CEPR's Marchesi/Marcolongo : Financial crises and tax havens

08 March 2024

This column shows that tax havens not only facilitate tax evasion and corruption in ‘normal times’, they also harbour funds during economic crises, slowing down recovery.

Much of the current research on offshore financial centres has focused on the roles of tax havens in advanced economies, and less is known about the case of developing countries, especially after a financial crisis. This column shows that tax havens not only facilitate tax evasion and corruption in ‘normal times’, they also harbour funds during economic crises, slowing down recovery. This is particularly relevant for low income-countries characterised by high inequality. The diversion of capital to tax havens by the richest shifts the burden of the recovery onto the rest of the population, further exacerbating inequality.

Capital flight features prominently in contemporary debates about economic development. In developing countries, capital is relatively scarce and the same domestic investors may prefer to locate part of their assets outside of the countries' borders (e.g. Cuddington 1986, Eaton 1987). Starting from the great financial liberalisation in the 1980s, wealth has been moving across the borders at higher frequency, often reaching offshore destinations characterised by a close-to-zero tax rate. Offshore capital is not employed productively in the country of origin. Furthermore, when offshore wealth is hidden from the tax authorities of the country of origin, or when regulation – such as bilateral tax agreements – is not in place or not enforced, the country of origin cannot levy any taxes on it. This issue becomes more concerning for low- and middle-income countries, where the rule of law and state capacities are typically weaker.

According to Zucman (2013), about 8% of all global financial wealth reached tax havens, corresponding to a tax revenue loss of $190 billion. More recent evidence suggests that firms book around 7% of their global profits in tax havens, resulting in significant revenue losses (Zucman and Wier 2022). This subtraction of resources, being it direct (through capital flight) or indirect (through non-levied taxes) becomes even more concerning at times of financial crises, when productive use of domestic resources could foster recovery. If, at the extreme, the movement of capital toward tax havens accelerates even more during a financial crisis, then two sets of negative consequences derive: slower recovery on one side, and higher burden of the crisis on poorer citizens on the other. Indeed, access to tax havens is skewed heavily towards the highest-income individuals (Alstadsaeter et al. 2018, 2019).

Our study

In our recent paper (Marchesi and Marcolongo 2023), we focus on the cross-country relationship between financial (i.e. banking and sovereign debt) crises and ‘hidden wealth’. We measure hidden wealth using data on bank deposits in offshore financial centres provided by the Bank of International Settlements (BIS) and, as robustness, data from the Offshore Leaks Database (the Panama Papers and subsequent leaks such as the Pandora Papers and Paradise Papers) measuring the probability of observing the incorporation of shell companies in tax havens....

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