During the greater part of the twentieth century, it was possible to transport huge amounts of wealth across borders easily, by traveling with one’s “pay to bearer” securities. This is no longer true today, be- cause securities aren’t tangible objects: they now exist only in electronic form. So to shelter one’s money, in lieu of moving suitcases filled with bank notes across borders, the common solution is electronic transfer to offshore accounts.
Let’s look at a fictitious example. Michael is CEO of the US company Michael & Co., a firm with 800 employees of which he is the single stock- holder. To send, say, $10 million to Switzerland, Michael proceeds in three stages. First, he creates an anonymous shell company incorporated, for example, in the Cayman Islands, where regulations on disclosure of company owners are very limited.* He then opens an account in Geneva under the shell company’s name, which takes all of a few hours. Finally, Michael & Co. buys fictitious services from the Cayman shell company (consulting, for example), and, to pay for these services, sends money to the shell company’s Swiss account. The transaction generates a paper trail that appears legitimate, and in some cases it actually is. Because companies carry out millions of transfers to Switzerland and other large offshore centers every day—and it is impossible to identify in real time those that are legal (for example, sums paid to true exporters) and those that are not (money evading taxes)—the transaction from Michael & Co. to the shell company’s Swiss bank account is unlikely to trigger any money- laundering alarms at the banks.
And Michael wins twice. By paying for fictitious consulting, he first reduces the taxable profits of Michael & Co., and thus the amount of cor- porate income tax he must pay in the United States. Then, once the money
has arrived in Switzerland, it is invested in global financial markets and generates income—dividends, interest, capital gains. The IRS can tax that income only if Michael self-reports it or if the Swiss bank informs the US authorities. Otherwise, Michael can evade US federal income tax as well.
century European banks developed a new activity: wealth management.The basic service consisted of providing a secure vault in which depositors could place their stocks and bonds. The bank then took responsibility for collecting the dividends and interest generated by these securities. Once reserved for the richest individuals, in the interwar period these services became accessible to any aspiring capitalist. Swiss banks were present in this marketplace. But—an essential point—they offered an additional service: the possibility of committing tax fraud.The depositors who entrusted their assets to them could avoid declaring the interest and dividends they earned without the risk of being caught, because there was no communication between the Swiss establishments and other countries.
If Michael wants to use the money, he has two possibilities. For small amounts, he can simply go to an ATM. But for large amounts, he has to be more clever. The most popular technique is what’s called “Lombard credit”: Michael takes out a loan with the US branch of his Swiss bank, using the money held in Geneva as collateral. So the money stays in Switzerland, still invested in stocks and bonds, while it is also spent in the United States, to buy, for example, a painting by a famous artist or a condominium in Florida.
In sum, the IRS is cheated out of millions—all the taxes owed over time on the income generated by the wealth hidden in Geneva—and Michael can secretly spend his hidden money however he likes.
* Although the Cayman Islands appear often in these kinds of stories, there is evidence that it is even easier to form anonymous companies in Delaware and many OECD countries. See Michael Findley, Daniel Nielson, and Jason Sharman, “Global Shell Games: Testing Money Launderers’ and Terrorist Fi- nanciers’ Access to Shell Companies,” working paper, Centre for Governance and Public Policy, Griffith University, 2012.
Gabriel Zucman, The Hidden Wealth of Nations (2015), the University of Chicago Press