Economist spots tax haven loophole in EU legislation

In 2005, the EU introduced a new set of rules called the Savings Di-rective, which was aimed at ensuring that all savings hidden away in tax havens were taxed.

A number of tax havens, including Switzerland, Luxembourg and Jersey, had agreed to collaborate on tax avoidance of EU citizens with secret accounts in these tax havens. Under the agreement, banks in these tax havens would withhold 15 per cent of the interest which EU citizens earned on their accounts and to send 75 per cent of the proceeds to the tax authorities in the EU citizens' home countries, but without revealing the identity of the individual account holders.

On the face of it, this was an elegant com-promise: it enabled EU countries to collect tax on savings that would otherwise be out-side the reach of the tax authorities, while still allowing tax havens to retain their rather controversial policy of keeping bank account information secret.

In 2009, Niels Johannesen, an economics professor at the University of Copenhagen, started a research project aimed at measur-ing the effect of this Directive by answering the question: Did EU citizens with savings in Switzerland and other tax havens change their behaviour when they were suddenly charged 15 per cent tax on interest earned? If the answer was yes, in what way? 

Method

Niels Johannesen used data from the Bank for International Settlements, which contains information about foreign bank customers’ deposits and is used by the largest financial centres in the world. Here you can find in-formation, listed quarter by quarter, about for example Danes' total amount of bank deposits in Switzerland, Germans’ total bank deposits in Luxembourg, Canadians’ total bank deposits in Jersey, etc.

In order to analyse the impact that the Sav-ings Directive had on EU citizens' behaviour, Niels Johannesen compared international bank information with data for citizens from countries outside the EU that remained unaf-fected by the Directive.

Results

The first significant results from Niels Johan-nesen's research (see illustration below) show the estimated trends in deposits in Swiss banks for EUcitizens and non-EU citizens respectively. The two groups follow each other very closely over a 10-year period, but during the quarter prior to the Savings Directive coming into force on 1 July 2005, the amount of money in the EU citi-zens' bank deposits in Switzerland decreased dramati-cally.

If you assume that EU citizens and non-EU citizens would have followed the same trend if the directive had not been introduced, the effect of the directive is estimated to be around 40 per cent. This means that 40 per cent of the EU-owned savings held in Swiss banks disappeared, thus avoiding taxation.

But did these savings really disappear from the Swiss bank accounts? The answer is no: over the same period as EU citizens' deposits in Switzerland dropped sharply, the amount of capital owned by companies in Panama and in other countries who typically provide havens for shell companies  increased by more or less the same amount.

This pattern indicates that the holders of the secret bank deposits frequently made use of a loophole in the Directive. The rules only applied to EU citizens who held secret bank accounts in their own names. However, if a holder transferred their Swiss holdings to a shell company in, for example, Panama, the bank in Switzerland would consider the holder to be a non-EU
citizen and therefore not subject to the Di-rective and so their savings would not be taxed.

The results of Niels Johannesen's research had a profound impact on the EU system. When, in 2012, the European Commission carried out an evaluation of the effect of the Savings Directive, it did so by drawing heavily on Johannesen's assessment method and referred to his results 18 times.

Currently, a huge number of new policies are being introduced in order to combat tax evasion. It is vital that these policies are based on factual knowledge rather than merely on media stories and ideological gut feelings. Economists have a vital role to play

In 2014, the Savings Directive was revised, and one of the changes was implemented specifically to close the loophole that Niels Johannesen's research article had identified.

Under the new rules, banks in the European tax haven countries are obliged to identify the holder of each bank account, irrespective of whether the account is held directly or indirectly through a shell company; and they must apply the Directive in cases where the account holder lives in an EU country. When the 2014 Directive itself was later re-placed, these rules were also adopted in the new directive.

Further research

Niels Johannesen has since carried out sev-eral studies of different countries' rules and laws intended to combat tax evasion using tax havens. In the research project 'Taxing Hidden Wealth: the Consequences of U.S.  Enforcement Initiatives on Evasive Foreign Accounts', he worked together with the US tax authorities to measure the impact of the US efforts to combat tax evasion using tax havens.
The results are expected to be published at the beginning of 2018.

Niels Johannesen's research made an im-pression on the EU

• The European Commission's 2012 evaluation of the Savings Directive’s impact was very much the result of applying Johannesen's as-sessment method.
• The Commission referred to his results no less than 18 times.
• In 2014, the Savings Directive was revised in order to close the  loophole identified though Niels Johannesen's research.
• Banks in the EU's tax havens now have to identify account holders even if the account is owned by a shell company, and are obliged to apply the Directive in cases where the account holder is resident in an EU country.

Billions kept in tax havens

During a hearing in the Danish Parliament in April 2016, Niels Johannesen estimated that:

• Globally, approximately 10 per cent of all savings - approximately 6,000 billion dollars - are banked in
  tax havens.
• In Denmark, this amounts to some 100-150
  billion Danish kroner.

Media reviews and publications

Journal of Public Economics, 2014: Tax evasion and Swiss bank deposits.

Review/overview in the Danish newspaper BT, April 2016: Why initiatives against tax havens have failed.