The Panama Papers consist of 11.5 million documents from Panama-based law firm Mossack Fonseca. The papers apparently implicate a number of high-profile global figures in potentially illegal financial activities. (Deirdra O'Regan/The Washington Post)

The International Consortium of Investigative Journalists has started to release information based on a massive leak of information from a secretive Panamanian law firm that specializes in setting up shell corporations that can be used, for example, by people looking to hide their money from the taxman.

This may have serious consequences. Close associates of Russia’s president, Vladimir Putin, appear to have moved $2 billion through a series of complex financial maneuvers. Iceland’s prime minister, Argentina’s president and the speaker of Brazil’s house of representatives are among those struggling to explain why they set up offshore companies. The newspaper that first received the leaked information is promising revelations about U.S. owners of shell corporations very soon. Here’s what you need to know to understand this story.

Shell corporations are a common way to avoid taxes

Shell corporations — firms that have no concrete business activity — allow people to conceal the true ownership of assets. This can have legitimate uses — for example, a pop star might not want people to be able to track down her home address, or a business might want to conceal its research activities so as not to give its competitors information about a planned product. However, shell corporations are also very commonly used to hide activities from governmental authorities. For example, if you are very rich and want to avoid taxes, you might pay a law firm to set up a complicated set of shell corporations with tangled ownership relations to hold your assets and conceal them from tax officials. You might also use shell corporations to launder money from criminal acts, to hide the fact that you are bribing someone, or being bribed by someone, or are trying to evade economic sanctions. It is plausible that most, but not all, of the activity revealed by the leak involves tax avoidance and tax evasion. According to one leaked memorandum, 95 percent of the law firm’s work consists of “selling vehicles to avoid taxes.”

They have typically been set up offshore

Gabriel Zucman, one of the academic experts who has been briefed on the leaks, previously estimated that about 8 percent of the world’s total wealth — a staggering total of $7.6 trillion — is held in offshore arrangements. As Australian political scientist J.C. Sharman notes in his book, “The Money Laundry: Regulating Criminal Finance in the Global Economy,” these arrangements typically do not involve anonymous bank accounts anymore; instead, they involve anonymous shell corporations. These shell corporations now hold the bank accounts or other financial assets, providing a high degree of secrecy — it is very hard to trace back true ownership. In Zucman’s pungent description:

In the 1960s, accounts in Switzerland were identified by a series of numbers. Today, through the miracle of financial innovation they are identified by a series of letters: on bank statements the “account 12345” has become that of “company ABCDE.” In all cases the true owner remains undetectable.

The law firm whose files had been leaked specialized in setting up such shell corporations, with a nominal board (composed of people who agree, typically in return for compensation, to lend their names) in Panama, which has become a notoriously friendly jurisdiction toward dubious tax-avoidance strategies.

U.S. authorities have tried to crack down on tax havens like Panama

As political scientists Ronen Palan, Richard Murphy and Christian Chavagneux document in their comprehensive “Tax Havens: How Globalization Really Works,” tax havens — countries such as Panama that make it easy for people to avoid taxes — are an “integral part of modern business practice.” However, over the past two decades, the United States has done a lot to make life difficult for tax havens. The United States was the main actor pushing a set of OECD principles and an associated effort to “blacklist” countries that refused to adopt them. It also helped set up the Financial Action Task Force which adopted a similar approach to blacklisting. Finally, the United States has taken unilateral action against, for example, Swiss banks to encourage the government to change its rules.

As Sharman’s research shows, this has been relatively successful in getting most states to adopt the guidelines, although Panama remains a holdout. However, the true effectiveness of the principles is uncertain — it may have done more to change the ways in which people try to dodge taxes than to make tax evasion substantially more difficult.

However, the U.S. is itself becoming a tax haven

Even though the United States pushed the OECD principles, it has not itself adopted them. Instead, it adopted its own legislation, which resembles the principles except in one crucial respect — it does not provide automatic reciprocity in providing information. This has led to a booming new business in the United States — wealth management businesses and law firms, who are advising foreign clients to put assets in the United States, where they can hide them from their own governments.

Academic research supports the notion that U.S. financial institutions are very lax when dealing with foreign clients. When conducting experimental research, Sharman and his collaborators tried to set up shell corporations in a number of traditional tax havens while retaining anonymity. They found that providers in many of these tax havens were unwilling to set up companies without getting some kind of identification, such as a notarized copy of a passport. Providers in rich countries in the OECD — including especially the United States — were much happier to set up shell corporations. Only three out of 27 U.S.-based providers demanded some proof of identity.

Life may be becoming a little more difficult for tax evaders. However, it won’t be nearly as difficult as it ought to be until rich countries such as the United States start complying with the rules that they demand that other countries adopt.

The United States is now becoming one of the world's largest tax and secrecy havens. Here's why. (Daron Taylor/The Washington Post)