Dan Mitchell interviews: Ann Hollingshead

Read the article in the Cayman Financial Review Magazine 

Ann Hollingshead specialises in sustainable economic development, anti-corruption and human rights.  

Dan: Why does “offshore” have a negative connotation to some people?

If there’s one thing Americans don’t like it’s “unfairness.” I think much of the American public (I won’t speak for other nations) accurately perceives tax avoidance via the offshore industry as an advantage that only wealthy people get to use. The average household with a $50,000 annual income pretty much has to pay the taxes that they have to pay. When you get up into the upper income brackets – and this became abundantly clear this year with Mitt Romney’s run for president – there is a lot of gray area.

Those households can adjust their tax rates downward pretty substantially. One of the reasons for that is the offshore industry, which to some extent facilitates the lower tax rates paid by wealthier Americans. It’s one of the reasons Warren Buffet pays a lower rate than his secretary. And it’s definitely something that only our nation’s wealthy are able to exploit. That’s fundamentally unfair.

Dan: Do you think so-called tax havens have been treated unfairly when many OECD nations also have “offshore” policies to attract foreign capital?

Yes. But we’re going to differ on the solution.

The United States and the United Kingdom have many of the same opaque financial laws as “tax havens”. By the way, I don’t like that word either, though I’m sure not for the same reasons. A lot of the international dialogue has pointed fingers at places like Switzerland and Cayman Islands, while ignoring the fact that Delaware and Nevada have many of the same policies.

Actually many US states have even more extreme versions of these policies. When it comes to shell corporations, for example, some OECD countries have much laxer regulations than traditional tax havens, including Cayman Islands. And the United States is pretty much the worst offender.

So to get back to your question, yes I think it’s unfair. But only because we should be applying our condemnation evenly throughout all nations, regardless of size and proportionally to the offence.

Dan: Are there legitimate reasons for people to shield their financial affairs from government?

Yes, I think there are. A lot of people will point out that Swiss banks, for example, protected the assets of Jewish people during World War II from the Nazis. On a moral or philosophical level, I think that religious or other persecution is a legitimate reason to shield your finances from the government.

The truth is, though, that this doesn’t happen that much and it doesn’t justify the offshore industry. How much of that kind of behaviour accounts for the 11 trillion offshore industry that also includes tax evasion, money laundering, terrorist financing and the proceeds of the drug trade, weapons dealing, sex trafficking and other international crimes?

We could probably go back and forth on just how much of each of these activities (legitimate or not) represents what percent of the opaque banking industry. But the truth is, neither of us have the answer to that question because no one knows for sure where all that money came from. And that’s precisely the problem.

And by the way, those same banking secrecy laws also helped out the Nazis who stole gold, jewellery, and other valuables from the millions of Jews they murdered. When they needed a way to place these commodities in the international market, they opened Swiss bank accounts.

I’d also point out, on a philosophical level, that I also believe there are morally legitimate reasons for people to steal. But I don’t think that means we shouldn’t punish criminals.

Dan: Would you support financial privacy protections for people from nations with governments that don’t respect human rights?

This is a complicated one. On a theoretical level, maybe. On a practical level, though, I’m hard pressed to see how it would work in part because it’s so difficult to define. There are a lot of countries that don’t respect human rights on different levels, but it depends on your perspective.

For example, you and I have disagreed on exactly what we should and should not include as a “right”. It comes down to competing values. Who would determine exactly who was violating what right?

This brings up a more important underlying issue, though, which is the interaction between governance and development. There is a spectrum: on one hand we have egregious perpetrators of human rights violations that I’m sure we can both agree on and on the other end we have…

Norway. Pretty much. Anyway, if you look at the countries that fall in the middle-lower end of that spectrum, you see there is an interplay between development, governance and human rights.

With exceptions of course, as countries become more richer, they tend improve their governance (reduce corruption, improve efficiency of government, etc), their population becomes more educated and human rights improve.

Illicit financial flows (illegal cross-border flows of money from developing countries, some of which includes tax evasion) tend to worsen corruption and erode development. In many countries, illicit financial flows are both a cause and an effect of poor governance and slow growth. Stemming illicit financial flows is one way to improve governance and human rights. So if you implement those financial privacy protections, you’re denying those countries one source of development that will eventually improve their governance. These issues don’t exist in a vacuum.

Dan: Without tax havens, do you think tax rates would increase?

No, I don’t. Certainly not in the United States. If this “fiscal cliff” debacle has taught us one thing, it’s that it’s pretty much impossible to change tax rates in this country – in either direction. Our lawmakers make fiscal policy in an incredibly complicated, and often convoluted, way. I think there are a lot of political forces exerting a lot of force in various directions. Tax havens might be one of those forces, but not a decisive one.

Of course, the plural of anecdote isn’t data. Ultimately we have no empirical way of testing that hypothesis. It would be great if we did.

If we were to prove that tax competition lowers tax rates, the larger questions are: (1) whether or not lower tax rates are universally a good thing – I know your answer to that; and (2) whether or not every nation in the world could afford a “race to the bottom” with respect to taxes.

I’m a pragmatist on the first question. In some cases taxes should go up and in some cases taxes should go down. I’d rather we make policy decisions based on data than dogma. To answer the second question, I think there are a lot of developing countries (and probably developed countries, too) where such a race to the bottom would significantly impair their ability to meet their people’s needs for basic services.

