Tax Havens, Tax Evasion and Tax Information Exchange Agreements in the OECD

• Date: 01 June 2017
• Published date: 01 June 2017
• DOI: http://doi.org/10.1111/eufm.12118

Tax Havens, Tax Evasion and Tax

Information Exchange Agreements

in the OECD

David M. Kemme

Fogelman College of Business and Economics, University of Memphis, Memphis, TN, USA

E-mail: dmkemme@memphis.edu

Bhavik Parikh

Gerald Schwartz School of Business, St. Francis Xavier University, Antigonish, Nova Scotia,

Canada

E-mail: bparikh@stfx.ca

Tanja Steigner

School of Business, Emporia State University, Emporia, KS, USA

E-mail: tsteigne@emporia.edu

Abstract

Using data on Foreign Portfolio Investment (FPI), we find a positive relationship

between higher tax burden and OECD residents’tax evasion, especially via tax

havens. Contrary to established investor preference for certain country

characteristics, we find they are less important to tax evaders who value privacy

and want to remain undetected by their home tax authorities. We find very limited

evidence that OECD Tax Information Exchange Agreements (TIEAS) reduce tax

evasion, controlling for other determinants of overall OECD FPI. Without the US

in the OECD sample, tax havens play a lesser role and OECD policies appear to

make a marginal impact.

Keywords: tax haven, tax evasion, foreign portfolio investment, tax information

exchange agreements, OECD

JEL classification: F38,G38,H26

We thank John Doukas and an anonymous referee for very helpful comments and

suggestions on an earlier draft.

European Financial Management, Vol. 23, No. 3, 2017, 519–542

doi: 10.1111/eufm.12118

© 2017 The Authors. European Financial Management Published by John Wiley & Sons Ltd

This is an open access article under the terms of the Creative Commons Attribution License, which permits use, distribution and

reproduction in any medium, provided the original work is properly cited.

1. Introduction

With an estimated USD 190 billion per year in lost revenues, tax evasion via offshore tax

havens challenges tax authorities of many nations.

1

We provide empirical evidence of

OECD country residents’tax evasion using the concept of round tripping, i.e., when

OECD residents funnel money through an undeclared offshore account and,

unbeknownst to their local tax authorities, subsequently reinvest back into their home

country’s capital market posing as a foreign investor.

2

Thus, as a result these OECD

residents (typically) pay a lower tax rate on their investment returns. For the period

2002–2013 we find that foreign portfolio investment (FPI) flows increase with tax

benefits from round tripping, which is an indirect measure of tax evasion.

3

For the entire

OECD sample we also find that higher tax savings result in more FPI flows from tax

havens. This finding appears to be driven by US flows.

In addition to tax savings , what other factors might tax evaders value? We argue

that certain country char acteristics make collabo ration between tax author ities more

challenging, and are therefo re desirable for evasion. Genui ne investors want to

reduce information costs and pre fer investing in close-by countri es with which they

are familiar in terms of lan guage, legal system and cor ruption oversight (Chan et a l.,

2005; Gaston et al., 2005; Grinb latt and Keloharju, 2001; and Wei and Shleifer, 2000).

In the case of round tripping v ia tax havens, we find opposite re sults where FPI flows

are positively related to gr eater distance, different le gal systems and greater

corruption. Different le gal systems and higher pote ntial corruption likely res ult in less

efficient information shari ng and subsequent detection o f tax evasion by the tax

authorities. This new findin g adds to the existing literature by highlighting the ten acity

and persistence of tax evade rs.

The Organisation for Economic Co-operation and Development (OECD) addressed

its members’call for measures against harmful tax competition in its 1998 report,

Harmful Tax Competition: An Emerging Global Issue (OECD, 1998), with

recommendations for legislation, tax treaties and intensified international cooperation.

4

Subsequently, the OECD developed a standard for Tax Information Exchange

Agreements (TIEAs), of which more than 800 were signed by 2013.

5

In addition to

TIEAs, the Council of the European Union introduced information exchange for taxation

of interest income between member states in 2003 (Council Directive 2003/48/EC), and

the European Union Savings Tax Directive (STD) implemented in 2005 provided a

multilateral institutional means of collecting taxes and exchanging information

1

See Griffith (2015). Approximately half of the global flows of foreign direct investment are

routed through offshore financial centres (Palan et al., 2010; Palan and Nesvetailova, 2013),

and the accumulated private financial wealth in registered offshore tax havens was estimated

to be between USD 21 and USD 32 trillion in 2010 (Henry, 2012).

2

A more in-depth explanation of round tripping is provided in the Background section below.

3

See Hanlon et al. (2015).

4

See also Dermine (1996).

5

Oversight of Tax Co-operation and Information Exchange is currently facilitated by the

OECD’s Global Forum, consisting of 126 member jurisdictions and the European Union. See

http://www.oecd.org/tax/transparency and http://www.oecd.org/tax/exchange-of-tax-

information/.

© 2017 The Authors. European Financial Management Published by John Wiley & Sons Ltd

520 David M. Kemme, Bhavik Parikh and Tanja Steigner