Multinational firms and tax havens

A new column by Anna Gumpert, James Hines and Monika Schnitzerat at VoxEU.org looks at the investment activities of multinational firms in tax havens. They argue that multinational firms may invest in tax havens to avoid taxation in non-haven countries, but other motives, such as business opportunities in these countries, may also drive such investment.

The Gumpert, Hines and Schnitzerat research uses data on German firms to investigate the motives for tax haven investment. Tax avoidance does appear to be a motive, particularly for manufacturing firms. Policies that raise the costs of reallocating profits maybe be effective in attenuating firms’ use of tax havens.

The column ends by arguing that

While the tax haven investments of some multinational firms attract considerable public attention, many multinational firms do not have affiliates in tax havens. Our evidence is consistent with tax avoidance as a motive for tax haven investments, in particular for manufacturing firms. At the same time, the size of a multinational firm’s operations and business opportunities in tax havens also induce multinational firms to invest in tax havens. As higher costs of reallocating profits attenuate firms’ tax haven use in response to higher taxation, policy measures that raise the costs of income reallocation may be effective at discouraging tax haven investment, as long as they do not induce firms to shift real activities to tax havens.

Of course there does seem a much simpler way of stopping the use of tax havens, lower the company tax rate in non-haven countries.

What problems and opportunities are created by tax havens?

I first posted this about a month ago, but it seems more timely now. One important point made below is that, far from what you may think given recent outcries, tax havens are not all bad.

The question in the title is asked in an article in the journal Oxford Review of Economic Policy, Volume 24, Issue 4 Winter 2008, pp. 661-679. The article is by Dhammika Dharmapala.

The abstract reads,

Tax havens have attracted increasing attention from policy-makers in recent years. This paper provides an overview of a growing body of research that analyses the consequences and determinants of the existence of tax-haven countries. For instance, recent evidence suggests that tax havens tend to have stronger governance institutions than comparable non-haven countries. Most importantly, tax havens provide opportunities for tax planning by multinational corporations. It is often argued that tax havens erode the tax base of high-tax countries by attracting such corporate activity. However, while tax havens host a disproportionate fraction of the world's foreign direct investment (FDI), their existence need not make high-tax countries worse off. It is possible that, under certain conditions, the existence of tax havens can enhance efficiency and even mitigate tax competition. Indeed, corporate tax revenues in major capital-exporting countries have exhibited robust growth, despite substantial FDI flows to tax havens.

Importantly Figure 1 from the paper lists the tax havens around the world. The interesting thing to notice is who isn't on the list (Hint: NZ).

Tax haven (DH)' refers to the definition of tax havens used in Dharmapala and Hines (2006). Tax haven (OECD)' refers to the definition of tax havens in OECD (2000, p. 17), but includes an additional six countries (listed in Hishikawa, 2002, p. 397, fn 72) that otherwise satisfied the OECD's tax haven criteria but were not included on the list because they provided 'advance commitments' to eliminate allegedly harmful tax practices. In each case, 1 = tax haven and 0 = non-haven.

An intriguing finding from the literature surveyed in the paper is that tax havens tend to have stronger governance institutions (i.e. better political and legal systems and lower levels of corruption) than comparable non-haven countries. Also while many people would argue that tax havens erode the tax base of high-tax countries, the paper stresses a more 'positive' view of havens. This view suggests that, under certain conditions, the existence of tax havens can enhance efficiency and even mitigate tax competition. Such a view appears to be supported by recent experience with corporate tax revenues: despite substantial FDI flows to tax havens, corporate tax revenue in major capital-exporting countries has increased.

Such findings may come as a surprise to many of those shouting their keyboards off about the Panama Papers. But I'm sure it will do little to change their views.

Refs.:

• Dharmapala, D. and Hines, J. R., Jr (2006), 'Which Countries Become Tax Havens?', NBER Working Paper No. 12802.
• Hishikawa, A. (2002), 'The Death of Tax Havens', Boston College International and Comparative Law Review, 25, 389-417
• OECD (2000), Towards Global Tax Cooperation: Progress in Identifying and Eliminating Harmful Tax Practices, Paris, Organization for Economic Cooperation and Development.

What problems and opportunities are created by tax havens?

A question asked in an article, with the same title, in the journal Oxford Review of Economic Policy, Volume 24, Issue 4 Winter 2008, pp. 661-679. The article is by Dhammika Dharmapala.

The abstract reads,

Tax havens have attracted increasing attention from policy-makers in recent years. This paper provides an overview of a growing body of research that analyses the consequences and determinants of the existence of tax-haven countries. For instance, recent evidence suggests that tax havens tend to have stronger governance institutions than comparable non-haven countries. Most importantly, tax havens provide opportunities for tax planning by multinational corporations. It is often argued that tax havens erode the tax base of high-tax countries by attracting such corporate activity. However, while tax havens host a disproportionate fraction of the world's foreign direct investment (FDI), their existence need not make high-tax countries worse off. It is possible that, under certain conditions, the existence of tax havens can enhance efficiency and even mitigate tax competition. Indeed, corporate tax revenues in major capital-exporting countries have exhibited robust growth, despite substantial FDI flows to tax havens.

Importantly Figure 1 from the paper lists the tax havens around the world. The interesting thing to notice is who isn't on the list.

