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In Defense of Tax Havens?

August 28, 2009

By Ann Hollingshead

Ann Hollingshead is a Task Force blog contributor, whose posts appear on Wednesdays and Fridays. Formerly a Junior Economist at Global Financial Integrity, Ann is now a Research Analyst for ECONorthwest, an economic consulting firm in the Pacific Northwest. Follow her on Twitter: @AnnHollingshead.

Any worthwhile point of view will always be met with opposition. The stance against tax havens is no exception. In that spirit, I think this is as good of time as any to present some arguments for tax havens. But, since this is my blog and I do what I want, I’m also going to take some time to refute these arguments. Discussion on the topic and “devil’s advocates” opinions are always welcome.

There are four prevalent myths about tax havens.

Myth 1: Forcing American companies out of tax havens will hinder their ability to compete globally.

False. And this argument is ridiculous. Essentially they are saying, “Yes, this is the law, but we should allow our companies to break it because everyone else is doing it.”

As Raymond Baker pointed out in a recent testimony on Capitol Hill, the same argument was made in the 1970s about U.S. corporations and bribes; those against legislation that would make it illegal for U.S. corporations to pay bribes to corrupt foreign officials argued the law would hurt U.S. competitive advantage. The law was passed, U.S. corporations competed just as effectively, and the U.S. gained some serious international street cred. In the years that followed, every major industrial country eventually passed a similar law.

Second, there isn’t compelling evidence that making these companies play by the rules would hurt them in the first place. As I showed in a recent blog (see The Usual Suspects) about U.S. Corporations and tax havens, FedEx has 101 foreign subsidiaries, including 21 in tax havens. The United Parcel Service, its main competitor, has no subsidiaries in tax havens and, actually, no foreign subsidiaries at all. Last I checked UPS was competing pretty effectively against FedEx.

Myth 2: Tax havens keep taxes in developed countries lower through competition

False. This is probably tax haven proponents’ most prized argument. That’s sad, because it’s a complete fantasy.

First, governments should not be in the business of “competing” with tax havens for the lowest common denominator. Legislators need to set fiscal policy (expenditures including military, health, and education) based on their tax revenue and the needs of their people. Governments should be held accountable by their people, not held hostage by tax havens.

Second, competition with tax havens is a fundamentally unfair game. These small countries often have tiny populations, so their governments do not need much tax revenue as they do not have many expenditures. Governments of larger countries–like the US and UK–have vast populations, and therefore require large expenditures on public goods like a military, numerous schools, and a huge public transportation infrastructure.

Third, there isn’t a scrap of compelling evidence that “tax competition” between industrial countries and tax havens even happens at all. What a grossly oversimplified view of macroeconomics.

Myth 3: Eradicating tax havens might ultimately hurt the U.S. because it is just as guilty as the others

True (finally)! It could hurt the U.S. It will also help the U.S. This was the topic of my last blog post (see Wicked). I am not arguing we should persecute tax havens like Liechtenstein and ignore our own complicity. In fact, as I argued, U.S. corporations are evading taxes right in their own boarders and this ultimately hurts honest taxpayers and middle class citizens.

At GFI, we advocate a level playing field. The U.S. will win and lose if there is an eradication of tax havens. Developing countries will also win and lose, though their gain will be much greater than their loss, since tax havens are a major destination of illicit financial flows (see 10 times ODA, but what is that in Apple Pies ?).

Myth 4: There is a moral case for tax havens as they protect people in developing countries who are subject to religious, ethnic, sexual, political, or racial persecution (for example Jewish people during World War II used Swiss banks to hide assets from the Nazis)

True, but only partially. This is the most reasonable argument, because it does actually happen. But it does not even come close to justifying the 11 trillion dollar industry of offshore banking, which also encourages massive tax evasion and other morally reprehensible behavior, like money laundering, terrorism, drug trade, weapons dealing, sex trafficking, and other international crimes.

Also (what the proponents of banking secrecy will never tell you) is that Swiss banking secrecy also aided the Nazis. During the war, the Nazis stole gold, jewelry, and other valuables from the millions of Jews they murdered. When they needed a way to place these commodities in the international market, they opened Swiss bank accounts.

In my opinion, the back and forth on tax havens is not as interesting as other debates in Economics, because the arguments for tax havens are rife with vested interests and generally lack sound economic theory behind them. Nonetheless, it is important to present these arguments (and then refute them) because ignoring these paranoid cries will not make them go away.

For another lively debate on the topic, take a look at Richard Murphy’s blog “Thank Heaven for Little Tax Havens.” The string of comments below the post is particularly enlightening.

