How many tax havens are there?
About 40 countries have been identified as tax havens by the Organization for Economic Cooperation and Development (OECD). These countries levy little or no tax on corporate and personal income, and advertise their low tax rates to lure foreign money. They also have a “don’t ask, don’t tell” policy regarding foreign income. Tax havens don’t inquire about the source of that income, and they stonewall requests for information from other countries hunting tax evaders. The secrecy has helped attract an estimated $12 trillion in assets. “There is no doubt that offshore anonymity encourages big companies and rich people to use these tiny islands as a means of avoiding or evading tax,” says British economist David Boyle.

Are they really all ‘tiny islands’?
No. Switzerland, Andorra, and Liechtenstein—landlocked countries in the heart of Europe—are among the world’s busiest tax havens. But it’s true that many tax havens are small island nations, ranging from the Cayman Islands in the Caribbean to Nauru, a flyspeck in the Pacific Ocean, through which some $70 billion in looted Russian assets flowed after the ruble collapsed in 1998. Because their government budgets are tiny, the havens can afford not to tax foreigners who set up bank accounts or corporations in their territory. In return, the havens get thriving banks, good-paying jobs, and higher living standards for their citizens.

Who hides their money in these banks?
Everyone from retirees with modest incomes to big-time gangsters and drug dealers to giant corporations such as News Corp., American Express, and AIG. Legitimate users of tax havens include people who set up accounts in places such as Bermuda because they plan to retire there as well as local citizens who work overseas and send money back home to their families. But most of the wealthy individuals and corporations that open bank accounts or set up shell corporations in tax havens are trying to shield  their money from the taxman or from law-enforcement authorities.

How do criminals use tax havens?
Bank secrecy enables them to launder their money, disguising its source. Consider the case of Colombian economist Franklin Jurado, who in the 1990s set up several shell companies in Panama, a notorious tax haven, on behalf of a Colombian drug lord. He deposited
$36 million in cocaine profits in the corporate accounts, then moved the money to accounts in 68 banks in nine European countries. Eventually, the money would re-emerge in Colombia, looking like corporate dividends or bill payments from foreign customers. Investigators tried for years to trace the transfers back to Panama, but some banks there refused to cooperate. Jurado’s scheme was not exposed until police investigated the noise coming from his apartment: It was a money-counting machine that was in almost constant operation.

What about legitimate companies?
Their main motivation is to shelter income from taxes in their home countries. The federal government says 83 of the 100 largest U.S. companies, including 14 recipients of federal bailout money, have set up subsidiaries in tax havens. Bank of America has 59 subsidiaries in the Caymans, and Citigroup has 427 subsidiaries in various havens, including 90 in the Caymans. The Treasury Department estimates that it loses $100 billion a year in tax revenue from companies that ship their income offshore. “We cannot tolerate $100 billion in offshore tax abuses burning a hole through our budget each year,” says Sen. Carl Levin (D-Mich.)

How do companies get away with that?
Under current U.S. law, American companies operating overseas don’t have to pay taxes on foreign earnings until and unless those earnings are transferred back to the U.S. (They often aren’t.) The Obama administration wants to close that loophole, and Sen. Levin has proposed legislation that would tax the foreign earnings of U.S. companies. The member nations of the G-20, meanwhile, have agreed to “name and shame”—as well as impose economic sanctions on—tax havens that refuse to share information with other governments investigating possible tax evasion and money laundering. “If tax information is exchanged on request,” says British Prime Minister Gordon Brown, “then the benefits of being in these countries will diminish every day.”

Is the crackdown working?
It’s too early to tell. Some countries, such as Liechtenstein, have vowed to resist, but Switzerland, long a bastion of secrecy, has made substantial concessions. After U.S. authorities caught UBS, Switzerland’s biggest bank, helping American clients evade U.S. taxes (see below), the Swiss reluctantly agreed to ease their long-held tradition of total bank secrecy. In addition to paying a $780 million fine, UBS agreed to give the U.S. information on 300 account holders suspected of evading U.S. taxes. But the bank is fighting a U.S. subpoena for data on 52,000 additional accounts. It promises to be a long legal battle, but with a deep recession biting into tax receipts, the U.S. won’t give up easily. “The No. 1 thing is, we need revenue,” says lawyer Jack Blum, an expert on tax havens who frequently consults with Congress. “This business of letting people get away with bloody murder by taking money offshore is inconsistent with trying to fund our government.”

Swiss banking under siege
The Swiss tradition of banking secrecy dates back to the Middle Ages. But under pressure from revenue-hungry countries seeking tax evaders, the wall of secrecy is starting to crumble. It started even before UBS agreed to give the U.S. the names of depositors suspected of dodging U.S. taxes. Beginning in the 1990s, the Swiss agreed to tax the accounts of European citizens and remit the payments to their countries of origin. But the UBS case has raised suspicions that the Swiss aren’t complying with that agreement, and foreign governments are leaning on Swiss banks to be more forthcoming about the $2 trillion in foreign deposits they hold. Come clean, other governments warn, or lose your licenses to operate overseas. In recent weeks, alarmed account holders have been pulling their money out of Swiss banks and negotiating settlements with tax authorities in their home countries. “Switzerland has to take action,” says an apologetic Roland Meier of the Swiss finance ministry. “The international pressure is tremendous.”