A world of secrecy
International political factors and secrecy jurisdictions
Jarle Aarbakke Tollaksen
Department of Political Science Faculty of Social Sciences
University of Oslo Spring/May 2016
A world of secrecy
International political factors and secrecy jurisdictions
Jarle Aarbakke Tollaksenc
2016
A world of secrecy. International political factors and secrecy jurisdictions.
Jarle Aarbakke Tollaksen
http://www.duo.uio.no/
Trykk: Reprosentralen, Universitetet i Oslo
Words: 34 315
Abstract
Much of the literature on secrecy jurisdiction thus far has revolved around the domes- tic political factors inducing countries to become secrecy jurisdictions. In this thesis, I identify political factors at theinternational level related to position in the international system and to geographic location, and assess the importance of these as determinants of which countries become secrecy jurisdictions and of their degree of financial secrecy. In addition, I evaluate the international political factors’ ability to predict which countries may become secrecy jurisdictions in the future. I find that none of the international political factors identified in this thesis significantly increase the likelihood of a country becoming a secrecy jurisdiction, or increase their expected degree of financial secrecy.
Rather, the results of this thesis mainly give credit to the domestic political factors, as well as the non-political country characteristics. However, international political factors may be useful in predicting future secrecy jurisdictions, and thus be important guides to policy. The results of this thesis underscore the importance of continuing to push secrecy jurisdictions to take domestic measures to ensure greater financial transparency, and the need for a more coordinated effort at the international level to curb financial secrecy and the use of secrecy jurisdictions.
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Acknowledgements
There are a great number of people I would like to thank for supporting me over these years as a student of political science, and for contributing to my academic development.
I can only name a few, but all of your encouragement and input are greatly appreciated.
First, I would like to thank my main supervisor Sirianne Dahlum. I am so grateful for all of your insights and feedback as this thesis has been coming along. I really appreciate you letting me be in charge of my own thesis throughout the whole process, while at the same time always giving me advice and pointing me in the right direction. I am also very grateful to Tore Wig for joining in on the final leg of this project, with fresh eyes and new perspectives and suggestions for improvements.
To all of my friends and fellow students who have helped me in the process of writing this thesis, with proofreading, helping me with R, giving constructive feedback and many other things: I am so grateful! A big thank you to Ingebjørg Finnbakk for encouragement, good conversations and lasting friendship; to Eilev Hegstad for good methods discussions, as well as conversations on everything from politics to religion; to Julia Stangeland, for many lunches and small breaks needed to survive the long days at Blindern.
A shout-out to Astrid-Therese Theisen and Maria Moe: You are strong and indepen- dent women, and we are going to take on the world together!
The biggest thank you of them all goes to my awesome family, and to my parents who have never stopped believing in me. Thank you for continuing to encourage me to keep stretching after the greatest achievements possible. Thank you to my brother and sister, and the in-laws, for continuing to cheer me on.
Any remaining mistakes in this thesis are solely my own.
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Contents
1 Introduction 1
1.1 The research puzzle and its relevance . . . 3
1.2 Research design and findings . . . 7
1.3 Outline . . . 9
2 Secrecy jurisdictons 13 2.1 Definitions . . . 13
2.2 Background . . . 16
3 Literature Review 23 3.1 Domestic political factors . . . 24
3.2 International political factors . . . 29
4 Theory 33 4.1 Motivations . . . 34
4.2 Position . . . 36
4.3 Location . . . 44
4.4 Summary . . . 50
5 Research design 51 5.1 Data . . . 51
5.2 Dependent variables . . . 55
5.3 Independent variables: International determinants . . . 62 vii
5.4 Control variables . . . 73
5.5 Statistical models . . . 78
5.6 Inferences . . . 79
5.7 Evaluating predictive power . . . 82
6 Results 87 6.1 Secrecy jurisdiction status . . . 88
6.2 Degree of financial secrecy . . . 98
6.3 Summary of main findings . . . 105
6.4 Evaluating predictive power . . . 107
6.5 Discussion . . . 114
7 Robustness checks 125 7.1 Model specification . . . 125
7.2 Multicollinearity . . . 127
7.3 Outliers and influential observations . . . 128
7.4 Alternative operationalizations . . . 129
7.5 Summary . . . 131
8 Implications 133 8.1 Implications for theory and further research . . . 134
8.2 Policy implications . . . 135
9 Conclusion 141
Bibliography 144
Appendix A 155
Appendix B 161
List of Figures
4.1 The hierarchy of world cities as core-periphery relations . . . 38
4.2 Geographic distribution of secrecy jurisdictions . . . 48
5.1 Frequency of tax haven listings . . . 58
5.2 Secrecy scores . . . 61
5.3 Membership of international organizations . . . 64
5.4 Membership of international organizations by country group . . . 66
5.5 Map of dependent territories . . . 67
5.6 Average corporate tax rates by region . . . 69
5.7 Distance from major financial centers . . . 70
5.8 Concentration of secrecy jurisdictions by region . . . 71
5.9 International characteristics of secrecy jurisdictions . . . 72
5.10 Other characteristics of secrecy jurisdictions . . . 77
5.11 5-fold cross validation . . . 84
6.1 Predicted probabilities of being a secrecy jurisdiction — position . . . 91
6.2 Predicted probabilities of being a secrecy jurisdiction — location . . . 96
6.3 Plot of estimated coefficients in position OLS models . . . 101
6.4 Plot of estimated coefficients in location OLS models . . . 104
6.5 In-sample AUROC . . . 109
6.6 Out-of-sample AUROC . . . 112
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List of Tables
4.1 Summary of theoretical framework and hypotheses . . . 50
5.1 Descriptive statistics . . . 52
5.2 List of secrecy jurisdicions . . . 57
5.3 Summary of operationalizations and data sources . . . 76
6.1 Logit estimates of determinants of secrecy jurisdiction status — position 89 6.2 Logit estimates of determinants of secrecy jurisdiction status — location 93 6.3 OLS estimates of determinants of degree of financial secrecy — position . 99 6.4 OLS estimates of determinants of degree of financial secrecy — location . 103 6.5 Summary of main findings . . . 106
6.6 Summary of out-of-sample predictive performance . . . 114
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Chapter 1 Introduction
Tax havens with their financial opacity are one of the key driving forces behind rising wealth inequality, as well as a major threat to our democratic socities.
Thomas Piketty
Secrecy jurisdictions, often called ‘tax havens’, are central components of today’s global- ized economy.1 This thesis investigates international political factors as determinants of which countries become secrecy jurisdictions and of their degree of financial secrecy. By identifying political factors at the international level along two dimensions—position and location—I am able to assess these factors’ explanatory power, as well as predictive power.
While secrecy jurisdictions facilitate legal tax planning and profit shifting, they also create opportunities for a variety of illegal activites, ranging from tax evasion to corrupt practices and money laundering. With more than half of world trade, at least on paper, passing through secrecy jurisdictions (Christensen and Hampton 1999:15), this is
1Chapter quote from Zucman 2015:vii
1
not a marginal phenomenon, but rather an integral part of the global economy.
