The price of offshore revisited

The price of offshore revisited

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Overall Size

A significant fraction of global private financial wealth -- by our estimates, at least $21 to $32 trillion as of 2010 has been invested virtually tax-free through the world's still-expanding black hole of more than 80 "offshore" secrecy jurisdictions. We believe this range to be conservative, for reasons discussed below.

Remember: this is just financial wealth. A big share of the real estate, yachts, racehorses, gold bricks - and many other things that count as non-financial wealth --are also owned via offshore structures where it is impossible to identify the owners. These are outside the scope of this report.

On this scale, this "offshore economy" is large enough to have a major impact on estimates of inequality of wealth and income; on estimates of national income and debt ratios; and - most importantly - to have very significant negative impacts on the domestic tax bases of key "source" countries (that is, countries that have seen net unrecorded private capital outflows over time2.)

2. Our 139-country focus group: who are the real debtors?

We have focused on a subgroup of 139 mainly low-middle income "source" countries3 for which the World Bank and IMF have sufficient external debt data.

Our estimates for this group underscore how misleading it is to regard countries as "debtors" only by looking at one side of their balance sheets.

Since the 1970s, with eager (and often aggressive and illegal) assistance from the international private banking industry, it appears that private elites in this sub-group of 139 countries had accumulated $7.3 to $9.3 trillion of unrecorded offshore wealth in 2010, conservatively estimated, even while many of their public sectors were borrowing themselves into bankruptcy, enduring agonizing "structural adjustment" and low growth, and holding fire sales of public assets.

These same source countries had aggregate gross external debt of $4.08 trillion in 2010. However, once we subtract these countries' foreign reserves, most of which are invested in First World securities, their aggregate net external debts were minus $2.8 trillion in 2010. (This dramatic picture has been increasing steadily since 1998, the year when the external debts minus foreign reserves was at its peak for these 139 countries, at +$1.43 trillion.4)

So in total, by way of the offshore system, these supposedly indebted "source countries" - including all key developing countries - are not debtors at all: they are net lenders, to the tune of $10.1 to $13.1 trillion at end-2010.

The problem here is that the assets of these countries are held by a small number of wealthy individuals while the debts are shouldered by the ordinary people of these countries through their governments.

As a U.S. Federal Reserve official observed back in the 1980s: "The real problem is not that these countries don't have any assets. The problem is, they're all in Miami (and, he might have added, New York, London, Geneva, Zurich, Luxembourg, Singapore, and Hong Kong)"

These private unrecorded offshore assets and the public debts are intimately linked, historically speaking: the dramatic increase in unrecorded capital outflows (and the private demand for First World currency and other assets) in the 1970s and 1980s was positively correlated with a surge in First World loans to developing countries: much of this borrowing left these countries under the table within months, and even weeks, of being disbursed.5

Today, local elites continue to "vote with their financial feet" while their public sectors borrow heavily abroad - but it is First World countries that are doing most of the borrowing. It is these frequently heavily indebted source countries and their elites that have become their financiers.

In terms of tackling poverty, it is hard to imagine a more pressing global issue to address.

3.  How this wealth is concentrated.

Much of this wealth appears to be concentrated in the hands of private elites that reside in a handful of source countries - many of which are still regarded officially as "debtors."

By our estimates, of the $7.3 - $9.3 trillion of offshore wealth belonging to residents of these 139 countries, the top 10 countries account for 61 percent and the top 20 for 81 percent. (See Appendix 3, p55 for more details.)

4.  Untaxed Offshore Earnings start to swamp outflows.

Our estimates also correct the sanguine view that since new outflows of capital appear to have recently declined from countries like Mexico and Brazil, capital flight is no longer a problem for these countries.

Once we take into account the growth of large untaxed earnings on accumulated offshore wealth, it turns out that from 1970 to 2010 the real value (in $2000) of these earnings alone may be has much as $3.7 trillion - equivalent to about 60 percent of the global total unrecorded capital outflows during this period.6 For Latin America, Sub-Saharan Africa and the Middle East that have long histories of accumulating offshore wealth and unreported earnings abroad, the ratio is close to 100 percent or more.

By shifting attention from flows to accumulated stocks of foreign wealth, this paper calls attention to the fact that retention of investment earnings abroad can easily become so significant that initial outflows are eventually replaced by "hidden flight," with the hidden stock of unrecorded private wealth generating enough unreported income to keep it growing long after the initial outflows have dried up.

5.  Offshore earnings swamp foreign investment.

Another key finding is that once we fully account for capital outflows and the lost stream of future earnings on the associated offshore investments, foreign direct and equity investment flows are almost entirely offset - even for some of the world's largest recipients of foreign investment.

6.  Wide open and "efficient" capital markets: how traditional theories failed.

Standard development economics assumes that financial capital will flow predominantly from "capital-rich" high-saving rich countries to "capital-scarce" countries where returns on investment are higher.

But for many countries the global financial system seems to have enabled private investor motives - understandable ones like asset diversification along with less admirable ones like tax evasion -- to swamp the conventional theory. Reducing frictions in global finance, which was supposed to help capital flow in to capital-starved developing countries more easily and efficiently, seems to have encouraged capital to flow out. This raises new questions about how 'efficient' frictionless global capital markets are.

7.   The active role of private banks.

Our analysis refocuses attention on the critical, often unsavory role that global private banks play. A detailed analysis of the top 50 international private banks reveals that at the end of 2010 these 50 collectively managed more than $12.1 trillion in cross-border invested assets from private clients, including via trusts and foundations.

Consider the role of smaller banks, investment houses, insurance companies, and non-bank intermediaries like hedge funds and independent money managers in the offshore cross-border market, plus self-managed funds, and this figure seems consistent with our overall offshore asset estimates of US$21-$32 trillion.

A disproportionate share of these assets were managed by major global banks that are well known for their role in the 2008 financial crisis, their generous government bailouts and bountiful executive compensation packages. We can now add this to their list of distinctions: they are key players in many havens around the globe, and key enablers of the global tax injustice system.

It is interesting to note that despite choppy markets the rank order at the top of the private banking world has been remarkably stable - key recent trends have been for an increased role for independent boutique money managers and hedge funds, and a shift toward banks with a strong Asian presence.

8.   Offshore Investor Portfolios.

Based on a simple model of offshore investor portfolio behavior, data from the Bank for International Settlements (BIS), and interviews with private bankers and wealth industry analysts, this yields a "scale-up" factor that is also consistent with the aggregate range for 2010 noted earlier.

A simple model, based on a combination of BIS data on cross-border deposits and other asset holdings by "non-bank" investors, an analysis of portfolio mix assumptions made by wealth industry analysts, and interviews with actual private banks, suggests an overall multiplier of 3.0 to scale up our cross-border deposits figure to total financial assets. This is very conservative.

9.   New Revenue Sources for Global Needs.

Finally, if we could figure out how to tax all this offshore wealth without killing the proverbial Golden Goose, or at least entice its owners to reinvest it back home, this sector of the global underground is also easily large enough to make a significant contribution to tax justice, investment, and paying the costs of global problems like climate change.

10.  Other estimates.

In compiling the evidence for this paper, we've had a chance to
examine other recent work by analysts. We find a number of shortcomings, particularly in methods that rely heavily on studies of intra-company transfer pricing. Section 4,below, explores this in more detail.