Tags: Banking secrecy, Tax Havens

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Disclaimer: Unless specifically stated to be the views of the Task Force, the opinions expressed on this blog are solely the opinions of the individual blogger and are not necessarily those of the Task Force on Financial Integrity & Economic Development.

Dev Kar
Ann:
A very nice post that dispels a lot of the myth associated with tax havens. The current financial crisis shows that financial institutions failed us in many ways. The crisis was essentially a failure of regulatory oversight. Surely, tax havens and offshore financial centers with too little regulatory oversight should not be cited as role models when onshore financial institutions did such a poor job of conducting themselves when no one was looking.
Lowell
First of all, what is a “tax haven?” It is simply a country that has lower taxes than another country.
Second, the United States is already, and has been for a long time, the only country in the world that thinks it has the right to demand income tax on income earned outside of the country. Not only that…if I gave up my citizenship, I am first considered a criminal on the grounds of tax evasion (and have to prove that it’s not true — i.e., guilty until proven innocent); and, then, I’ll have to pay taxes on all income earned worldwide for the 10 years after I give up my citizenship in order to enter the United States to visit family or friends.
Third, if I’d never been a citizen of the United States, I am eligible all kinds of tax breaks that aren’t available to the regular citizen.
Fourth, there are numerous states within the United States that don’t have income tax; thus, they are “tax havens.”
Fifth, what in the heck is fair? I don’t know how you make anything “fair.” No matter what decision you make, it will always favor one group over another.
Sixth, a law is nothing more than a political compromise between competing entities. It inherently favors one group more than another. Where is the “fairness” in that?
Seventh, I don’t know of one instance where a “level playing field” existed…let alone worked. That to me is a “pipe dream” without any sense of reality. That is just another form of utopia which exists in definition only.
Eighth, the “current financial crisis” is part of a “natural” cycle of economics. There is one catch! It should have happened a couple decades ago. The only reason it didn’t was because of the interference of government. Now the price will be steeper and higher because “the government” let everything get overvalued. In other words, we have further to fall.
Ninth, nothing in life is “safe, secure, fair” or any of the other words of “fairness” thrown around by the liberal left. Recent examples of “fairness” can be seen in the former USSR and China. Have you noticed that it didn’t work. In fact, it was a complete disaster.
So, get over it and figure out how you can compete in the market and the world as it is. The sooner you change your thinking… so sooner you’ll find success in this world… and the sooner you’ll find your “security”. Stop depending on government to make it happen! That is an open invitation to dictatorship… not democracy.
http://www.gfip.org Ann Hollingshead
1. Actually, four basic conditions must hold for a country to be defined a “tax haven” and none of them are “lower taxes than another country.” These conditions are:
a. No or nominal tax on the relevant income;
b. A lack of effective exchange of information;
c. Lack of transparency;
d. No substantial activities (which means the country has no sizeable domestic economy to warrant huge foreign deposits)
This definition is officially maintained by the OECD. You can read more about it here.
2. U.S. citizens are taxed on worldwide income. The Foreign Earned Income Exclusion (FEIE) allows a U.S. taxpayer to earn up to a certain amount each year and exclude it from his or her income tax return in the U.S. In order to qualify for the exclusion, the individual has to either be a bona fide resident of the foreign country for a period that includes a full tax year, or be physically present out of the U.S. for a period of 330 days in a 12-month period.
In 2008, the exclusion was $87,600, and is indexed for inflation so that the 2009 exclusion is $91,400.
For corporations, the United States taxes the foreign income only to the extent that the U.S. corporate tax rate exceeds the foreign rate of tax on that income. If the foreign rate of tax is equal to or exceeds the U.S. rate, the United States collects no tax on that income. This is to prevent “double counting.”
This is not a discussion of the fairness of the U.S. tax code. If you have qualms about taxes on money you are earning abroad, take it up with the IRS.
3. I don’t see what you’re driving at here, but I think you’re referring to the “ring-fence regime” in U.S. law, which means that banks don’t report interest made in U.S. bank accounts by non-residents. This policy is riddled with hypocrisy. Though the U.S. is cracking down on Swiss bank UBS, it has not agreed to offer Mexico a policy to exchange tax information, though Mexico has specifically requested such an agreement.
4. This is almost right. But it’s definitely not new. I wrote about it last week (see Wicked).
5. Fair means everyone pays the taxes their home country meant for them to pay. Maybe some people will have lower taxes and maybe some will have higher taxes. This is not a philosophical debate on whether or not governments have the right to tax their citizens. That is assumed.
6. I see you have a neo-realist, zero sum game view of lawmaking. Most laws probably do favor one group at the expense of another (our laws against murder inherently favor innocent citizens at the expense of serial killers). I’m not sure how this point furthers your line of reasoning, though.
7. I probably should have been more specific and not thrown around phrases that are easily grabbed and touted into hyperbole. A level playing field means transparency in international banking and automatic exchange of tax information so that wealthy individuals cannot evade paying domestic taxes. It means an eradication of trade mispricing and transfer mispricing. These are lofty goals, yes, but by no means do they lack a “sense of reality.”
8. Did you put “the government” in quotes for a reason? Or were these “fingerquotes” to indicate satire and/or euphemism?
