Counteracting offshore tax evasion Evidence from the Foreign Account Tax Compliance Act
This paper aims to investigate the effect of the Foreign Account Tax Compliance Act (FATCA) on the deposits held by US global banks through their branches located around the world. Using an unpublished dataset on deposits held by branches of US banks on a geographically unconsolidated basis, we find that the FATCA led to a reduction in deposits held in branches located in tax havens. We find that this effect is more severe in those jurisdictions signing a reciprocal exchange of information agreement. We also advance evidence in support of deposit shifting within the US banking system towards locations without a reciprocal intergovernmental agreement.
Tax evasion is one of the biggest challenges faced by tax authorities. The global value of hidden assets by households in tax havens, including securities and bank deposits, is estimated at $5.8 trillion, leading to adverse implications on the distribution of wealth in society. Furthermore, the involvement of the banking system in sophisticated money evasion schemes raises important questions on the ethics of some activities of banks. Understanding the implications and the effectiveness of the regulations aimed to counteract offshore tax evasion is of crucial importance for normative considerations and future regulatory agendas. Uncovering how banks and depositors act to new legal frameworks for offshore tax evasion is particularly important for policy evaluation.
This paper investigates the impact of the boldest regulatory initiative to date: the Foreign Account Tax Compliance Act (FATCA). This regulation aims at increasing the transparency and accountability of deposits held by US taxpayers located abroad by (1) improving reporting standards and (2) incentivizing the exchange of information with foreign banking institutions and foreign tax authorities. I focus on the effect on US global banks by using an unpublished dataset on foreign deposits of foreign branches of US banks obtained from the US regulator. I test for several scenarios that US banks may face following the implementation of the FATCA. First, I investigate whether the enhanced FATCA reporting system adopted by US banks, involving most notably a more thorough investigation of the identification of the ultimate beneficiary of shell companies, has led to an overall decline in deposits held in tax havens. Second, I explore whether branches located in Inter-Governmental Agreements (IGA)-signing tax havens, having an exchange of information agreement in place, experience a heightened decline in deposits. A more pronounced flight of US tax evaders’ deposits may be observed in branches located in tax havens that sign an IGA, possibly due to increased pressure in the local banking systems to enhance transparency and due diligence (driven by the compulsory exchange of information system faced by local banks) which increases the probability of detection of tax evaders. Last, I investigate whether US banks engage in the cross-border transfer of US tax-evading deposits held in tax havens to branches located in non-IGA locations.
The results point to a post-FATCA flight of US taxpayers’ deposits held in US global banks located in tax havens, particularly in those jurisdictions signing an IGA with the US tax authority. Finding evidence of an implication of US banks in offshore asset shielding is important evidence, as very little is known about the institutions facilitating asset shielding, even if tax havens are well documented to host tax evasion. I also find evidence of cross-border deposit transfer within the US banking system to branches located in non-signing IGA countries. Deposit shifting across related branches, consistent with regulatory arbitrage, can be interpreted as an attempt by US global banks to contain the loss of deposits and to maintain a level playing field in offshore banking services with their foreign competitors.
The empirical strategy is based on a panel difference-in-differences (DiD) framework. The dependent variable is the natural logarithm of nonbank deposits outstanding in the balance sheet of foreign branches located in the sample jurisdictions over time. An indicator variable takes a value of 1 from 2011 onwards and captures the implementation of the FATCA. Our benchmark tax haven country dummy follows Hines (2010). The DiD parameter captures the extent to which average deposits in tax havens have changed post-FATCA, compared to what deposits in this group would have been without the FATCA implementation. A negative estimated DiD coefficient indicates that average deposits of branches located in tax havens deviate negatively from those of the non-tax haven control group.
Applications and beneficiaries:
Understanding the extent to which regulation aimed to counteract offshore tax evasion affects the behavior of economic agents is relevant for regulators given the normative implications and the interdisciplinary scope of the research. This paper has provided an assessment of the effects on deposit liabilities of foreign branches of US banks of the latest offshore tax enforcement regime, the FATCA. Uncovering how banks and depositors act under the new US legal framework for offshore tax evasion is important for policy evaluation underpinning the normative branch of the field.
Reference to the research
D’avino, C. (2023). Counteracting offshore tax evasion: Evidence from the foreign account tax compliance act. International Review of Law and Economics, 73, 106126.
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