There has been a lot of noise and some heat raised over the issue of tax laundering and gnashing of political teeth in raves against tax havens. While much of the focus of publicity will be on stopping money laundering associated with criminal activity, the subtext of it all will be to restrain tax competition. Despite the initial aim to limit "harmful tax competition," a repackaging spin puts the purpose as a means to increased regulatory rigor and enhanced fiscal transparency.
Last month, European finance ministers raised the issue of tax haven status during the most recent Group of Seven (G7) meeting. In the coming weeks,members of the Organization for Economic Cooperation and Development (OECD),a group that includes the 30 largest industrialized countries, are to meeting Paris to consolidate plans for a crackdown on so-called tax havens. One sideshow will be attacks on the Bush administration for withdrawing its support to yet another (flawed) international protocol.
As it is, in June of last year, the OECD applied the "stick" when it published a blacklist of 35 tax havens and threatened potential national economic sanctions if they failed to agree to share fiscal information by this July. Now a "carrot" is on offer to tax havens to encourage them to improve financial transparency, cooperate with overseas tax authorities and eliminate laws that provide advantages to international investors.
Although the OECD has no jurisdiction or means to enforce such measures, its constituent members can apply a variety of pressures. At least four Caribbean tax havens, all British overseas territories, are expected to agree to cooperate with an international initiative to limit tax evasion and avoidance in offshore financial centers. Their acts are almost certain to be an attempt to avoid economic sanctions. As it turns out, such sanctions in response to non-compliance might actually be in contravention of WTO rules.These moves follow a set of initiatives undertaken in the late 1990s under the auspices of the OECD. Whatever the ostensible purpose, such actions offer protections of the tax bases of countries with high-tax regimes. And they undermine sovereignty. In answer to the complaints against weakening the sovereign rights of governments to determine their own tax rates and systems, the OECD insists that it is only encouraging good tax practices.
Tax-haven threat
Since many OECD members maintain high-tax policies, it is not surprising that they feel threatened by tax havens. Therefore, much of the finger pointing by them should be taken with a grain of salt. However, before the protests to this disclaimer become too audible, consider the following. It is not the small offshore financial centers that are the principal recipients of dirty money. In fact, much more money laundering is being undertaken in London, Frankfurt and New York.
Impeding money transfers by gun runners and drug barons is one thing.However, denouncing differences in tax regimes as "harmful" competition is quite another kettle of fish that ignores the substantial benefits brought about by competitive differences.
These benefits do not accrue only to citizens of high-tax countries. Developing countries can enjoy large gains by developing domestic financial centers that attract offshore capital. In all countries, the presence of tax competition puts political leaders under pressure to consider carefully the local mix of taxes and services. This enhances democracy and can encourage increased efficiency by government agencies. For those countries worried about revenue losses, there is hope. Recent history in the US during the 1980s and 1990s indicates that a good way to capture large additional amounts of tax revenue is to attain high rates of economic growth. And one of the best ways to enjoy high growth is to lower domestic tax rates.
For example, America gained a competitive advantage over many of its trading partners and soon helped propel other economies during the 1990s after taxes were cut sharply in the 1980s. Because growth brought about increased revenue, budget deficits eventually began to shrink and then be replaced by surpluses.
It would be wrong to interpret the steps taken by the advanced industrialized countries under the guise of the OECD as being motivated by the search for truth and justice. Indeed, it involves a sort of "fiscal imperialism" that seeks to impose conditions that benefit rich countries on others.
Tax competition actually does not pose a great threat to the citizens of rich countries. Instead, it forces politicians and bureaucrats and their supporting special interests to tighten their belts and trim their sails.
In all events, the gap between total taxation in the richer and poorer countries has closed over the past 20 years. In large measure, this is because taxes have risen in poorer countries. From the mid-1980s, average corporate tax rates have fallen slightly in the richer countries while rising in poorer countries.
Corporate location is based upon much more than mere differentials in tax rates. Businesses often choose rich countries due to the possibility of higher returns and the stability of their institutions. To this end, the US has attracted enormous sums of foreign direct investment over the past few years. (But then in relative terms to most of Western Europe, it is also a tax haven.)
It is unsurprising that most Western European governments are the most vocal about telling other countries to close their loopholes or raise their taxes. But by sorting out just the agricultural policies of the European Union (EU) through subsidy reductions would make its member's economies much more competitive.
Subsidies unfair
An OECD report indicates that subsidies granted to the farming sector in 1998 operated as a trade barrier that imposed an effective tax of 82 percent on imported foods. This greatly exceeds the average of 59 percent for OECD countries. US agricultural protections act as an implicit tax increase of 28 percent while in New Zealand it amounts to only 1 percent.
These additional taxes and higher prices cause a European family of four to spend an additional US$1,200 or so a year. Poorer Europeans are disproportionately injured since they spend a larger percentage of their income on food. And most of the agricultural funds were paid to the wealthiest farmers.
According to the OECD, subsidies provided by the EU totaled US$203 billion in 1997. That number is estimated to be high as US$217 billion in 1999. These payments are substantially greater than in the US, where subsidies were US$33 billion in 1997 and US$39 billion in 1999.And then there is also the imbalance in the payment of indirect taxes. Citizens of EU countries paid indirect taxes of about US$968 billion in 1999, almost 13 percent of its combined GDP. In the US, revenue from indirect taxes were US$455 billion, about 5 percent of its GDP.
European governments also collect about US$300 billion a year that would fall under the guise of environmental taxes. For example, Danish taxpayers must deliver about US$1,500 a year in "ecotaxes" before paying the basic income tax rate of 50 percent. Registration fees for new cars are for 180 percent of their value, plus another 25 percent in VAT.
And they spend a lot. For example, EU spending on labor-market programs exceeded US$100 billion in 1998.
No wonder European politicians are so edgy about tax competition. But all this hypocritical posturing should be seen for what it is.
Christopher Lingle is Global Strategist for eConoLytics.com.
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