Following the 2008 financial crisis and the large public deficits faced by many countries, fighting offshore tax evasion and curbing the use of secrecy jurisdictions by multinational corporations and individuals have become a key policy issue for governments and international institutions alike (Johannesen and Zucman 2014:66).
With legally enforced secrecy provisions, lack of transparency and absent information exchange agreements, the use of secrecy jurisdictions gives rise to substantial revenue losses for governments, and seriously challenges the design of the modern tax systems.
The recent release of the ‘Panama Papers’, revealing that a number of politicians, government officials and other people in positions of power use secrecy jurisdictions to hide away money, has called further attention to this issue. The fallout of the revelations of the Panama Papers also shows that the use of secrecy jurisdictions is not only an economic issue, but also a political one. Although the entirety of the repercussions of the Panama Papers remains to be seen, the leaks have already forced the prime minister of Iceland, Sigmundur David Gunnlaugsson, to step aside after revelations of his ownership in a holding company registered in a secrecy jurisdiction (Duxbury, Gauthier-Villars and Verbergt 2016). UK prime minister David Cameron also face pressure after it was revealed that he has benefitted from an offshore trust (Chan 2016), while investigations are being launched in both Pakistan and Argentina to look into the use of secrecy jurisdictions by politicians and government officials (Duxbury et al. 2016). These responses, by politicians, the public and regulatory institutions alike, to the revelations of the Panama Papers show that the politicians’ use of secrecy jurisdictions to hide away money pose a serious threat to their legitimacy as public servants, and to our democratic societies.
1.1. THE RESEARCH PUZZLE AND ITS RELEVANCE 3
1.1 The research puzzle and its relevance
In order to understand secrecy jurisdictions—how they work, how to effectively tackle the threats they are posing, and how to curb the use of them—it is important to understand the political factors, international as well as domestic, inducing countries2 to become secrecy jurisdictions and to pursue financial secrecy. The understanding of which political factors act as determinants of this will, in turn, influence which measures are taken to curb the use of secrecy jurisdictions.
Whereas domestic political factors relate to the internal structures of a country, such as the country’s legal system, regulatory institutions and so on, international political factors relate to the external structures that give rise to secrecy jurisdiction, such as protectionist banking systems in other countries, financial centers in the near vicinity securing a substanital flow of capital and so on. Domestic political factors associated with secrecy jurisdictions have received some scholarly attention. These studies have first and foremost investigated how governance quality (see e.g. Dharmapala and Hines 2009, and Rose and Spiegel 2007), political stability (see e.g. Shaxson and Christensen 2013), population and country size (see e.g. Hudson 2000 and Hampton and Christensen 2002), level of democracy (see e.g. Hampton and Christensen 2002; 2007, and Shaxson and Christensen 2013) and legal system (see e.g. Dharmapala and Hines 2009, and Dyreng, Lindsey and Thornock 2013) are associated with secrecy jurisdictions.
Few have, however, examined the international political factors associated with secrecy jurisdictions closely. This thesis aims at contributing to reduce this gap in the research on secrecy jurisdictions by identifying political factors on the international level inducing countries to become secrecy jurisdictions and to introduce financial secrecy provisions, and assess the importance of these factors as determinants of which countries become secrecy jurisdictions and of their degree of financial secrecy.
2I use the word ‘country’ to denote any territory or area for which I have data, and these do not need to be e.g. diplomatically recognized sovereign states with UN seats. Thus I include: territories (e.g.
American Samoa); physical disparate parts of countries (e.g. Aruba); self-governing areas (e.g. Cook Islands); special administrative areas (e.g. Hong Kong); dependencies (e.g. Guernsey); disputed areas (e.g. Taiwan) etc.
1.1.1 International political factors
Why should we expect international political factors to matter when it comes to which countries become secrecy jurisdiction and their degree of financial secrecy? First of all, since secrecy jurisdictions are a truly global phenomenon, seeking to attract mobile capital and finance flowing across country borders, it seems plausible that international factors also play a role in giving rise to these jurisdictions. Structures of the international political system should offeropportunities and incentives for countries to establish them- selves as secrecy jurisdictions, and thereby serve as determinants of secrecy jurisdiction status and degree of financial secrecy. Second, in a more general sense, it is obvious that international factors and structures influence and cause domestic politics. It is shown in the literature that international factors influence domestic political decisions, political events, policies, coalitions and regime type or change (see e.g. Gourevitch 1978). It seems plausible that this kind of international influence should be evident when it comes to countries’ decisions to establish themselves as secrecy jurisdictions and to pursue financial secrecy as well.
Cayman Islands is perhaps the first country that springs to mind when you hear the words ‘tax haven’ or ‘secrecy jurisdiction’. It seems premature to explain why the Cayman Islands is a secrecy jurisdiction by examining only domestic political factors, like governance quality, regulatory institutions, legal system and so on, without taking into account the special relationship the Cayman Islands has to the host of the worlds premiere financial center, City of London, as a dependent territory of the UK, securing political, economic and legal stability. Or to leave out of the analysis the fact that the Cayman Islands is located in the near vicinity of another major international finance center, New York, that secures a steady flow of capital, or that it is situated within a region with a number of other secrecy jurisdictions that together offer a wide range of services to individuals and corporations wishing to escape taxation and regulations. To be able to provide the full picture of why a country becomes a secrecy jurisdiction, and pursues a higher degree of financial secrecy, it seems plausible that international political
1.1. THE RESEARCH PUZZLE AND ITS RELEVANCE 5 factors need to be included in the analysis.
A few scholars have examined some of the possible international political factors associated with secrecy jurisdictions. Baldacchino (2010) and Hampton (1994; 1996), among others, looks into the association between dependency status and secrecy jurisdictions, while Shaxson and Christensen (2013) and Christensen (2012) have investigated the international ‘safe haven’-role played by secrecy jurisdictions, which are both international political factors. These studies have not, however, examined the association between international political factors and secrecy jurisdictions in a quantitative way. Generally, few of the studies on secrecy jurisdictions thus far have distinguished between political, geographic and demographic factors, and few have, to my knowledge, distinguished between domestic and international political factors in their studies.
I make a clear distinction between domestic and international political factors, and identify political factors at the international level likely to explain which countries become secrecy jurisdictions and their degree of financial secrecy. The international political factors identified in this thesis relate to two theoretically distinct dimensions:
position and location. While the factors along the position dimension are related to a country’s position in the international systems regarding issues of power and dependence, the factors along the location dimension are related to the geographic region a country is located in regarding issues of policy and regimes.
