This is the location of tens of billions of dollars that won’t be declared to the IRS today

All 76 square miles of Grand Cayman, one of the largest sources of foreign investment in the US.
All 76 square miles of Grand Cayman, one of the largest sources of foreign investment in the US.
Image: NASA
We may earn a commission from links on this page.

Today is tax day in the United Sates, and most Americans pay their fair share without a peep. Some of the folks that aren’t playing ball keep their money in offshore accounts to dodge taxes and then invest it back in the US, and for the first time we have an estimate for how much: Some $34 billion to $109 billion, at least in 2008.

We’re talking about “round-tripping,” a fairly common technique in the world of tax evasion: Send your money to a shell company overseas in a low-tax country, then reinvest in your home country while avoiding taxes and perhaps garnering special treatment designed to attract foreign investment. It’s frequently cited as a problem for emerging markets: Chinese investors dodge taxes by routing their money through Hong Kong before it returns to the mainland; Russian oligarchs do the same thing in Cyprus. In the US, Caribbean islands are the haven of choice.

But how much of that money is actually dodging taxes? There are, after all, legitimate reasons to invest money through tax havens—many banks and hedge run funds through them to attract actual foreign investors, and report relevant tax data to the authorities. What researchers really want to know—how much of the money is illicit—is by definition the hardest thing to tell, wreathed behind bank secrecy laws that are typically penetrated only by leaks of insider information.

The authors of a paper to be published in the Journal of Finance set out to figure out, at least in aggregate, a good estimate of the foreign investment that isn’t legitimate. They rely on a model designed to see how criminals react to incentives to benefit from crime—in this case, higher US taxes, which wouldn’t affect true foreign investors—and incentives that make committing crime riskier—here, new agreements between the US and tax havens that make it easier, though not easy, to find tax cheats.

By mapping changes in the flow of foreign portfolio investment—stock purchases of less than 10% of a company’s value—against changing incentives, the economists determined that US tax authorities missed out on round-tripping funds equal to $34 billion to $109 billion in 2008. That effectively cheated the US government out of billions of dollars in tax payments. The researchers say each 1% increase in the top US tax rate results in a 2.1% to 2.8% increase in foreign investment from tax havens—which suggests to them that the amount of round-tripping going on is “economically meaningful.” Perhaps as important, they see tax disclosure agreements with these jurisdictions reducing the amount of illicit investment. That’s more ammunition for critics seeking to limit abuses of the international tax system.