What do the Panama Papers have to do with inequality? A whole lot.

The exposé arrives at a time when income inequality is a major issue worldwide, and it suggests that global tolerance of offshore tax havens is one of the important roots of the rich-poor gap.

Stigtryggur Johannsson/Reuters
People demonstrate against Iceland's Prime Minister Sigmundur David Gunnlaugsson in Reykjavik, Iceland, Tuesday. Mr. Gunnlaugsson became the first major casualty of the Panama Papers revelations, stepping down on Tuesday after leaked files showed his wife owned an offshore firm with big claims on the country's collapsed banks.

With the so-called “Panama papers” shedding light on how a global elite hides fortunes offshore, experts say this isn’t just a tale of corruption – it also goes to the heart of the world’s yawning chasm of economic inequality.

It may seem obvious enough: If people with connections are able to shelter their money from scrutiny and taxation, those rich people get richer. Yet the import of this fact may be obscured by the raw and personal details emerging this week as investigative journalists report on how one Panama-based company has helped hide well- or ill-gotten money in the anonymity of shell corporations.

Headlines include news about friends of Russian President Vladimir Putin moving $2 billion overseas, about shell companies being created by Chinese power brokers including a relative of President Xi Jinping, and about a firm set up years ago as a tax shelter by the father of British Prime Minister David Cameron. Revelations about secret dealings toppled Iceland’s prime minister Tuesday after citizens took to the streets.

And corruption probes that threaten governments in South Africa and Brazil, which were in motion before this week, include ties to the same Panama entity as all those others – the law firm Mossack Fonseca.

The questions go beyond whether the financial activities were legal or illegal. The news puts names and faces on the problems of political cronyism and tax evasion by the wealthy, and on the global scale of these problems. That’s politically volatile in its own right. But the news, arriving at a time income inequality is an issue of high worldwide concern, also suggests that global tolerance of tax havens is one of the important roots of the rich-poor gap.

“Financial secrecy enables inequality. Tax havens enable inequality,” says Matthew Gardner, executive director of the Institute on Taxation and Economic Policy, a nonprofit research organization in Washington.

“It may feel like window into a different world,” he says, referring to the Panama Papers data, which was reported Sunday by the International Consortium of Investigative Journalists (ICIJ). “But it is also a window into how our financial system works in the United States” and beyond.

How shell corporations work

Panama, and the specific law firm whose records were leaked to the ICIJ, is just the part of a much larger network of tax havens worldwide – including opportunities to hide assets in the United States as well as in smaller nations such as Luxembourg and the Cook Islands.

“The cache of 11.5 million records [from the firm Mossack Fonseca] shows how a global industry of law firms and big banks sells financial secrecy to politicians, fraudsters and drug traffickers as well as billionaires, celebrities and sports stars,” the ICIJ reporters write in an overview of their findings.

Shell corporations lie at the center of this secretive realm. Individuals can easily set up entities to park their money in, maintaining effective control of it while tapping other individuals to be publicly listed as directors.

The basic process isn’t illegal, and the fact that prominent or wealthy people use such havens isn’t much of a surprise. But the scale and detail of the ICIJ’s Panama Papers makes the issue concrete to an unprecedented degree.

How everyday people lose out

And the reports sketch the connection between financial secrecy and inequality. For instance, one ICIJ report calls out a Ugandan company for avoiding taxes on a $400 million oil deal – and notes that the forgone tax revenue would be enough to cover a shortfall in health-care spending that currently leaves some Ugandan patients sleeping on hospital floors.

The tax-avoidance tactics help rich individuals and firms become wealthier still, and they deprive nations of tax revenue that’s as needed in Kalamazoo, Mich., as it is in Kampala, Uganda. If the wealth was ill-gotten to begin with – whether through activities like drug trafficking or politicians accepting bribes – the adverse impact on average people is all the worse, experts say.

“For those who are seeking to use the financial system to steal money, ... anonymous corporations are basically their getaway car,” says Mr. Gardner, who spoke to the Monitor by phone.

