Offshore Tax Havens: How Corporations Legally Capitalize on Tax Evasions
Nike, after earning almost $2.9 billion in income during their 2019–2020 fiscal year, paid absolutely nothing to the U.S. government in terms of tax money.
During the same year, Dish Network, a satellite television company, welcomed $2.5 billion in income, yet just like Nike, completely ignored the need to pay American income tax.
In 2020, 55 of the Fortune 500 companies paid no U.S. income tax. This decades-long economic pattern of large corporations evading taxes has surprisingly played a notable role in global finances, perpetuating the single largest drain on many developing countries’ economies. For context, a tax haven is often defined as a country or independently regulated area that allows foreign entities and individuals to levy taxes at a low rate; collectively, these havens are incredibly expensive for governments, often costing them upwards of $600–800 billion a year in lost corporate tax revenue. In recent years, the problem of tax evasion through havens is the lack of transparency and traceability of financial assets, making it difficult for governments to acknowledge financial affairs as criminal activity or otherwise.
If companies are able to keep the majority of their profits and pay no income tax, how does this federal loophole exist? Also, how do these companies even legally pursue tax evasion?
Tax evasion through havens must first be understood as a developmental strategy that can only evolve in a vigorous international market, with respect for foreign law. Here’s a basic process for how entities utilize tax havens:
- A country or state must first decide to operate as a tax haven. Becoming a haven is especially enticing for developing countries because they contribute to heaps of profit from fees that are paid by foreign companies/individuals who take advantage of the haven. In addition, thousands of job opportunities are made. For instance, Mauritius (a country in East Africa) stated that approximately 5,000 workers would lose their jobs if they stopped operating as a tax haven.
- Companies and/or individuals must create a “shell company” that can legally function in a chosen tax haven. A shell company is an extension of an existing business entity, but the catch is, every record of that shell company exists only on paper; no full-time employees exist, and thus no office space is needed. For example, the Cayman Islands houses a single office building that serves 19,000 businesses.
- Reroute payments, revenue, and investments into those offshore subsidiaries (shell companies) created in a tax haven. Parent companies might pay unnecessarily large fees to offshore shell companies and make it seem like they earn the majority of their profits from their offshore subsidiaries, allowing parent companies to report smaller financial statements to the U.S. government. This means that the company now can pay a significantly lower income tax bill.
Once a country decides to become a tax haven, its finances begin to boom, but only because of the foreign subsidiaries that take advantage of them; as the country rapidly develops, its economy becomes attached to its status as a tax haven and relies on subsidiary fees to stay afloat. Once the title of haven is stripped away, their economy eventually collapses.
how we are affected, and how we can improve:
When large corporations and wealthy individuals decide to pursue tax evasion, it means that we, U.S. citizens, have to pay higher taxes and invest in fewer services, or else the deficit of lost corporate tax revenue will skyrocket. Tax havens also promote financial instability because of the insurmountable amounts of capital flowing freely across borders without consistent regulation.
In order to improve, we first need the government to take action. Tax laws, and the penalties for breaking those laws, need to be much more clarified. David R. Burton, an economist, believes that by utilizing lower marginal tax rates, taxpayers on average evade taxes less (proven by various empirical studies that Burton mentions). To an extent, I agree with his opinion, but cutting marginal tax rates is very tough, and if they are not supported by spending cuts, the federal budget deficit will most likely increase. In the future, this could possibly lead to less national savings and money circulation.
Another interesting solution to this problem would be to ratify an international tax system, where American companies pay the same rate of taxes on both domestic and offshore assets/profits. This solution would also be able to reduce the loopholes that foreign countries utilize when manufacturing within the U.S. (which is a whole other story). The difficulties with this would be that it’s obviously challenging to implement, and it involves the cooperation of many foreign governments.
As an individual, there’s not much you can do to cut down on tax evasion practices, but spreading awareness about it is the next best solution.
Originally chosen to be published on Professor Conway’s economic newspaper: Advanced Economics.