Yesterday’s column focused on the theoretical argument for tax havens.
At the risk of oversimplifying, I explained that the pressure of tax competition was necessary to prevent “stationary bandits” from saddling nations with “goldfish government.”
And I specifically explained why the left’s theory of “capital export neutrality” was only persuasive if people just paid attention to one side of the equation.
Today, let’s look at some real-world evidence to better understand the beneficial role of these international financial centers.
We’ll start with a column in the Hill by Jorge González-Gallarza.
Using as a natural experiment the terminal phase-out in 2006 of corporate tax exemptions to affiliates of U.S. companies setting shop in Puerto Rico, the research finds that scrapping the island’s status as a tax haven led U.S. companies to cut back investments and job creation in the mainland substantially.
The provision in question was Section 936 of the Internal Revenue Code and it exempted Puerto Rico-based affiliates of U.S. companies from paying any corporate income tax altogether. …In 1996, President Clinton signed the Small Business Job Creation Act, spelling §936’s full phaseout by 2006. …ditching §936 appears to have raised U.S. companies’ average effective tax rate on domestic corporate income by 10 percentage points. Notably yet unsurprisingly, they responded by cutting global investment by a whopping 23 percent while balancing away from domestic projects, in Puerto Rico and the mainland alike — domestic investment fell by 38 percent, with Foreign Direct Investments’ (FDIs) share of the total growing 17.5 percent. …Employing 11 million workers in the continental US before repeal, firms taking advantage of §936 laid off a million of them, amounting to a 9.1 percent decline in payrolls.
In other words, higher taxes on business resulted in less investment and fewer jobs. Gee, what a surprise.
Hopefully, the 2017 reduction in the corporate tax rate is now offsetting some of that damage.
In an article for the Tax Foundation, Elke Asen shares some academic research on how tax havens help mitigate the destructive policies of high-tax governments.
Tax havens, or “offshore financial centers,” can be defined as small, well-governed tax jurisdictions that do not have substantial domestic economic activity and impose low or zero tax rates on foreign investors. By doing so, they attract a considerable amount of capital inflow,
particularly from high-tax countries. …academic research reveals that high-tax jurisdictions may also have something to gain from tax havens. …A 2004 paper by economists Mihir Desai, C. Fritz Foley, and James Hines…found that tax havens indirectly stimulate the growth of businesses in non-haven countries located in the same region. …These findings suggest that although high-tax countries can lose tax revenue due to profit shifting, tax havens can indirectly facilitate economic growth in high-tax countries by reducing the cost of financing investment in those countries.
By the way, I cited the Desai-Foley-Hines paper in my video on “The Economic Case for Tax Havens” because it makes the key point that governments hurt their own economies when they go after low-tax jurisdictions.
Here are some excerpts from an article by Abrar Aowsaf in the Bangladesh-based Dhaka Tribune. It’s especially worth citing since it notes that tax havens are a refuge for oppressed people around the world.
A tax haven is basically a jurisdiction with low taxes, high legal security, and a high degree of protection of savers’ privacy. …The Cayman Islands, Switzerland, Singapore, Hong Kong, Cyprus, Jersey, and Bermuda — all of these jurisdictions that we recognize as tax havens are characterized by their high legal safety. Savers know that the government will not decide to take their money on a whim. …Operating in tax havens is not illegal in itself.
…Singer Shakira, for example, uses tax havens to minimize her tax bills within the bounds of the law. …Another very important detail is that tax havens are a refuge for millions of citizens who have had the misfortune of being born in authoritarian and unstable countries. In many countries, the most basic human rights are not guaranteed. There also exist states where authoritarian governments arbitrarily decide who to repress or prosecute. Many investors do not seek protection just for the lower taxes, but they are also escaping political, ideological, and religious persecution. …In reality, tax havens are not to be blamed…nor do they force us to pay more taxes or harm our economies. Ireland, for example, was poorer than Spain in 1980. Today, thanks to its low taxes, it is the second richest country in the Eurozone. In order to improve general welfare, what we need are more companies, not more incompetent politicians and haphazard public spending. The problems faced by countries with economic difficulties do not come from tax havens, but from their politicians and ineffective policies.
Amen. More people need to be making “The Moral Case for Tax Havens.”
Andy Morriss, the Dean of Texas A&M’s School of Innovation, explains the vital role of these low-tax jurisdictions in bring more investment and prosperity to poor nations.
