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'Harmful' Tax Competition and the Future of Offshore Financial Centres, Such As Vanuatu

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'Harmful' Tax Competition and the Future of Offshore Financial Centres, Such As Vanuatu PACIFIC ECONOMIC BULLETIN Harmful tax competition and the future of offshore financial centres, such as Vanuatu Terry Dwyer Offshore financial centres are coming under increasing pressure Terry Dwyer is a from both the OECD and the European Union. They are seen by Visiting Fellow at the many bureaucrats and politicians in OECD countries as facilitating National Centre for criminal activities such as laundering drug money as well as tax Development Studies, evasion and tax avoidance by residents of high-tax welfare states. Asia Pacific School of Economics and While there are good reasons for nation states to cooperate to Management, The suppress criminal activity, this is not true in relation to tax Australian National competition. The notion that by engaging in ‘harmful’ tax University. competition, offshore financial centres are damaging the legitimate interests of OECD nations has no sound foundation in economic theory. Competition in tax matters is beneficial and world welfare enhancing. Governments of offshore financial centres serve their own and the world’s interests by providing zero or low tax environments for global business and investment and they are right to insist that treaties on criminal matters not be used to enforce other countries’ tax claims. History of tax havens responsibilities to a post-colonial country required it to think about what industries In 1970, the then British administrators of could generate income for the Vanuatu the Condominium of the New Hebrides economy and its efforts met with the introduced Banking Regulation no. 4 of 1970. endorsement of its then French government That regulation introduced offshore banking partner in the Condominium. In view of more to Vanuatu and led to the development of recent OECD and European Union views on Vanuatu’s offshore financial centre. Later tax havens, Vanuatu might find it legislation provided for trust companies, worthwhile to remind the former colonial insurance and exempt company laws. The powers of the parentage of its offshore development of Vanuatu’s financial services financial sector. industry was not a casual decision on Tourism and financial services are London’s part. Britain recognised that its natural complements for a small South 48 HARMFUL TAX COMPETITION AND THE FUTURE OF OFFSHORE FINANCIAL CENTRES, SUCH AS VANUATU Pacific economy as part of its development an active role) has launched an attack on strategy. A country’s development strategy ‘harmful’ tax competition from tax havens. has to focus on attracting locationally mobile Indeed the history of offshore financial industries to raise the productivity and centres reflects the historical evolution of the wages of its people. In any case, a country tax systems of major countries, notably the such as Vanuatu with pristine coral reefs United States and United Kingdom. When might be expected to prefer clean industries Lloyd George and his Treasury officials like financial services to dirty factories which refused the request of the Vesteys that UK might damage its tourism income (as well as taxation not be extended to overseas income the environmental amenity enjoyed by its in World War I, the Vesteys decided on self- citizens). help. Their overseas income eventually If you have a largely subsistence flowed to the trustees of a settlement based agricultural sector and virtually all your in Paris at a time when France did not seek revenue is raised by indirect taxes or resource to tax overseas gains. Given the current rents, you do not need income taxes, capital attitude of France as an OECD member to gains taxes, withholding taxes or death offshore financial centres, it is worth noting duties. If you do not have these taxes, there is that France was one of the first offshore no need to enter into tax treaties. Vanuatu is financial centres. thus a natural tax haven. An absence of taxes, After World War I, as tax rates rose in the like an absence of war or internal violence, is United States and the United Kingdom, both something a country can turn to its countries sought in the 1930s to attack the advantage. It is understandable that Vanuatu transfer of assets abroad. The United continued the policy of developing its Kingdom legislated against offshore schemes financial sector after independence in 1980. based in Canada and the United States The presence of an offshore financial sector legislated against offshore pocketbook can provide collateral spin-off benefits for the companies held by US millionaires in the rest of the economy. It may gradually lead to Bahamas. funds being lent to or invested in developing For the vast majority of taxpayers in the domestic economy and it may assist in industrial countries, tax havens held little developing the legal expertise necessary for interest. With onshore tax havens such as a market economy to work. These are no life insurance, pension or superannuation small things when one observes the problems funds available, only the very wealthy