Leak-Driven Lawmaking

Shu-Yi Oei
Hoffman F. Fuller Professor of Law, Tulane Law School

Over the past decade, a steady drip of tax leaks has begun to exert an extraordinary influence on how international tax laws and policies are made. The Panama Papers and Bahamas leaks are the most recent examples, but they are only the tip of the leaky iceberg. Other leaks include (in roughly chronological order) the UBS and LGT leaks; the Julius Baer leak; HSBC “SwissLeaks”; the British Havens leaks; and the LuxLeaks scandal.

These tax leaks have revealed the offshore financial holdings and tax evasion and avoidance practices of various taxpayers, financial institutions, and tax havens. In so doing, they have been valuable in correcting long-standing informational asymmetries between taxing authorities and taxpayers with respect to these activities. Spurred by leaked data, governments and taxing authorities around the world have gone about punishing taxpayers and their advisers, recouping revenues from offshore tax evasion, enacting new domestic laws, and signing multilateral agreements that create greater transparency and exchange of financial information between countries.

Thus, it is clear that leaked data has started to be a significant driver in how countries conduct cross-border tax enforcement and make international tax law and policy. But using leaks to direct and formulate tax policy responses comes with some potentially serious pitfalls.

In a new paper—coming soon to an SSRN near you[fn.1]—Diane Ring and I explore the social welfare effects of leak-driven lawmaking. Our argument, very generally, is that while data leaks can be socially beneficial by virtue of the behavioral responses they trigger and the enforcement-related laws and policies generated in their wake, there are under-appreciated downside hazards and costs to relying on leaked data in deterring tax evasion and making tax policy.

Some granularity: Leaks can function as “free audits” that reduce enforcement costs, force governments to confront rules and loopholes historically favorable to elites, help ferret out corruption and evasion by public officials themselves, create political impetus for enforcement actions, and highlight disparities between taxpayers who are able to reduce their tax burdens using evasive tax minimization strategies and those who are less able to do so. The threat of leaked data may even discourage taxpayers, organizations, and governments from engaging in abusive behavior in the first place.

There are, however, downsides to relying on convulsive and high-salience data leaks to direct tax policy and guide tax enforcement. Our paper discusses these downsides and flags three key risks inherent in leak-driven lawmaking that can create unexpected costs:

Agenda Setters. Leaks may draw too much focus to the specific phenomenon being leaked or may tend to highlight specific jurisdictions while drawing attention away from others, leading to inefficient allocation of scarce enforcement resources. This risk may be particularly troubling given the significant control that whistleblowers and leakers, key media organizations (such as the International Consortium of Investigative Journalists (ICIJ) and WikiLeaks), NGOs, and other secondary commentators have in timing, packaging, framing, and describing the leaked information. These actors essentially have the power to direct and even manipulate the responses of governments, taxing authorities, and the public. And—Surprise!—some of them may be motivated by agendas that do not include optimal tax enforcement. Therefore, reliance on the actions of these agenda setters is likely to create some degree of agency costs.

Bumpy Transmission Pathways. The data leaks we have seen to date reveal that the path from initial theft or taking of data to eventual policy responses has never been smooth or fast. Instead, the transmission of leaked information from the leaker to a government (or governments) or to a media organization such as ICIJ or WikiLeaks and then its subsequent transmission to the public and other key policymakers takes time, is unpredictable, and invites varied policy reactions from governments ranging from inaction to overreaction to denial. The bumpy process of data transmission, publication, and eventual receipt by taxing authorities—which is something I’ve written about previously in connection with the HSBC Suisse leak—is likely to generate costs and delays. In other words, it’s not as seamless as simply taking data and using it. There’s a process, and the process may be costly.

Poorly Designed Laws. Finally, the ultimate welfare effects of a tax leak will depend on the specific legal and policy responses that a government adopts. It is possible that governments might embrace well-designed laws and enforcement policies that perfectly maximize the social welfare function in response to a tax leak. But it also possible that governments might enact poorly designed laws and enforcement mechanisms that impose costs in excess of benefits, or that burden the “wrong” taxpayers. For example, if the worst tax evaders turn out to be most elastic in their responses to these enforcement measures, then any heightened compliance burdens might well fall on less culpable or less egregious offenders. In the paper, we discuss FATCA—the controversial 2010 legislation enacted in the United States after the UBS leak—as an example of a law with uncertain cost-benefit consequences and potentially problematic distributive results. While FATCA has unquestionable improved compliance and generated additional revenues, the law is by some accounts quite costly, and it is hard to tell whether the law’s benefits exceed its costs. Moreover, while FATCA was aimed at catching offshore tax evaders—Americans who had deliberate stashed assets offshore to evade taxes—the law has also imposed burdens on three other groups: Americans expats living and working abroad, so-called “accidental Americans,” and green card holders and certain other long-term immigrants living in the U.S. who may hold assets in their home countries. It is quite plausible that these latter populations—who have lives, connections and assets abroad—are less elastic in their offshore holdings than those who were simply hiding assets, and that they will bear disproportionate FATCA compliance burdens over the long run.

The roles played by agenda setters, the inefficiencies in information transmission, and the real possibility of poorly designed laws and enforcement responses to leaks are key risks in using leaked data to enforce tax laws and develop new ones. These risks are likely to emerge any time there is a data leak.

In short, even though tax administrators and policymakers have by and large assumed that data leaks are a net positive in the global fight against offshore tax evasion, this is not necessarily the case. Policymakers need to think more carefully about the dynamics underlying leak-driven lawmaking, and about how to ensure that reliance on data leaks yields welfare-enhancing, rather than welfare-reducing outcomes.

[fn.1] Shu-Yi Oei & Diane Ring, The Law of the Leak (on file with authors). Feel free to email us for a copy.