Dan: Do you think there should be some sort of international tax organisation, with policing powers over national tax systems?

“Policing powers?” Absolutely not. You and I may differ on our definition of “policing”, though. To me, that word entails force, either physical or otherwise.

Our international system is made up of players with, theoretically, even footing when it comes to matters that occur within their own borders, although I’ll agree it doesn’t always work that way in practice. There is no one at the top of this system to tell our nations what to do. I believe that’s a good thing.

Now, at the same time, I do think there may be a role for an international organisation to observe or witness the practices of these autonomous states and ensure they live up to their treaties and agreements. Ultimately, though, the power to enforce the agreements would still lie with the nations.

Dan: To what extent are nations obliged to enforce the laws of other countries?

Nations are obliged to enforce the laws of other countries to the extent they have agreed to do so. Which is to say, not at all, in many circumstances.

But in the matters of tax, I think we’re not framing the question correctly. I would argue that while countries do not have a moral obligation to “enforce” each other’s laws, they do have a responsibility not to aid or abet citizens of other nations in violating those laws. In some of the more egregious, obvious examples, you’ve got Swiss bankers telling American clients “not to worry” about the IRS because their bank has a “long tradition of bank secrecy”. If that’s not aiding and abetting a crime, I’m not sure what is.

Dan: In places such as the Cayman Islands, the vast majority of the financial sector is comprised of completely transparent and fully compliant businesses such as hedge funds and captive insurance companies. Is there anything wrong with investors picking tax-neutral locations for cross-country business activities?

There are plenty of legitimate banking activities that go on in so-called tax havens, like the Cayman Islands. But I have to disagree that the vast majority of these are “completely transparent”. I can point to lots of examples, but take the Bayou Group and Wood River Capital Management, both high-profile hedge funds that collapsed and were registered in the Cayman Islands.

According to both court documents and SEC lawsuits, managers purposely registered these funds on the island in order to take advantage of laxer regulations that would allow them to cheat investors and avoid more transparent financial disclosures.

But I think what you mean when you say “fully transparent” is that these institutions are complying with existing laws and regulations on the island with regard to financial transparency and disclosures. Maybe they are.

For me, this is not a question of whether or not they are obeying existing laws. This is a question of the economic consequences of those laws and the risks associated with them.

I’m not singling out the Cayman Islands. There are negative consequences associated with the existing international financial system, on its entirety. It’s a system that could use some reform.

Dan: Does Europe’s fiscal crisis suggest that governments will sometimes over-tax and over-spend and that perhaps some sort of external force is needed to limit the choices of politicians?

I think Europe’s fiscal crisis suggests that governments will sometimes under-tax relative to their spending or, conversely, over-spend relative to their taxation.

To answer your question directly, no, I don’t think external forces are needed to limit politicians’ choices. I think internal forces – like voters, a free and fair press and if necessary economic realities – should limit their choices.

I think your particular example is a good one to show how differently we interpret the same set of facts. Let’s take Greece, arguably the quintessential example of the European fiscal crisis.

Several factors have played into its current crisis, but one major component of that equation is Greece’s rampant tax evasion. Greece actually has one of the poorest rates of tax collection in Europe. For Greece, tax evasion is part of the problem, not the solution.

If elected officials, voters and academics want to have a conversation about whether both spending and taxation should be lower in countries in Greece, then let’s have that conversation. That’s a good way to set fiscal policy. But one of the worst ways to set fiscal policy is to set spending rates, set taxation rates, and then allow external forces to impose a discrepancy.

Dan: Critics of tax havens often argue that low-income nations need more tax revenue to support development, but the western world became rich when the total burden of government spending averaged about 10 per cent of GDP. How do you react to the argument that poor nations need better governance rather than more government?

I think the question of what level of government spending leads to the highest level of economic growth is not one that is settled among economists or in the literature. I’ve read some of your own excellent work on the subject, and as you’ve observed, there are some circumstances in which lower government spending would enhance economic growth and some in which it would hinder it.

I could point to a number of studies that support the argument that higher levels of spending will achieve higher economic growth. But the truth is the subject is excruciating complex and I think we can both agree that there’s more to economic growth than taxes.

Moving on to the second part of your question, I absolutely agree that many developing countries need better governance rather than more government. And I think there are a lot of ways to address better governance, but one of them is tax compliance. Don’t get me wrong, I don’t believe that better taxation is a panacea, but since it’s on topic

I think it’s worth bringing up. Taxation can improve governance by developing: a shared interest between the government and citizens with respect to economic growth, a stronger state apparatus as improvements in functional capacity that may extend beyond tax collection and accountability and responsiveness by engaging tax-payer citizens.

Finally I want to bring up one point that is a bit tangential to your question, but worth noting. While it is both a measure and determinant of well-being, GDP is not the only way to measure economic growth and it’s a poor way to measure improvements in human well-being. GDP growth is not, nor should it be, the only objective of government policy or the only metric we should use to appraise it.

Tax matters, particularly tax evasion, are of utmost importance to other measures of well-being and can make a significant difference in terms of other objectives of government, such as reducing income inequality and alleviating poverty.

The opinions expressed here are solely the opinions of Ann Hollingshead and are not necessarily those of the Task Force on Financial Integrity & Economic Development or ECONorthwest.



Ann Hollingshead