The recent Panama Papers leak has brought tax havens to the forefront of public policy discussions. Naturally, many individuals and supranational entities have advocated for more stringent regulations on tax havens and tougher Anti-Money Laundering (AML) programs in response to these revelations. Entities such as the Organization for Economic Co-operation and Development (OECD) have spearheaded this push to penalize tax havens.
The OECD has used the recent release of the Panama Papers to not only condemn Panama for its tax haven status, but has also doubled down in its efforts to impose more onerous rules on money laundering and tax evasion. Interestingly, organizations such as the Financial Action Task Force (FATF) recently removed Panama from its grey list of countries that did not have adequate measures that impede money laundering and dirty money practices.
Like the OECD, the FATF is not very keen on the idea of tax competition but it is rather telling that it decided to remove Panama from its list of suspicious countries. This is no isolated incident, as countless other offshore jurisdictions such as the Cayman Islands have actually beefed up their laws against dirty money over the past few years. Ironically, these much maligned offshore sites have stricter due AML measures than many OECD countries.
So what is truly at stake in the recent response to the Panama Papers? This article will seek to analyze what PEPs are; which notable politicians were involved in the Panama Papers; whether or not expanding current PEPs and Anti-Money Laundering (AML) measures are effective forms of policy; and the political implications of the Panama Papers.
What are PEPs?
The FATF, which was established in 1989 by the G7, has led the push against money laundering around the world. Over the years, FATF has developed a “politically exposed person” (PEP) standard as a way to combat money laundering and terrorist financing at the highest echelons of government.
In short, a PEP is an individual – a government official or their family members or close associates – who could use their public office for ill-gotten gains or be at greater risk for corruption or terrorist financing. The standards for determining what constitutes a PEP are not universal, but there is general consensus among countries that the 2003 FATF standard is the norm for the financial services industry.
List of PEPS involved in the Panama Papers
The following politicians have become targets of controversy because of information in the Panama Papers:
Former British Prime Minister David Cameron had criticized complex offshore structures for not operating in a fair manner in 2013. In an ironic twist of fate, the Panama Papers would later reveal details of the offshore trust, Blairmore Holding, Inc., that his father Ian Cameron established in 1982. While Cameron did hold shares in Blairmore in the past, he claimed to have sold his shares before becoming prime minister. Nevertheless, he has received significant criticism for his dealings in the offshore trust by opposition leaders. More fuel has been added to the fire as new details have emerged that implicate fellow Conservative Party members in offshore activities.
In response to the Panama Papers, President of Ecuador Rafael Correa proposed an ethical pact to reject candidates in upcoming elections that hold money in tax havens. At first glance, this response seemed natural given Rafael Correa’s penchant for populist economic policies. However, new developments emerged from the Panama Papers in which Correa and his estranged brother Fabrcio Correa were reported to have bought Orlion S.A., an offshore company, in 2006. To add more intrigue into the mix, Orlion S.A. was under investigation in 2012, during Correa’s presidency, by the Panamanian government for the alleged embezzlement of state funds.
Sigmundur Davíð Gunnlaugsson
Sigmundur Davíð Gunnlaugsson involvement in Wintris, a foreign company and a creditor of failed Icelandic banks, is one of the most notable political revelations of the Panama Papers. Prior to his resignation as prime minister, Gunnlaugsson was a major player in Icelandic politics who ascended the ranks as chairman of the Progressive Party, eventually becoming prime minister in 2013. The Panama Papers shed light on his activity with Wintris, in which he owned a 50 percent share when he entered office in 2009. Eight months after entering office, he would sell his share to his wife for $1. Although Gunnlaugsson broke no laws, his failure to disclose his share in Wintris did not sit well with Icelandic voters. After widespread protests and pressure from political opponents, Sigmundur Davíð’s resigned from the office of prime minister on April 5, 2016.
Understanding the anti-tax haven motives
What the Panama Papers have demonstrated is that politicians are very involved in offshore activities. According to WikiData, politicians were the most cited occupation group in the Panama Papers. There is nothing inherently wrong in using offshore services, but these recent findings show a degree of hypocrisy on the part of some politicians. Many politicians are quick to lambast tax havens when they themselves or their colleagues use these services.
Moreover, there is an elephant in the living room that is frequently ignored – the fiscal predicament of many OECD countries. The majority of the OECD countries are characterized by generous welfare states. While the benefits of a welfare state make for good politics in the short term, they are very expensive to maintain in the long-term. Coupled with demographic realities, welfare states will find themselves on unsustainable paths after years of lavish spending put them on the verge of potential bankruptcy.
History has shown that when countries are in fiscal dire straits they will look to find a scapegoat domestically or abroad as a pretext for increased taxation. In this case, tax havens are the political class’s new target.
Policy effects of PEP and AML measures
Given the fact that so many political figures were exposed by the Panama Papers, perhaps the real lesson is that FATF and other bureaucracies should focus on reforms that will make it harder for politicians to misuse their power to loot their nations.
