Offshore Wealth and Global GDP

Introduction

Alstadsæter, Johannesen, & Zucman (2018) stated that it is very challenging to quantify the global wealth of rich families due to the existence of large offshore wealth management in the industry that was developed in Switzerland, Hong Kong, and the Bahamas among other financial centers in the 1980s. The policies in these countries allow banks to cater to the needs of wealthy individuals around the world. As much as the financial services offered by these banks are legal and acceptable, they bur external authorities from observing the wealth of their clients in terms of their national accounts, and their respective tax records. The study estimated that 10% of the whole world’s Gross Domestic Product (GDP), has been held in various offshore accounts. Therefore, it would be right to assert that the world cannot account for 10% of its GDP. The researchers estimate that in the last four years the offshore wealth and increased massively since the growing number of offshore centers have been integrated into the market for cross-border wealth management. Besides the growth of technology and financial innovations has made it even simpler to transfer money to the oversee accounts. Since most offshore centers would rarely publish any information on such issues, most researchers, scholars, and policymakers do not have the actual picture of who exactly uses the tax havens. The lack of a clear picture has led to various speculation as to who uses the tax heavens and for what reasons. Some speculations are that these offshore centers are used by corrupt political elites, while others think that these accounts are used by people who simply want to get access to better financial services than is not available in their respective countries.

First, the paper starts by quantifying the amount of wealth that is held by each country in all the world’s known offshore tax heavens; this is done by using the newly disclosed BIS bilateral banking statistics to assign the global amount of offshore wealth to every country. Secondly, the researchers investigate the effects of offshore wealth on the levels and trends in wealth concentration. In reference to the studies conducted by Kuznets (1953) and Atkinson and Harrison (1978), various researchers have used tax data to construct top income and the amount of share for different states. A fundamental issue raised by the application of tax return to quantify inequality and also one of the major reasons for tax data have for a long time been perceived with a lot of skepticism is because of tax avoidance and evasion. Therefore, the aims at examining the size and distribution of tax evasion and its effects on inequality. As the findings of this study state the wealthier an individual are, the more likely they are to hide their assets in offshore accounts. One of these banks is identified as HSBC in Switzerland, which held close to 1% of the assets owned by the richest families in the Scandinavian. Besides, those who aimed at evading taxes hid close to 40% of their real wealth in the same bank. Across the three countries, the chances of using an offshore institution and owning assets in tax heavens rise sharply with the wealth. The researchers stated that 50% of the offshore assets are owned by the 0.01% households and close to 80% is owned by 0.1% of the wealthiest individuals. The study revealed that tax evasion is much higher in developed countries as compared to the underdeveloped states. Scandinavian countries are ranked as among the countries with more people using the offshore accounts, with reference to the respect to the law. The underlying question from the increasing offshore trends is why do rich people evade so much? While the most obvious answer is because they can due to the existence of a whole industry in Switzerland, Bahamas and Hong Kong among other countries that would facilitate the concealment of services to the world’s wealthiest people. The offshore industry majorly targets only the wealthiest people who have more than $ 20 million or about $50 million people to invest. The industry is stratified to serve only a few because serving a lot of people would increase the risk of these banks and law firms being found guilty of violating financial laws. People with moderate income, do not have access to such services because they are service providers and business people and therefore do not have a lot of tax to evade. The average and low-income earners who are the majority earn from salaries, wages and pension, which can never be hidden from the tax authority. The paper concludes that for governments and policymakers to tackle the problem of tax evasion, it is crucial that they consider lessening the supply of wealth concealment services. Such frameworks can be attained by changing the incentives derived by the law and financial institutions in the tax heavens such as implementing tax tariffs to non-cooperative tax heavens and high financial sanctions to the offshore institutions found to be promoting tax evasion.

Methods

This is a review based on one paper by Alstadsæter, Johannesen, & Zucman (2018), titled, “Who owns the wealth in tax havens? Macro evidence and implications for global inequality.” The authors of the primary paper used secondary sources to write the research and therefore, the information is written in this review will also be based on secondary data. The study was published n 2018, and therefore, its findings are still relevant to the current global economy and can be used by future researchers, policymakers and interested parties for analysis or to inform policy formulation. The fact the research is two years old renders valid, and therefore this study will be perceived to be up to date and valid. Both Alstadsæter, Johannesen, & Zucman are reputable researchers on their own individualistic reputation and therefore this adds to the reliability and validity of this review. Besides, “Who owns the wealth in tax havens? Macro evidence and implications for global inequality” have been peer-reviewed by various educational moderators and researchers, which renders the whole paper valid and reliable and by extension of this review.