The two international political factors of the position dimension are hierarchical position in the international system, where countries in a weak hierarchical position are assumed to become secrecy jurisdictions and to pursue a higher degree of financial secrecy in order to gain a more prominent position in the international hierarchy, and dependency status in relation to metropolitan countries, where dependent territories are assumed to use their special ‘within, yet without’-role to engage in rent-seeking
financial secrecy activites. The international political factors of the location dimension are level of taxation of surrounding countries, distance from a major international financial center, and geographic diffusion of financial secrecy. The level of taxation of surrounding countries, and being located in the near vicinity of a major international financial center, is assumed to spur countries to, as a competitive strategy, engage in secrecy jurisdiction activites, specializing in economic and political services few others provide. Being located in a region with many other secrecy jurisdictions is assumed to bring about economies-of-scale benefits and mutual rewards based on similarity of regimes, which could make a diffusion effect apparent, where countries engage in secrecy jurisdiction activities because their neighboring countries already do. Together, these constitute international political factors that could function as determinants of which countries become secrecy jurisdictions and determinants of these jurisdictions’ degree of financial secrecy.
1.1.2 Research question
Based on the knowledge gap described above, the research question of this thesis is, Can international political factors explain the likelihood of a country becoming a secrecy jurisdiction, and the jurisdiction’s degree of financial secrecy?
This research question consists of two parts. The first part of the research ques- tion relates to the association between international political factors and secrecy jurisdiction status, and I investigate international political factors as determinants of which countries become secrecy jurisdicions, and which do not. The second part of the research question relates to the association between international political factors and degree of financial secrecy, where I go one step further and compare secrecy jurisdictions with each other along the dimension of degree of secrecy. According to this understanding, the question is not only if a country is a secrecy jurisdiction or not, but also how secretive the different secrecy jurisdictions are.
1.2. RESEARCH DESIGN AND FINDINGS 7 It is also important to note that the research question not only relates to examin- ing international political factors that can explain which countries have become secrecy jurisdictions already, but also which countries that are likely to become secrecy juris- dictions in the future. Examining the model’s predictive performance will therefore be an important part of this thesis. Much like Hampton (1994) on a theoretical basis tries to identify which small island economies might be potential offshore financial centers in the future, this thesis sets out not only to identify international political factors as determinants of which countries are secrecy jurisdictions and their degree of financial secrecy today, but also of which countries might become secrecy jurisdictions, and have a high degree of financial secrecy, in the future.
1.2 Research design and findings
To answer the research question posed above, I rely on existing data by combining a number of datasets from, among others, the World Bank, The Tax Foundation, the Correlates of War project, and Tax Justice Network, as well as collecting part of the data manually. The empirical analysis proceeds in two steps. First, I conduct an analysis investigating the likelihood of being a secrecy jurisdiction. In this analysis, the dependent variable is a clear-cut choice of being, or not being, a secrecy jurisdiction.
Second, I conduct an analysis investigating the degree of financial secrecy of the secrecy jurisdictions identified in this thesis. Here, I compare the secrecy jurisdictions with each other, and the dependent variable is a question of degree of opacity. In addition, I evaluate the predictive power, both in-sample and out-of-sample, of the international political factors.
I find that none of the international political factors identified—hierarchical posi- tion, dependency status, tax rates of surrounding countries, distance from financial center or geographic diffusion—significally increase the likelihood of a country being a secrecy jurisdiction, when controlling for domestic political factors, other country char-
acteristics, as well as regional effects. Two of the domestic political factors—governance quality and legal system—perform well, however, indicating that being well-governed and having a legal system of British origin (Common Law) is associated with a high likelihood of being a secrecy jurisdiction. In addition, I find that there is a strong association between having a small population and being a secrecy jurisdiction.
When investigating international political factors as determinants of degree of fi- nancial secrecy, I find that most of the international political factors do no significantly increase the degree of financial opacity in secrecy jurisdictions, with the exception of dependency status. The results of this thesis indicate that being a dependent territory is associated with a lower degree of financial secrecy. However, this effect pulls in the opposite direction of what is expected, and does not support the notion of dependent territories as jurisdictions with a higher degree of financial secrecy compared to indepen- dent states. In addition, I find that both being an island and being affluent is associated with a lower degree of financial secrecy, while being well-governed and having a small population is associated with a higher degree of financial secrecy.
The analyses of determinants of secrecy jurisdiction status and degree of financial secrecy mainly give credit to the domestic political factors, as well as the non-political country characteristics. In addition, the analyses show that there are different mecha- nisms at work when it comes to whether a country is a secrecy jurisdiction or not and the jurisdiction’s degree of financial secrecy. While being well-governed and having a small population is associated with both being a secrecy jurisdiction as well as having a high degree of financial secrecy, being an island and being affluent is associated with lower degree of financial secrecy, and has no significant effect on the likelihood of being a secrey jurisdiction.
By examining the predictive power of the models in this thesis, I find that in- cluding international political factors give a better ability of predicting which countries
1.3. OUTLINE 9 become secrecy jurisdictions compared to focusing solely on domestic political factors and non-political country characteristics. This is only the case for models examining secrecy jurisdiction status, and not models investigating degree of financial secrecy. The predictive performance of the international model indicates that international political factors should not be completely dismissed as important factors related to secrecy jurisdictions, as they—in a more practical sense—can help identify which countries could become secrecy jurisdictions in the future.
The findings of this thesis spur the need for further research on secrecy jurisdictions, both to find improved ways of measuring and operationalizing secrecy jurisdictions, to make sure that data are available for these jurisdictions, and to identify more political factors at the international level. They also offer theoretical insight that can lead to refinements of the approaches to research on secrecy jurisdictions. The findings have implications for the policy initiatives and approaches launched to combat, and curb the use of, secrecy jurisdictions in the future, where the emphasis should continue to be put on making the secrecy jurisdictions themselves reform and make changes to their domestic policies. However, more coordinated efforts at the international level and multilateral approaches, are needed, as well as measures that shift the incentives of secrecy jurisdictions toward cooperation and transparency.
1.3 Outline
This thesis proceeds as follows. In chapter two I introduce the concept of secrecy jurisdictions. I do this by offering a definition of secrecy jurisdictions, make clear the different components of the concept, and explain the different terms associated with this concept. I continue by providing some background information to introduce the reader to the phenomenon of secrecy jurisdicions and financial opacity.
In chapter three I introduce the reader to the relevant literature on political fac-
tors associated with secrecy jurisdictions. I organize the literature around two dimensions already introduced in this chapter: domestic and international political factors. The literature review makes clear that substantially more research has been done on domestic political factors compared to international political factors.
I proceed by presenting the theoretical underpinnings of the empirical analysis in chapter four. In this chapter I show how the discussion on international political factors as determinants of secrecy jurisdiction status and degree of financial secrecy fits into the larger discourse on international hierarchy, dependence, geopolitics and policy diffusion by extending well-known theories in these fields, and apply them to the case of secrecy jurisdictions. By doing this, I identify international political factors I expect to be associated with secrecy jurisdictions, and derive hypotheses that will be tested in the empirical analysis of this thesis.
