Black Money

Explainer: Why #PanamaPapers is just the tip of the iceberg

And how tax evasion hurts the world's poorest people.

The leak of information from the database of Mossack Fonseca, the giant law firm headquartered in Panama, is a reality check.

Not because the information, which went public in India late Sunday night, exposes over 214,000 offshore companies typically used as structures to evade taxation connected to people in over 200 countries.

Or because its dragnet includes 140 politicians and public officials including the president of Argentina, the king of Saudi Arabia, the children of Nawaz Sharif, folks close to Russian president Vladimir Putin, and more.

It’s daunting because – for anyone trying to understand black money flows – it is just the tip of the proverbial iceberg.

That is because...

1 Mossack Fonseca is just one of many firms creating shell companies
All this data came from one law firm – Mossack Fonseca – in Panama.

Even if the firm, as an overview posted on the website of the International Consortium of Investigative Reporters says, is “one of the world’s top creators of shell companies, corporate structures that can be used to hide ownership of assets”, it isn't likely to be the only law firm doing such work in Panama – a country known as a tax haven.

2 The world has over 80 tax havens. Panama is just one of them.
Organisations working on tax havens, like the Tax Justice Network, estimate there are over 80 tax havens in the world. The total quantum of money tucked away in these, a 2010 report by the Network estimates, is somewhere between $21 trillion and $32 trillion.

To put that in perspective, the World Bank estimated the Gross World Product – adding up the GDPs of all countries – at about $62.2 trillion that year.

Why are there so many tax havens in the world? As periodic reports on global inequality tell us, the lower half of the global population possesses barely 1% of global wealth while the richest 10% of adults own 86% of all wealth. The top 1% account for 46% of the total.

A part of that money flows to tax havens like Panama. Some of it is parked there. And some of it is recirculated.

Here is why. Tax havens have two large propositions. They offer secrecy – by offering confidential bank accounts, and by helping create companies with anonymous or opaque ownership structures.

Both are harmful. Anonymous company ownership, as an Oxfam briefing paper dated March 14, 2016 says, is “a consistent feature of international corruption cases, including money laundering and the theft of public assets”. For its part, tax evasion reduces government revenues, forcing the authorities to, says the paper, “rely instead on indirect taxes such as those on consumption of goods and services – both of which are likely to hurt people at the bottom of the distribution”.

For this reason, it’s popular practice amongst politicians to point fingers at tax havens and promise to bring back this money.

And yet, it is important to not focus only on tax havens.

3 All black money doesn’t get invested in tax havens
Unaccounted money doesn’t necessarily flow to bank accounts in tax havens.

Take India. A lot of black money gets parked within the country. Some of it flows to sectors like farmland and real estate.

As Sanjoy Chakravorty, a professor at Temple University in the US, writes, urban land prices have risen five fold in the decade 2001-'11. According to him, a citizen with an average national income would need to work for 62-67 years to buy property at the highest end of the market in Hong Kong, London, Tokyo and Paris.

In contrast, it would take her 580 years to buy property at the highest end in Mumbai and 100 years to buy a modest 800 square foot flat at the metropolis-wide average rate.

Till about two years ago, India’s farmlands were reporting a similar spike in prices. Both phenomena, economists feel, are partly driven by the need to park black money.

In fact, some of the money (illicit or otherwise) sent to tax havens flows back to India in the guise of foreign investment. This is called “round-tripping”. In the case of India, this mostly happens through sham corporations registered in Mauritius. As a 2014 article in Scroll.in reported, “While the money comes back as investments, the earnings on such investments are not taxed in India because India and Mauritius have a double tax-avoidance treaty.”

As that article reported, between 2000-'12, 38% of the foreign direct investment in India came from Mauritius while only 6% came from the US.

4 Not all black money is necessarily routed through tax havens
The other proposition of tax havens is their indulgence towards companies with opaque ownership structures. But those are present in India as well. In recent years, India has seen a mushrooming of shell companies.

Most of these, as financial reporter Avinash Celestine found while reporting, were headquartered in Kolkata. These companies, as he detailed, are used to funnel black money.

The bigger picture

That is the most daunting aspect here. If tax havens account for a third of global wealth and if another tranche of illicit money is flowing into land and local shell companies, imagine the size of this shadow economy!

And think about the small number of people who control it.

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