The European Summit in March 2014, was one of the major economic turning points in Luxembourg’s banking history. This date, Luxembourg and Austria agreed on backing the EU intentions on rising tax transparency, hence heralding the end of Luxembourg’s banking secrecy. This decision comes as no surprise. The banking industry anticipated this situation and had been preparing the loss of the banking secrecy already years before. Luxembourg had anyway been cooperative, especially when it came to tax frauds or illicit affairs. Moreover, the country ratified 70 double taxation conventions with other fellow member states. However, the most recent development will not be a painless procedure as smaller banks who are mostly dependent of the private banking sector are about to shut down their activities. How did it come to this situation?

Leaders of major developed economies have repeatedly pledged to crack down on so-called “tax havens” since the outbreak of the financial crisis in 2008. The intense pressure of rising public deficits was often the common ground of fear to initiate joint action on a supranational level in the pursuit of hunting down the “missing” wealth which is still continuously slipping past into tax havens. For most major economies targeting e.g. the wealth of the so called high net worth individuals (HNWI) is a welcoming source of revenue and even a popular measure for democratic elected politicians.

Despite the fact that in recent years, countries are joining forces for the sake of developing mutual standards of transparency and exchange of information, the act of signing and the implementation of the agreements have rather followed a sequential pattern and were focused only on a few countries.

The sequential implementation of agreements – or in other words, the fact that most of the agreements were not made simultaneously – was the main focus of Prof. Kai Konrad’s presentation “Strategic Aspects in the Fight against Tax Havens”[1] during the last CREA Conference Talk on “Tax competition and Public Finance”[2]. Largely based on his paper “Fighting multiple tax havens”[3], Konrad develops a game theoretical framework about the interactions between various tax havens by taking into account external pressure that actually arose from supranational organisations such as the OECD or the European Union. The sequential nature of deactivating tax havens may have proven to be successful at the initial phase, however this approach will change the nature of competition among tax havens that still remain active. In general the capital held by HNWI is highly mobile, so anyway they will always find ways to place their wealth under the most appealing conditions. As competition among “tax havens” will relax and the market changes to a more oligopolistic setting with high monopoly rents, the remaining tax havens continue to accumulate wealth, thus becoming even more reluctant on giving up their business model.

The author even goes as far that the sequential approach and further strengthening of the remaining players would generate a greater welfare loss among “non-tax haven” economies than in a situation with a large number of tax havens. Tax revenues will still remain low among non-haven countries, however fees on the sheltered capital become even higher (due to the higher monopoly rents), and the owners have to relinquish a larger share of their returns on capital.

The final point of his presentation was quite interesting, as Konrad predicts an equilibrium with two global tax havens. One sheltered by the United States (Delaware?) and another by China (Hongkong), two countries towards fellow member states wouldn’t even think to impose sanctions. One may still imagine a so-called tax haven in the Middle East (oil rich countries) to emerge by then, however this might depend on the evolution of the energy market and the reliability of alternative energy sources.

As Luxembourg already exited the “game”, private banking clients (mostly with lower levels of “wealth”) have been progressively drawing back their funds, so now efforts are initiated to attract HNWI clients to Luxembourg. In order to succeed in this operation, the financial centre has to promote its main assets and bring forward its long tradition of financial expertise and extensive knowledge of the needs of an international clientele. However, the success of this initiative depends as well on how the supranational institutions proceed in cracking down the tax havens that are left over. The sequential procedure as advanced by Konrad may be proven as inefficient as it diminishes competition gradually, hence reinforcing the position of the few tax havens that are left over. It will be difficult for Luxembourg to compete for HNWI in such an environment, as HNWI will always ensure that their wealth will find the most attractive home. And by taking out tax havens sequentially, the remaining tax havens will ever become more reluctant in giving up their status. If it comes to fighting tax havens, as mentioned by Konrad, a coordinated “big-bang” policy initiative forging a simultaneous multilateral agreement between all participants is probably the most appropriate measure to be taken as welfare losses in such an environment are less pronounced.


[1] This contribution does not aim at holding a debate on the meaning of a tax haven. It simply replicates the vocabulary as used by the speaker.

[2] 4th CREA Conference Talk on Economics – « Tax Competition and Public Policy, 20 June 2014

[3] Elsayyad, May & Konrad, Kai A., 2012. « Fighting Multiple Tax Havens, » Munich Reprints in Economics 13964, University of Munich, Department of Economics.

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