In chapter five I present a research design that enables a quantitative analysis of the international determinants of secrecy jurisdiction status and degree of financial secrecy. I describe the data used in this thesis and how it has been gathered, provide variable operationalizations, present the statistical models as well as the validation methods that will be used, and discuss what inferences can be drawn from the analyses I will be performing.
The results of the analyses are presented in chapter six, along with discussions of the findings. The results of the analyses are validated through an evaluation of both the in-sample and out-of-sample predictive performances of the models. This is followed by robustness checks in chapter seven, where I evaluate how robust the results are to different variable operationalizations and model specifications, and to the removing of outliers and influential observations.
In chapter eight I give a brief presentation of implications for both theoretical ap-
1.3. OUTLINE 11 proaches to research on secrecy jurisdictions, the need for further research on this topic, as well as implications for policies to curb financial opacity and the use of secrecy jurisdictions, before I conclude the thesis in chapter nine.
Chapter 2
Secrecy jurisdictons
The provision of legally enforced secrecy is a key attraction to users of secrecy jurisdictions.
John Christensen
In this chapter, I introduce the concept of secrecy jurisdictions.1 I do this by first offering a definition of secrecy jurisdictions, make clear the different components of the concept, and explain the different terms associated with it. I return to detailed operationalizations in chapter 5, but will introduce the reader to these concepts as they may be unknown to many. I then provide some statistics to shed light on the issues of secrecy jurisdictions, before I give a short introduction to the history of the development of these jurisdictions and how they are used by both individuals and multinational corporations.
2.1 Definitions
2.1.1 Secrecy jurisdictions
Tax Justice Network (TJN) offer a definition of a secrecy jurisdiction that will serve as a guideline for the way the term is used in this thesis: “A secrecy jurisdiction
1Chapter quote from Christensen 2012:326
13
provides facilities that enable people or entities escape or undermine the laws, rules and regulations of other jurisdictions elsewhere, using secrecy as a prime tool” (Tax Justice Network 2015a:3).
Shaxson offers a similar definition of a secrecy jurisdiction2: “(...) a place that seeks to attract business by offering politically stable facilities to help people or entities get around the rules, laws and regulations of jurisdictions elsewhere” (2011:8). Shaxson also points to several features of a secrecy jurisdiction: (1) it offers secrecy combined with refusal to cooperate with other jurisdictions in exchanging information; (2) it offers very low or zero taxes; (3) it ring-fences its economy from the services it offers, in order to protect itself from its own offshore tricks; (4) its financial service industry is very large compared to the size of the local economy; (5) its local politics is captured by financial services interests (2011:9-10).
The main difference between the two definitions offered here is that TJN’s defini- tion stress and emphasize the secrecy aspect of these jurisdictions. In short, the secrecy provisions these jurisdictions offers are (a) banking secrecy laws in combination with limited government right of inquiry; (b) allowance of establishment of entities whose ownership is hard to identify; and (c) loose regulation combined with bureaucratic hur- dles against information exchange with other countries (Palan, Murphy and Chavagneux 2010:33-35). Together, these secrecy provisions constitute the opacity that characterize these secrecy jurisdictions.
2.1.2 Financial secrecy spectrum
In addition to being, or not being, a secrecy jurisdiction, one can talk about the existence of a financial secrecy spectrum that secrecy jurisdictions are placed along (Tax Justice Network 2015c:1). In TJN’s Financial Secrecy Index, secrecy jurisdictions are ranked
2Shaxson uses the terms ‘secrecy jurisdiction’ and ‘tax haven’ interchangeably, “depending on which aspect I want to stress” (Shaxson 2011:9).
2.1. DEFINITIONS 15 according to their degree of financial secrecy and the scale of their trade in international financial services. Using this approach, TJN move away from the notion of a clear-cut choice of being, or not being, a secrecy jurisdiction, and acknowledge and emphasize that the question of whether a location is a secrecy jurisdiction or not cannot be answered simply by yes or no, but is a question of degree (Tax Justice Network 2013:1). Employing this understanding of a secrecy jurisdiction, the question is not only if a location is a secrecy jurisdiction or not, but also a question of how secretive these jurisdictions are, understood as where they are placed along a financial secrecy spectrum. I return to a detailed discussion of how this is operationalized in chapter 5, along with a list of which countries and territories are considered secrecy jurisdictions in this thesis in accordance with the definition offered in section 2.1.1.
2.1.3 The different terms of offshore banking
As pointed out by Gregory, “The terms associated with the world of offshore banking—secrecy jurisdictions, tax havens, and offshore financial centers—are used inconsistently and are often confusing” (2012:863). In this section, I briefly explain the various terms, and explain why the term ‘secrecy jurisdiction’ will be used in this thesis.
I also explain secrecy jurisdiction in relationship with the other terms.
A ‘tax haven’ is normally understood as a country or jurisdiction with no or low direct or indirect tax rates compared with other states (Gregory 2012:863). This is sometimes also referred to as “low or now tax jurisdictions”. An ‘offshore financial center’
(OFC), on the other hand, refers to a country or jurisdiction that offers sophisticated financial instruments and services (Gregory 2012:863). Often these jurisdictions are characterized by the location of branches and subsidiaries of major international banks.
Finally, ‘banking secrecy’ is understood as a “bank’s legal obligation not to disclose information obtained from its customers through their banking relationship” (Auwarter in (Gregory 2012:863)). Countries and jurisdictions characterized by banking secrecy—or other secrecy provisions—are often referred to as ‘secrecy jurisdictions’.
Shaxson (2011) use the term ‘secrecy jurisdiction’ interchangeably with the term
‘tax haven’, depending on which aspect—taxation or secrecy—he wants to stress, and Palan et al. (2010) understand secrecy jurisdictions as similar to tax havens, the only difference being that opacity, rather than level of taxation, is considered the key trait of these locations. Palan et al. (2010) also underscore that the term ‘secrecy jurisdiction’ is the term most often used today by those campaigning for reform in the area of financial secrecy and international taxation (2010:3).
In this thesis, I will primarily use the term ’secrecy jurisdictions’, as defined in section 2.1.1 above, and follow the understanding of Palan et al. by treating it as similar to tax havens, but with secrecy as the main feature. This is because low taxation and sophisticated financial services are not the main benefits of using offshore banking; what really matters are these jurisdictions’ total confidentiality (Gregory 2012:865).
Of course, there are significant overlaps in these terms, and many jurisdictions of- fering no or low taxation also offer sophisticated financial services and financial secrecy provisions etc. Still, by primarily focusing on secrecy jurisdictions, the focus of this thesis will be on the real attraction of these countries and jurisdictions: the veil of secrecy that ensures that stakeholders can operate largely in the dark.
2.2 Background
2.2.1 Statistics
It is notoriously hard to pin down numbers for how much money are located in, or passing through, secrecy jurisdictions. In this section, I provide rough estimates to give an impression of what kind of numbers we are talking about, and to show that secrecy jurisdictions are not a marginal phenomenon, but central components of today’s globalized economy.
