The Panama Papers and the Case of Pakistan:
How the System of Tax Havens Is Used and Abused
The revelation of the Panama Papers scandal provided rare insight into a world that had previously only existed in the shadows. It exposed how a global industry secretly manages the finances of the world’s elite, from politicians and FIFA officials, to celebrities and international athletes, through a system led by major banks and legal firms. This unrelenting transfer of wealth brings light to issues of tax evasion and non compliance, and how they have existed through the years, threatening the fabric of a fragile financial system. This essay attempts to draw attention to the debate of taxation, the issues of morality that come with it, and its overlying economic and political implications. It attempts to do so by looking into the case of Pakistan, and how that played a role in the global economy.
Introduction
The issue of the Panama Papers came to light in 2016, when an anonymous source leaked 11 million files from one of the world’s most secretive companies, Panamanian law firm Mossack Fonseca to a German newspaper known as Suddeutsche Zeitung. These files were then shared with the International Consortium of Investigative Journalists (ICIJ), but the identity of the source was never revealed. Looking into these files, however, highlights the unethical tax evasion practices the powerful elite employ, going as far as to breach legal frameworks completely.
My research paper attempts to bring light to the literature on tax morality, tying it to the issue of the Panama Papers in Pakistan, as it is an important new source of both evidence and initiative for greater reflection on the principles of tax morality on a global scale, bringing light to issues of rising inequality, low transparency, corporate leverage and weak oversight. It does so by looking into the background of taxation itself, and the justifications behind tax noncompliance, and then going further, to understand the motives behind the Panama Papers, especially in Pakistan, and how that applies on an international scale.
The foundation of my debate lies in legality vs. ethics. Tax evasion and tax avoidance are conducted in way that is not technically illegal, but brings up a multitude of moral issues. I am investigating the fine line that exists between the two and attempting to figure out how the legal loopholes created can be minimised.
What is Taxation and Why is it Important?
Issues of taxation raise multiple questions about fairness and justice. It has been contested over centuries, but the values that can be identified as bearing weight on tax policy revolve around freedom, material well being, employment, welfare and equity.
Taxation is commonly defined as the process whereby governments (or, less formally, communities of persons) raise revenue by imposing compulsory contributions, and tax policy is considered an essential instrument of of social reform and social betterment. More than just revenue, it serves as a tool that helps build institutions, markets and democracy by making the state accountable to its taxpayers. As noted by Ben Dickinson, just as excessive tax burdens might hinder growth in wealthier countries, in developing economies a lack of tax structures is a major cause of weak, unresponsive governance and an overreliance on aid.
A strong taxation system benefits the public as it holds the government accountable for their actions, and helps developing countries feel like they are not totally tied to the will of their aid donors. It also helps the government help plan for the future with a greater sense of security. Recent evidence also indicates that reforms of the tax administration may catalyse reforms in other parts of the public sector, thus rejuvenating stagnant change processes.
Background on the Legality of Tax Evasion
The sense of a “just” form of taxation, one can argue, is one of the oldest and most ambiguous fiscal questions that mankind has grappled with. The saliency of this issue has evoked a set of varying responses, which are most often powered by a combination of exogenous variables such as warfare, famine, conflict, drought; while also deriving from endogenous pushes outwards, including peaceful and conflictual debates within ruling structures, as well as levels of resistance from taxed units, particularly as these units were found at greater actual or perceived distance from the central taxing body. Issues of legitimacy, justice, oppression, and fairness came about in many different forms, but often took on the shape of trade-offs between efficiency and a sense of “morality”. Excessive taxation was often a unifier of resistance against authority, and the notion of “hoarding” and concealing wealth was almost universally characterized as an act worthy of disdain.
These were the exact issues Mossack Fonseca, the Panamanian law firm dealt with once the issue of the Panama Papers came to light. They claimed they had always complied with international protocols to ensure the companies it incorporates are not used for tax evasion, money-laundering, terrorist finance or other illicit purposes. This goes on to further raise questions about what exactly is legal? And what is the difference between tax evasion and tax avoidance?
In truth, there are legitimate or “legal” ways of using tax havens, and the 11.5 million leaked files, allegedly connected to Mossack Fonseca, do not necessarily indicate illegal activity. But shell companies and offshore accounts can be used to mask the origin of financial transactions and ownership. More than half of the 300,000 firms said to have used Mossack Fonseca are registered in British-administered tax havens. In another instance, an American millionaire was offered fake ownership records to hide money from the authorities. The leaked files, then in turn, raise questions about the ways in which the system can be used and abused.
Tax havens have less rigid taxation laws. The global elite are hence drawn to their promises of little to no taxes, while maintaining secrecy and providing solicitor client privilege to conceal their wealth and its origins. Furthermore, because of their distant locale, and lax economy, their only aim is to profit off of the legal services they provide to avoid taxation structures. They have very little incentive to try and ensure that the extremely wealthy pay their taxes.
