TCS Daily

Paradise Lost

By Roger Bate - June 9, 2003 12:00 AM

Grand Cayman - it's not often that one erroneous idea in a novel has an enormous impact on so many livelihoods. Rachel Carson's book "Silent Spring" has unfairly undermined the use of DDT for malaria control for decades, and probably cannot be beaten in terms of impact. But perhaps John Grisham's "The Firm" comes in a worthy second. In that book, the Cayman Islands is portrayed as the home of tax evasion and money laundering.

Perhaps it was a long time ago, but the reality in Cayman for at least 15 years is of probity and a spotless reputation in the banking community. Yet everyone else still has Grisham's view and most TV shows that deal with the topic of money laundering mention Cayman (like in an episode of "JAG" last week). Cayman is the most famous of the low-tax centers, which are pejoratively known as "tax havens." They are under attack by high-tax European countries that want them shut down so that they lose fewer taxes. It is essential that the U.S. defend them, because they show the way to the developing, aspiring nations of the world. They demonstrate that an economy can be successful no matter how small it is, if it follows fiscally conservative measures. Furthermore, jurisdictional competition keeps government in check, so we all win when places like Cayman keep their taxes low.

The Downside to the War on Terror: Data Overload.

Internal revenue agents want to trace terrorists and tax evaders and they demand more and more data from banks. They require banks to file suspicious activity reports. But what is suspicious is highly debatable, and so to play safe (since there are high fines) bank employees file thousands of SARs every day. The result is an increasing mass of unusable financial information on the desks of the IRS and similar European agencies.

As Brad Jansen, an adjunct scholar at the Competitive Enterprise Institute, explains: "It's much easier to find the key missing piece of paper on your desk if you don't have a lot of paper. If your desk is a mess, it takes much longer to find." Jansen says that as a result of the informational demands, there have been fewer prosecutions of tax evaders and money launderers since September 11th than before. For example, new IRS demands mean that honest people buying homes with cash, who come from countries whose people distrust banks (such as many Latin Americans), are chased, which wastes time, money and the best detective minds that should be spent on chasing al Qaeda actors and other terrorists and despots. Furthermore, U.S. citizens' financial privacy is harmed as a result.

But is it just the U.S. that is driving the demands for such information?

High-tax countries like France want information from Cayman banks since they are concerned that their citizens are evading taxes. The U.S. also wants to find tax evaders, but is most concerned about unearthing terrorists. Generally, U.S. courts protect citizens' rights. Similarly, there is a due process of law that French courts follow to ensure that their citizens' rights are not significantly abused. But more disturbing is that international initiatives, such as the proposed EU Saving Tax Directive, and various Organization for Economic Cooperation and Development (OECD) suggestions, which are opposed by the U.S., are trying to make low tax centers like the Cayman Islands and Bermuda provide even more information than the rich countries like France and Germany provide to their own treasuries. The informational provision they demand, if it were done domestically, would breach the rule of law in their own countries.

Small centers, which rely heavily on financial business, are scared to fight such initiatives because they fear they will be added to blacklists. The media report those that are listed and portray the listed as being the home of money launderers and despots' loot. This then pressures large corporate depositors to remove their funds or fear reprisals, such as intrusive audits. Fortunately, the small centers, many of which are independent states, have joined together and explained that the demands placed upon them are unfair, pointless and disproportionate. But their initial success in stopping OECD demands for open exchange of bank information may backfire.

Cayman, for example, has followed an apparently sensible tactical line by demanding that all OECD countries enact the informational exchange provisions that were being demanded of them. If everyone else agreed to comply, then they would also enact the laws. Since it takes a long time for 30 countries to independently change regulations, this was always going to be a sensible delaying tactic - even more so when some of the OECD countries (like France, the U.K., and the U.S.) had no intention of changing their laws to provide widespread information without informing those being investigated (since this would breach the rule of law domestically).

However, what may seem tactically sensible may prove to be strategically dangerous in the long run. By agreeing to the demands, in principle at least, these states lose the moral high ground, and the fact that the demands are unlikely to be adopted is irrelevant. The media naturally accepts that the demands are correct since even tax havens like Cayman say it will agree. But when in-depth reporters ask Caymanians about the demands they privately attack them, implying that they are willfully delaying the process. Their reports are picked up by mainstream media, who already primed by John Grisham portray Cayman as the bad guy. So while Cayman is winning a short run reprieve they may lose in the long run since their reputation is harmed.

When the OECD or other agency re-writes the demands in a more palatable form, and they surely will, Cayman will at that stage have to oppose what they previously agreed to. Bankers in Cayman may expect fair media reporting of their concerns, but they will probably come off badly. Cayman will appear inconsistent and will have an uphill battle to make its case and it will likely fail.

John Grisham may have been correct in his assessment of how the Cayman Islands acted a few decades ago but today the Cayman Islands is a large respectable banking center (the fifth largest investment location in the world). It is far harder for me as a Brit to establish a bank account there (I tried) than in the U.S. Cayman and its allies behave well, none of Al Qaeda's terrorist money was invested there, and they must maintain the moral high ground rather than becoming involved in tactical activities that undermine their own long-term future.

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