MONEY AND POWER AND GOVERNMENTS.....
An Insider Spills the Beans on Offshore Banking Centers
By STANDARD SCHAEFER
The oil industry created the practice of countries (SHIPS?) flying "flags of convenience" as a means of avoiding income taxes nearly a century ago. Since the 1960s the U.S. Government itself has encouraged American banks to set up branches in Caribbean hot-money centers and more distant islands as a means of attracting foreign money into the dollar. The initial aim was to help finance the Vietnam War by turning America into a new Switzerland for the world's hot money.
This policy succeeded in turning the United States into a flight-capital center for third-world dictators, Mexican presidents and Russian oligarchs. The former Soviet Union now finances a substantial portion of the U.S. balance-of-payments deficit with the flight capital that neoliberal "reformers" facilitated by backing the kleptocrats. The result has grown into a full-blown system enabling multinational corporations to evade taxes everywhere, including the United States itself. It enables domestic investors to globalize their operations by setting up offshore affiliates Enron-style in the Cayman Islands, Dutch West Indies or some small and newly notorious Pacific Island of their choice.
The permissive regulatory system relating to these offshore beachheads of tax avoidance has evolved to a point that enables U.S. and European investors to shed taxes simply by hiring a lawyer to set up a boiler-place office and finding an accounting firm willing to take its records at face value--which is good enough for the tax authorities to accept in these days of downsized fiscal operations. The resulting plunge in the ratio of corporate tax obligations to national income has been a major factor in America's soaring federal budget deficit. Businesses--and especially the financial sector--establish dummy companies and adjust their transfer pricing (e.g. on sales of raw materials to refineries, and of refined or semi-manufactured products to their final distributors in the industrial nations) so as to take all their profits in these tax-free enclaves.
Flight capital would not leave countries without having somewhere safe to go. A rising number of tax-avoidance islands have made use of the fact that they are small enough to adopt whatever tax code they wish. Lawyers acting on behalf of financial and business lobbies in North America and Europe have drawn up laws to turn these banking centers into what Prof. Hudson calls anti-states.
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SS: In earlier interviews you described how the economy has been "financialized" in ways that free companies from taxation. What role do offshore tax havens play in this?
MH:Companies set up trading companies in tax-avoidance islands and declare whatever income or capital gains they earn on real estate, stocks or other investments to be made by these shells. This has led to the quip that taxes have become purely voluntary for modern businesses.
SS:How does this affect the domestic U.S. economy?
MH:Un-taxing business income--and financial income in particular--leaves individual taxpayers to bear the fiscal burden through wage withholding for Social Security, Medicare and pension-fund contributions. Consumers also bear a rising burden through the sales tax and other local taxes.
SS:Do the statistics confirm this?
MH:Offshore tax havens enable multinational companies to give an impression that they do not earn any income on business done in countries where taxes are levied at European and North American rates. The reality is that U.S. companies make a lot more money than they report. However, offshore banking centers free them from having to pay taxes on this income, or on capital gains. That's why we're running such high budget deficits today.
SS: I understand you have had a forty-year experience with these offshore banking centers and tax-free enclaves.
MH: I was taught the ropes in the course of my work as a balance-of-payments economist, and later as a mutual-fund manager. My first clue to how these enclaves were set up came when I worked for the Chase Manhattan Bank in 1965-66 and was assigned the task of writing a report on the oil industry's impact on the U.S balance of payments. After reading the usual books about how the cartel operated worldwide, I still had difficulty making my way through the oil industry's income-and-expense statements and the statistics published by the Department of Commerce.
My main problem was to find just where oil companies made their profits. Was it at the production end where crude oil was drilled out of the ground, at the processing stage where the oil was refined, or at the distribution end where it was sold to its end-users to heat buildings, run cars, fly airplanes and make into petrochemicals and plastics?
David Rockefeller arranged for me to meet one afternoon with Jack Bennett, the treasurer of Standard Oil of New Jersey (the old Esso before it changed its name to Exxon). "The profits are made right here in the Treasurer's office," he explained, "wherever I decide." He showed me the broad leeway a vertically organized global conglomerate enjoyed in being able to assign "transfer prices" do as to report the overall profit at whatever point taxes were lowest on oil's statistically labyrinthine journey from wellhead to gas station.
Taxes were lowest (in fact, non-existent) in Panama and Liberia, where the oil industry's tankers duly registered their flags of convenience. Standard Oil priced its crude oil low to these shipping affiliates, and sold it at a high, nearly retail price to refineries and marketing outlets in the industrial oil-consuming nations.
