Britain's role in the growth of tax havens

Andrew Verity in The BBC


Here's the received wisdom: when the British Empire faded in size and significance after World War Two, a few scattered islands around the globe wanted to keep their imperial ties to London.

The British government had to find a way to reduce the economic dependence of the likes of Bermuda, Montserrat or the British Virgin Islands, so it awarded them special tax-exempt status, creating the conditions for a thriving financial services industry.

Yes, tax evasion and money laundering may have got a little out of hand from time to time, but overall it succeeded in lifting them out of dependence on the UK government.

But there's a deeper story. It wasn't by design that the remnants of a dying British Empire morphed into a world leader in offshore financial services, selling secrecy and tax avoidance to multi-nationals and the wealthiest individuals in the world.

Instead, the crucial moment was more of an accident - which gave rise to advantages no-one had foreseen.

And it began not in Bermuda or Jersey but in another offshore centre - "offshore" not to the UK, but to the US - the City of London.

Incentives to avoid

When the 20th Century began, income tax was in single digits and progressive taxation - charging richer people a higher rate - had barely begun.

In the run-up to World War One, chancellors of the exchequer - from Asquith to Lloyd George - began raising taxes to pay for social reforms, such as the old age pension.

As the war progressed, the state demanded more and more income tax from every citizen and higher rates for the wealthy, leading to a top rate of 30% by 1919.

Accountants to wealthy individuals began to devise ways to avoid tax. Clients could become resident in Jersey, where tax rates were far lighter.

Or, if they wanted to stay in London, they might put their money in a trust registered elsewhere, perhaps on the Isle of Man, where in theory it was no longer theirs - and therefore not visible to the prying eyes of an Inland Revenue inspector.

David Lloyd George served as Chancellor in Herbert Henry Asquith's government, before rising to PM in 1916

But it was in the dying days of the Empire that the offshore financial services industry truly boomed.

Defined by purpose rather than geography, "offshore" means any jurisdiction that seeks to attract investors on the basis of light taxes and looser regulations.

On that basis, the epicentre of the offshore industry is not Nassau in the Bahamas or George Town in the Cayman Islands.

As author Nick Shaxson points out in his fascinating offshore expose, Treasure Islands: "The modern offshore system did not start its explosive growth on scandal-tainted and palm-fringed islands in the Caribbean, or in the Alpine foothills of Zurich. It all began in London, as Britain's formal Empire gave way to something more subtle."

By accident - not design

In 1957, Britain and its imperial remains were trying to recover from a financial crisis. The previous year the UK had joined forces with France and Israel to try to recapture the Suez Canal after it was nationalised by the defiant anti-colonial Egyptian President, Gamal Abdel Nasser.

Viewing the invasion as European imperialism at its worst, the US refused any assistance.

By the end of 1956, a run on the pound was under way. The Bank of England wanted to curb the outflow of pounds by boosting interest rates sharply, but Her Majesty's Treasury had other ideas.

Since the Bretton Woods economic conference of 1944 towards the end of World War Two, countries had agreed to control movements of capital to curb the speculative flows into and out of countries that had worsened the economic crises of the past.

If, say, Tate & Lyle wanted to invest several million pounds in a new sugar production facility in Jamaica, it would need signed approval from Her Majesty's Treasury.

Normally this was a formality. But during the Suez crisis, the Treasury announced that, on a temporary basis, it would no longer approve foreign capital investments.Image copyrightREUTERSImage captionThe Bank of England did not get its way against the Treasury

The City's merchant banks were alarmed. Arranging finance for projects in the former colonies was their lifeblood. How would they avoid ruin?

Digging through the archives, financial academic Gary Burn unearthed what happened next.

Hearing the banks' complaints in a series of meetings, the Bank of England agreed in late 1957 to allow the commercial banks to continue to lend and borrow to foreign clients on two conditions:
the lending had to be in a currency other than sterling, and
both sides of the transaction - the lender and the borrower - had to reside somewhere other than the UK
"The decision was momentous in all respects," says one of the leading experts in offshore finance, Prof Ronen Palan of City, University of London. "They simply deemed certain transactions as not taking place in the UK. Where did the transactions take place for regulatory purposes? Nowhere.

"I think it wasn't at all by design; it was a mistake. They didn't understand the implications. It was seen as an accounting device."

