens appear — the Cayman Islands, Singapore, Hong Kong, Panama, Bermuda, and so on. And so at the global level, the use of tax havens increases dramatically starting in the 1980s.

LN: What's causing this increase?

GZ: Changes in financial regulation have made it possible for tax havens to develop and grow. Technological change has made it much easier to move money all over the world. And there have been cultural changes in the ways people see taxes — starting in the 1980s, a growing fraction of the population started thinking it's okay to really, minimize your taxability and even evade taxes.

You have all these things combined that explain this spectacular increase that continues to this day. Today about 10 percent of all US equities in the data belong to tax havens.

LN: So how should we see the revelations from the Panama Papers in light of everything you already know about the harms tax havens cause?

GZ: These are leaks that are recent, that cover really recent stuff, all the way to the end of 2015.

What's shocking is that we thought we had made quite a bit of progress, in particular in terms of convincing offshore financial institutions to apply the international anti-money laundering regulations. What we discover is they don't — they just don't care about these regulations. There's an important lesson, which is that we should rethink the way we regulate these institutions. It's good and it's necessary to have regulations and to ask the countries in the world to apply them and have inspections from time to time, but it's not enough.

Many banks and financial institutions in tax havens, and many bankers, have become very rich by servicing tax evaders or criminals. If they have nothing to lose in continuing to do this, some of them will continue. That's what we see in the leaks. In principle, the basic requirement of anti-money laundering regulations is to identify the owners of the wealth that you manage. But the vast majority of the shell companies created by these Panama firms did not even try to identify the initial owners. It was okay to service potential criminals or tax evaders.

And the reason is very simple: It is profitable to do this, and right now tax havens and the firms that operate there don't have much to lose by doing this.

LN: What can be done to change that?

GZ: I think it's important to acknowledge that there's been progress through the financial crisis. So in particular before 2008, there was strictly no exchange of bank information between tax havens and foreign countries' tax authorities. So it was really easy to evade taxes, because there was total bank secrecy.

And this has changed mostly thanks to the US law starting to be implemented right now that forces foreign institutions to automatically tell the IRS about their US clients and their holdings. Now other countries are trying to do the same thing. There's going to be an automatic exchange of bank information that involves many countries around 2017, 2018. So there's been significant progress. The problem is it's not enough to just create laws.

I think we need to clearly say there's clear evidence that out of the 100,000 shell companies in Panama and the British Virgin Islands, many of them are used for illegal activity. Why do we even tolerate these activities taking place? Why do we tolerate that these countries host such an enormous amount of financial activity?

We should have immediate sanctions against places like that and say that the sanctions will remain in place until you're able to prove that you've correctly identified all the initial owners of all the companies that are incorporated on your territory. We need to have this approach that's centered on sanctions to change the incentives and the behavior of the countries and the firms and the people involved in this business.

LN: Would sanctions be enough? What about the activity that isn't necessarily illegal but still leads to losses of revenue?

GZ: We need to invent new modern transparency tools. I think the main challenge is to create financial registries.

All the wealth in the shell Panama companies and the Swiss bank accounts is not invested in Panama and Switzerland. It's invested in New York and London real estate and so on. And what the US and European countries could do is say, Okay, let's start from the wealth that's on our territory and try to find out who owns it. Who are the actual owners of the real estate, and the equities, and mutual funds and bonds and shares on our territory?

This means creating financial registries of wealth and recording the owners of the wealth, and at the end of the day that's the main way to make a lot of progress on these money laundering and tax evasion issues.

It will also be a global public good, in particular for developing countries, which right now are totally unable to have any idea of the wealth of their elite, a big fraction of which is in the US and in Europe. Having this register would be a great service to these countries. They are not involved in the talks for automatic exchange of bank information, so at this stage there's no hope that things are going to improve for them.

LN: That would be an amazing global financial audit. Has anyone tried to create one?

GZ: Well, we have land and real estate registries. They've been in place for decades or even centuries.

All countries are very familiar with their logic: If there's real estate in New York City, we are recording who owns it. Everybody can go online and type any name in the website to find out who owns a building in Brooklyn. This is public, it has been for a very long time, and there's a long track record. I think we need to start from what exists and works well, and expand the scope of these registries by trying harder to find out who are the initial owners.

LN: Right, because you go to look up who owns a building, and it turns out to be a corporation in Delaware with a meaningless name.

GZ: Right now you find out in these registries that these buildings belong to shell companies in Panama and the Cayman Islands. And you need to do much more to find out who's behind these shell companies.

We need to apply the same logic to financial assets, starting from the wealth management industry and asking who their clients are. You are required by law to identify your initial owners to use it for statistical purposes, for financial transparency purposes, for anti-money laundering, and so on.

LN: What don't we know about tax havens that you're hoping to learn through your research?

GZ: What I'm working on at the moment is trying to know more about who really uses these and who really evades taxes. Is it a very tiny elite, or has it increased in other parts of the distribution?

In the financial crisis, there have been a number of tax amnesties in lots of countries that many tax evaders have used [where they can disclose their offshore holdings and pay a smaller penalty]. There's this whole new mass of information that becomes available — I'm not talking about the elite, but about hundreds of thousands of people who have been using tax amnesties.

We can now use this tax amnesty data to have a sense of who evades taxes, how the prevalence of tax evasion varies by income group or wealth group, and the reasons for this, which are very interesting and important questions. That's something I'm particularly excited about, and I think we are going to discover lots of things in the years ahead.