'Escaping the Exchange of Information: Tax Evasion via Citizenship-by-Investment' by Dominika Langenmayr and Lennard Zyska (CESifo Working Papers, 2021) comments
Over the last decade, the OECD and G20 countries launched various initiatives to promote international tax transparency. In the wake of these activities, countries have signed more than 3000 bilateral tax information exchange treaties; more than 100 countries have committed to automatic exchange of tax information. The exchange of tax information between countries has become the main policy instrument to enforce the taxation of capital income across borders.
Several recent papers show that while tax information exchange decreases offshore tax evasion at the bilateral level, a large share of tax evaders does not repatriate their funds, but instead finds other ways to hide their money (see e.g. Johannesen and Zucman, 2014; Miethe and Menkhoff, 2019). However, previous literature did not identify how tax evaders circumvent tax information exchange. Our paper fills this gap by suggesting that one such strategy is the use of citizenship-by-investment programs.
Citizenship-by-investment (CBI) programs offer citizenship rights in return for a financial investment in the country or for a donation as low as US$100,000. If a tax evader uses the acquired citizenship to open a bank account in a tax haven, the tax haven will exchange tax information with the country of acquired citizenship, not the true country of (tax) residency. Thus, CBI programs enable tax evaders to escape tax information exchange.
We first illustrate the interplay between tax information exchange and citizenship- by-investment programs in an analytical model. The model frames tax evasion as a rational decision. Individuals can evade taxes by transferring money to a tax haven. The risk that the home country detects this tax evasion depends on whether the tax haven exchanges tax information with it, and on whether the individual has acquired a foreign citizenship. We model the agreement to exchange tax information as a Nash bargain between the individual’s home country and the tax haven. We show that high- income individuals evade taxes and the richest evaders acquire a new citizenship to lower the detection probability when evading taxes. The existence of CBI programs has two effects on tax evasion: First, these programs decrease individual detection probabilities (and thus, from the high-tax country’s point of view, expected fines). Second, they make it less likely that countries exchange tax information, as part of the potential revenue gain from information exchange is siphoned off by the CBI country.
We then provide indirect empirical evidence that CBI programs are indeed (mis)used to circumvent tax information exchange. To do so, we use bilateral, quarterly information on cross-border bank deposits provided by the Bank for International Settlements (BIS). Consider the example of a German who acquires Dominican citizenship for US$100,000 and uses her new passport to open a bank account in Switzerland. With the new citizenship, her deposits in Switzerland will appear in the BIS data as a deposit from Dominica (instead of Germany), even though she continues to live in Germany and is still tax resident in Germany. We thus expect that the deposits in tax havens originating from countries offering CBI programs increase after such programs have been installed. Using regressions with country-pair fixed effects and an event study approach, we find that tax haven deposits from CBI countries increase by about half after the introduction of CBI programs, compared to deposits from countries not offering CBI. Our results are robust to using a large number of country-level control variables and different samples. We find no effect for residency-by-investment programs, potentially because they are less suited to circumvent tax information exchange.
Our paper adds to two strands of literature. First, it contributes to the literature on individual tax evasion (see Sandmo, 2005; Slemrod, 2007; Alm, 2012, for reviews). Recently, several papers in this literature have evaluated the success of tax information exchange as an instrument to fight offshore tax evasion. TIEAs (Johannesen and Zucman, 2014; Hanlon et al., 2015; Heckemeyer and Hemmerich, 2020; Ahrens and Bothner, 2020), the EU Savings Directive (Johannesen, 2014; Caruana-Galizia and Caruana-Galizia, 2016), the U.S. Foreign Account Tax Compliance Act (FATCA, De Simone et al., 2020), and the OECD’s Common Reporting Standard (Miethe and Menkhoff, 2019; Casi et al., 2020) all decreased offshore tax evasion at the bilateral level. However, several of these studies have found that many tax evaders did not repatriate their funds, but relocated the money to other, non-compliant countries (Johannesen, 2014; Johannesen and Zucman, 2014; Casi et al., 2020) or invested in alternative assets not subject to reporting, such as residential real estate and artwork (De Simone et al., 2020). Overall, there is no evidence that information exchange led to a transition to legality. Our paper contributes to this literature by pointing out a novel way in which tax evaders can circumvent information exchange.
Closest to our paper, Ahrens et al. (2021) analyze whether tax evaders engage in regulatory arbitrage to circumvent tax information exchange from a political science perspective. They study citizenship- and residency-by-investment programs as well as anonymous trusts and shell corporations as options for such regulatory arbitrage. In contrast to our paper, they find little evidence that CBI programs are used to circumvent tax information exchange. The fundamental difference in the results can be explained by several factors: First, Ahrens et al. (2021) look at over forty citizenship-and residency-by-investment programs together, while we focus on a subset of “high- risk” CBI programs defined by the OECD. Second, they use a smaller sample, focussing on investments in twelve major financial markets, while we focus on investments in tax havens. Thus, while the overall topic is similar, our paper is more narrowly focused on the use of CBI for offshore tax evasion and reaches rather different conclusions.
As a second contribution, our paper also adds to the small literature studying the economic implications of CBI programs. Xu et al. (2015) discusses recent developments and implications of such programs for the real economy, i.e. risks to macroeconomic and financial stability for the mostly small countries offering such programs. Konrad and Rees (2020) focus on CBI programs in the European Union. Because of free movement in the EU, these programs automatically give a right to settle in any country within the EU. The authors argue that individual EU countries sell their citizenship at prices lower than what would be optimal from an EU perspective, as they do not consider the effect of their CBI programs on other European countries. Parker (2017) points out that such a conflict is inherent in the idea of ‘post-national’ citizenship championed by the EU. Our analytical model argues that the proliferation of tax information exchange made it attractive to offer CBI for tax reasons, and points out that individuals acquiring citizenship do not necessarily relocate to their new country. This idea complements the literature above, which mostly focused on the implications of people relocating after acquiring the new citizenship.
Section 2 provides some background information on tax information exchange and citizenship-by-investment programs, and Section 3 illustrates their interplay in a simple model. Section 4 presents the empirical setting, including some descriptive evidence. Section 5 discusses the results, and Section 6 concludes.
A study of Vanuatu is noted here.
The new OCCRP 'Passports of the Caribbean' report notes that Dominica, with a population of around 70,000, appears to have sold upwards of 7,700 passports since 2007.