SS:How can someone use the statistics to trace what is happening?
MH:It is not easy to find transactions with these flag-of-convenience countries in the U.S. balance-of-payments statistics. Instead of being listed as bona fide countries in Africa or Latin America, they appear under a rather obscure column heading called "international." Cursory viewers tend to overlook it, as it does not indicate a specific country or region. Some people may imagine that it even refers to venerable international organizations such as the United Nations, IMF or World Bank. But what "international" means is, quite simply, "international shipping" registered under flags of convenience. Quite properly, it doesn't really belong to a foreign nation's economy at all, because it is a legal fiction that U.S. companies simply make use of to produce tax filings on an unrealistic "as if" basis.
SS:You're saying that the statistics are translated into a language of unreality.
MH:A carefully structured unreality--and one that has real-world consequences, to be sure. The essence of this game is that Esso and other oil majors were able to "game" the world's tax systems by selling their crude oil at so low a price to their tanker companies as to leave little income for Saudi Arabia, Venezuela or other oil producing countries. This discouraged them from taking control of their mineral wealth, especially as they had no tanker fleets to move this oil. The corporate shipping affiliates turned around and sold their oil to their downstream refineries. These generally were located safely offshore in different political jurisdictions (e.g., Trinidad for Venezuelan oil). The oil was transferred at so high a price that despite the heavy capital investment in these facilities, the refiners and distributors reported losses year after year, decade after decade.
SS:How could the tax authorities in Europe and America not catch on to what was happening?
MH:That's where the political lobbying power of major vested interests came into play. Their ability to avoid having to declare earnings on which taxes would be due reflected the passivity of tax collectors in Europe and North America where most downstream facilities were located. One might think that such governments would have imputed a minimum tax, on the principle that any investment must expect to earn at least a normal rate of return; otherwise it would not be made or kept in place. Turning a blind eye to this logic, governments accepted the profit-and-loss statements as company accountants submitted them. They permitted the profits from oil drilling, refining and marketing to disappear down the statistical black hole of international shipping.
Mining companies followed a similar accounting practice with their shipping fleets and refineries. These oil and mineral companies were among the largest multinationals.
SS:You are saying that profits fell statistically, but not really. What does this mean for the theory that market prices allocate resources efficiently by reflecting supply costs and demand?
MH:The development of tax shelters in flag-of-convenience countries to record corporate profits hardly can be viewed as a merely marginal phenomenon. For nearly a century it has played a central role in the U.S. and European economies. But the prices are fictitious rather than a result of being based on actual costs or on supply and demand. Only the immense political power of these extractive sectors could have induced their governments to remain so passive in the face of the fiscal drain they entail--a favorable tax treatment denied to other taxpayers.
Gradually, however, other sectors learned to emulate the strategy of avoiding taxes by using offshore banking centers.
SS:Apart from transfer pricing, were other accounting gimmicks used?
MH:Parent companies consolidated their oil fields in the Near East, Africa and South America into their domestic U.S. balance sheets by organizing them not as corporately distinct foreign affiliates but as "branches." This technicality allowed them to take the full U.S. depletion tax credit against their income. Depleting the resources of other countries was treated as if they were part of the American economy--except that the profits were taken in Liberia and Panama.
SS:Did you have any conflicts working for Chase and the oil companies to produce this report?
MH:I was given free rein. I was told to come up with the best statistics possible. They made it clear that if the answers were not what they and the oil industry expected, they would not publish my report, but at least they wanted to know what the statistical situation was. I accepted the assignment on these terms.
How the Russian and U.S. Governments nurtured offshore capital-flight dollar centers
SS: How did these flag-of-convenience tax havens evolve into offshore financial centers independent of corporate shipping operations?
MH:The common denominator is tax avoidance, but the proliferation of offshore banking centers has taken on a life of its own, based on flight capital and hot money.
SS:Did this also occur as a result of corporate tax maneuvering?
MH:That was not the main motivation. Switzerland and Liechtenstein would have sufficed for the level of flight capital and criminal savings that characterized the 1950s. In order for modern-type hot-money havens to emerge, an institutional set-up had to be created to hold dollars or other hard currencies outside their countries of origin--somewhere that would provide the same degree of "privacy," "confidentiality" and hence immunity from the authorities that Switzerland provided with its notorious bank secrecy laws.
The oil and mineral companies did not break the laws or do anything illegal, and hence did not need this kind of privacy. They simply wrote and amended the tax laws to insert loopholes in their own favor. The actual money was kept in their home offices. But offshore banking centers aimed at a different source of deposits--those which needed to be kept outside the reach of U.S. or European authorities.