The seemingly endless debate over the role of IFCs in corporate and personal tax avoidance ignores these jurisdictions’ crucial role in providing the rule of law for international transactions. …The world’s poorest countries desperately need their economies to grow if their populations are to have better lives. For example, Africa has about 17 per cent of the world’s population but only 3 per cent of global GDP. The root causes of African nations’ underdevelopment are complex, but one critical element is that there is too little investment in their economies.
…most developing countries lack the legal and regulatory infrastructure necessary to support a domestic capital market. …When multiple investors pool their investments, they need a mechanism to address the governance of their pooled investment. …By providing legal systems which offer a powerful combination of modern, efficient, well-designed laws and regulations, regulatory agencies staffed with experienced, well-credentialed experts, and court systems capable of quick, fair, and thoughtful decisions, IFCs offer alternative locations for transactions and entities. …In short, the price of investing in a developing economy is reduced. And when the price of something falls, the amount demanded increases. That’s good for investors, it’s good for developing countries, and it’s good for the world’s poorest. …Improving the lives of the poorest around the world is going to require massive private investment in productive activities. This need cannot be met by government provided aid… Only economic growth can solve this problem. And growth requires investment… Fortunately, IFCs are helping to meet this need.
Click here if you want more information on how tax havens help the developing world.
Writing for the Bahamas-based Tribune and citing former Finance Minister James Smith, Neil Hartnell warns that the OECD’s agenda of “neo-colonialism” will cripple his nation’s economy.
The Bahamas “may devastate the economy” if it surrenders too easily to demands from high-tax European nations for a corporate income tax, a former finance minister warned yesterday. …OECD and European Union (EU) initiatives…calling for all nations to impose some form of “minimum level of” taxation on the activities of multinational entities.
…Mr Smith…blasted the OECD’s European members for seemingly seeking to “recast our economy in their own image”, adding that this nation’s economic model had worked well for 50 years without income and other direct forms of taxation. …Describing the OECD and EU pressures as a form of “neo-colonialism”, Mr Smith said The Bahamas shared few economic characteristics with their members. He pointed out that this nation was suffering from high unemployment and “low wages for the majority” of Bahamians. “Conceptually the take from an income tax may devastate the economy,” he told Tribune Business.
The former Finance Minister is correct in that the OECD is trying to export its high-tax policies.
For what it’s worth, I’ve reversed the argument and pointed out that OECD nations should be copying zero-income tax jurisdictions such as the Bahamas.
So what’s the argument against tax havens?
As illustrated by this article from the International Monetary Fund, authored by Jannick Damgaard, Thomas Elkjaer, and Niels Johannesen, all the complaints revolve around the fact that some people don’t like it when governments can’t grab as much money.
Although Swiss Leaks, the Panama Papers, and recent disclosures from the offshore industry have revealed some of the intricate ways multinational firms and wealthy individuals use tax havens to escape paying their fair share, the offshore financial world remains highly opaque. …These questions are particularly important today in countries where policy initiatives aiming to curb the harmful use of tax havens abound.
…a new study…finds that a stunning $12 trillion…consists of financial investment passing through empty corporate shells… These investments in empty corporate shells almost always pass through well-known tax havens. The eight major pass-through economies—the Netherlands, Luxembourg, Hong Kong SAR, the British Virgin Islands, Bermuda, the Cayman Islands, Ireland, and Singapore—host more than 85 percent of the world’s investment in special purpose entities, which are often set up for tax reasons. …private individuals also use tax havens on a grand scale… Globally, individuals hold about $7 trillion—corresponding to roughly 10 percent of world GDP—in tax havens. …the stock of offshore wealth ranges…to about 50 percent in some oil-producing countries, such as Russia and Saudi Arabia, and in countries that have suffered instances of major financial instability, such as Argentina and Greece.
I find it interesting that even the pro-tax IMF felt obliged to acknowledge that people living in nations with bad governments are especially likely to make use of tax havens.
Though I’m not sure I fully trust the data in this chart from the article.
Because of problems such as corruption, expropriation, crime, and political persecution, I’m sure that usage of tax havens by people in nations such as China, India, Iran, Mexico, and South Africa is much greater than what we see in the chart.
Though perhaps the numbers are distorted because the authors didn’t include the United States (sadly, the policies that make the U.S. a tax haven are only available for foreigners).
P.S. American taxpayers legally can use Puerto Rico as a tax haven.
