To save democracy, close tax havens

People have been trying to dodge paying taxes since time immemorial, but globalization has turned tax avoidance and evasion, as well as money laundering, into a lucrative business model. Over the past few decades, offshore tax havens such as the Cayman Islands, Bermuda, Cyprus, and Ireland have enabled corporations and wealthy individuals to conceal profits and private wealth on an unprecedented scale.

While quantifying how much wealth is stored in offshore tax havens is notoriously difficult, a 2018 paper estimated that the equivalent of 10% of the world's GDP is held in low-tax jurisdictions. In recent years, high-profile leaks like the Panama Papers, the Paradise Papers, and the Pandora Papers have shed light on this shadow financial system and on the tax-avoidance schemes used by the world's business and political elites. Each revelation triggers a public outcry and demands for reform. Even Pope Francis declared that tax evasion is a sin.

By highlighting the crucial role that tax havens play in propping up autocratic regimes, Russia's invasion of Ukraine has underscored the urgent need to rein in offshore finance. But it has also illustrated how little progress had been made. In 2013, for example, the OECD launched its Base Erosion and Profit Shifting initiative, a package of corporate tax reforms meant to ensure that multinationals pay their fair share. But while 138 countries have endorsed BEPS, its achievements have been modest so far. As a 2020 paper notes, the framework failed to introduce proper accounting standards, leaving it ill-equipped to tackle some of the more egregious forms of corporate tax avoidance and evasion.

One reason for the lack of progress is that BEPS and similar programs inevitably encounter a collective-action problem: for tax reforms to be effective, all countries must agree to them. But while some countries want to fight tax evasion, others have an incentive to attract foreign capital by lowering tax rates and making information-sharing more difficult. The fact that many Western countries have been benefiting from illicit wealth for years, by enabling it to be laundered through real-estate acquisitions in cities like London and New York, further complicates matters. As a result, efforts to promote global tax reform have stalled.

But the battle is far from over. As rising public debts and growing deficits force Western governments to look for new sources of revenue, tax havens are obvious targets. Similarly, public outrage over income and wealth inequalities has put significant pressure on policymakers to crack down on the offshore tax-dodging industry.

But the war in Ukraine is the real game changer. For years, Russian President Vladimir Putin and his cronies have relied on shell companies in offshore tax havens to finance their blatant corruption, election meddling, subversion of democratic institutions, and the production of propaganda and fake news.

Russian oligarchs, long considered puppets of Putin's regime, have been central to this effort, using funds hidden in various offshore havens to foster relationships with far-right extremists in Europe and the United States. When Donald Trump's personal lawyer, Michael Cohen, paid hush money to pornographic film actress Stormy Daniels in 2016, the shell company he used reportedly received more than $1 million from a company linked to Russian oligarch Viktor Vekselberg. And in 2014, as France's far-right National Rally (then called the National Front) received a $12 million loan from a Russian bank, the party's founder and former leader Jean-Marie Le Pen took out a separate $2.5 million loan from a Cypriot offshore company linked to a former KGB agent.

Since Russia's full-scale invasion of Ukraine last February, what were dismissed as isolated embarrassments have come to be seen as part of a systematic assault on Western democracies. Over the years, Putin's oligarchs have made extensive use of Russian offshore holdings – estimated to be about three times larger than the country's official foreign reserves – to finance Kremlin-friendly propaganda outlets, think tanks, far-right politicians, and radical groups.

Shocked by Russian aggression, Western governments quickly imposed sanctions on Putin's political allies, freezing Russian oligarchs' assets and seizing their yachts and villas. But they are just scratching the surface. If Western governments want to protect themselves and others from Russian interference, they must get serious about combating offshore tax havens, which limit Western governments' ability to enforce economic sanctions. And it is crucial to penalize financial institutions that enable money-laundering schemes like the Russian Laundromat, as the Austrian Meinl Bank and others reportedly did.

Some, including Ukrainian Prime Minister Denys Shmyhal, have made the case that Russia should cover some of the costs of Ukraine's reconstruction, currently estimated at more than $1 trillion. To this end, the international community could use Russian oligarchs' offshore wealth. In addition to frozen assets belonging to the Russian government and state-owned enterprises, there is a lot of reconstruction money in Mayfair, Courchevel, and Lake Como.

By illustrating the danger that the offshore financial system poses to the rules-based global order, the war in Ukraine presents Western governments with a unique opportunity to achieve fairer taxation, reduce inequality, curb corruption, and remove threats to global stability. If we squander this opportunity, we will pay dearly – in lost tax revenues, in democratic erosion, and in human lives. To paraphrase Lenin, we must not allow Russia to sell us the rope with which we will hang ourselves.

Yuriy Gorodnichenko is Professor of Economics at the University of California, Berkeley.

Ilona Sologoub is Editor of VoxUkraine.