found faced by some Eastern European economies much need to consider the use of offshore in transition. Educating people on how tax havens. In the United Kingdom, the money and finance work in a market combination of a still-wealthy upper class economy is an important part of facing extraordinarily high marginal tax development. rates, a tradition of overseas investment and Notwithstanding the logical reasons the unique circumstances of offshore tax which might favour Vanuatu developing its havens within the then exchange control area offshore financial sector, Vanuatu’s existence meant the British were leaders in tax haven as a tax haven has not been welcomed by all development. To these were added after people. In particular, it would be surprising World War II the multinational corporations if the Australian Treasury welcomed its which found that the services of tax havens emergence after closing down Norfolk were essential in overcoming the problems Island as a tax haven. It is therefore perhaps created for international business by not surprising that the OECD (in whose inconsistent tax treaties or dual claims to Committee on Fiscal Affairs Australia plays income. 49 PACIFIC ECONOMIC BULLETIN It is not generally recognised by most of a global capital market set limits to the economists that without tax havens, multiple redistributive financing of welfare states national taxation would still exist and pose (Frenkel, Razin and Sadka 1991:213:4; enormous difficulties for mutually beneficial Schjelderup 1993:377). trade and commerce. Since the 1980s, there has been the As public expenditure rose, notably on adoption generally within Europe of expanding welfare states, and as onshore tax controlled foreign companies legislation as shelters or tax havens were attacked, one after well as other anti-avoidance legislation. More the other, by treasuries in industrial significantly, the OECD report on harmful countries, the demand for the services of tax competition and its cognate report on tax offshore tax havens rose. No longer were sparing (OECD 1998), together with EU offshore tax havens merely of interest to initiatives, have seen the emergence of a major multinational corporations or the multilateral attack on tax havens or offshore super-wealthy. With high postwar income financial centres (OECD 1999).1 The OECD tax rates and death duties and a widespread Council is expected to consider a list of tax legacy of colonies which had inherited the havens at its meeting in June 2000. In common law and the law of trusts, the British particular the United Kingdom has clearly led the offshore migration. The Americans come under pressure from its European were not slow to patronise the British- partners to ‘do something’ about its developed Caribbean jurisdictions and to dependent territories. The first example of take advantage of common law legal systems this was the UK Edwards report (Edwards with which they were familiar. 1998) which examined the Channel Islands The Europeans with a tradition of and the Isle of Man and which has now been territorial taxation and civil law systems had followed by the White Paper on the overseas less need to patronise Anglo-Saxon tax territories (UK 1999). havens with whose legal systems they were The Edwards report, which, in the less familiar. However, as European method of its inception, broke long- countries moved to wind back the scope of established constitutional usages governing exemptions for extra-territorial income, it was the relationship between the United no longer enough merely to have Kingdom and the Crown’s offshore islands, undisclosed bank accounts in Switzerland did not recommend wholesale elimination or Luxembourg. By the 1980s the gradual of the offshore tax havens. Indeed the removal of capital controls in the United Edwards report was surprisingly fair, given Kingdom and the European countries its genesis, but it did foreshadow substantial opened the way for further European inroads on client privacy in the interests of patronage of places such as the Channel overseas regulators and tax collectors. Islands. Since before the American revolution, The consciousness of European the United Kingdom has had a practice that treasuries was raised after Germany failed British colonies with self government are in an attempt to impose an interest entitled to administer their own taxation withholding tax in the face of a flight of affairs.2 No pressure from its European capital. It now seemed clear to the treasuries partners is likely to alter that position. of ageing welfare states that tax competition, Hence the UK government is proceeding to when combined with freedom of capital assuage its European partners by seeking movement, was a threat to their ability to more subtle methods of removing the raise further revenue. European writers attractiveness of its overseas territories as increasingly recognised that the emergence tax havens. The ostensible focus of its 50 HARMFUL TAX COMPETITION AND THE FUTURE OF OFFSHORE FINANCIAL CENTRES, SUCH AS VANUATU initiatives is to ensure credible regulation of Are offshore financial centres ‘tax the offshore financial industry in each of its havens’? territories.
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