SS:So how did the offshore vehicles for dollar deposits develop?
MH:Actually, the great catalysts were the Soviet and U.S. Governments themselves. The story starts with the creation of the Eurodollar market during the Cold War years.
In the late 1950s the Soviet Union had a problem. It needed bank accounts denominated in U.S. dollars to defray its various spending programs in the West. But as the Cold War heated up, it feared that the U.S. Government might confiscate its U.S. bank accounts (much as Chase Manhattan would do to Iran after the Shah was overthrown). Russia therefore approached a number of British banks and suggested that they establish accounts enabling Soviet agencies to keep their dollar receipts denominated in U.S. dollars (rather than converting them into sterling), and to use these dollar accounts to pay dollars various suppliers in the West (not to mention more nefarious agents). British banks agreed, and the Eurodollar market was born--a market for dollar deposits held outside of the United States.
SS:So a great finance-capital innovation was established by the Soviets themselves. Did they realize what they were dong? And by trying to evade U.S. control, did they end up helping or hurting U.S. global interests?
MH:Nobody grasped the implications at first. As so often happens, this financial innovation bred a train of unanticipated consequences. U.S. multinationals found it helpful to hold dollars offshore to facilitate their own transactions, especially as they began to buy European and other foreign firms and establish their own overseas branches.
U.S. banks set up branches in London and other money centers to serve these companies. When monetary policy was tightened during the Vietnam War years, these banks found the easiest supply of money to come from their foreign branches. Bank regulatory agencies had not foreseen this development, and had not imposed any requirement that head offices set aside reserves against the deposits that came from these foreign branches. So Eurodollar deposits became a great source of deposits for the large international U.S. banks to lend out when money was getting tight as a result of the Vietnam War's balance-of-payments drain.
How the U.S. Government urged Chase to set up branches in hot-money centers
SS: What was the most remarkable experience you had with these institutions?
MH:The Vietnam War was pushing the balance of payments into deficit, draining the gold supply that backed the currency. Gold had been America's lever of international financial power since World War I, and now it was flowing out to pay for the war in Southeast Asia.
The Johnson and Nixon administrations knew that if fighting the war meant less consumption at home, voters would oppose the war. So they pursued a guns-and-butter policy, promoting heavy domestic consumption and deficit spending, leaving little to sell abroad. The United States was not willing to permit key economic sectors to be sold to foreigners to balance its international payments, although this is what it directed other debtor countries to do after 1980.
U.S. officials sought to attract foreign exchange in any way they could, but their options were limited. One great possibility remained: attract foreign flight capital. This could be done without raising interest rates at home, but providing a safe haven for foreign hot money. Therefore, what U.S. geopolitical strategists were willing to accept were foreign bank deposits, regardless of where they came from.
In balance-of-payments terms, foreign money being converted into dollars and kept in foreign branches of U.S. banks would do just as well as money in U.S. banks, as long as these deposits were held in dollars rather than in foreign currency.
SS:Was this an explicit policy?
MH:Pretty explicit. This was at a time when so much hot money was going to Switzerland that its franc was becoming the world's hardest currency. American financial strategists sought a policy to support the dollar in much the same way. The State Dept. and Treasury approached the nation's leading international banks with a proposal to do something that they would have feared to do without official inducement. They were to establish and expand their own branches in the world's major capital-flight centers--and perhaps to help establish some new ones. Not only would this attract foreign flight money, it would keep at home the substantial sums were being sent abroad by U.S. tax evaders.
In 1996 a former State Dept. employee who had become a Chase officer asked for my opinion of a memorandum outlining the common interest between U.S. economic diplomacy and the nation's international banks with regard to establishing offshore branches aimed at attracting some of the world's hot money away from Switzerland and other flight-capital centers.
The US is probably the second major flight center in the world, but with little probability of rivaling Switzerland for the foreseeable future. Like Switzerland, flight money probably flows to the US from every country in the world. It is handled almost exclusively by the major New York and Miami brokers, lawyers, and leading commercial banks. Officers of CMB International Department and Trust Department confirm that CMB Home Office itself handles a reasonable amount of foreign flight money. However this is insignificant relative to the total potentially available.
There is general consensus among CMB officers and both US and European experts in the field that US-based and US-controlled entities are badly penalized in competing for flight money with the Swiss or other foreign flight-money centers over the long run. This is because of the following interrelated factors:
(a) The demonstrated ability of the US Treasury, Justice Department, CIA, and FBI to subpoena client records, attach client accounts, and force testimony from US officers of US-controlled entities, with proper US court back-up.
