The so-called Pandora Papers recently made the news, being a review by the International Consortium of Investigative Journalists (ICIJ) of some 11.9 million documents previously thought to be confidential by the parties involved, gathered from 14 financial services firms located in offshore debtor havens who were apparently underbudgeting their information technologies departments as least as it relates to preventing hacking. Whereupon, I started getting a lot of calls from journalists wondering why there were so few wealthy Americans who were mentioned in these documents.
There are two reasons, which sort of dovetail into one. The primary reason that wealthy American no longer show up routinely in offshore disclosures such as this is that the cost-benefit of hiding offshore accounts from the IRS is not favorable.
On the benefit side, the U.S. Tax Code is highly favorable to wealthy Americans insofar as with relatively little planning they are able to convert what would be income taxed at the highest federal bracket (37%) into long-term capital gains (LTCG) taxed anywhere from 0% to 20% (plus, in some cases, a 3.8% Net Investment Income Tax) depending on the circumstances. But even that doesn’t tell the entire story, since the U.S. Tax Code doesn’t tax capital gains yearly, but instead taxes them only when the gain is realized, i.e., when the asset is finally sold. This is why the nation’s richest men—such as Elon Musk , Jeff Bezos and Mark Zuckerberg —can watch their net worth go up by tens-of-billions in a given year, but only have to pay tax on whatever Tesla TSLA or Amazon or Facebook stock that they liquidate in a given year, if any, plus their relatively nominal salaries. (You can see here how much they saved when Democrats backed off the idea of taxing billionaires unrealized gains.) But even the highest LTCG rate is only 23.8%, included the NII tax, which is lovely compared to the U.S. 37% highest income tax bracket, and often much higher tax brackets found in some other major industrialized countries.
On the cost side, the fines and penalties for undisclosed foreign accounts are extremely painful, and of course there is the potential for time at Club Fed for tax evasion. Because money is no longer physically transferred, at least beyond the retail levels of finance, there is substantial and redundant tracking of money flows such that the chances of getting caught are pretty high, and that’s even before one considers groups like the ICIJ lurking about. And on top of all that, merely getting into the position of being accused of offshore tax evasion could have painful consequences in terms of being forced out of their companies and thereby damaging their own stock holdings, which could cut deeper into their net worth much more than even the worst IRS penalties. Thus, it just isn’t worth it for wealthy Americans to even think about offshore tax evasion for even a nanosecond.
This isn’t to say that wealthy Americans do not sometimes use offshore planning for this, that, or the other thing, but in the vast majority of cases where they do, it is done on a basis that is fully disclosed to the IRS, and with the advice of high-priced international tax law firms whose very job is to keep them out of trouble.
So that is the first reason why wealthy Americans rarely show up in these disclosures, much to the confusion of journalists who think that each treasure trove of documents will suddenly reveal a herd of Americans hiding money abroad but then are painfully disappointed. The second reason is somewhat similar to the first: The United States itself is a tax haven, if not the single largest tax haven on the planet.
What the Pandora Papers do show is that the offshore havens are largely a giant laundromat for the ill-gained moneys of foreign persons to invest in the United States. To quote verbatim from the ICIJ’s website :
“Among the hidden treasures revealed in the documents:
- A $22 million chateau in the French Riviera – replete with a cinema and two swimming pools – purchased through offshore companies by the Czech Republic’s populist prime minister, a billionaire who has railed against the corruption of economic and political elites.
- More than $13 million tucked in a secrecy-shaded trust in the Great Plains of the United States by a scion of one of Guatemala’s most powerful families, a dynasty that controls a soap and lipsticks conglomerate that’s been accused of harming workers and the earth.
- Three beachfront mansions in Malibu purchased through three offshore companies for $68 million by the King of Jordan in the years after Jordanians filled the streets during Arab Spring to protest joblessness and corruption.”
Here, it must be remembered that the U.S. has for the last half-century or so been the world’s financial center in terms of investments. Money flows out of the U.S. to make investments, those investments generates profits abroad, and then those profits return to the U.S. where they are again reinvested. This circular flow of investments and investment returns generate substantial income to U.S. financial firms, and contributes to the largest sector of the U.S. economy being finance, roughly estimated at around 22% of the U.S. gross domestic product. Thus, it has made economic sense over the years for the U.S. to enact laws and regulations to make it as easy as possible for foreign persons to invest here.
But how are these foreign investments tracked and regulated? Certainly the money flows through the U.S. financial centers are followed, but the American system breaks down when it comes to foreign money. The job description of the IRS is primarily to assess and tax American citizens and companies, and also profits earned in the U.S. by foreign persons doing business here. It is not within the job description of the IRS to ferret out foreign corruption, so long as taxes are being paid on that money. The U.S. Treasury outside of the IRS has some responsibility for preventing dirty money from being laundered on U.S. soils, as evidenced by the Suspicious Activity Report (SAR) forms that are required to be filed, but there is little evidence that the U.S. Treasury puts much effort towards that responsibility.
The U.S. has thus become the leading tax haven, allowing foreign persons to escape the relatively high taxation of their home countries and by permitting a tax arbitrage where the foreign person will pay — at worst — the 20% LTCG tax on their investments, assuming that with some tax planning they can’t avoid any tax altogether as is quite possible. Along the way, this also allows foreign government officials and the like who have wealth well in excess of their meagre salaries, i .e., obtained through their own corruption, to hide that wealth from their folks back in their home. That’s what is really going on here. Does the King of Jordan really need three homes in Malibu? Of course not, but California real estate is generally a very good investment, and of course when it is sold it is subject to the LTCG rate which might or might not actually get paid.
What to do about all of this is well beyond the scope of this article, but let me leave you with a thought: If all this foreign money flowed back out of the U.S. at once, the economic effect on the U.S. would be catastrophic. Again, more than 1/5th of the U.S. economy lies in the financial sector, and if the U.S. suddenly ceased to be the world’s tax haven then something much worse than hilarity would ensue. So, the issue for U.S. policymakers, assuming that they have any real inclination to take on these problems, is how to pinch off the worst of the offenders without endangering the circular system of investments abroad, profits abroad, profits reinvested in the U.S., flow of money.
Perhaps the most obvious solution is to simply increase transparency, meaning that all inflows of money into the U.S. may be traced from their source through to their final investment destination. That sort of transparency would allow the fiscal and anti-corruption authorities abroad to take action, assuming that they are politically capable of doing so. More importantly, it would also let the folks in those countries know how their leaders are personally benefitting. But such transparency is heavily resisted by some U.S. firms (think trust companies, company providers, and international law firms), for the very reason that to do so risks pinching off a goodly number of their clients — and they make the balancing point that if this sort of investing is not allowed in the U.S. then these foreign investors will simply take their wealth, legitimately gained or ill-gotten, elsewhere. Whether Congress will be able to find the political backbone to take on this problem, other than by some useless window-dressing, remains to be seen.
At any rate, the purpose of this article was to tell you why so relatively few rich Americans seem to turn up in these offshore revelations, and now you know.
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