Tax evasion is a pervasive phenomenon. Countries face a significant tax revenue loss due to individuals relocating their untaxed capital to tax havens. To reveal the untaxed money stashed away in tax haven countries, the OECD and G20 adopted the Common Reporting Standard in 2014. In a new publication, researchers from the University of Mannheim show that this new global standard successfully led to a reduction of cross-border deposit holdings in classical tax havens from the EU and OECD member states. However, they also detected an unintended consequence: the United States, not having signed the agreement, became a more attractive tax haven.
Previous research shows that earlier implementations of information exchange agreements, such as bilateral treaties, have not resulted in less tax evasion overall. Instead, people relocate their capital to countries that are not part of the treaty. However, the Common Reporting Standard, the first global and therewith most powerful agreement so far, has several clear advantages over previous initiatives. We were therefore interested to study the direct impact of this recent agreement.
Advantages of the Common Reporting Standard
First, in contrast to previous initiatives the Common Reporting Standard is multilateral. More than 107 countries signed, therewith committing to the exchange of information with each other. Furthermore, instead of focusing on receiving information, the agreement mainly concerns providing information: financial institutions of the participating countries are requested and authorized to collect information on accounts of non-resident persons. Moreover, in contrast to other agreements the information is not exchanged upon request, but automatically, and thus actively, with counterparties. Finally, it has a broad scope. Exchanged information is not limited to interest income, but covers a comprehensive set of information on deposits held by individuals as well as entities.
USD 46 billion decrease in tax haven deposits
These advantages initially seem to be reflected in the effect of the new standard. We studied the effect over a short time period, the fourth quarter of 2014 to the third quarter of 2017, and found a significant reduction of cross-border deposits in major tax havens around the world. More specifically, we documented a USD 46 billion decrease of cross-border deposits held in the tax havens in our sample and owned by residents of EU and OECD countries. This suggests a clear effect of this multilateral standard for the information exchange.
Nonetheless, we also found that, similar to earlier implementations of information exchange agreements, the Common Reporting Standard may not result in less tax evasion overall. Instead, we observe a change in the dynamics. We see a relocation of capital to an unexpected country: the United States.
Tax Haven United States
Classifying the United States as a tax haven may seem surprising. Most will not consider the country when asked what the current tax havens are, instead Luxembourg, Switzerland or Jersey would come to mind. However, the degree of bank secrecy is relatively high in the U.S. and it offers advantageous tax-free facilities for nonresident individuals. More importantly, it is the only major financial center that remains uncommitted to the Common Reporting Standard.
This may come as a surprise but can be explained. The U.S. was one of the first countries to strongly react to whistle blowing events and international data leaks concerning tax evasion. Their response was the Foreign Account Tax Compliance Act (FATCA), implemented in 2010. The act forces foreign financial institutions to collect and transfer financial account information on U.S. citizens to the IRS. In fact, it was this initiative that aroused interest among OECD member states and led them to adopt the Common Reporting Standard. One key reason behind the non-adoption of the Common Reporting standard might be that FATCA already provided the U.S. the desired information on their own citizens.
Our results show that following the CRS effectiveness and during the investigated period (2014-2017), the cross-border deposits in the United States increased significantly. We noted a USD 60 billion increase of cross-border deposits held in the U.S. and owned by residents of EU and OECD countries. This shows that there is more potential to fight tax evasion by obtaining the US participation to the Common Reporting Standard.
Firms’ tax planning
Our study focuses on tax evasion by individuals. Bank deposits of individuals fall under a specific category of assets, characterized by being very mobile. This means that our results cannot be directly transposed to firms’ tax planning activities, as their assets are less easily moved across tax havens. In our project “Costs and Benefits of Tax Transparency” within the TRR 266, we focus on the interplay between voluntary and mandatory tax reporting that jointly determine tax transparency. We want to understand what drives the decision of firms to become tax transparent and to assess its consequences. The results of this study on the Common Reporting Standard show that imposed tax transparency can be an effective tool in addressing tax evasion behavior. Furthermore, they show the importance of multilateral cooperation in ensuring that tax transparency measures have bite. These two more general conclusions may equally inform about tax transparency measures in a firm context, and, therefore, contribute to our understanding of the roles and consequences of tax transparency in a firm setting in our project on “Costs and Benefits of Tax Transparency” within the TRR 266.
Read the full paper “Cross-border tax evasion after the common reporting standard: Game over?” by Elisa Casi, Christoph Spengel und Barbara Stagein the Journal of Public Economics.