I’ve heard rumours now and again that some think my position on secrecy jurisdictions is radical, forcefully stated and unacceptable to those who work in such places. I disagree, of course, but it’s always nice to find someone who proves the point. Lee Shepherd is one such person. She is a contributing editor of Tax Notes, a Washington-based weekly tax journal and like me she writes a column for Forbes. The title of this blog comes from her latest contribution to Forbes, in which she says:

Why do tax havens exist? This brief history of tax havens was inspired by unanswered reader questions posted by Yves Smith, in her must-read financial blog Naked Capitalism.

Tax havens are the financial whorehouses on the edge of town. We fuss about them, howl that the activity is illegal, but we don't shut them down, because the town fathers are in there with their pants around their ankles. Tax havens cannot exist without the consent of the countries whose transactions they accept.

And she continues:

Tax havens could not exist unless their transactions were cleared by the bank clearing system. The solution is straightforward: Kick the bank secrecy/tax havens out of the clearing system.

We can cut off the havens, but we won't. The U.S. has cut off bank transactions by some countries, so the failure to cut off the tax havens can only be read as a deliberate decision to tolerate their activity.

Why don't politicians act on tax havens? The U.S. is a net importer of capital. The U.S. wants the world's hot money. It is entirely legal (and encouraged) for foreign investors to invest in the U.S. anonymously. Trouble is that investing anonymously is so easy that Americans do it, too, and it is impossible to stop them, though Congress is trying.

Some foreigners who invest in the U.S. are hiding their assets and income from their home governments, be they oppressive regimes or merely high-tax jurisdictions like France. Tax havens help them invest in the U.S. while avoiding home-country tax on the investment income. Congress is terrified that this flow of funds will dry up if they do anything about the havens.

Brazil is so annoyed about its own citizens hiding money in the U.S. that it has blacklisted U.S. limited liability companies, which need not disclose their ownership to state registrars.

All of this is right. So too is her argument that the US is a tax haven. My own work with the Tax Justice Network says the same thing.

How did the U.S. financial system become enmeshed with bank secrecy jurisdictions? In the 1960s the Vietnam War and the Eurodollar market exploited a need for way stations for inbound capital.

The Vietnam War was expensive--there's nothing quite like misguided foreign adventures to wreck the finances of an empire. The desperate Johnson and Nixon administrations quietly encouraged the big banks to accept foreign dollar-denominated deposits without asking too many questions about their origin. The big banks set up shop in havens to bring in foreign investors. Wall Street loves these anonymous foreign investors as much as the government does.

British bankers established the Eurodollar market to enable customers to hold dollar-denominated deposits outside the U.S. U.S. corporations used tax haven finance subsidiaries to issue dollar-denominated securities to avoid 30% withholding tax on interest payments to foreigners. Finance subsidiaries were organized in the Netherlands Antilles because the Dutch treaty exempted them from withholding on interest payments. (Portfolio interest withholding was repealed during the Reagan administration.)

Later, hedge funds and other participants in the shadow banking system were commonly organized as offshore entities (even though they were managed in Greenwich, Conn.). Pension and charitable investment has legitimized them. Hedge funds originally wanted to avoid SEC registration and regulation as investment advisors, while taking in foreign investment, but soon discovered that some classes of investors and managers could use havens to avoid or defer U.S. tax.

American investors could avoid tax by the simple expedient of making their investments through a tax haven corporation, behind which U.S. law did not look (until now). Managers could defer compensation because U.S. creditors could not effectively reach funds held for their benefit in tax havens (who wants to sue in a Cayman court?).

The regular banking system began to behave like the shadow system. The big banks were effectively hedge funds with public shareholders. They run their own hedge funds, trade for their own account, and some had even more leverage than hedge funds. The watered-down Volcker rule in the new financial regulation legislation is an attempt to address this problem.

Why were CDOs incorporated offshore? Foreign investors would not have bought CDO interests if they had been issued by U.S. entities. As the Goldman Abacus 07-AC1 deal demonstrated, foreign investors were the dumb money that continued to invest in mortgage derivatives even after if became obvious that the housing bubble was bursting.

And now you think that tax havens did not contribute to world financial melt down — as Mark Field MP claims? Think again.

And don’t think this is just a US problem. I explained it in its UJK context — with reference to Gordon Brown — when he had achieved ten years in office — and my analysis is as damning for the UK as Lee Shepherd is for the US.

So make no mistake — offshore exists because it is tolerated.

And that toleration has to end.