Data collection

As stated earlier the primary research paper used secondary data, for the researchers to capture offshore tax evasion of the wealthiest in the world, they used a new micro-data that made it possible to examine tax evasion patterns by the richest people around the world. The data was majorly derived from the massive leaks from various offshore institutions such as HSBC Switzerland through Swiss Leaks and Mossack Fonseca through the Panama papers. More data was also collected from the tax amnesties that was conducted in the aftermath of the 2008-2009 financial crisis. Working in tandem with past researchers and referring to prior studies, the researchers were able to analyze the leaked data and the amnesty micro-data that was matched to population-wide administrative income and the wealth records of different countries in the world as will be shown in the subsequent sections. In the year 2007, one of the employees working at HSBC Switzerland retrieved the internal record of the bank and handed over the information to the French government. The leaked documents include a comprehensive internal record of close to 30,000 individuals who were using the bank. During the same period, HSBC was among the key players in offshore banking and was managing close to 120 billion USD worth of assets, which was equivalent to 5% of all the foreign wealth that was managed by swiss banks. The HSBC leaked proved to be a unique, yet a helpful source for analyzing tax evasion and studying the trends that were associated with this act. The leak proved to be helpful because first, it was a random event that took the institution by surprise and therefore, the bank had no time to doctor or alter the report. Secondly, the report was produced by a trusted employee of the bank; these two factors rendered the data reliable and trustworthy. Thirdly, the shares held by HSBC Switzerland in the report corresponded to the share of the wealth that was held by Scandinavians in Switzerland, as per the statistics given by the Swiss central bank. More evidence that HSBC Switzerland was a representative provider is that there was only an overlap of 2% of the sample of the bank’s evaders and Scandinavian voluntary disclosures, therefore it was not the case that HSBC was the main service provider of the offshore services that were aimed at creating tax havens for Scandinavians. However, it is important to note that it is not illegal to have an account with banks such as HSBC, however, the illegality aspects creep in when tax evasion is involved. That is if the individual account is not reported to the revenue collection agencies. In this case, about 90% of all the accounts held by the bank were never reported, or rather they were undeclared, which made up a huge sample for the primary researchers to use, to quantify their hypothesis, which was to measure wealth inequality by establishing new estimates of the amount of household wealth that was kept in offshore accounts.

Results

Heterogeneity among countries

The data revealed that the wealthier a country is the more likely its citizens are likely to engage in tax avoidance actions such as hiding their assets at HSBC Switzerland. Besides, it was clear that 1% of the wealthiest people in the Scandinavian countries had undeclared accounts in HSBC, which was the only bank in one tax haven. Besides, tax evaders concealed about 40% of their average wealth in HSBC Switzerland. The most stunning revelation was that offshore wealth was more or less concentrated among certain countries. According to figure 3 of the primary research, the following countries were identified as the countries that had wealth in the Swiss tax haven. The graph plotted each country’s share in the total amount of offshore wealth that was managed by Swiss banks against its share in world GDP. Countries that were above the 45-degree line had more wealth in Switzerland as compared to their world GDP, and vice versa for those below the 45-degree line. From this information, it is expected that countries with low GDP are likely to appear above the 45-degree line as compared to those with higher GDP. Figure 4 also plotted countries that owned offshore accounts in other countries apart from Switzerland. In this figure, states that were below the 45-degree line tended to favor Switzerland as their preferred tax haven, and vice versa for states above the line. The homogeneity identified among countries with large stock offshore assets could be classified in different categories. The first classification was autocratic countries which were identified as Saudi Arabia and Russia, the second was states that had a recent history of autocratic rule and those were Argentina and Greece, the third classification involved old democracies, which were France and Russia. Among these countries, there were also states with the lowest stock of offshore assets, which were mainly low tax countries such as Korea and Japan, alongside states with the world's highest tax countries which are Denmark and Norway. Besides, the proximity to a tax haven also mattered a lot in terms of the preferences of a tax haven. Most countries in Europe and Western Asia tended to prefer Switzerland as their preferred offshore investment destination. Besides, Switzerland was the first state that developed cross border wealth management industry in early 1920 and has gained a reputation for doing so. Therefore, it developed to become the preferred tax haven for individuals in most countries

The major problem that was raised by the swiss data was that a huge percentage of the wealth held in Switzerland as in various tax haven is disguised in paper to belong to the shell companies, foundations, trusts and personal holding entities that were integrated into tax havens. Due to this fact, a huge percentage of the offshore wealth that was managed by Swiss banks was allotted to Panama British Virgin Islands or Jersey in the data. The perpetual use of shell companies became more prevalent after 2005 when the European Union enacted the Saving Tax Directive that aimed at introducing a tax on interest income that was earned by EU residents in Switzerland and other tax havens. Since the tax was not applicable to accounts owned by shell companies, most European depositors hugely changed their assets to shell companies. To prove the effects of the European directive, the researcher went back to the data collected between 2003 to 2004, before the enactment of the policy. Prior to the directive, there was no evidence that residents from specific countries preferred using shell corporations as compared to others, however, after implementing the tax directive, it becomes clear that most European countries preferred using shell companies for their investments.