The so-called "Eurodollar" was born - a global offshore financial market, transacting in dollars and allowing unlimited sums to be borrowed and lent, but under the control of no single state. No act of Parliament (or Congress) sanctioned the decision. There was no thoughtful policy-making, no careful debate.

Success of the Eurodollar

The Treasury was at first left in the dark. But within years the implications were obvious - this could revive the City of London's fortunes.

"By the time the Treasury figured it out, they thought, 'this is good business for the City'," said Prof Palan.

Banks from all around the world could borrow and lend in dollars without being subject to US tax or banking regulations - making banking in dollars more profitable out of London than out of Wall Street.

Offshore banks didn't have to hold money in reserve for every dollar they lent (as they would in the US), which would dramatically cut their costs.

While transactions were arranged in London, the lenders and borrowers could be registered anywhere. But the parties to Eurodollar transactions needed addresses.

So, zero-tax jurisdictions from the Cayman Islands to the Montserrat were used by London's investment banks as the official tax residences of their wealthy customers.

Clients could avoid both tax and undesirable scrutiny - for example from the US tax authorities.

In the British Overseas Territories, local laws were passed to attract more registration business, collecting modest fees that mounted up. No need for a bank branch out there - just a drawer in an offshore lawyer's filing cabinet.

The City of London began its recovery to become the centre of finance it is today

Howls of protest from the US government were ignored. Between 1960 and 1970, the size of the Eurodollar market went from $1bn to $46bn.

In the 1970s, countries rich in petrodollars from soaring oil prices were faced with a dilemma: repatriate the money to New York - where they would be taxed on it - or keep it offshore.

By 1980, the so-called Eurodollar market was worth more than half a trillion.

After the deregulation of the City of London in the 1986 "Big Bang", US banks joined in, setting up in London.

And as the 1990s and 2000s progressed, it became the undisputed global centre for foreign currency trading.

Not for the weather

Banks' wealthy individual and corporate clients didn't incorporate in the Cayman Islands or the British Virgin Islands because they liked the weather there - many never visited.

Offshore centres were attractive to businesses looking to reduce their tax bill, but sometimes, more importantly, to avoid what they regarded as excessive regulation.

Cayman Islands-registered companies were used heavily, for example, by the energy giant Enron as it built its business model based on fraudulent accounts.

Tax-free, light regulation jurisdictions, including the Bahamas, the Cayman Islands and Delaware in the US, became the corporate locations of choice for legitimate hedge funds.

They were also used to incorporate the vehicles at the heart of the global financial crisis - the 'structured investment vehicles' that did not show up on bank's balance sheets and bought billions of mortgage-backed securities, massively increasing the unnoticed risks in the global financial system which led to the crisis of 2008.

Likewise, the British Virgin Islands has been used by many legitimate businesses. It has also become the favourite secrecy jurisdiction for clients of the Panama-based law firm exposed in last year's Panama Papers revelations, Mossack Fonseca.

Since those revelations, governments around the world have pledged to improve transparency with measures such as automatic information sharing and registers of beneficial owners of offshore companies.

Many of those measures are yet to be enacted or tested.

But as the Paradise Papers are now confirming, the secrets of Britain's offshore empire are no longer quite so safe.

How to blame less and learn more

Mathew Syed in The Guardian

Accountability. We hear a lot about it. It’s a buzzword. Politicians should be accountable for their actions; social workers for the children they are supervising; nurses for their patients. But there’s a catastrophic problem with our concept of accountability.

 Consider the case of Peter Connelly, better known as Baby P, a child who died at the hands of his mother, her boyfriend and her boyfriend’s brother in 2007. The perpetrators were sentenced to prison. But the media focused its outrage on a different group: mainly his social worker, Maria Ward, and Sharon Shoesmith, director of children’s services. The local council offices were surrounded by a crowd holding placards. In interviews, protesters and politicians demanded their sacking. “They must be held accountable,” it was said.

Many were convinced that the social work profession would improve its performance in the aftermath of the furore. This is what people think accountability looks like: a muscular response to failure. It is about forcing people to sit up and take responsibility. As one pundit put it: “It will focus minds.”

But what really happened? Did child services improve? In fact, social workers started leaving the profession en masse. The numbers entering the profession also plummeted. In one area, the council had to spend £1.5m on agency social work teams because it didn’t have enough permanent staff to handle a jump in referrals.