Though it is important to be realistic about what can be achieved. If politicians are comfortable with stealing public funds, it is very unlikely additional rules and regulations will have much impact, whether those policies come from FATF or elsewhere.
Alternatively, FATF can devise rules for financial institutions that arguably would be effective, such as mandatory disclosure of all assets owned by politicians, their families, and close associates, combined with prohibition of foreign financial accounts for those individuals. But such dramatic steps surely would face an uphill battle since FATF bureaucrats know that their (tax-free) salaries are dependent on approval by governments.
In any event, AML measures that make criminal actions more expensive for politicians would, on paper, make looting less likely.
But it would be very important for the rules to be narrowly targeted on politicians and the people close to them. Extending such rules to the broader population would necessitate a gross misallocation of resources. Economics has demonstrated repeatedly that policies often produce unintended consequences that deviate substantially from the lawmakers’ original intent. AML laws that require individuals and companies to complete extensive amounts of paperwork, for instance, result in increased costs that inhibit the effective functioning of the financial sector.
This dynamic is most visible in developing countries, where banking is at times cost prohibitive for many individuals. According to a 2014 World Bank report, 62 percent of adults worldwide have accounts at banks and other financial institutions. That being said, there still exists wide disparities in banking accessibility between the developed world and the developing world.
The 2014 World Bank report sheds light on how documentation requirements are a significant barrier to account ownership, with 18 percent of adults citing these types of requirements as a hindrance to account ownership. By the same token, 23 percent of adults cited costs as another barrier to setting up bank accounts.
Generally speaking, these high costs can largely be attributed to the regulatory expenses incurred by banks due to the anti-money laundering requirements. In turn, financial institutions pass the burden on to consumers through higher costs and fees. FATF has even recognized this unintended consequence and has tried to implement safeguards that promote more financial inclusion.
Panama Papers: Qui bono?
Who benefits from the recent release of the Panama Papers? It has become clear that not only multinational organizations such as the OECD have benefitted, but also populist politicians on the far left have gained much traction with the release of the Panama Papers. Politicians such as Jeremy Corbyn in the United Kingdom, Bernie Sanders in the United States, and Pablo Iglesias in Spain have unsurprisingly railed against the latest revelations from the Panama Papers. Their respective calling cards are their perceived independence from the “establishment” political left and right.
In reaction to the Panama Papers, Iglesias has called for an international tax collection agency to prevent tax evasion. Iglesias has had choice words for Spanish political elites, viewing them as the ruling “caste” that is supposedly fostering corruption and economic inequality. The Panama Papers has provided Iglesias and his party Podemos (We Can) the ideal springboard to pick up steam throughout Spain.
Similarly, Jeremy Corbyn, the Leader of the Labour Party in Great Britain, has capitalized on the release of the Panama Papers to attack the then-Prime Minister David Cameron for his involvement in offshore activities. The case that the Panama Papers brought to light did not reveal criminal action on Cameron’s part. Nevertheless, Corbyn has made sure to score points by demonstrating the purported corruption of Cameron and his Tory colleagues.
Bernie Sanders has long advocated for measures that would impede tax reduction practices. Five years ago, Sanders made his voice heard when he stood up against the U.S.-Panama Trade Promotion Agreement, where he claimed in a speech before Congress that large corporations evade $100 billion in U.S. taxes through the use of “abusive” and “illegal” offshore accounts based in Panama. Fast forward to the present, Sanders has advocated for an immediate repeal of the Panama Free Trade Agreement and has vowed to prosecute banks, corporations and individuals who hold money illegally in offshore accounts.
Although, it remains to be seen whether Corbyn, Sanders or Iglesias will make further political headway in their respective careers, they have undoubtedly used the recent Panama Papers controversy to advance their populist platforms. Politics has demonstrated that even when certain policy prescriptions are deemed to be too radical for the general public, political posturing by certain political gadflies can gradually shift the proverbial Overton Window of public opinion towards their pet policies.
It is ironic that politicians and international bureaucracies are using the Panama Papers as an excuse to impose higher burdens on the private sector when the only real revelation from the stolen documents was that politicians were the biggest users of offshore structures. And unlike private sector users, who generally utilize companies, trusts and other structures for legitimate purposes, it is far more likely that politicians were seeking to hide ill-gotten gains.
All in all, AML measures should be focused on elected officials and other figures that hold national office. In theory, public officeholders are agents of their respective political jurisdiction, thus must be held to higher standards of conduct in all spheres of their lives. It stands to reason that any individual that pursues public office must cede a certain degree of privacy.
However, AML standards that are applied to the general populace may turn out to be costly for countless individuals. Developing countries are often the forgotten man in these discussions as they do not necessarily have the luxury of having cost-effective banking services at their disposal.
The world would be better off with a vibrant system of tax competition among countries in which citizens are treated as customers and nations are incentivized to compete with each other to acquire the most productive individuals across the globe. In the end, simplified tax laws that emphasize territorial taxation through consumption taxes on all economic activity realized within a country’s borders, would be a more cost-effective manner of reducing the incentive for tax evasion and the circulation of dirty money.