Implications of Offshore Wealth on Inequality Is Evident

Wealth stored in offshore accounts has been proved to affect inequality in Spain, France and the United Kingdom by about 30-40% of all the wealth of the 0.01% wealthiest household is held in oversees offshore accounts. Such actions have various effects in Russia, where most of the wealth at the top is held in overseas accounts. The same effect has also been felt in the United States of America, however, the impact is less felt than in Europe, since the US top wealth shares are high regardless of the ones in tax havens. Generally, considering the effects of offshore wealth, it is likely to lead to inequality in tax data. The results point towards the importance of going past the trends given by tax data to study wealth accumulation among the richest individuals in a global world. Besides, accounting for offshore investments also increase the rise in inequality that is seen in tax data markedly. Figure 9, gives a summarized depiction of the same.

Discussion

The study revealed that close to 10% of world GDP is held in tax haven globally, but the percentage is different across countries. The Scandinavian states have only an equivalent of only a few ratios of GDP in offshore wealth, but the percentage increases to close to 15% in Europe, and goes above 60% in Russia, countries in the middle east, and various Latin American states. The fact that is the size of offshore wealth cannot be appropriately explained by tax, financial or institutional factors. Countries that had a large stock of offshore assets include Saudi Arabia which is autocratic in nature, Argentina and Greece, which were recently led by dictators and established democracies such as France and the United Kingdom. There are also other countries on the list with a developed financial industry such as Germany and Belgium, in tandem with poorly developed financial institutions such as Venezuela. Low tax economies such as Korea are also in the list alongside the world's highest tax countries such as Norway and Denmark. From the analyses, it is clear that most factors that earlier scholars thought that led to increased offshore assets such as the political system, tax regimes, and the nature of the financial regime, clearly do not lead to the problem. Instead, the study revealed that geography and specific national trajectories mattered a lot. Proximity to Switzerland (a state that has gained the reputation of managing cross-border wealth since 1920) is associated with higher offshore wealth, and the presence of natural resources in a country, for example, oil Saudi Arabia and Gas in Russia. Lastly, the political and economic instability of a country after the second world war also played a huge factor. The study was also consistent with past studies that indicated that the flow to tax havens varied with the availability of the oil industry and political shocks like elections and military coups.

Conclusion

The study aimed at enhancing the quantification of wealth inequality by establishing new estimates of the amount of household wealth that is kept in offshore accounts and research on the effects of oversees offshore assets for top wealth shares. In this paper, we attempt to improve the measurement of wealth inequality by constructing new. The paper successfully draws on newly released data on cross-border bank deposits and provides a detailed country analysis of the estimated amount of offshore wealth that is owned by each state. It was noted that close to 10% of all the World GDP is held in offshore accounts, although other countries such as in the middle east, Europe and Latin America have recorded higher numbers, with Russia leading with close to 50% of its GDP. Besides, the researchers examined the effects of the hidden assets for top wealth shares, among a sample of 10 economies, which has comparable wealth inequality data. In particular, offshore wealth had drastic implications for the Russian Wealth distribution systems. According to the study estimates close to 60% of the wealth owned by the richest households in Russia is held in offshore accounts. Additionally, offshore wealth is likely to have huge implications for the concentration of wealth in various countries especially the emerging economies. Emerging economies like Zimbabwe and Kenya that have been listed in the study pose a good example of how offshore wealth can affect wealth distribution in a country. For example, Zimbabwe has recorded the highest inflation in the world, very high poverty levels, to a point where most citizens were surviving on less than a dollar per day. The country is ravaged with poor infrastructure, low levels of literacy, poor access to healthcare and high mortality rates. On the other hand, Kenya is a country gripped by corruption, high illiteracy levels, poor infrastructure, poverty and poor governance systems. Such are good examples of the effects of offshore investment in a developing country; the richest households’ that store money in these oversee account develops the oversee country at the expense of their own country. For developing countries with no natural resources such as Kenya and Zimbabwe, mostly these assets are obtained through corrupt deals or embezzlement of the public fund to satisfy the interest of a few people.

Reference

Alstadsæter, A., Johannesen, N., & Zucman, G. (2018). Who owns the wealth in tax havens? Macro evidence and implications for global inequality. Journal of Public Economics, 162, 89-100.