Tax havens seem to have multiplied as thousands of people sock away billions of dollars in exotic locations and infuriate tax collectors. To find the origin of these tax shelters don't look to Switzerland, the Cayman Islands or even Cyprus. Check out New Jersey.
The first building block for today's tax havens dates back to the late 1880s, when New Jersey governor Leon Abbett came up with a novel way to boost his state's revenue. Mr. Abbett had been looking longingly at his neighbour New York, which was rapidly becoming a business and financial centre. Urged on by corporate lawyers in New York, the governor hit upon an idea: Why not make it easier for companies to incorporate in New Jersey and then charge them a relatively lower tax rate? The plan worked and it was soon followed by Delaware and then a poor canton in Switzerland called Zug and, finally, Zurich.
From there the idea of luring companies and rich individuals – with the promise of low taxes, light regulation and secrecy – blossomed and tax havens are now estimated to hide up to $1-trillion annually from tax officials around the world. Countries as diverse as Ireland, Singapore and Dubai offer some form of incentive to attract foreign investors eager to find somewhere to put their cash. Using a tax haven isn't necessarily illegal, and many multinational corporations have been shifting profits around the world legally for years in a bid to pay lower taxes. But cash-strapped governments are becoming increasingly put off by citizens who use havens to avoid paying taxes and many countries are now cracking down.
"Until just a few years ago there had never been any serious attention paid to this," said Nicholas Shaxson, a British investigative journalist and author of Treasure Islands, a history of tax havens. "What had been growing without really any checks at all, without anybody really questioning it, now is facing its biggest challenge ever."
Tax havens have been around in one way or another for centuries. The ancient Romans opened a tax-free port to undermine competition from a port in Rhodes, and some of the immigration from Europe to the New World in the 1600s was driven by the attraction of paying lower taxes in America. Modern tax havens combined elements of government policies that were originally designed to boost economic growth, like in New Jersey.
"The history of [tax havens] is not of somebody who thought, 'Let's set up a tax haven,'" said Ronen Palan, a professor of international political economy at City University London, who has studied the history of tax havens. "Nobody had the foresight to understand that that can work as a policy, as a way of developing a financial centre. The history is more of different elements introduced in different countries and slowly, slowly people began to understand that [the elements] can work together."
Decades after New Jersey cleared the way for liberalized incorporation, Switzerland provided the next key building block: secrecy. In 1934, as the Nazis were taking control in Germany, the Swiss government introduced strict privacy provisions in its Bank Law. The move was done at the behest of local bankers who were wary of losing their thriving business of keeping private accounts for wealthy Europeans. Under the provision, banks were prohibited from disclosing any information, even to government officials. London became a global financial centre in the 1950s thanks to several court rulings and regulatory changes that cut taxes on foreign companies and left currency trading largely unimpeded.
When many countries began hiking up individual and corporate taxes – with tax rates soaring as high as 70 per cent – incentives to avoid paying tax increased as well. Suddenly offering foreigners a secret, low-cost place to put their money became a thriving business, particularly in places that largely followed British law, such as former colonies in the Caribbean, Singapore and the Channel Islands. By the 1990s, the number of tax havens was estimated to be around 100 and new players had emerged in the former Soviet republics, Ireland, Cyprus and across the Pacific islands.
But public attitudes are changing. The financial crisis and subsequent recession across much of the world has increased scrutiny on tax havens. And pressure to do something about them has been heightened by the recent disclosure of thousands of offshore trusts and individual account details by the non-profit, investigative journalism organization, the Center for Public Integrity. The United States has introduced legislation requiring any foreign bank doing business in the United States to provide detailed information on their American clients. Several major European Union countries, including Britain, France and Germany, have also recently announced plans to exchange information to help identify tax dodgers.
This week, France became the latest country to signal all-out war on tax havens. French President François Hollande announced the creation of a special prosecutor to pursue tax evasion and promised to eliminate tax havens "in Europe and around the world."
Prof. Palan said some of the measures look good on paper but there are few signs they actually work. "So far, we haven't seen any decline in the overall signs of these offshore havens," he said.