2.2. BACKGROUND 17
In 2010, IMF estimated that the balance sheets of small island financial centers alone added up to $18 trillion, equivalent to a third of the the world’s GDP (Shaxson 2011:8). More than half of cross-border lending is conducted through offshore jurisdic- tions, and around a third of foreign direct investment by multinational corporations is invested, or at least passes, through secrecy jurisdictions (Palan et al. 2010:50-52;
Shaxson 2011:8). The Bank of International Settlements estimate that offshore bank deposits of individuals totales $2.3 trillion, which means that approximately one-fifth of all bank deposits of individuals are held offshore (Palan et al. 2010:62). Illicit capital flight, or illicit money flows, going to secrecy jurisdictions are estimated to between
$1 trillion and $1.6 trillion annually (Palan et al. 2010:71). In a report by Global Financial Integrity, illicit financial flows from developing countries are estimated to $ 991 billion in 2012, and between 2003 and 2012 developing countries are estimated to have lost $6.6 trillion in illicit outflows (Kar and Spanjers 2014:7). These illicit fi- nancial flows consist of money from corruption, criminal activities and illicit capital flight.
Palan et al. claim,
Tax havens undoubtedly facilitate tax evasion, tax avoidance, money launder- ing, and corruption, but no one is able to estimate the sums involved with any degree of accuracy. Consequently, no one is able to address the corruption that underpins this market. (2010:76)
Although the above-mentioned numbers are rough estimates, and the inaccuracy of the numbers make it hard to address the full consequences of secrecy jurisdictions, the esti- mates still give an indication of the role secrecy jurisdictions play in the global financial system. The numbers show with absolute certainty that secrecy jurisdictions are not a marginal phenomenon that researchers and politicians need not concern themselves with.
Rather, the estimates provide grounds for claiming that secrecy jurisdictions are central components of today’s economy that deserve more scholarly and political attention.
2.2.2 History
Sometimes secrecy jurisdictions are understood as a new phenomenon associated with the current wave of globalization and technological revolution. Although it is true that there have been a rapid increase in the number and scope of secrecy jurisdictions since the 1970s, this development can be traced all the way back to the end of the 19th century. In this section, I provide a brief introduction to the history of the development of secrecy jurisdictions to show that this phenomenon has been a part of the global economy for a long time.
Palan et al. (2010:108) distinguish between three stages in the development of tax havens and secrecy jurisdictions. The first stage lasted from the late 1800s to the 1920s, witnessing the emergence of most of the familiar instruments of secrecy jurisdictions.
Permissive laws were passed in the states New Jersey and Delaware in order to attract capital from their wealthier neighbors, followed by other European countries, first and foremost Switzerland and the United Kingdom.
During the second stage, from the end of World War I through the early 1970s, the proliferation of the tax haven strategy started. The Swiss banking law of 1934, which placed banking secrecy under the protection of criminal law, further developed Switzerland as a secrecy jurisdiction, and this practice was also soon copied by other countries and jurisdictions (Palan et al. 2010:120). From the end of the 1920, the City of London developed as “the world’s premier financial center” (Palan et al. 2010:135), with the dependent territories and jurisdictions functioning as a network of offshore satellites in all parts of the world3 (Shaxson 2011:14-16).
In the third stage, from the early 1970s and through the late 1990s, there was an explosion in the number of secrecy jurisdictions, leading into what is called “the golden
3Shaxson calls this “the British spider’s web”, claiming, “The British havens scattered all around the world’s time zones attract and catch mobile international capital flowing to and from nearby jurisdictions, just as a spider’s web catches passing insects” (2011:14-16).
2.2. BACKGROUND 19 years” of tax havens. This increase in number can partly be explained by the 1970s financial crisis caused by high oil and raw material prices, accelerating inflation and declining growth, propelling multinational enterprises to seek ways to increase their profitability. And, as Palan et al. puts it, “(...) tax havens were only too happy to help”
(2010:140). Furthermore, development in communication and transportation made tax havens more easily accessible (Palan et al. 2010:140-141).
Even now, new secrecy jurisdictions are being created, and used by individuals and multinational enterprises in new ways. At the same time, more and more organi- zations and institutions are comitting themselves to fighting secrecy jurisdictions, with OECD, EU and G20 at the forefront. An increasing number of states are also adopting policies aimed at combating financial secrecy.
2.2.3 The use of secrecy jurisdictions
Both individuals and corporations use secrecy jurisdictions. For obvious reasons, proponents and opponents of secrecy jurisdictions have different explanations of why and how these jurisdictions are used. The proponents emphasize legal corporate tax planning, healthy tax competition and economic efficiency, while the opponents point to tax evasion, capital flight, corruption and money laundering (see e.g. Christensen 2012, Dharmapala 2008, and Rose and Spiegel 2007). In this section I, briefly summarize how corporations and individuals use secrecy jurisdictions, and the main opportunities these jurisdictons offer.
For individuals, the main motivation for using secrecy jurisdictions is pretty straight- forward: they want to hide away their wealth from the relevant tax authorities. This is mainly done in three ways: (i) relocating to a secrecy jurisdiction, (ii) becoming a
“permanent tourist”, or (iii) shifting capital into secrecy jurisdictions through various offshore instruments, such as trusts and foundations (Palan et al. 2010:81-94). The primary goal of these techniques is to achieve secrecy in financial affairs, and to add
layers of secrecy by making sure the money are cloaked under strong bank secrecy laws or impenetrable trust mechanisms. For multinational corporations, however, the use of secrecy jurisdictions is a little more complex.
According to Dharmapala, “(...) corporations use tax havens for legal tax avoid- ance and tax-planning activities” (2008:666). It is important to note the word legal: most of the activities in secrecy jurisdictions pursued by corporations are, although questionable, within the law. The tax avoidance and tax planning of multinational enterprises mentioned by Dharmapala takes the form of profit shifting, whereby the corporations use secrecy jurisdictions to reduce their tax liabilities (Schindler and Schjelderup 2013:3; Dharmapala 2008:667).
The profit shifting is usually done through either transfer pricing or debt shifting.
Transfer pricing happens when affiliates of the same multinational corporation trade goods and services among themselves, and locate their activities in a way to ensure that payments from other affiliates flow towards those located in secrecy jurisdictions (Dharmapala 2008:667). Multinational corporations can also use the strategy of debt shifting, where debt is shifted from low-tax to high-tax jurisdictions. The essence of profit shifting, in other words, is to shift the profits of the company into low-tax jurisdictions in order to minimize the tax costs, while at the same time shifting the costs of the same company into high-tax jurisdictions, where these costs can be deducted against tax.
