How the U.S. Became a Top Secrecy Jurisdiction

By Richard Phillips

This article is cross-posted from Just Taxes Blog.

Sometimes, ranking near No. 1 in the world is not a badge of pride. According to the Financial Secrecy Index released by the Tax Justice Network (TJN), the United States is the second largest contributor to financial secrecy in the world, placing it in the company of infamous tax havens such as Switzerland (ranked No. 1) and the Cayman Islands (ranked No. 3). Financial secrecy is enabling people to hide income from the authorities to evade taxes or financial regulation, launder profits from crime, finance terrorism, or otherwise break the law.

As the new TJN report explains, the United States contributes more to financial secrecy in the world than any country other than Switzerland for two reasons. First, this country has the largest share (22.3 percent) of the global market for offshore financial services. Second, several U.S. states promote financial secrecy by allowing individuals to form corporations without providing any real identifying information. In some states, people who want a library card must provide more identifying information than those who want to incorporate. The result is a huge amount of money held in shell companies in the United States that cannot be traced to any individual anywhere in the world.

The TJN report reveals how the United States is, therefore, facilitating tax evasion and illicit financial flows throughout the world. As the report explains, the United States’ role as a top secrecy jurisdiction has been a century in the making. The first major move to make the United States into a tax haven of sorts was the 1921 Revenue Act, which exempted interest income on bank deposits by non-U.S. residents from taxation. This change created a significant tax advantage for foreign individuals to set up bank accounts and move other financial instruments into the United States. When this tax break is combined with U.S. rules that allow individuals to hide their financial assets from the public and inquiring governments, it creates a powerful incentive for criminals to hide their illicit money in the United States.

Hiding Behind Anonymous Shell Corporations

The most significant type of secrecy laws noted by the Financial Secrecy Index allow individuals to form anonymous shell corporations. When a company is created in the United States there is no requirement that the true owner or operator of that company (known as the “beneficial owner”) be disclosed publicly or to any government authority. This means that criminals have free reign to create shell companies without any real concern that any criminal activity perpetuated by the company will be traced back to them. Some U.S. states make the creation of these anonymous shell companies so simple that an academic study found that the United States is the easiest country in the world to set up such entities.

Evidence of the harm that anonymous shell companies enable is not hard to come by because these companies are at the center of any crime that produces a profit. Anonymous shell corporations created in the United States fuel sex trafficking, perpetuate the opioid epidemic, undermine national security, enable weapons trafficking, and encourage terrorism, tax evasion, and a whole range of other crimes. The infamous weapons trafficker Viktor Bout(memorably played by Nicholas Cage in the movie “Lord of War”) used 12 anonymous shell companies in Delaware, Florida and Texas to facilitate his crimes.

One way to significantly improve the United States’ ranking on the Financial Secrecy Index is requiring individuals to disclose the beneficial owner of the corporations they create. Unlike many proposals before Congress, legislation to collect this information has strong bipartisan support. The Corporate Transparency Act has five Republican and six Democratic co-sponsors in the House and the Senate companion to this bill was introduced by Senators Ron Wyden (D-OR) and Marco Rubio (R-FL). Another version of the bill requiring collection of beneficial ownership information, the True Incorporation Transparency for Law Enforcement (TITLE) Act, was introduced by Senators Sheldon Whitehouse (D-RI), Chuck Grassley, (R-IA) and Diane Feinstein (D-CA). Given the widespread support for it, 2018 should be the year when the United States finally puts an end to anonymous shell corporations.

Reciprocal Information Sharing

In 2010, the United States passed the landmark Foreign Account Tax Compliance Act (FATCA), which created a new world standard for bank transparency. The law requires that foreign financial institutions file annual reports on any American-owned accounts to the IRS. The collection of this information has proven to be a vital tool for the IRS in combatting tax evasion because it means that U.S. citizens can no longer hide their money in offshore accounts with impunity. While FATCA has been a powerful tool for U.S. authorities, its biggest flaw is that it does not require U.S. banks to provide the same information to foreign governments except in very limited circumstances. This means that while we require other countries to report on U.S. individuals potentially evading U.S. taxes, we are hiding foreign tax evaders’ money in the United States.

To end the U.S.’s tax haven status and lower its high financial secrecy rating will require the nation to reciprocate the exchange of information on foreign-held assets in the United States with governments around the world. The most straightforward way to accomplish this would be for the United States to harmonize FATCA with the Common Reporting Standard (CRS), the global standard for financial exchange. Combining FATCA with the CRS would allow other countries critical access to financial information allowing them to crack down on tax evasion. It would also foster compliance with the CRS since any financial institution not complying with the U.S. standard could face a harsh penalty via the enforcement mechanisms in FATCA.

The United States should use its role as a global leader to promote financial transparency and crack down on illicit finance. The TJN’s Financial Secrecy Index is a jarring reminder that the United States has some significant changes it needs to make to take back the mantle on these issues.

Richard Phillips is a Senior Policy Analyst at The Institute on Taxation and Economic Policy