Gaps and holes: How the Swiss cheese was made

by Daniel on April 8, 2016

When some things have holes in them, it’s a sign of decay, like a beam with termites. But some things are meant to have holes, like Swiss cheese. I agree with John’s view on “holes and gaps”, but as always, I tend to assign agency to the political system more than to the financial sector. Nearly all of those holes were intended to be there, and it was intended that the financial system used them. The process whereby the behaviour involved is redefined from acceptable deviancy to unacceptable is very interesting, like the last chapters of a John le Carre novel by way of Foucault. A few thoughts below, ranging in geopolitical scope from “vast” to “cosmic”, in a comment which grew into an alternative monetary history of the second half of the twentieth century.

Tax havens

Once upon a time, the United Kingdom decided it no longer wanted to have colonies in the Caribbean and elsewhere. So it started the process of giving independence to a lot of small islands which had very few export industries other than sugar cane. The ethical thing to do would have been to provide significant subsidies for the industrial development of these former colonies, but that was politically a difficult sell. After all, dismantling an Empire is psychologically difficult enough to begin with – to find out that doing so is going to cost money is surely a step too far.

However, it’s possible to do something which has a similar fiscal effect. And that was to “encourage the development of a financial services industry”, by allowing the former colonies to benefit from tax treaties with the United Kingdom (and thereby access to the global financial system), while making their own arrangements regarding the local taxation of offshore shell companies. Sometimes (insurance in Bermuda) it worked well in terms of seeding a genuine value-creating industry cluster. Sometimes (the British Virgin Islands) it didn’t. In either case, the economic effect was a steady and predictable leakage of tax from the British fisc, which subsidised a gain to the islands. One might say that this is an incredibly self-serving and inefficient way to hand out foreign aid. One might also say “compared to what?”. The British were the biggest users of this tactic of post-colonialism, by the way, rather than the only ones.


You don’t have to be a geopolitical genius to work out exactly why it was that so many people all over the world in the third quarter of the twentieth century were so keen on the idea of bank secrecy. Lots of them had been given a pretty harsh lesson about confiscation of assets, and millions more were living in the shadow of the Soviet Union. Bank secrecy was the default position.

And once more, the provision of secrecy jurisdictions for ill-gotten gains was very much supported by public policy, which during the Cold War was very much a driver of their ill-getting. If you are going to bribe a dictator, then he is going to want to put that bribe into a bank account, and he is understandably going to want to be sure that his bribe-taking account is not transparent. One of the most startling examples of the “Le Carre effect” that I’ve ever seen came shortly after the Tahrir Square protests, when the US State Department announced that they would be launching an inititative to find and prosecute the banks which had been handling the fortune of Hosni Mubarak. This initiative didn’t really go anywhere, because a number of people pointed out that the State Department had been writing cheques to Mubarak for the preceding forty years, and that it was consequently a bit late to complain that he was banking them.

Tax and secrecy…

So there were reasons why the tax holes were put there, and reasons why the secrecy holes were put there, and in both cases, the financial sector was using the postwar international structure as it was supposed to be used. (“Technically legal”, after all, is a phrase which means “legal”). The trouble, and the expansion of the financial sector into a machine based on regulatory and tax arbitrage, came when the secrecy holes and the tax holes matched up with one another, and both were turned into products aimed at the mass-affluent market. These arrangements had one major effect; they significantly lowered the effective tax rate on the very wealthy. That’s not good tax policy, but it needs to be looked at in political economy terms.

The post war social and economic settlement was a massive change from how things had been before. The UK built a National Health Service. Other countries built similarly massive systems based on a ratio of government expenditure (and therefore taxation) to national output which was wholly unprecedented. And this all happened, with basically no reactionary movement, no coups, hardly any resistance at all from the very wealthy, whose position in society went through a shock (described in detail in the relevant chapters of Thomas Piketty’s book) from which they have only comparatively recently recovered. How did it all happen so smoothly?

Well, one reason is that for very rich people who didn’t like the new economic and fiscal reality of “one for you, nineteen for me” (“Taxman” by the Beatles, accurately describing the top rate of marginal tax at the time), there was a choice between exit and voice. If you couldn’t live with 95% supertax, then you didn’t have to fight it; you could hire a good advisor and rearrange your fortune. The price of doing so, however, was a diminution in your political influence back home. Looked at this way, the holes in the system were a safety valve for upper class rage, during a period of social change which might have been expected to very much need such a safety valve.

And now here we are…

My story, as told above, ends in the late 1970s, some time between the oil shock and the Reagan revolution. The global upper class found out (the hard way) that inflation is the tax you can’t avoid, and their reaction to it was to reverse the exit-voice choices that they had made during the trentes glorieuses. Obviously, in an environment of rapidly falling top tax rates, the purpose of the tax holes was obsolete. And post the end of the Cold War, the secrecy holes were also largely obsolete. But they didn’t end, of course. And this was the period at which the financial sector’s use of tax and regulatory arbitrage become wholly pathological in the way John describes. We could have expected, with the perspective of a highly functionalist philosophy of history, that one of the stories of the following thirty years would be of rising onshore inequality, out-of-control financialisation and so on. And that it would end badly, and that in the aftermath, the “onshore” segment of the global elite would have little continuing use for the “offshore” segment. The winding up of the offshore centres is, really, just one of the later stages of the winding up of the whole post-war settlement.