Those who stayed in the profession found themselves with bigger caseloads and less time to look after the interests of each child. They also started to intervene more aggressively, terrified that a child under their supervision would be harmed. The number of children removed from their families soared. £100m was needed to cope with new child protection orders.

Crucially, defensiveness started to infiltrate every aspect of social work. Social workers became cautious about what they documented. The bureaucratic paper trails got longer, but the words were no longer about conveying information, they were about back-covering. Precious information was concealed out of sheer terror of the consequences.

Almost every commentator estimates that the harm done to children following the attempt to “increase accountability” was high indeed. Performance collapsed. The number of children killed at the hands of their parents increased by more than 25% in the year following the outcry and remained higher for every one of the next three years.

Let us take a step back. One of the most well-established human biases is called the fundamental attribution error. It is about how the sense-making part of the brain blames individuals, rather than systemic factors, when things go wrong. When volunteers are shown a film of a driver cutting across lanes, for example, they infer that he is selfish and out of control. And this inference may indeed turn out to be true. But the situation is not always as cut-and-dried.

After all, the driver may have the sun in his eyes or be swerving to avoid a car. To most observers looking from the outside in, these factors do not register. It is not because they don’t think such possibilities are irrelevant, it is that often they don’t even consider them. The brain just sees the simplest narrative: “He’s a homicidal fool!”

Even in an absurdly simple event like this, then, it pays to pause to look beneath the surface, to challenge the most reductionist narrative. This is what aviation, as an industry, does. When mistakes are made, investigations are conducted. A classic example comes from the 1940s where there was a series of seemingly inexplicable accidents involving B-17 bombers. Pilots were pressing the wrong switches. Instead of pressing the switch to lift the flaps, they were pressing the switch to lift the landing gear.

Should they have been penalised? Or censured? The industry commissioned an investigator to probe deeper. He found that the two switches were identical and side by side. Under the pressure of a difficult landing, pilots were pressing the wrong switch. It was an error trap, an indication that human error often emerges from deeper systemic factors. The industry responded not by sacking the pilots but by attaching a rubber wheel to the landing-gear switch and a small flap shape to the flaps control. The buttons now had an intuitive meaning, easily identified under pressure. Accidents of this kind disappeared overnight.

This is sometimes called forward accountability: the responsibility to learn lessons so that future people are not harmed by avoidable mistakes.

But isn’t this soft? Won’t people get sloppy if they are not penalised for mistakes? The truth is quite the reverse. If, after proper investigation, it turns out that a person was genuinely negligent, then punishment is not only justifiable, but imperative. Professionals themselves demand this. In aviation, pilots are the most vocal in calling for punishments for colleagues who get drunk or demonstrate gross carelessness. And yet justifiable blame does not undermine openness. Management has the time to find out what really happened, giving professionals the confidence that they can speak up without being penalised for honest mistakes.

In 2001, the University of Michigan Health System introduced open reporting, guaranteeing that clinicians would not be pre-emptively blamed. As previously suppressed information began to flow, the system adapted. Reports of drug administration problems led to changes in labelling. Surgical errors led to redesigns of equipment. Malpractice claims dropped from 262 to 83. The number of claims against the University of Illinois Medical Centre fell by half in two years following a similar change. This is the power of forward accountability.

High-performance institutions, such as Google, aviation and pioneering hospitals, have grasped a precious truth. Failure is inevitable in a complex world. The key is to harness these lessons as part of a dynamic process of change. Kneejerk blame may look decisive, but it destroys the flow of information. World-class organisations interrogate errors, learn from them, and only blame after they have found out what happened.

And when Lord Laming reported on Baby P in 2009? Was blame of social workers justified? There were allegations that the report’s findings were prejudged. Even the investigators seemed terrified about what might happen to them if they didn’t appease the appetite for a scapegoat. It was final confirmation of how grotesquely distorted our concept of accountability has become.

Dodgy Academic Papers - the link between Austerity and MMR

 

Both sagas have their roots in dodgy academic papers, the agenda-pushing press and politicians – and willing believers

• 
• • Aditya Chakrabortty
  • The Guardian, Monday 29 April 2013 19.11 BST

A measles outbreak in Swansea has affected 900 people. Photograph: Alamy

Dodgy research pushed by publicity-happy academics. False claims burnished into golden truths by irresponsible newspapers, apparently trying their hardest to manufacture a panic. Finally, the repercussions: bad decisions and, years later, huge worries about the harm posed to the public.