Tax haven (DH)' refers to the definition of tax havens used in Dharmapala and Hines (2006). Tax haven (OECD)' refers to the definition of tax havens in OECD (2000, p. 17), but includes an additional six countries (listed in Hishikawa, 2002, p. 397, fn 72) that otherwise satisfied the OECD's tax haven criteria but were not included on the list because they provided 'advance commitments' to eliminate allegedly harmful tax practices. In each case, 1 = tax haven and 0 = non-haven.

An intriguing finding from the literature surveyed in the paper is that tax havens tend to have stronger governance institutions (i.e. better political and legal systems and lower levels of corruption) than comparable non-haven countries. Also while many people would argue that tax havens erode the tax base of high-tax countries, the paper stresses a more 'positive' view of havens. This view suggests that, under certain conditions, the existence of tax havens can enhance efficiency and even mitigate tax competition. Such a view appears to be supported by recent experience with corporate tax revenues: despite substantial FDI flows to tax havens, corporate tax revenue in major capital-exporting countries has increased.

Such findings may come as a surprise to many of those shouting their keyboards off about the Panama Papers. But I'm sure it will do little to change their views.

Refs.:

• Dharmapala, D. and Hines, J. R., Jr (2006), 'Which Countries Become Tax Havens?', NBER Working Paper No. 12802.
• Hishikawa, A. (2002), 'The Death of Tax Havens', Boston College International and Comparative Law Review, 25, 389-417
• OECD (2000), Towards Global Tax Cooperation: Progress in Identifying and Eliminating Harmful Tax Practices, Paris, Organization for Economic Cooperation and Development.

The morality of tax avoidance

Emile Yusupoff has written on the above topic at the Adam Smith Institute blog. Thinking about such things is of course due to the debates around the Panama Papers leak and whether taking advantage of legal tax avoidance schemes is moral. The claim of many of those upset by the Panama Papers seems to be that it is not. Although it is not clear why. Should we just happily give up whatever amount of our income the government demands and to not do so is a form of theft.

Yusupoff writes,

The view that all taxation is theft may not have much currency outside of hardcore libertarian circles. The opposite view, that there’s no such thing as ‘your money’ and you have an absolute obligation to give up whatever the government thinks is fit, sadly seems to be gaining currency.

The perspective that avoiding tax is inherently theft rests on some very peculiar assumptions. It needs to be accepted that current tax rates are either just, or not high enough, that the right things are being taxed in the right way, and that taking advantage of any loopholes is wrong.

For instance, in order to think that setting up a company to avoid income tax is immoral, you need to assume that: (i) income should be taxed at a higher rate than corporate profits; (ii) there is an obvious and absolute moral distinction between income and profit; and (iii) there are objective grounds to determine when it is legitimate to register a company.

And what about government encouraged avoidance schemes, such as ISAs and tax relief for risky investments? Is it wrong to take advantage of these?

It also needs to be assumed that providing the government with all the funds it demands is moral. It’s easy to talk about hospitals, schools, the roads, defence, and welfare. But that skirts over the real question of whether government should be funding these things at all and, if so, whether they should cost what they do.

It also ignores less palatable areas of expense, such as spending on foreign wars, nuclear weapons, a quixotic and destructive drug war, nonsensical vanity projects, bloated and pointless government departments, and corporate welfare. The same people who attack tax avoidance also (I think correctly) decry much of this, yet remain absolutely committed to the ‘obligation’ to fund the state’s largesse above and beyond what the law requires.

These issues may not have an obvious answer. But that’s exactly why tax dodging cannot just be lazily and self-righteously vilified as ‘disgusting’ by definition.

What is so terrible about this Mossack Fonseca thing?

I can't help thinking not much. One has to keep in mind there is a difference between tax avoidance and tax evasion. Eamonn Butler at the Adam Smith Institute blog makes the point,

The two are different, of course. Theft, fraud, tax evasion and money-laundering are rightly illegal: any firm or country that helps mafia bosses or dictators conceal stolen millions should be exposed and punished. But if you work within the rules and find ways to cut your tax bill, or invest your money in some place where it won’t be taxed within an inch of its life, that is legal and should remain so. Indeed, low-tax jurisdictions act as a safety valve that makes it harder for politicians to oppress their citizens with crippling taxes.

But it is too easy for those politicians to lump together the illegal evasion with the legal avoidance and say that both should be swept away.

And not just politicians, many commentators and journalists who are losing their collective minds over this whole issue make the same mistake.

Butler continues,

That is why politicians hate them. They know that if other places have lower taxes, people will move their money (or their businesses, or even themselves) abroad – so their citizens can no longer be taxed with impunity. It’s pure tax protectionism: governments don’t produce widgets, so they are all in favour of free trade in widgets; but they do produce taxes, so they want to keep out the competition.

So its competition for thee but not for me! Not that anti-competitive behaviour by governments in that unusual.

And if governments are so worried about tax havens then their is an obvious solution, lower their taxes.

Low taxes encourage enterprise, investment, growth and freedom. So low-tax jurisdictions don’t need to flout the rules, and it is insulting to suggest that they do: in fact, many have financial sectors that are better regulated than ours. Rather than try to bully them out of existence, the big countries should ditch their tax protectionism, square up to the competition, lower and simplify their own taxes.

What's the bit they won't?