While profit shifting and tax avoidance may be legal, secrecy jurisdications also create opportunities for a variety ofillegal activities, ranging from tax evasion to corrupt practices and money laundering. Shaxson explains a practice called laddering, where a corporation’s structure is sliced between several jurisdictions, where each jurisdiction
“(...) provides a new legal or accounting ’wrapper’ around the assets”, deepening the secrecy and complexity of the corporation’s structures and assets (2011:25). This
2.2. BACKGROUND 21 practice of laddering and added secrecy provides a fertile ground for illegal activites.
The use of secrecy jurisdictions for individuals to illegally evade home-country taxes is a known problem (Dharmapala 2008:665). Both Christensen (2012:325-326) and Rose and Spiegel (2007:1329) claim that these jurisdiction offer a supply side to corrupt practices, and point to the fact that these jurisdictions facilitate money laundering, fraud, embezzlement, insider-trading and bribe-paying.
For individuals seeking to hide away their wealth, secrecy provisions are the most important reasons for using secrecy jurisdictions. For multinational corporations financial secrecy is important, but in addition, provisions regarding corporate structures and flexible incorporation of company entities are essential.
To sum up, secrecy jurisdiction is a multifaceted concept. The essence of secrecy jurisdictions, however, is the provision of legally enforced secrecy, which makes them attractive for both individuals and multinational corporations wanting to escape regulation. Secrecy jurisdictions are an integrated part of the international system, and, as the historical account of this chapter shows, have been so for quite some time.
Chapter 3
Literature Review
Some of the characteristics of tax havens are well-documented in the literature.
Dharmapala and Hines
In this chapter, I introduce the state of the art in the literature on political factors characterizing secrecy jurisdictions.1 The literature review is organized around two dimensions: the domestic political factors and the international political factors as- sociated with secrecy jurisdictionss. As this literature review reveals, there is done substantially more research on domestic political factors compared to international political factors. This underscores the necessity for more research on the relationship between international political factors and secrecy jurisdictions, which resonates well with the research question of this thesis.
Before presenting the different contributions, it may be helpful to make the dis- tinction between the two dimensions—domestic factors and international factors—even more clear. Domestic political factors relate to the internal structures of the countries themselves. These are factors the countries have control over and to a certain degree can
1Chapter quote from Dharmapala and Hines 2009:1058
23
change themselves. Such structures are legal systems, regulatory institutions, political institutions and so on. International political factors, on the other hand, relate to external factors that give rise to secrecy jurisdictions. These external factors can create a “favorable environment” for the emergence of secrecy jurisdiction activities, such as protectionist banking systems in other countries, and financial centers in the near vicinity securing a substanital flow of capital. These are characteristics not of the countries themselves, but of theenvironment the countries are situated in. The countries have not produced this environment, and cannot influence it in a significant way. However, the countries can take advantage of the conditions they face in this environment (Palan et al.
2010:18). External factors are also related tooutside dominance. That is, a country may experience that another country exerts influence over them, for example by being in an asymmetric power relationship with another country. In other words, while domestic factors relate to the countries themselves and the structures they control, international factors relate to the environment the countries are situated in and the structures they can take advantage of, as well as the outside dominance other countries may exert over them.
3.1 Domestic political factors
Quite a few studies have examined the association between certain domestic political factors and secrecy jurisdictions. In this section, I present five related, yet distinct, aspects that together will hopefully give an understanding of the scholarly attention given to domestic political factors related to secrecy jurisdictions thus far.
3.1.1 Governance quality
The quality of governance seems to be an imporant determinant of which countries and territories become secrecy jurisdictions and which do not. According to Dharmapala and Hines, ”there are almost no poorly-governed tax havens” (2009:1058). Using the Worldwide Governance Indicators (WGI), which includes measurements of voice and
3.1. DOMESTIC POLITICAL FACTORS 25 accountability, political stability, government effectiveness, rule of law, and the control of corruption, the authors find that the association between good governance and the likelihood of being a secrecy jurisdiction is both statistically significant and quantita- tively very large (Dharmapala and Hines 2009). Dharmapala and Hines propose an explanation where only well-governed countries credibly can commit not to expropriate foreign investors or not to mismanage the economy. Such a commitment is necessary to attract high levels of foreign investments, and secrecy jurisdictions are therefore thought to be unsuccessful in the abscence of high-quality governance.
While governance quality can be treated as a unitary concept, it can also be bro- ken into individual parts. In researching the determinants of offshore financial centers, Rose and Spiegel (2007) test the effect of rule of law, political stability and regulatory quality, all dimensions encompassed by the concept ‘governance quality’ and included in the WGI. Somewhat surprising, Rose and Spiegel find that neither rule of law nor the political stability of secrecy jurisdictions seems to be relevant determinants (Rose and Spiegel 2007:1316). However, countries with higher regulatory quality are much more likely to attract assets and to be a secrecy jurisdiction than countries with lower regulatory quality.
It seems safe to claim that governance matters, and that good governance is asso- ciated with higher likelihood of being a secrecy jurisdiction. It is interesting to note, however, that while Dharmapala and Hines find a strong and significant effect of governance quality when treated as a unitary concept, Rose and Spiegel find that when broken into separate dimensions, neither rule of law nor political stability has an effect, while regulatory quality, on the other hand, seems to be a relevant determinant of a country being a secrecy jurisdiction.
3.1.2 Political stability
Although political stability is included in the measurement of governance quality in the WGI, it is an important dimension that deserves more attention in and of itself. In the WGI, political stability is understood as the likelihood of destabilization or overthrowing of a government by unconstitutional or violent means (Kaufmann, Kraay and Mastruzzi 2009:6). This is clearly an important part of the concept ‘political stability’, and Hamp- ton and Christensen (2007) highlight that negative risk perceptions related to this kind of instability affect the willingness to hold assets offshore. However, political stability can also be understood in another way: the stability of domestic financial laws and rules. Shaxson and Christensen capture this aspect in their notion of ‘the double-edged stability requirement’, comprising of two elements: stability and rule of law, along with a flexible democracy so that democracy does not “get in the way of finance” (2013:73-74).
The focal point in this latter understanding of political stability is not so much stability in the form of absence of international turbulence or the destabilization of government, but rather, stability in the form of safety from rules and regulation, and an assurance that the needs of finance is protected from political challenge. Shaxson and Christensen claim that this double-edged stability is a requirement for a country becoming a successful secrecy jurisdiction.
3.1.3 Size and island status
A considerable amount of the literature on secrecy jurisdictions is centered on the relationship between Small Island Economies (SIEs) and secrecy jurisdictions. Many of the world’s SIEs are dependent territories or subnational jurisdictions, although a few of them are independent countries. The fact that so many SIEs are secrecy jurisdictions are often explained by economic factors like restricted comparative advantages, diseconomies of scale, high transport costs and small labor markets, or physical-geographic factors like the boundedness and insularity of islands (Hampton and Christensen 2002; Baldacchino 2010). However, there are a couple of political factors associated with size and island
3.1. DOMESTIC POLITICAL FACTORS 27 status and secrecy jurisdictions worth mentioning.
Firstly, as a way of overcoming the challenges and restrictions of small size, small states and territories can use the capacity to formulate their own regulatory structures in a way that attracts foreign capital (Hudson 2000). Of course, larger states can also do this, but in this case it is directly linked to the small size of the jurisdictions employing this as a competitive strategy to overcome some of the disadvantages of being a small state.
