Tax Havens For One And All?

In this electronic age, little guys can play big guys. If you want to be The New York Times, you can create your own Web site and see if the world runs to you for news. If you want to be Random House, you can use your desktop computer to publish novels and self-help books. If you want to be Goldman Sachs, you can start as a day trader in stocks and bonds. It now turns out that you can do something else, too: you can imitate giant multinational companies by scouring the world for a favorite tax haven.

The Internal Revenue Service last week suggested that between 1 million and 2 million Americans have overseas bank accounts that issued them credit or debit cards--the apparent purpose being to evade U.S. taxes. What we have (the IRS implies) are executives, doctors, lawyers and entrepreneurs all hiding their wealth abroad and, even better, being able to spend it instantly through the convenience of plastic. Gulp.

Let's admit: the IRS estimates are probably exaggerated. Based on MasterCard records--provided under court order--the IRS said there were 230,000 card accounts in Antigua, Barbuda, the Bahamas and the Cayman Islands alone. Well, there are dozens of other tax havens (including Liechtenstein, Hong Kong and Latvia), and MasterCard (with about 37 percent of cards issued) lags well behind Visa (about 51 percent). In making its estimates, the IRS tried to cover all havens and all cards.

Be skeptical. In 1999, about 2.4 million tax returns reported adjusted gross income exceeding $200,000. These are the people most likely to shift significant money abroad. If 2 million evade taxes through foreign accounts, four out of five would be cheaters. If 1 million do, two out of five would cheat. These are huge numbers, especially because getting caught could mean jail time. Not all offshore accounts are illegal. In one case, the IRS secured the records of a Cayman Islands bank with about 1,500 depositors, largely Americans. Most were allegedly tax cheaters, but the IRS has opened criminal investigations against only 63.

Estimates of lost taxes are also suspicious. In court papers, the Justice Department suggested $70 billion annually. That equals about 7 percent of federal personal income taxes. To be true, the amount of money hidden abroad would have to total at least $2 trillion. This seems implausibly high. Jack Blum, a private attorney who made the estimate, concedes: "It's a guess. The problem is that you don't know what you don't know."

Still, even if the numbers are soft, the tax evasion is real, disturbing and--almost certainly--growing. Tax havens are not just for billionaires and multimillionaires anymore. They're being democraticized--shopped to the upper middle class by financial advisers, books, seminars and Web sites. "It's a big mistake to think membership in the offshore club is restricted to the ultrarich jet set," writes Jerome Schneider in "The Complete Guide to Offshore Money Havens." "[It's] attracting more and more of what I call the 'working affluent'... [They are] wealth maximizers, tax minimizers."

Every money haven has two features. The first is bank secrecy. Banks and brokers aren't required to disclose account holders. The second is low or no taxes on foreigners. Instead, governments make money through annual fees on accounts. As for how U.S. tax law applies to money havens, there's a critical difference between corporations and individuals. Generally, companies don't pay taxes on foreign income until it's returned to the United States. Companies can have offshore accounts without violating U.S. law. By contrast, individuals owe taxes regardless of where it's earned. Although Americans can open foreign accounts, these must be reported on tax returns. In 1999, about 117,000 people did so, says the IRS.

Tax evasion isn't the only reason to move cash, stocks and bonds offshore. People try to deter financial attack from creditors, lawyers, business partners and family members. "You want more financial privacy. Maybe your ex-wife is suing you," says Robert Bauman of the Sovereign Society, a group promoting offshore accounts. Bauman writes a regular newsletter that, he says, is e-mailed to 25,000 people.

But Web sites confirm that tax evasion is a big come-on. One boasts: "You will... be able to trade U.S. stocks, options and bonds through an offshore brokerage account, hold your asset secretly and conduct your business in a tax-free country." Another Web site provides a calculator to show the joys of skipping taxes. Consider a $100,000 investment earning 15 percent annually. Without taxes, that doubles to $201,136 after five years. A 20 percent capital-gains tax cuts profits by almost $25,000.

A successful tax system depends on trust. People must believe that most others obey the rules. The perception of evasion will stimulate more evasion. No one wants to be the last patsy. The danger of a flight to tax havens--like any major evasion--is that it will erode trust and reduce compliance. One reason that tax havens seem tempting is that IRS enforcement is widely regarded as toothless. "Who's scared of the IRS anymore?" asks a tax specialist at a big accounting firm. "Who do you know who was audited?" In 1979, the IRS audited 2.11 percent of individual returns; in 2000, the audit rate was only 0.49 percent.

Perhaps this is changing. The IRS has successfully gone to court to get Visa to turn over records of offshore card accounts. Presumably these will be screened for evidence of illegally hidden funds. Pressure is also growing on tax havens. "The worst thing to happen to them was September 11," says Tom Field of Tax Analysts, a nonpartisan group, because secret accounts also finance terrorist groups. The U.S. Treasury is demanding more openness. The Organization for Economic Cooperation and Development in Paris is negotiating to curb secrecy in more than 40 havens. What we now have is a struggle between financial promoters (who want to expand tax havens) and government bureaucrats (who want to shrink them). This is one contest the bureaucrats ought to win.