The Hidden Costs of Tax Havens

According to The Missing Profits of Nations report, a research collaboration between the University of California, Berkeley and the University of Copenhagen, at least 72 percent of Fortune 500 companies maintain subsidiaries in offshore tax havens, with an estimated 40 percent of multinational profits shifted to tax havens each year.

Rackham student Simon Rakei, a joint Ph.D. student in the history and anthropology departments, studies the modern formation of non-sovereign tax haven states in the Caribbean and financial capital outflows from Southern African mineral extraction companies.

Tax havens are countries that allow companies to incorporate and register as international businesses with very low or no tax liability. While this provides enormous benefits to the businesses themselves, it can have negative impacts on local communities around the world where these companies pursue their projects.

“Intuitively, you would expect that if a diamond company was mining in the Democratic Republic of Congo, they’d pay taxes in that country,” Rakei says. “That’s not usually the case.”

Community Impacts

When countries welcome multinational companies to do business in their backyards, they are often swayed by job creation possibilities, infrastructure enhancements, and other promises that rarely come to fruition.

As Rakei explains it, countries often will require reinvestment in local communities from companies, in alignment with the company’s revenue growth. This can take a decade or longer to establish, especially in the case of mining operations, due to the massive capital investments needed. In the meantime, utility companies offer bulk discounts to companies for water and electricity while passing the cost along to regular consumers, making the lives of everyday people more expensive. Losses to everyday people are compounded further when relocation is part of the equation, with impacts that can devastate families as they are removed from friends, family, and livelihoods. Additionally, the economic boost that’s meant to strengthen communities is speculative and often short term.

“The thinking is that there’ll be new businesses—convenience stores, restaurants—opening up to support the new company in town—and these are just the projections of what the economic activity is expected to generate. Some of these kinds of businesses can live on after the life cycle of the mining operation, but it’s very rare,” Rakei says.

Reinvestment in local communities is stunted and stalled further when companies use tax havens, as they don’t have to pay income tax, capital gains tax, or wealth tax.

“Attaining foreign direct investment as a panacea to actually do the work of development has negative costs that are quite high,” Rakei says.

“When those companies fail to meet their objectives, it’s more than the company’s failure—the government has now also failed to deliver its own mandate in terms of basic delivery for goods, services, and basics like water.”

Survival in a Post-Colonial World

Having returned recently from a research trip to the British Virgin Islands, a non-sovergin tax haven, Rakei grapples with the region’s deep and entwined history with the tranatlantic slave trade and its impacts.

Small, sparsely populated nations with few natural resources and a legacy of exploitation without reparation, Caribbean islands rely on tourism and the revenue generated from corporate license registrations to survive, Rakei says. At least 60 to 65 percent of the gross domestic product is financed through these fees.

Rakei also notes the precarious nature of this form of self sufficiency, as the British Virgin Islands are territory under British rule and subject to any financial laws the British government decides to impose upon them. 

To Rakei, an exploited region has taken on an exploitative global financial practice in order to survive in a post-colonial world—and a nuanced understanding of that reality is needed in order to address the issue responsibly.

“Non-sovereign nations like the British Virgin Islands aren’t just parasitic tax haven states,” Rakei says. “This is their way of supporting themselves.”

Growing up in Johannesburg during a tumultuous time in South Africa’s political history following apartheid, Rakei’s capacity for interpreting the many historic and economic factors that lay the groundwork for systemic issues has been a lifetime in the making—and a skill he continues to refine in his graduate studies today.

Questioning Systems

Rakei’s mission to research corporate tax havens started when he was in high school and a South African labor movement was met with deadly force, resulting in the deaths of 34 people. The incident, known as the Marikana Massacre, happened in August 2012 when Cyril Ramaphosa—then serving on the National Executive Committee of the African National Congress and elected as its Deputy President in December of that year—authorized lethal force against striking Lonmin mine workers fighting for a better wage. In addition to his role in politics, Ramaphosa was a board member of the mining company.

“You had this alliance between private capital and strong political actors,” Rakei says. “From this incident, I learned that I didn’t trust politics as an avenue, but it made sense to me at the time to try to understand and control the levers of the economy. So that actually made me want to study accounting.”

As a finance undergraduate at the University of Cape Town, Rakei was very involved in an activist movement called Rhodes Must Fall, a student-led demand to decolonize higher education in South Africa, starting with the removal of statues of English mining magnate Cecil Rhodes from campus. Rhodes laid the groundwork for apartheid in South Africa, working to alter laws on voting and land ownership.

“I was a student in a very tumultuous period in South Africa’s history, and in universities in particular,” Rakei says by way of explaining the genesis of his research interests. “I had strong critiques of capitalism by the time I was done with my undergrad.”

During his undergraduate studies, Rakei was signed with the auditing and finance company Ernst & Young. After a time at the company, he made the switch from corporate accounting to researching and organizing, working with the Association of Mineworkers and Construction Union and a non-governmental organization called the Alternative Information and Development Center. One of his lead projects: a whistleblower case against Samancor, one of the world’s largest chrome mining companies.

“Samancor was being accused of engaging in transfer pricing—an accounting technique multinational companies use to move profits to tax havens—tax evasion, and profit shifting,” Rakei says.

“My role was to try to help the organizations I was working for understand how tax evasion works, how transfer pricing works, how companies enter into shared buyback agreements where you can legally transfer funds out of the country, and how companies move money offshore.”

Rakei continues to advocate for economic justice in South Africa through his work as a scholar and researcher at U-M.

“If you aren’t paying your fair share of taxes, that undermines democracy for everyone,” Rakei says. “The stakes are very high in terms of just maintaining these principles of democracy and freedom.”