Why draining Vladimir Putin's secret bank accounts is so difficult

If you'd like to know how Russian President Vladimir Putin and some of his closest associates allegedly hid billions from their own country, an anonymous leak shed 2.6 terabytes worth of light on the subject over the weekend.

It's being called the "Panama Papers," and it's the biggest leak of its kind ever: 11.5 million documents provided by an unknown source to the German newspaper Süddeutsche Zeitung, which in turn shared them with an international group of journalists and other major news outlets. The documents come from the Panama-based Mossack Fonseca, a law firm that allegedly specializes in helping people from other countries set up shell companies in Panama to hide assets from their own governments. It's reportedly the fourth biggest provider of such services in the world, and the leak covers its last four decades of work.

This is a rare and extremely detailed glimpse into the world of offshore tax havens. And while Putin's entanglement is ironic — he himself has called for "de-offshorization" from Russia's elite — his shenanigans just scratch the surface of the report: The leak reveals the dealings of major players in Pakistan, Ukraine, Iceland, Iraq, and more.

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It also reveals how difficult this sort of thing is to combat.

As Matt Yglesias laid out in a helpful explainer, there are lots of reasons people might set up this sort of shell company. Some are banal, like a celebrity using the company to buy real estate so the public and the press don't know where they live. Other reasons are more sinister or brazenly illegal, like drug cartels and human traffickers hiding their dirty cash flows, or the money laundering Putin is implicated in. But the vast majority of shell companies are simply used to dodge taxes: “Ninety-five percent of our work coincidentally consists in selling vehicles to avoid taxes," one of Mossack Fonseca's leaked memos said.

Here's where the problems start. While people can call this sort of tax avoidance a lot of things — "unethical," "greedy," "unpatriotic," etc — one thing they generally can't say is "illegal." In free societies, if you want to set up your company in one country as a matter of legal paperwork — even if for all practical purposes your company exists, operates, employs, and makes its money in a second country — you can do that. And if that first country you set up in places way lower tax rates on your company than that second country, well, them's the breaks. So by all accounts, much of Mossack Fonseca's services are above board.

In a way, fighting this sort of international tax avoidance is a lot like fighting climate change. The problem requires all countries (or at least most countries) to adopt very similar sets of policies. But there's no world government to direct nation states to do so. To fight climate change, every individual country has to set up carbon taxes or cap-and-trade systems and green energy investment through its own legislative process. And to fight tax evasion, every country has to individually refrain from passing the kinds of laws and tax policies that allow them to function as a tax haven. So countries have to rely on trust, cooperation, and dealmaking to create and sustain an international system that can actually tackle the problem.

That's difficult because, again like climate change, any individual country has a motive to break from the pack. When it comes to carbon emissions, if everyone else is cutting theirs, then maybe you can get away with just continuing to burn fossil fuels. You get to benefit while everyone else imposes costs on themselves via their principled discipline.

Likewise, there are incentives countries have to break from the pack and become tax havens. The company may employ some of your local population, and even if you're taxing the company at a super low rate, that revenue could still go a long way if you're small.

One complication with this metaphor is that if small nations with small economies don't get on the carbon-cutting bandwagon, we can still solve global warming if big nations like America, China, India, and European countries get onboard. But for tax havens, all it takes is for a few small countries to decide to become one, and every rich person in the world can flood in there. About half of all Mossack Fonseca's tax shelters were created in the British Virgin Islands, for example.

But these similarities between climate change and tax havens also produce similar solutions. One prominent proposal for tackling climate change is for major countries like America to pass a carbon tax in their own borders, and then impose punitive tariffs on countries that don't have a complimentary carbon tax. It's a replicable model that can spread from country to country, and thus organize international cooperation.

Gabriel Zucman, who wrote a whole book on this topic, proposed a similar model to get the fight against tax havens started. One, reform corporate tax policy in the U.S. to make shifting to an offshore tax haven as difficult as possible. Two, set up a shared global financial registry so that tax collection agencies in all participating countries can keep track of who owns what within everyone's borders. This would not need to be accessible to just anyone in the public. And in fact, lots of countries like the United States already have these sorts of registries, as that's what Zucman relied on to compile the data for his book. They just don't share data that well. Finally, Zucman recommends imposing punitive tariffs on any country that refuses to reform its own laws so that it's no longer a tax haven, or that refuses to cooperate with the global registry.

International tax dodging doesn't actually do tremendous harm to the U.S. government's finances. We only lose about $35 billion a year to it — less than 1.3 percent of 2015's tax revenue. But the total tax revenue loss for all countries collectively is around $200 billion a year, and that money can mean a lot to smaller or poorer countries. A lot of elites in Russia and China made use of Mossack Fonseca's tax haven services, as did the wealthy in countries like Brasil, Peru, and Argentina. Globally, the practice keeps about $7.6 trillion in wealth hidden from the eyes of national tax systems.

So while America may not be the biggest victim of the practice, we do have a stake. Furthermore, we have the diplomatic and geopolitical clout to start setting up these policies, and thus bring the rest of the world onboard for a healthier and fairer set of interlocking tax systems. In fact, as my colleague Ryan Cooper and others have pointed out, we already have the beginnings of a model: America passed the Foreign Account Tax Compliance Act back in 2010, which requires foreign banks to send the IRS information about what accounts they hold for Americans, and imposes tough financial penalties if they fail to do so.

As the Panama Papers dramatically illustrate, someone needs to get the ball rolling. It might as well be us.