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Why Are There Tax Havens? William & Mary Law Review Volume 52 (2010-2011) Issue 3 Article 5 December 2010 Why Are There Tax Havens? Adam H. Rosenzweig Follow this and additional works at: https://scholarship.law.wm.edu/wmlr Part of the Tax Law Commons Repository Citation Adam H. Rosenzweig, Why Are There Tax Havens?, 52 Wm. & Mary L. Rev. 923 (2010), https://scholarship.law.wm.edu/wmlr/vol52/iss3/5 Copyright c 2010 by the authors. This article is brought to you by the William & Mary Law School Scholarship Repository. https://scholarship.law.wm.edu/wmlr WHY ARE THERE TAX HAVENS? ADAM H. ROSENZWEIG* ABSTRACT Recently, the issue of tax havens has risen to the fore of the fiscal policy debate, with tax havens being singled out as the root cause of many of the fiscal shortfalls plaguing the governments of the world. Surprisingly, however, although there has been a fair amount of literature on why tax havens are harmful to the modern interna- tional tax regime, which countries become tax havens, and what means are available to combat tax havens, there has been less written specifically on the underlying question of why, notwithstanding all these points, tax havens exist in the first place, or why they persist in the face of such overwhelming criticism. This Article will fill that gap by directly confronting the question: why are there tax havens? To this end, this Article will propose for the first time that the focus of the international tax laws of wealthier countries, such as the United States, on capital neutrality—or making the flow of capital across borders easier and cheaper—can actually create or exacerbate the incentives necessary for poorer countries to act as tax havens. This can be thought of as a “capital neutrality paradox” in that it is the pursuit of capital neutrality—meant to increase worldwide efficiency—which leads to more countries acting as tax havens, effectively undermining worldwide efficiency. Consequently, pun- ishing such countries in response would also prove counterpro- ductive, because it would only exacerbate these incentives created by * Associate Professor, Washington University School of Law. I would like to thank Amitai Aviram, Cheryl Block, Dhammika Dharmapala, Christopher Hanna, Andrew Moin, Andrew Morriss, Kirk Stark, Peter Wiedenbeck, and the participants at the Columbia Law School Summer Tax Conference, the Washington University School of Law Incubator Series, the University of Illinois Law School Faculty Speaker Series, the Annual Junior Tax Scholars Forum, the Annual Meeting of the Law & Society Association, the Brooklyn Law School Economic Law Forum, and the SMU Dedman School of Law Tax Policy Colloquium for their helpful comments on prior drafts. Special thanks to my research assistant Allen Injijian whose work was invaluable to completing this project. 923 924 WILLIAM AND MARY LAW REVIEW [Vol. 52:923 U.S. law in the first place. This “punishment paradox” in connection with the “capital neutrality paradox” can fundamentally alter the way in which the law should conceptualize and respond to the issue of tax havens. Rather than ask “why are there tax havens?”, the question would become “why pursue capital neutrality?” Rather than ask “what can we do to punish tax havens?”, the question would become “would punishment be effective?” Such an approach could not only lead to a more efficient international tax regime, but could also be the first step to finally answering the question of why there are tax havens. 2010] WHY ARE THERE TAX HAVENS? 925 TABLE OF CONTENTS INTRODUCTION ....................................... 926 I. THE INTERNATIONAL TAX REGIME: THE PROBLEMS OF DOUBLE TAXATION AND TAX COMPETITION ............. 936 II. DOUBLE TAXATION RELIEF AND TAX COMPETITION: THE TWO PARADOXES .............. 943 A. The Capital Neutrality Paradox ................... 944 B. The Punishment Paradox ........................ 957 C. The International Tax Paradoxes Operationalized .... 963 1. Territorial Exemption and Tax Competition ...... 964 2. Worldwide Tax Base, Credits, and Blending ...... 968 III. HOW DID WE GET HERE? THE MOVE TO NEUTRALITY AND THE RISE OF THE INTERNATIONAL TAX PARADOXES ..................... 972 IV. TOWARD RESOLVING THE INTERNATIONAL TAX PARADOXES ................................... 982 CONCLUSION ........................................ 