In recent years, leaks like the Pandora Papers or the Panama Papers have allowed the public a glimpse into what goes on in tax havens and sparked international outrage. Is there a connection between the world of offshore finance and rising global inequality?
The data leaks from the heart of the offshore finance industry have not only sparked public outrage but also triggered in-depth scientific inquiry about the nature and functioning of offshore financial services. Today, we have significant evidence on how offshore financial structures are used by global elites to shield their wealth from taxation and protect the integrity of their estates across generations. We also know now that tax planning is only one of many offshore financial services. Others include offshore banking and offshore incorporation services. What binds all these services together is that they are offered only to people who are not residents of the respective financial centre. The result is a mismatch between (at least) two jurisdictions: the offshore centre and the home country of the respective economic actor.
Going through an offshore financial centre allows economic actors to circumvent rules that would apply in their home country, because regulations in offshore financial centres are famously lax. This way, these actors pay lower taxes, can borrow at better rates, and have less administrative costs than those actors who cannot funnel their money through offshore financial centres. In other words, offshore finance is a rent-creating machine.
Add to this the fact that offshore financial services are only available to super-rich individuals, multinational corporations, or global banks and it becomes evident why offshore finance acts like a catalyst for pre-existing inequalities. Importantly, most of these offshore financial services are not illegal if used with a good legal advisor. In fact, they can be fully legal, but they also often “play in the grey” as the sociologist Kimberly Hoang puts it. And where there are lax rules and regulations, there is also little oversight. That is why outright criminals also love offshore financial services.
How do phenomena like illicit capital flight impact countries domestically?
Illicit capital flight has a profound impact on domestic economies. It occurs when financial assets, such as cash or bearer bonds, leave a country in violation of its laws. A good example is Brazil. The country has historically experienced high inflation and strict capital controls. For years, Brazilians were forbidden from holding assets abroad or in foreign currencies. However, during periods of extreme inflation, many middle-class citizens still sought to protect their wealth by moving it to more stable currencies like the US dollar. This often involved them using informal money exchangers, known as “doleiros,” who facilitated the conversion of Brazilian currencies into US dollars on the black market. Once exchanged, these dollars were often used to open foreign bank accounts or purchase assets abroad, constituting a form of illicit capital flight.
While this capital flight allowed individuals to safeguard their wealth, it had damaging effects on Brazil’s economy. It drained the country of investment that could have been used for economic and social development. Though understandable as a response to hyperinflation, the practice undermined the stability of the country’s domestic financial system.
Offshore financial centres often serve as destinations for capital flight, because they offer a haven for funds to avoid the scrutiny of national authorities.
Offshore financial centres often serve as destinations for this form of capital flight, because they offer a haven for funds to avoid the scrutiny of national authorities. In other cases, these centres are also used to hide illicitly acquired wealth, such as proceeds from drug trafficking, which further exacerbates their negative effects on domestic politics and economic stability.
You also research the creation of money in offshore financial centres and the related effects on the global financial system. What are the main risks here?
Illicit capital flight and offshore money creation are distinct but interconnected phenomena.
Offshore money is created when non-resident banks located in offshore financial centres make loans in foreign currencies, primarily the US dollar, outside the regulatory oversight of the home country of that currency – most importantly: the United States. This practice leads to the unregulated creation of money, because these loans are not under the direct control of the US Federal Reserve or other regulatory bodies. While this offshore creation of dollars facilitates cross-border transactions and thus helps lubricate the wheels of the global financial system, it also poses risks. US firms in particular benefit from what is known as the “exorbitant privilege”: the fact that most global transactions are settled in US dollars protects US American companies from exchange rate volatility that affects firms in other countries.
Moreover, the sheer volume of US dollars being created offshore raises concerns about the US government’s ability to manage its currency. Research shows that more dollars are created outside the sphere of US regulation than within it, which complicates the Federal Reserve’s ability to control liquidity and address financial crises. This lack of oversight became particularly apparent during the 2007-2009 global financial crisis and the COVID-19 pandemic, when the US had to intervene with international bailouts to stabilise markets that had become reliant on offshore dollar creation.
While illicit capital flight drains resources from developing economies and fuels inequality in these countries, offshore money creation has broader global implications – it benefits some actors but threatens the financial sovereignty of others.
Do you see a realistic prospect for meaningful multilateral governance in this area? If so, which avenues or fora strike you as most promising?
There are multilateral efforts to govern parts of what goes on in offshore financial centres, particularly regarding tax avoidance, financial crime, and banking. But the impact of these initiatives has been mixed.
Efforts in the area of taxation have been most visible through the OECD’s Base Erosion and Profit Shifting (BEPS) project, which targets corporate tax avoidance via offshore mechanisms. Recent advances include the global minimum corporate tax agreement, which seeks to prevent the "race to the bottom" in tax rates. Additionally, Brazil has proposed a global minimum tax on billionaires through the G20, aiming to prevent the wealthiest individuals from escaping taxation altogether. The European Commission has implemented a tax haven blacklist, designed to pressure non-compliant countries. However, this list is often criticised as being politically biased, because it spares major EU-based tax havens like Luxembourg and Ireland while targeting smaller offshore centres in regions like the Caribbean.
When it comes to fighting financial crime, the International Financial Task Force (FATF) has spearheaded initiatives to combat money laundering and other illicit activities in offshore centres. While these measures have made it somewhat more difficult to engage in illegal activity, their enforcement is uneven, and many financial criminals continue to exploit gaps in the system.
A significant blind spot across all areas is the absence of efforts that target the enablers of offshore finance: law firms and accounting firms.
For banking, the regulatory landscape is even more sparse. Offshore banks have remained largely untouched by any multilateral initiative – despite their role in creating a parallel set of rules for large financial actors. Success in addressing the issue of offshore banking would likely require strong leadership from major economies like the US, rather than efforts relying solely on multilateral cooperation.
Overall, the multilateral initiatives of the past years have made offshore financial services more costly and complex for those who seek to take advantage of them. But real reform remains elusive as long as political and economic elites are themselves deeply involved in these systems. And a significant blind spot across all areas is the absence of efforts that target the enablers of offshore finance – law firms and accounting firms. These key actors facilitate the complex legal and financial structures that make offshore finance possible in the first place, yet they have largely escaped scrutiny in multilateral initiatives.
Andrea Binder is a Freigeist Fellow and research group leader at the Otto Suhr Institute of Political Science, Freie Universität Berlin. Her research focuses on the international political economy and humanitarian politics.
Photo: Ronny Rondon / Unsplash
.png)