Methods of Non Compliance – Why People Avoid Taxes
Tax avoidance, by principle, is technically legal. It is thought of more as “bending the rules” as opposed to breaking them. On a small scale it can mean putting money into an Individual Savings Account (ISA) so you do not have to pay income tax or capital gains on that money. On a larger scale it can mean paying an accountant or tax expert to exploit loopholes in the law to minimize your tax bill. However, not all methods of tax avoidance are condoned, which lends way to where the grey area lies.
Tax evasion, on the other hand, is entirely illegal. It is where you deliberately break the rules and deceive the taxation authorities about what your tax bill should be. Examples of tax evasion are failing to file a tax return, not declaring your full income or hiding taxable assets. However, all methods of tax non compliance fall under the “morally wrong” category.
The matter of taxes has always been an economic issue. Intuitively one expects that the greater the government's tax revenue collection, the better is the delivery of public goods and services that in turn spurs economic growth. However, compliance with tax regulation is not always 100%, even in developed nations. There is a group who simply cheat on their taxes, under-declaring revenues to try to minimize their tax payments. It draws attention to what is the moral decision of an individual person and what ethical standards does an individual live by?
Nobody likes to pay taxes. So tax compliance is as issue every state deals with, and the state has to create appropriate legislation to ensure compulsory taxes are fair, acceptable and useful to the community. Most taxpayers comply with their fiscal obligations when they see the tax system as a fair exchange for private or collective goods. Citizens start protesting when they realize that the tax burden is not equally shared among citizens, when the fiscal regime is suddenly seen as unfair and oppressive. At this moment, resistance derives from increasingly concrete concerns about taxes and is fueled by the way taxes are both collected and spent.
The next question that needs to be answered is if tax evasion is ethically justified in certain circumstances, what are the limits? At what point does tax evasion become ethically justified? This is the grey area that most economists and politicians are currently struggling with, and this was made only murkier with the issue of the Panama Papers. Looking into the case with more detail may attempt to help navigate that road.
The Panama Papers Controversy
The 2016 Panama Papers controversy caused an international uproar by raising legitimate concerns about the low level of transparency involved in the oversight of the finances of the “1%”. Current and former Heads of State of numerous countries, convicted criminals, entrepreneurs, and countless others have been implicated in dealings revealed by the anonymous release of more than 2 Terabytes of data, equating to more than 11.5 million document. Various countries have begun immediate inquiries, and harsh criticism over the morality of non-transparent fiscal behavior continues to worsen.
How Tax Havens Are Constructed – Why Panama?
What makes the Panama Papers particular interesting is why Panama is chosen as a tax haven. Panama has passed laws that serve to entrench corporate and individual financial secrecy. Strict confidentiality laws and regulations were put in place, with severe civil and criminal penalties for violations. The names of corporate shareholders were not required to be publicly registered.
Furthermore, Panama has very strict banking secrecy laws, where financial establishments are not allowed to divulge information about offshore bank account or account holders. The only exception is reported to be a specific Panamanian court order in conjunction with investigations into terrorism, drug-trafficking or other serious offences (not including tax evasion). Additionally, tax treaties with other countries do not exist in Panama, which act as an extra cover of protection for foreigners putting their money there. Also, due to the fact that there are no exchange control, there are no limits or reporting requirements for money transfers in or out. It is said that Panama makes available "an especially strict form of secrecy, a type of opacity of ownership, and (if the reports of backdating are correct) a class of wealth management profession[als] some of whom have especially compromised ethics. "You go to Panama, in short, because, despite its profound disadvantages, you value these things”. Campaign group, the Tax Justice Network, says of Panama: "In recent years, it has adopted a hard-line position as a jurisdiction that refuses to cooperate with international transparency initiatives”. Thus, tax, and making legal avoidance arrangements, is a global business and havens compete to provide the services, and secrecy, that clients may seek.
Clients engaging in this behavior make it a point to argue that the tactics they use are legal forms of tax avoidance, not illegal tax evasion, which in some cases may be true. Many of the transactions examined by The Times were not illegal, including the use of offshore accounts to set up a business overseas. But many of the transactions are extremely suspicious and demand investigation and, if warranted, prosecution by federal authorities.
At its most basic, law requires citizens to disclose their foreign holdings and pay any taxes on capital gains, interest and dividends earned on those holdings. Noncompliance with the law is rampant: unpaid taxes on foreign accounts are estimated at $40 billion to $70 billion a year. Emails and other correspondence between Mossack Fonseca and some of its American clients discuss efforts to conceal assets and evade taxes. In one exchange, a citizen in Washington State asked the firm how to invest money in Panama without the United States government knowing anything about it. Instead of telling the potential client that that would be illegal, the firm wrote back that it had “effective solutions” for the problem, involving interlocking and anonymous offshore accounts, a private foundation and a shell corporation.
The Case of Pakistan
The Panama Papers reveal had devastating consequences on many countries, but especially took its toll on the political framework in Pakistan and Iceland. Mr. Nawaz Sharif was the second world leader, along with Sigmundur David Gunnlaugsson, the former prime minister of Iceland, that were sacked when allegations of corruption arose from the trove of leaked documents from Mossack Fonseca. This was definitely interesting to contrast and compare, as popular belief would have you believe non tax compliance is more of an issue in developing countries, where the legal and political framework is not as strong. Researching into the effects the leaks had globally, pointed to the fact that even developed countries, with stronger constitutions had political leaders embroiled in such controversies.