Secondly, Hampton and Christensen (2002) point to a specific culture characteriz- ing small islands and microstates that is well suited to facilitate the successul emergence of secrecy jurisdictions. This culture includes partial or absent media independence, absence of higher education institutions or an intellectual community that can critique and oppose policy, in addition to a suppression of whistle-blowing explained by insularity and inward-looking focus in these states and territorities.
The fact that most secrecy jurisdictions are small countries or territories is one of the most robust findings in the literature on determinants of which countries become secrecy jurisdictions (see e.g. Dharmapala and Hines 2009, Slemrod and Wilson 2009, and Kanbur and Keen 1993). This if often explained by either economic, geographical or political factors. Although the political factors are of most interest in this thesis, it is safe to presume that it is the interaction between all of these factors that account for why so many secrecy jurisdictions are small countries or territories.
3.1.4 Level of democracy
Associated with the issue of size, is the democratic challenges that follows from being a small polity. Hampton and Christensen (2002; 2007) point out that small polities often have few democratic checks and balances upon the executive power, and often a weak or no formal parliamentary opposition. Such weak democracies with few checks
and balances are vulnerable of being captured by financial elites and the interests of international capital, making them susceptible to becoming secrecy jurisdictions.
Related to another aspect discussed earlier, the double-edged stability requirement presented in section 3.1.2, is the soft authoritarianism necessary to keep finance protected from democratic challenge, and to stop democratic politics to interrupt the business of making money. Shaxson and Christensen claim that in order to be a successful financial center, financial actors must “take deliberate and sustained steps to neutralise democracy and undercut potential democratic challenges to finance”
(2013:74). Democracy not getting in the way of finance is an important aspect of secrecy jurisdictions, making the level of democracy a relevant determinant of which countries become secrecey jurisdictions and which do not.
3.1.5 Legal system
The last domestic political factor given scholarly attention worth mentioning in the literature on secrecy jurisdictions, is the countries’ legal systems. Dharmapala (2008) finds that secrecy jurisdictions are more likely to have British legal origins, and less likely to have French legal origins, compared to non-secrecy jurisdictions. Dharmapala and Hines (2009) find that the effect of legal origin on tax haven status is significant, and explain this by the fact that most capital exporting countries (e.g. the United Kingdom and the United States) have a legal system of British origin, and that a legal system matching those countries could raise the return of being a secrecy jurisdiction (2009:1062).
However, Blanco and Rogers (2010) find that legal origins do not have a signifi- cant effect on attracting foreign capital. This might question the explanation of Dharmapala and Hines (2009). The prevalence of legal systems of British origins in secrecy jurisdictions, may rather be explained by the simple fact that so many secrecy jurisdictions are former British colonies or current dependent territories, and thus countries and territories with British legal origins.
3.2. INTERNATIONAL POLITICAL FACTORS 29
Exploring the role of Delaware as a domestic tax haven, Dyreng, Lindsey and Thornock (2013) claim that Delaware’s legal system is an important factor because it can provide significant legal benefits compared to other states. Delaware has a separate court system devoted to resolving corporate legal disputes, and has well-established and predictable laws and precedents. This leads Dyreng et al. to conclude, “(...) few other states can effectively compete with Delaware’s economies of scale and legal efficiencies in the market for incorporation” (2013:753). It makes sense that legal systems making it attractive for firms to incorporate, often with strong anti-takeover statutes (Bebchuk and Cohen (2002)), will attract foreign capital, and be associated with secrecy jurisdictions.
3.2 International political factors
Substantially more research has been done on domestic political factors characterizing secrecy jurisdictions than on international political factors. However, a few scholars have also investigated political factors on the international level. In this section, I present the international political factors that have received scholarly attention thus far.
3.2.1 Dependency status
An important political factor associated with secrecy jurisdictions is a country’s depen- dency status, that is, whether it is an independent state or in a dependent relationship with another metropolitan country. Eden and Kudrle (2005) note that about half of all secrecy jurisdictions are linked to an OECD member country, either as a former colony or dependency, possession or free association. Many of these are linked to Britain, either as an Overseas Territory, Crown Dependency or Commomwealth member country (Christensen 2012:332). According to Dharmapala, secrecy jurisdictions are “somewhat more likely to be dependent territories, rather than sovereign states” (2008:663).
Following Baldacchino, the explanation of the association between dependence
and secrecy jurisdictions can be found in the fact that these dependent territories occupy a fuzzy middle ground between full sovereignty and conventional municipality (2010:xxii+19). The dependent territories have enough jurisdictional capacity so that they can carve out a space—juridical, regulatory and legislative—of reduced regulation essential to the emergence of offshore finance (Palan 1998; Vlcek 2007), and at the same enjoy the benefits of the stability that follows being linked to a major metropolitan economy and being within a currency or monetary union with a major trading currency (Hampton 1996; Hampton 1994). It is this duality, this ‘within, yet without’-aspect of these territories, that makes them suitable as secrecy jurisdictions.
3.2.2 Safe haven
Associated with the issue of political stability on the domestic level, is the notion of political stability of a country in an international context. Political stability here, is related to the idea of a secrecy jurisdiction functioning as a sanctuary regarding international conflicts and instability. Shaxson and Christensen (2013) claim that part of the attractiveness of a secrecy jurisdiction is the idea of it being a safe haven from international turbulence. For a secrecy jurisdiction to constitute as a real safe haven, it should be situated in a region of instability and turbulence, and can thus establish itself as a peaceful oasis where assets and capital safely can be funneled.
Christensen (2012) also claims that secrecy jurisdictions can be seen as a reaction to the high tax and strict regulatory regimes imposed by other governments. Surrounded by “overly protectionist, anti-competitive, and over-regulated onshore banking systems”
(Christensen 2012:327), secrecy jurisdictions can establish themselves as sancturaries from taxation and regulation.
The determinants and motivations of being a secrecy jurisdiction can in both of these instances be found on the international level; in the face of international turbulence and strict regulation in other countries, offshore banking services emerges.
3.2. INTERNATIONAL POLITICAL FACTORS 31
To summarize, a substantial amount of research has been done on the association between domestical political factors and secrecy jurisdictions, such as governance quality, political stability, size and island status, level of democracy and legal system. However, only a few scholars have investigated international political factors in this regard.
Moreover, the association between the few international political factors identified in the literature and secrecy jurisdictions, have not been investigated in a quantitative way.
There is therefore a need to fill this gap in the literature on secrecy juridictions, by performing more systematic analyses of the association between international political factors and secrecy jurisdictions.