I'm describing the MMR scandal, the story of how one paper published in a top medical journal prompted a mass scare about a possible link between the triple jab and autism, and led to around one million children being deprived of full vaccinations against measles, mumps and rubella. It's been in the news again this week, following a measles outbreak in Swansea affecting 900 people, and worries that London may be next.

Yet listening to the radio discussions, a feeling nagged at me. Didn't this saga, with its origins going back more than a decade, sound similar to a more recent episode in a different field – the economics of austerity? Over the past fortnight, an academic paper regularly used by George Osborne to justify his cuts, public-sector redundancies and tax hikes has also been exposed as riddled with errors and dubious statistics.

At first, I'll admit, the comparison felt like too much of a stretch. On the one hand, there was Andrew Wakefield, the MMR heretic whose image would regularly flicker up on the 10 O'Clock News; on the other, there was Carmen Reinhart and Ken Rogoff, two Harvard economists of great renown – but hardly box-office. Wakefield was struck off for malpractice; Reinhart and Rogoff are guilty of no such breaches and their book on banking crises, This Time Is Different, will be considered a classic. MMR was a scare foisted on New Labour (remember those stories about whether baby Leo Blair had been injected?), which it had to defuse; this coalition has pushed austerity. The MMR debate boiled down to a question raised by every parent: should I vaccinate my child? The arguments about austerity can't be rendered in personal terms.

So much for the obvious caveats (there's one more, which I'll come to later). Yet whenever I raised the comparison with colleagues or others who had watched the cuts debate, nearly all saw the parallels. At the root of both sagas lies research, heavily contested then and now discredited, but given excessive credibility by outsiders in politics or the press – and used to push distinct agendas. That public-health scare from the turn of the noughties, and this public-finance panic from the start of this decade share common themes. Combined, we could call these lessons: how to flog a terrible idea.

Lesson 1: Have a suspicious public

For a terrible idea to take flight, the public must be in a receptive mood. The MMR scare was preceded by the mad-cow scandal, in which the government had kept insisting that British beef was safe. The arguments over austerity followed on the great bust of 2007-8 – and hadn't then-prime minister Gordon Brown promised to abolish boom and bust? In both cases, the press had been gulled by the official expertise. Do you remember those spreads in the Daily Mail about the coming chaos at RBS? No, I don't either.

Lesson 2: Bad ideas sound like common sense

The press had trusted establishment scientists and the economic technocrats; by the time MMR and the banking bust came along there was a market for policies that sounded easy to understand. So David Cameron really could get away likening the British economy to a household that had maxed out its credit card. It was nonsense, of course, but it was easy to understand nonsense. Unlike Bloomsbury-style Keynesianism, which was much more sensible amid a slump but was treated as far-out science to do with money supplies and fiscal multipliers.

Lesson 3: Bad ideas need strong supporters

My memories of the MMR story were to do with Wakefield. But when academics Tammy Speers and Justin Lewis looked at the news stories, they found that Wakefield got fewer mentions than baby Leo. The scare about MMR was never centred around a paper in the Lancet; rather, the research was recruited into the service of a general scare. That goes much more so for austerity, where the government here and the European troika used available research to push the cause of cuts and lay-offs. The Reinhart-Rogoff paper was published two years after Osborne had adopted austerity as his policy; academia provided justification, but they didn't change minds. And austerity has been fully cloaked in the language of morality: of debt being a bad thing, of southern Europeans being feckless.

The final caveat is: pure science lays much more emphasis on reproducing tests to see if the results bear up; macroeconomists can't run big experiments on entire countries to see which policies work, meaning that fights in the dismal science are necessarily more ideological (however disguised) than methodological. Yet so many economists hanker after hard science status there's even a term for it: "physics envy". Indeed, that key finding from Reinhart-Rogoff – that countries with debt of more than 90% of their GDP experience sharply slower growth – sounds like something you'd hear at the back of a school lab. But it isn't a rule at all: high debt can mean slow growth, but obviously so too can slow growth produce high debt. Still, whether MMR or austerity, the bottom line in both is that plausible science can make bad decisions seem sensible. When the science no longer seems implausible, the game is up. Wakefield was rumbled; slowly but surely the same is happening to the austerity-mongers.