The case of Pakistan, however, was criticised on a global level. While, Sharif’s name never exactly appeared in the Panama Papers, three of his six children, were deeply involved. Maryam Nawaz Sharif, Hasan Nawaz Sharif and Hussain Nawaz Sharif – were found to have purchased luxury properties in London using offshore holdings. While they all consistently claimed that that these had been obtained legally, there was overwhelming evidence that supported the fact that these were illegally acquired.
Detailed reports from the ICIJ revealed many properties and shell companies acquired under the Sharif name. These included four luxury flats in London’s Park Lane neighborhood, and two British Virgin Islands-based shell companies – Nielsen Enterprises Limited and Nescoll Limited – which were set up in the early 1990s, under his underage daughter at the time, Maryam Sharif’s name. However, after months of legal back and forth, The court ruled unanimously that Mr Sharif was “not honest” in disclosing all his assets when filing nomination papers for the 2013 parliamentary elections. The judges thus disqualified him from holding office under the terms of the constitution, which requires MPs to be “sagacious, righteous, non-profligate, honest and truthful”.
This political scandal has deep rooted implication on post Panama Pakistan. The files proved that members of the political elite have not played by the rules their citizens obey. The wealthy realised long ago that they could maximise and conceal their wealth (and its origins) by exploiting the existence of multiple jurisdictions. This, in turn, would aggravate the patronage based economy killing the roots of meritocratic economy which was budding now. Furthermore, it continues to paint the picture that Pakistan is still a corrupt country with a corrupt ruling elite. This means more cost of doing business despite being an attractive big market for multinationals, and consequently, less FDI (Foreign Direct Investment).
In terms of economic impact, the anticipated increase in expenditure in the political business cycle will be affected. Political business cycle is the increase in fiscal expenditure and alteration of monetary policy near the elections to lure voters for the ruling party’s re-election. The accusations against Sharif have damaged his political standing, which would mean he would have to invest more before the next set of elections on his political campaign to win over voters, which could mean an increased fiscal deficit for the election year and an increased fiscal deficit would also mean that we may have to again turn back to IMF or the World Bank for lending.
How the Issue of the Panama Papers Originated on a Global Scale
The saliency of the Panama Papers can be seen when looking into how it originated. Stemming from the same concept of not wanting to pay taxes as mentioned earlier, the leaked emails reveal the extraordinary measures that the elite are willing to take to conceal their wealth. This is especially common in the United States and Europe, as major actors have found themselves under scrutiny, which had made way for increased anxiety. Wealthy individuals with feel like they are cheated out of their money, and have to pay a larger amount of taxes than is necessary. This gives rise to the theme of victimhood, as the wealthier elite feel like they are persecuted unfairly, and to prevent doing so, establish offshore accounts. This also draws attention to the fact these individuals and firms hold a deep mistrust of the system, and would go as far as to put their money into foreign countries, further distancing their personal relationship from the sovereign state.
This form of tax evasion, is seen as a direct threat to the democratic governments of law, as noted by investigative economist, James Henry. He goes on argue that if political leaders and the ruling class is not responsible for its citizens, and are freel engaging in corruption and tax evasion, they are not responsible of those who elected them. This goes to undermine democracy as the concealing of their wealth can only be seen as a method of enriching themselves, and increasing their power and control. This gives rise to increasing concerns about representative democracy, and the the basic rule of law.
Conclusion: Why The Controversy is Relevant
What makes the Panama Papers important is the transparency in shining a light on the sometimes shady but, in many cases, the legal tax practices of these elites. While these practices may be legal, it does not mean they are fair or democratic. The Panama Papers raise serious issues of political morality, transparency and accountability. Transparency ensures wealthy elites and corporations pay their fair share of taxes and keep their wealth here instead of sending it elsewhere. Transparency, furthermore, makes it harder for these elites to profit from and take advantage of health care, education, safety, security, social benefits, and other services, for themselves and their families, while secretly sending their business and money elsewhere. The way to address the tax imbalance created by these offshore low tax jurisdictions is to increase transparency.
Additionally, these ethically questionable legal practices act as a gateway practice to more pressing issues of terrorism and criminality. As Europol’s head of financial intelligence, Simon Riondet says, “The main point here is that we can link companies from the Panama Papers leak not only with economic crimes like money laundering, but also with terrorism, Russian OCGs [Organized Crime Groups], drug trafficking, human trafficking, illegal immigration, [and] cybercrime”. This was proved when Europool found 3,469 probable links between the Panama Papers database and those in their files about organised crimes and fraudulent behaviour.
Furthermore, the resolution requires an informed debate in parliament and developing a consensus on what needs to be done in terms of institutional change. Agreements to have required countries set up corporate registries, so the public has access to trust and corporate records, including names of the directors and trustees, and any legal or accounting professionals that set up and maintain the trust and corporation are needed. As scholars and researchers further analyze the findings of these papers, and a greater number of infractions and perpetrators is nominated, I believe, a space will arise for concerted action at the international level that will mitigate tax avoidance