Offshore banks may be havens for tax dodgers as well as international terrorists
"Banking on secrecy," Time, October 22, 2001
Offshore banking is one of the most rapidly growing industries in recent years. Offshore banks exist in places ranging from small countries such as Liechtenstein, Panama and the Cayman Islands to Vanuatu, a tiny rock in the middle of the Pacific. Together they hold total deposits of $5 trillion. The Cayman Islands alone, with a population of only 35,000, enjoys $800 billion in deposits, which are increasing $120 billion per year.
Wealthy people deposit their money, mostly cash, in offshore banks rather than in their own countries, because offshore banks maintain complete anonymity on the identity and source of deposits. Therefore, the depositors can avoid tax payments or shield the money from spouses and business partners. In contrast, an American bank must report a cash deposit of more than $10,000 to the government, and the source of the money can be identified. As a consequence, the U.S. alone loses about $70 billion in tax revenue from offshore banking.
A more serious concern is that terrorists or criminals, especially those associated with drug traffic, can also take advantage of the loose regulations of offshore banks. Cash deposited anonymously in an offshore bank can be relatively easily transferred to any part of the world, including the U.S., under a banking practice known as "correspondent banking." Under correspondent banking, a U.S. bank provides full banking services to its corresponding offshore bank, for a significant fee. Since the corresponding offshore bank exists in foreign soil, full U.S. banking regulations do not apply to the transactions conducted through the correspondence, especially in terms of identifying the source of the deposit. Using this system, a criminal or a terrorist can bring cash to an offshore bank and later transfer the funds legitimately to someone in the U.S., and the U.S. government has no way of knowing from whom the money originated. In the meantime, the offshore bank is happy to make a significant profit by paying extremely low interest rates to its depositors, and the U.S. bank is happy to earn a fat commission from the corresponding service.
To break this vicious cycle and regain the lost tax revenues, several bills have been introduced in Congress to crack down on offshore tax havens. In fact, an international organization of industrialized countries, the Organization for Economic Cooperation and Development (OECD) in Paris, initiated a campaign against offshore tax havens, and strongly desired participation by the U.S. The OECD indicated that without the cooperation of the U.S., and its clout as a world financial superpower, the intended campaign would have no practical usefulness.
However, every time such a bill was introduced in Congress, it was blocked by the strong banking lobbyists for economic reasons, as well as by conservative research foundations on ideological grounds. Their arguments were that a free market economy should encourage its people to seek the lowest tax rate anywhere in the world, and the resulting competition from the lower tax rate would, in fact, lower the tax rate in the U.S., as well. In addition, they argue that it is not fair to burden the U.S. banking industry to act as a "global tax police." As a consequence, such bills have always been blocked by some members of Congress or by the administration. In addition, the U.S. notified the OECD of its unwillingness to cooperate on the offshore banking regulations.
The September 11, 2001 terrorist attacks suddenly and completely changed the mood of Congress and the administration on this issue, and led to strong support for very strenuous regulations on offshore banking, especially to destroy the international financial networks of terrorists. New legislation was proposed which would empower the administration to identify all funds transferred from offshore banks. If any bank refused to comply with the new U.S. law, it would be barred from doing business with the U.S. Given the economic prowess of the U.S., many offshore banks desire close financial cooperation with the U.S. On the other hand, it is quite possible, as opponents of the new bill argue, that the blacklisted offshore banks will simply switch to another world financial center, such as London, Paris, or Tokyo, and continue to be prosperous. The new bill must address this possibility to be realistically effective.