(b) The restrictive US investment and brokerage regulations and policies, which limit the flexibility and secrecy of investment activity.
(c) The US estate tax and US withholding tax on foreign investments.
(d) The role of the US as a major contestant in the Cold War, and resulting likelihood that investments through a US entity may be exposed to any hostility or freeze of assets occurring as a result of the Cold War.
(e) The generally held (and partly unwarranted) view of many sophisticated foreigners that US investment managers are naïve and inexperienced in manipulation of foreign funds, especially in foreign markets.
Despite the above limitations, the US has brought appeal to flight money holders in other respects. These include: The largest and most active securities markets in the world, assuring both liquidity and diversification. Ease of transfer and mechanical handling of investments, partly through US banks' worldwide network. The world's leading reserve currency, the US dollar. In recent years, the unmatched financial stability and one of the highest levels of economic growth of any major industrial nation. Finally, negligible probability of revolution or confiscation, and low probability of inconvertibility.
The memo cited Beirut, Panama, Switzerland and other centers from which the U.S. Government invited Chase to attract international flight capital by placing its services at the disposal of the existing and prospective patrons of dictators, drug dealers, criminals and even Cold War adversaries.
Chase and other major U.S. money-center banks responded by setting up a network of offshore centers to turn America into a high-level Switzerland.
SS: Did this actually occur, and did the government go along with it?
MH:The government and banks were well aware of the fact that crooks are the most liquid people in the world, for the simple reason that they fear to hold property in plain sight of the authorities--except in cases where their actual ownership can be laundered through a maze of dummy companies and name-plates on legal folders in the offices of the offshore lawyers who make their livelihood by managing such financial stratagems. The major American accounting firms, law firms and investment advisors soon got into the business of advising corporations and wealthy clients how to set up offshore bank accounts in the name of paper companies.
SS:This would seem to be a bombshell. Have you ever published this?
MH:I showed it to the Canadian economics professor and journalist Tom Naylor, who reproduced it in 1987 in his book Hot Money, pp. 33-34. The book has been translated into many languages and reprinted numerous times. It is about to be reprinted again this year by McGill-Queens University Press up in Canada, and in fact I'm writing an introduction to the newest edition. But there hasn't really been much discussion, because the topic of hot money remains outside the concerns of most academic economists.
SS:Was there any debate over whether this was the right thing to do?
MH: Yes, a series of Congressional hearings were held, and many excellent reports were included. But right-or-wrong morality didn't play much of a role. One of the main policy issues was simply whether the government should impose a 15 percent withholding tax on foreign holdings of Treasury securities, on the ground that this would probably be the only tax revenue it would recover. Government spokesmen (WHO, WHAT DEPARTMENTS?) convinced Congress not to impose the tax, on the ground that this would discourage foreign hot money--and also U.S. hot money, for that matter--from holding Treasury bonds. The United States needed every market it could create for its bonds at this time, to stem the gold outflow. So the foreign withholding tax was abolished.
SS:In other words, the Treasury permitted domestic U.S. tax avoidance to occur in order to get a balance-of-payments inflow into the dollar, and to hold down domestic interest rates.
MH:Yes. The I.R.S. already had permitted tax avoidance to occur under pressure from the large multinationals such as the oil and mining companies. Vertical integration enabled them to administer transfer pricing in a way that minimized their global tax liability. Refraining from taxing the interest paid on U.S. Treasury bonds favored U.S. hot money.
By the late 1960s the United States was well on the way to making America the leading haven for the world's flight capital. Citibank, Chase and others established or expanded operations for their "private banking" subsidiaries offering "confidentiality" to clients ranging from Mexico's leading politicians to Russia's kleptocrats in the 1990s.
SS:But the price was to give international law-breakers a better tax treatment than law-abiding and tax-paying citizens.
MH:Yes, and there's a reason for that. The striking thing is that the most liquid savers in today's society are criminals and tax evaders. They have a good reason to avoid real estate or other tangible property. It is too visible to prosecutors and tax authorities. That is why balance-of-payments statistics classify capital movements as "invisibles." Prestigious accounting firms and law partnerships busy themselves devising tax-avoidance ploys and creating a "veil of tiers" to provide a cloak of invisibility for the wealth built up by embezzlers, tax evaders, a few drug dealers, arms dealers and government intelligence agencies to use for their covert operations.
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