How much of global inequality stems from this problem? It’s hard to say with precision, and most economists say some degree of rich-poor gap is inherent even in a well-functioning free market system. But experts on income disparities generally say inequality has reached troubling proportions – and that problems like those revealed in the Panama Papers are a meaningful factor.

Now the big question may be whether the Panama Papers result in strong public pressure for financial reforms – and in a shift away from the idea that tax havens and secrecy for the rich are to be accepted as the way the world works.

“It's interesting how crisis can be a catalyst,” says finance expert Tom Cardamone, referring to the way the 9/11 terror attacks prompted actions to improve transparency in the global banking system.

“Hopefully these revelations will also be seen as  a type of crisis,” says Mr. Cardamone, managing director of Global Financial Integrity, a research and advocacy group in Washington. They're a reminder of “how dark it is in many, many places around the globe.”

The potential for a pointed public response has already been revealed in Iceland, following the news that the prime minister’s wife had an offshore company holding bonds in failed Icelandic banks, at a time when her husband was part of a government negotiating as a creditor of the banks after the 2008 financial crisis. Sigmundur David Gunnlaugsson resigned as prime minister on Tuesday.

'An iceberg we knew existed'

Raymond Baker, an expert on global corruption and shadow finance who founded Global Financial Integrity, has called dirty money “the most damaging economic condition hurting the poor.”

“The best thing that can be done to lift people out of poverty and cut inequality is to clean up the global financial system,” he writes in his book, “Capitalism’s Achilles Heel: Dirty Money and How to Renew the Free-Market System.”

And Branko Milanovic, a economist who focuses on global inequality, tweeted on April 3: “The #panamapapers have a huge importance for figuring out global wealth #inequality. An iceberg we knew existed but had no idea of the size.”

This data leak, actually, merely hints at the size by showing the dealings of just one prominent law firm in the shell-company arena. Details from the data leak are still emerging. Some 100 news organizations aided the ICIJ effort, but so far the ICIJ has not made its data available for wider public view. The ICIJ's reports have not been corroborated by the Monitor.​

For its part, the firm Mossack Fonseca says its actions have been within the law. (And in one instance cited by ICIJ, a founder of the firm sought to ensure that it stopped harboring money from Iran.)

The size of the problem and its fixes

Although concern about inequality is strongest on the political left in the US and other nations, plenty of people across the ideological spectrum view it as problem threatening individual opportunity, trust in government, and even the basic rate of economic growth.

It’s now routine for the largest global corporations to tally up their revenue in low-tax locales and avoid liabilities in high-tax ones. In the US, corporate income taxes now supply just 11 percent of federal tax revenue, down from about one-third in 1945, according to numbers tracked by the Center for Budget and Policy Priorities in Washington. That means individual taxpayers have to pay more.
Gabriel Zucman, a finance expert at the University of California, Berkeley, has estimated that at least 8 percent of the world’s wealth is held offshore rather than in the owners’ home nations – costing some $200 billion or more in annual tax revenue.

Much of that lost tax revenue is in relatively well-off countries in Europe, North America, and Asia. But as a percentage of overall national wealth stashed offshore, some leaders in his calculations are Arab Gulf countries (57 percent offshore), Russia (50 percent), Africa (30 percent), and South America (22 percent).
In his book, Baker argues that the problem is nothing inherent in capitalism, but rather in a look-the-other way acceptance of cronyism. The solution, he argues, is in comitting to put the rights of individuals and the rule of law first.

A crucial next step of reform may be targeting the ease of creating shell companies. Cardamone calls for a push by G8 and G20 nations “to require that corporate ownership has to be public. It cannot be secret. There has to be a flesh and blood person attached to every company that's incorporated.”

The US could show leadership by passing federal legislation, to limit the leeway that states like Delaware currently use to allow corporate secrecy. Such legislation has already been proposed but has lacked the momentum to pass.

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