I don’t see why the current financial crisis should have happened before the subprime mortgage crisis in 2007, which was the trigger. If you’re arguing that the trigger should have happened sooner, than I’m not sure how a burst in the housing bubble could have preceded its expansion. And none of that could have preceded deregulation of the financial markets, which happened in the 1990s.
But I digress. This point is completely irrelevant to the debate at hand.
9. I’m not sure why the word “fair” implies that I am a Marxist or pro-dictatorships, as you suggest. A country can only be a democracy if it allows its citizens to evade their taxes?
http://www.taxresearch.org.uk/blog Richard Murphy
We should remember tax is only a small part of this debate.
People could not tax evade in ‘tax havens’ without secrecy. Secrecy facilitates this. hence the better term – a secrecy jurisdiction.
Secrecy jurisdictions are places that intentionally create regulation for the primary benefit and use of those not resident in their geographical domain. That regulation is designed to undermine the legislation or regulation of another jurisdiction. To facilitate its use secrecy jurisdictions also create a deliberate, legally backed veil of secrecy that ensures that those from outside the jurisdiction making use of its regulation cannot be identified to be doing so.
To understand how they work I quote this which was on my blog last week (http://www.taxresearch.org.uk/Blog/2009/08/28/tax-competition-is-criminal/) :
Let me offer an explanation from a strong supporter of tax competition, Richard Teather, a UK chartered accountant and lecturer at Bournemouth University, who when speaking of the OECD anti-tax haven initiative says (page 81):
“This is attacking a classic use of a tax haven, as explained in the previous chapter, in which a person resident in (or otherwise subject to the taxation system of) a highly taxed country places his capital in a tax haven where it can earn untaxed income. While there are many cases where the home country does not tax foreign source income (such as the UK’s non-domicile exemption discussed above), most Western countries have a worldwide taxation system that seeks to tax the worldwide income of its residents (or all of its citizens in the case of the USA). This tax haven income therefore does not cease (legally) to become liable to tax merely by being earned offshore: it is still liable to tax and the investor has a duty to report it to his home tax authority. In practice, however, if the investor does not report his income, then the home country can have great difficulties in discovering and taxing it, particularly if the haven country has strong banking secrecy laws.
While I am not seeking to condone dishonesty or criminal activity, from an economic perspective this is merely another example of tax competition: indeed, it is often necessary behaviour in order to take advantage of tax havens. Without the willingness of some to engage in this sort of activity, tax competition would be much less effective and therefore reduce the benefits that flow from it for the rest of us.”
As Teather makes clear criminality is often necessary behaviour in order to take advantage of tax havens. and he then argues the benefits flow to all of us.
This is the reality of tax havens.
It’s really not attractive, is it?
Richard
http://www.taxresearch.org.uk/blog
Graybar
OY !!! The somewhat distended enumeration post above seems overly-defensive and has the ‘look and feel’ of someone that is probably on the current disclosure list from UBS. The simple and irrefutable facts about tax havens and all of the subsidiary issues surrounding them is this: they are and always have been facilitaed by a wink and nod from not most — but all — governments on both sides of the equation. Now, there is ebb and flow (as witnessed by the recent UBS flap) where one government or another pushes back because the abuses and evasion simply become too blatant (or costly in terms of revenues lost) to ignore any further. But as with Wall Street, AIG, tobacco companies ad infinitum — take your pick — you can be absolutely certain that anytime there is bending of the system, there is deep wealth and their lobbyists asserting why such ‘exceptions’ should be made. Such realities in our world and in every country to one degree or another are as old as the hills and always will be. Hollingshead is only calling the sheer hipocracy of such flexible and convenient values to the attention of others; and doing a damn fine job of it as well.
http://www.timworstall.com Tim Worstall
“Myth 2: Tax havens keep taxes in developed countries lower through competition
False. This is probably tax haven proponents’ most prized argument. That’s sad, because it’s a complete fantasy.
First, governments should not be in the business of “competing” with tax havens for the lowest common denominator. Legislators need to set fiscal policy (expenditures including military, health, and education) based on their tax revenue and the needs of their people. Governments should be held accountable by their people, not held hostage by tax havens.”
That is a statement of what you think ought to happen. It is not a statement of what does happen. It is entirely possible for your desires above to be correct (not that I think they are but that is another matter) and that still there is tax competition.
“Second, competition with tax havens is a fundamentally unfair game. These small countries often have tiny populations, so their governments do not need much tax revenue as they do not have many expenditures. Governments of larger countries–like the US and UK–have vast populations, and therefore require large expenditures on public goods like a military, numerous schools, and a huge public transportation infrastructure.”
That’s close to nonsense. Yes, there are economies of scale but that’s all. A larger country has more people paying tax, does it not, to cover the costs of that larger population?
“Third, there isn’t a scrap of compelling evidence that “tax competition” between industrial countries and tax havens even happens at all. What a grossly oversimplified view of macroeconomics.”
Incentives and the like, business and individual decision making, they’re usually referred to as micro, not macro. But if there is no evidence of tax competition then what on earth is everyone complaining about? If people do not move themselves, their money or their businesses about in order to benefit from a better for them tax regime then no one would possibly be trying to close those places down, would they?
Richard Murphy’s often quoted $11 trillion in assets hidden away is proof perfect that tax competition happens: to exactly the tune of $11 trillion actually.