995 926 WILLIAM AND MARY LAW REVIEW [Vol. 52:923 INTRODUCTION A raging debate on the perils of tax havens grips the nation. Unscrupulous taxpayers indefinitely defer paying their fair share of U.S. taxes by funneling their income through artificial companies in tax haven countries. Tax havens threaten the long-term fiscal health of the country, undermining the ability of the government to address the pressing economic and social emergencies of the day, and thus the integrity of the modern state itself. The alarm has been raised, the gauntlet has been thrown; leading academics have been decrying the use of tax havens as “tax witchcraft,”1 and even the President of the United States himself has been imploring Congress to act.2 Is this a description of the state of U.S. tax policy in 2010? No—it describes international tax policy debate in the late 1950s and early 1960s. Yet, despite over fifty years of debate, schol- arship, analysis, legislation, and regulation, if one simply listened to the modern debate over tax havens, it would appear that little progress has been made over that time.3 1. Stanley S. Surrey, The United States Taxation of Foreign Income, 1 J.L. & ECON. 72, 94 (1958) (“The proposal would thus end the tax witchcraft which makes Panama or Liechtenstein or the Bahamas or even Canada the seat of enterprises of great magnitude owned and operated by American corporations.”); see also LAWRENCE B. KRAUSE & KENNETH W. DAM, THE BROOKINGS INST., FEDERAL TAX TREATMENT OF FOREIGN INCOME 13-19 (1964). 2. Special Message to the Congress on Taxation, 1 PUB. PAPERS 290, 295 (Apr. 20, 1961) [hereinafter Kennedy’s Special Message] (“[D]eferral has served as a shelter for tax escape through the unjustifiable use of tax havens.”); see also Lawrence Lokken, Whatever Happened to Subpart F? U.S. CFC Legislation After the Check-The-Box Regulations, 7 FLA. TAX REV. 185, 188 (2005). 3. See, e.g., DAVID L. BRUMBAUGH & JANE G. GRAVELLE, CONG. RESEARCH SERV., REFORM OF U.S. INTERNATIONAL TAXATION: ALTERNATIVES (2007), available at http://assets.opencrs .com/rpts/RL34115_20070731.pdf; Martin A. Sullivan, News Analysis: Will Obama Impose Sanctions on Tax Havens?, 121 TAX NOTES 1346 (2008); Jackie Calmes & Edmund L. Andrews, Obama Asks Curb on Use of Havens To Reduce Taxes, N.Y. TIMES, May 5, 2009, at A1 (“‘It's a tax code that makes it all too easy for a number—a small number of individuals and companies to abuse overseas tax havens to avoid paying any taxes at all,’ the president said.”); Press Release, Senator Carl Levin, Statement on Introducing the Stop Tax Haven Abuse Act, Part I (Mar. 2, 2009), available at http://levin.senate.gov/newsroom/release. cfm?id=308945. 2010] WHY ARE THERE TAX HAVENS? 927 What can explain this lack of progress?4 It cannot simply be attributable to myopia, inertia, or laziness; after all, the United States has enacted or fundamentally revised comprehensive anti- tax-haven legislation in 1962,5 1976,6 1986,7 and 1993,8 and it is currently the driving factor behind most international tax policy.9 Nor can it be a problem unique to the idiosyncrasies of U.S. tax policy, since tax havens have plagued most of the developed coun- tries of the world—as evidenced by the recent “name and shame” campaign against tax havens led by the Organisation for Economic Cooperation and Development (OECD).10 Yet tax havens not only arise and persist in the face of such seemingly overwhelming attack and criticism, they seem to flourish.11 4. See Robert J. Peroni, J. Clifton Fleming, Jr. & Stephen E. Shay, Getting Serious About Curtailing Deferral of U.S. Tax on Foreign Source Income, 52 SMU L. REV. 455, 497 (1999) (“[D]eferral is a topic that has long been on the reform agenda. There has been extensive and continuous debate since 1961 (when President Kennedy proposed to end deferral for most CFCs).”). Some have claimed that the tax haven “problem” significantly predates the tax haven debates of the 1950s, and even the modern income tax regime itself. See, e.g., Terence Dwyer & Deborah Dwyer, Transparency Versus Privacy: Reflections on OECD Concepts of Harmful Tax Competition, in I NTERNATIONAL TAX COMPETITION 259, 262-63 (Rajiv Biswas ed., 2002) (quoting Adam Smith, AN INQUIRY INTO THE NATURE AND CAUSES OF THE WEALTH OF NATIONS (1776)). In fact, at least one book attributes the modern tax haven phenomenon indirectly to the 1066 Norman conquest of England. See RICHARD ANTHONY JOHNS, TAX HAVENS AND OFFSHORE FINANCE: A STUDY OF TRANSNATIONAL ECONOMIC DEVELOPMENT 78 (1983) (describing how the collapse of the Norman Empire in 1204 led to the annexation of the Channel Islands under the British Crown in 1254 and the granting of the Charter to the People of Jersey, Guernsey, Sark and Alderney of 1341 and 1394, which then led to the fiscal autonomy of the Channel Islands). 5. Revenue Act of 1962, Pub. L. No. 87-834, 76 Stat. 960. 6. Tax Reform Act of 1976, Pub. L. No. 94-455, 90 Stat. 1520. 7. Tax Reform Act of 1986, Pub. L. No. 99-514, 100 Stat. 2085; Omnibus Budget Reconciliation Act of 1986, Pub. L. No. 99-509, 100 Stat. 1874. 8. Omnibus Budget Reconciliation Act of 1993, Pub. L. No. 103-66, 107 Stat. 312. 9. See, e.g., Reuven S. Avi-Yonah, The Obama International Tax Plan: A Major Step Forward 4 (U. Mich. Pub. Law & Legal Theory Working Paper Series, Working Paper No. 149, 2009), available at http://ssrn.com/abstract=1400624. 10. See ORG. FOR ECON. CO-OPERATION & DEV., HARMFUL TAX COMPETITION: AN EMERGING GLOBAL ISSUE 8 (1998), available at http://www.oecd.org/dataoecd/33/1/1904184.pdf [here- inafter OECD, HARMFUL TAX COMPETITION].
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