Chapter 4 Theory
To understand tax havens, one needs to appreciate the
geopolitical and environmental conditions that gave rise to them in the first place.
Palan, Murphy and Chavagneux
In this chapter, I present the theoretical underpinnings for the empirical analysis conducted in this thesis.1 I show how the discussion on international political factors as determinants of secrecy jurisdiction status and degree of financial secrecy fits into the larger discourse on international hierarchy, dependence, geopolitics and policy diffusion by extending well-known theories in these fields, and apply them to the case of secrecy jurisdictions.
In addition, I develop a framework that the international political factors can be analyzed within. I start by laying out four different motivations for countries to become secrecy jurisdictions. Each of these motivations underpin the theories and mechanisms
1Chapter quote from Palan, Murphy and Chavagneux 2010:17
33
presented in this chapter, and are explicitly connected to these. For each of the international political factors, I derive hypotheses that will be tested in the empirical anaylses in chapter 6. I organize the theories and mechanisms along two dimensions:
position and location. Position is related to a country’s position in the international systems regarding issues of power and dependence, while location is related to the geographic region a country is located in regarding issues of policy and regimes.
4.1 Motivations
The main reason for a country to become a secrecy jurisdiction is simple: to attract mobile capital (Palan et al. 2010:21). Secrecy juridictions do this in different ways, and offer a wide range of services and provisions in order to capture capital flowing across borders, but the underlying driving force of all secrecy jurisdictions is the search for capital and finance. However, one can go one step further and ask, “Why do these countries want to attract mobile capital?” I propose four different answers to this question, and each of them serve as a motivation underlying the theories presented in this chapter, and the hypotheses derived from these theories.
First of all, I propose that countries become secrecy jurisdictions, and seek to capture capital and finance, because they want to gain power, status and influence.
Among the top ten exporters of financial services, one can find relatively small countries like Luxembourg, Cayman Islands, Singapore and Hong Kong (Tax Justice Network 2015a). A motivation for these countries can be to use their increasing expertise in financial services to gain a more prominent position in the global economic system in the future than they otherwise would have had. In addition, countries may agree to be
“used” as secrecy jurisdictions in order to please a more powerful state. By doing this, the country hopes the connection to the more powerful state in turn will give them a status they otherwise would not enjoy. Hence, I propose that countries become secrecy jurisdictions as a way of gaining more influence, power and status, and below I connect
4.1. MOTIVATIONS 35 this to a country’s hierarchical position in the international system, as well as a country’s dependency status, and how this could serve as a determinant of secrecy jurisdiction status and degree of financial secrecy.
Second, I propose that countries seeking to attract capital do this as a form of rent-seeking. That is, to obtain economic and political gains without reciprocating.
Becoming a secrecy jurisdiction is then just another way of getting easy access to money and other rewards. I relate this to dependent territories’ “managed dependency”, where these territories exploit relations with their patron economies to extract political and economic privileges, thus making dependency status a determinant of secrecy jurisdiction status and degree of financial secrecy.
Third, for many countries, becoming a secrecy jurisdiction is a competitive strat- egy. With other countries imposing strict regulations on individuals and multinational corporations, secrecy jurisdictions engage in what is often called a “race-to-the-bottom”
by specializing in services other countries do not provide and by offering substantially lower tax rates. At its heart, secrecy jurisdictions use financial opacity and low tax rates as a competitive strategy, and I relate this to the ‘safe haven’-aspect of secrecy jurisdictions below.
Finally, attracting capital may be a way for countries to reap economies-of-scale benefits, so long as other surrounding countries engage in the same behavior. There are mutual rewards to be gained from the clustering of countries with similar tax and secrecy regimes, and by becoming a secrecy jurisdiction, countries may enjoy some of the benefits of economies-of-scale, as well as other less-tangible rewards of having similar regimes. Below, I relate this to the geographic diffusion of secrecy jurisdictions.
These four motivations should be understood as underlying logics of the interna- tional political factors I present in this chapter. While it is true that countries become
secrecy jurisdictions in order to attract mobile capital, there are many different reasons for why countries are interested in capturing capital and finance. While those presented above are the underlying logics and motivations, I will now go in detail on some of the theories and mechanisms that can be used to explain why countries become secrecy jurisdictions and pursue a high degree of financial secrecy.
4.2 Position
International political factors along the position dimension are related to a country’s po- sition in the international system. Issues of power, status and dependence are important factors of this dimension, and the focus is on the systemic environment that gives rise to secrecy jurisdictions. In this section, I outline two determinants of secrecy jurisdiction status and degree of financial secrecy along this dimension: hierarchical position and dependency status.
4.2.1 Hierarchical position
Palan et al. claim that over the years, more and more countries have adopted the
‘tax haven strategy’ and joined the ‘tax haven game’ (2010:141). What could spur countries into becoming secrecy jurisdictions? More specifically, what kind of hi- erarchical relationships between countries could be expected to be associated with countries becoming secrecy jurisdictions? By using a theory of financial integration, I propose that countries that have a weak hierarchical position in the international system will use the strategy of becoming a secrecy jurisdiction, and the strategy of increasing their degree of fincancial secrecy, to gain a stronger hierarchical position in the international system, moving itself from the periphery of the international system to the very center. This is related to the motivation of gaining more power, influence and status by becoming a secrecy jurisdiction, as described in section 4.1. This entails countries becoming secrecy jurisdictions having a clear agenda, and that the process of a country establishing itself as a secrecy jurisdiction is the result of a conscious strategy.
4.2. POSITION 37
It is when one state possesses authority over another state that hierarchy exists in the international system (Lake 2007:56). However, the extent of authority will vary, and the hierarchical relationships can take the form of dependencies, protectorates, spheres of influence, differentiating capabilities and so on. Many scholars agree that there is a wide variety of hierarchical relationships in the international system, and Lake emphasizes that anarchy and hierarchy are not mutually exclusive:
[I]t is a fallacy of division to assume that because the system is anarchic all relationships within that system are anarchic as well. Relations between states can be and often are characterised by varying degrees of authority and, in turn, hierarchy. (2009:37)
Although the international system as a whole must be understood as anarchic without a single overarching authority, the relationships between countries within this system is characterized by varying degrees of power and authority.
These hierarchical relationships create a system with dominant states and subor- dinate states, great powers and small powers etc. According to Clark,
This hierarchy is commonly assigned in terms of politico-strategic power, yielding the traditional groupings of Great Powers, medium powers, and small powers. (...) Outside a statist perspective, it may be analysed in terms of centres or cores, semi-pheripheries and peripheries. Its key theme is that disparities in capability are reflected, more or less formally, in the decision making of the society of states. (1989:2)
On the basis of capabilities, countries find themselves grouped within the international system, and in hierarchical relationships with other countries in this system. These relationships, in turn, have policy consequences, and influence countries’ behavior (Lake 2007:71).