http://www.gfip.org Ann Hollingshead
You argue: “That is a statement of what you think ought to happen. It is not a statement of what does happen. It is entirely possible for your desires above to be correct (not that I think they are but that is another matter) and that still there is tax competition.”
The above is an argument against the idea that tax competition is beneficial and not that tax competition doesn’t exist. The arguments for the latter are discussed at length in the original post and below.
You argue: “Yes, there are economies of scale but that’s all. A larger country has more people paying tax, does it not, to cover the costs of that larger population?”
Due to space limitations I did not go into the particulars of this argument. But here they are now:
Industrial country governments provide a much wider range of public goods than offshore financial centers. Some public goods are not provided at all in the case of tax havens (a standing military, for example). This occurs for two reasons. Firstly, some of the islands are too small to require a military (e.g. Mauritius, Costa Rica, Cayman Islands). Second, many of the tax havens are dependency of larger developed countries (Anguilla, Jersey and Isle of Man are provided by UK, Netherlands Antilles are a dependency of the Netherlands, and Niue’s defense is the responsibility of New Zealand).
Also developed governments provide a greater depth of public goods (i.e. per capita expenditures on services are higher) because their economies are diversified. Take roadways, for example. The United Kingdom provides has one roadway per 153 citizens (or 1 road per .6 square kilometer of land). Mauritius has one roadway for every 198 residents (1 per 8 sq. km.). And Costa Rica has 493 citizens per roadway (1 road for every 5 sq. km.). As an industrial country which provides a wide range of exports and has a large, diversified domestic economy, the UK has a greater need for roadways, both per person and per square kilometer of land. Costa Rica, has few exports and a relatively homogeneous domestic economy. It does not have a need for such a depth and variety of infrastructure.
More importantly, however, given low taxes and the ensuing large quantities of foreign deposits in tax havens, these jurisdictions are able to make healthy income (for their small populations) on service fees. A large economy cannot survive on this type of income because it requires a disproportionally large quantity of deposits. They must use an income tax instead.
You argue: “Incentives and the like, business and individual decision making, they’re usually referred to as micro, not macro.”
Decisions by “Industrial countries” and “tax havens” are made by governments, not individuals. This is macroeconomics. “Business” and “individual” decision making lies within microeconomics. So “tax competition between industrial countries and tax havens” refers to macroeconomics.
You argue: “But if there is no evidence of tax competition then what on earth is everyone complaining about? If people do not move themselves, their money or their businesses about in order to benefit from a better for them tax regime then no one would possibly be trying to close those places down, would they?
Richard Murphy’s often quoted $11 trillion in assets hidden away is proof perfect that tax competition happens: to exactly the tune of $11 trillion actually.”
No. You are confusing the movement of capital with competition (which again shows your lack of discernment between micro and macro economics). There is no compelling evidence that as a result of this movement of funds, taxes are any lower in “high tax jurisdictions.” Again, government is a not business and does not set taxes based on the tax rates of other jurisdictions (like a gas station might set the price of a gallon of gas). Tax rates are much more complicated, based on a set of macroeconomic realities, not competition between centers.
Also. If such a competition took place, economic theory tells us that tax rates would be arbitraged to zero or very near it, as that is the tax rate in many tax havens. Two things. 1) This has not occurred, so tax competition is probably not taking place. 2) Such a situation would have disastrous consequences for the developed world. Governments would no longer be able to provide defense, education, health care, police, a postal service, (the list goes on and on).
This is probably not a world we should strive for.