The true value of money – or why you can't fart a crashing plane back into the sky

Banknotes aren't worth the paper they're printed on. The entire economy relies on the suspension of disbelief

• 
• • Charlie Brooker
  • guardian.co.uk, Sunday 12 February 2012

I'm no financial expert. I scarcely know what a coin is. Ask me to explain what a credit default swap is and I'll emit an unbroken 10-minute "um" through the clueless face of a broken puppet. You might as well ask a pantomime horse. But even an idiot such as me can see that money, as a whole, doesn't really seem to be working any more.

Money is broken, and until we admit that, any attempts to fix the economy seem doomed to fail. We're like passengers on a nosediving plane thinking if we all fart hard enough, we can lift it back into the sky. So should we be storming the cockpit or hunting for parachutes instead? I don't know: I ran out of metaphor after the fart gag. You're on your own from hereon in.

Banknotes aren't worth the paper they're printed on. If they were, they'd all have identical value. Money's only worth what the City thinks it's worth. Or, perhaps more accurately, hopes it's worth. Coins should really be called "wish-discs" instead. That name alone would give a truer sense of their value than the speculative number embossed on them.

The entire economy relies on the suspension of disbelief. So does a fairy story, or an animated cartoon. This means that no matter how soberly the financial experts dress, no matter how dry their language, the economy they worship can only ever be as plausible as an episode of SpongeBob SquarePants. It's certainly nowhere near as well thought-out and executed.

No one really understands how it all works: if they did, we wouldn't be in this mess. Banking, as far as I can tell, seems to be almost as precise a science as using a slot machine. You either blindly hope for the best, delude yourself into thinking you've worked out a system, or open it up when no one's looking and rig the settings so it'll pay out illegally.

The chief difference is that slot machines are more familiar and graspable to most of us. When you hear a jackpot being paid out to a gambler, the robotic clunk-clunk-clunk of coin-on-tray, you're aware that he had to go to some kind of effort to get his reward. You know he stood there pushing buttons for hours. You can picture that.

The recent outrage over City bonuses stems from a combination of two factors: the sheer size of the numbers involved coupled with a lack of respect for the work involved in earning them. Like bankers, top footballers are massively overpaid, but at least you comprehend what they're doing for the money. If Wayne Rooney was paid millions to play lacrosse in a closed room in pitch darkness, people would begrudge him his millions far more than they already do. Instead there he is, on live television: he's skilled, no doubt about it.

Similarly, it may be tasteless when a rapper pops up on MTV wearing so much bling he might as well have dipped himself in glue and jumped into a treasure chest full of vajazzling crystals, but at least you understand how he earned it.

RBS boss Stephen Hester, meanwhile, earns more than a million pounds for performing enigmatic actions behind the scenes at a publicly owned bank. And on top of his huge wage, he was in line for a massive bonus. To most people, that's downright cheeky: like a man getting a blowjob from your spouse while asking you to make him a cup of tea.

But Hester earned his wage, we're told, because he does an incredibly difficult job. And maybe he does. Trouble is, no one outside the City understands what his job actually consists of. I find it almost impossible to picture a day in Hester's life, and I once wrote a short story about a pint-sized toy Womble that ran around killing dogs with its dick, so I know I don't lack imagination. Class, yes: imagination, no. If I strain my mind's eye, I can just about picture Hester arriving at work, picture him thanking his driver, picture the receptionist saying "Hello, Mr Hester", and picture him striding confidently into his office – but the moment the door shuts, my feed breaks up and goes fuzzy. What does he do in there? Pull levers? Chase numbers round the room with a broom? God knows.

Maybe if all bankers were forced to work in public, on the pavement, it would help us understand what they actually do. Of course, you'd have to encase them in a Perspex box so they wouldn't be attacked. In fact, if the experience of David Blaine is anything to go by, you'd have to quickly move that Perspex box to somewhere impossibly high up, where people can't pelt it with golf balls and tangerines. On top of the Gherkin, say. If Hester did his job inside a Perspex box on top of the Gherkin for a year, this entire argument might never have happened.

The row over bonuses has led some to mutter darkly about mob rule and the rise of anti-business sentiment. Complain about mobs all you like, but you can't control gut reactions, and you can't dictate the mood. And when you try to fart a crashing plane back into the sky, you only succeed in making the atmosphere unpleasant for everyone. And spoiling the in-flight movie. And making the stewardess cry. Looks like I'm all out of metaphor again. Time to end the article. Article ends.