http://www.taxresearch.org.uk/blog Richard Murphy
Tim
A very confused argument by you
Fact is that people like the Center fro Freedom and Prosperity do make this argument
Fact is it’s wrong
Fact is it does sem to have an affect on major states
Fact is it shouldn’t because this is the result of their reaction to the hype, not the reality of what happens
So everything Anne says is right
And nothing you say is
Which is about normal
Best
Richard
Graybar
Tim argues — among an array of other-planet notions — that “governments should be held accountable by their people, etc…etc.” This is of course, a great ideal but wholly ignores the reality that the populous at large in virtually every country in the world (the US likely top among them) is too lazy, apathetic and self-consumed to hold anyone accountable for anything. That includes themselves most of the time (just look at the level of personal indebtedness and personal bankruptcies as examples.) As well, governments — ours more than anyone — spends money like a drunken sailor so, if governments are waiting for us to ‘do as they say, not as they do’ they have a very long wait. The United States government has been serving as a role model for what NOT to do in terms of fiscal responsibility for at least the last 25 years, if not the last 50. So Tim, why should any citizen take them seriously? And just for the record, all attempts to hold anyone accountable for anything inside the beltway fail. Always.
No: holding governments and elected officials accountable in our country went out with square wheels. Witness the re-election of everyone from Marion Berry (after smoking and dealing crack on video tape) to virtually every crooked re-elected member of Congress over modern history — the list reads like a who’s-who in not being responsible. Even Sandford — desipte going AWOL from his position as state CEO and father — still enjoys majority support among his voters. So, while Tim’s assertions might be desirable in that “wouldn’t it be nice if….” fairy tale world, the sad reality is that governments for the most part run absolutely unbridled and unchecked. They act in their own self-interest and more to the point, the interest of their own self-perpetuation in spite of — and not because of — the people that they purportedly serve. Just when that got reversed
from a government of the people, by the people and for the people is a bit fuzzy.
Ann’s arguments are hyper-valid because they at least bridge the gap between idealism and reality and no amount of wishing for people to wake up and take an active part in holding elected officials responsible will make it so. Not ever.
We’re past that. A sad but progressively accurate characterization of our current and most likely foreseeable future reality.
The fact is that our government wastes more on toilet paper [read, useless 'brdige to nowhere' like projects] every year than 50% of the countries in the world have in GDP; so chasing tax cheats and evaders is a futile exercise when measured against a governemnt that spends money so recklessly. But drawning a line in the sand on tax evation might well be the first — or last — act of decency left to those that have themselves thrown $4 or $5 trillion away of late (Iran, Wall Street, GM, AIG etc, ad infinitum.) You have to give at least one thing to Ann: she tries; which is a hell of a lot more than we did as our country was spiriling downward in a frightening paralell to ancient Rome. Keep fighting Ann !
Jack Clark
Wait a minute!
“…..our government wastes more on toilet paper every year than 50% of the countries in the world have in GDP.”
I take exception to this statement.
Reason 1: There is no such thing as “wasted” T.P.
Reason 2: A majority of European countries use bidets that decrease T.P. consumption, however, increases water consumption.
Gary
You forgot to mention in myth 4 that the US confiscated gold from its citizens in the 30′s… The tax haven ‘crackdown’ is not about keeping people honest.. It is a way to reduce the options of a persons financial sovereignty – essentially setting up for money grab by bankrupted states….. most of them who happen to be in the G-20 (the biggest backer of the shakedown)…
http://www.taxjustice.net Nicholas Shaxson
The “partially true” response to Myth 4 drastically overstates the case. The response shoud be “untrue.”
Read more here
http://taxjustice.blogspot.com/2009/07/non-perils-of-information-exchange.html
http://www.facebook.com/people/Mônica-Arruda/2500028 Mônica Arruda
What about a sovereign country’s right to set the tax rates it finds to be most economically rewarding? It is amazing how you neglected the point of view of small countries in your comments. This global “attack” on tax havens is being engineered by a bunch of bully countries that fail to organize their own economies and, instead, want to solve their problems at the expense of many small countries that, frankly, don’t have much going on in their favor.