PACIFIC ECONOMIC BULLETIN

‘Harmful’ 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 . 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 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 . 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

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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 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 . 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 plays income.

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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). 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

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initiatives is to ensure credible regulation of Are offshore financial centres ‘tax the offshore financial industry in each of its havens’? territories. The overseas territories, on the face of it, find it difficult to complain if the UK So far I have used the terms ‘tax haven’ and government insists that they cooperate in ‘offshore financial centre’ interchangeably. measures to afford mutual legal assistance In fact the offshore financial centres have in to counter criminal activity and eliminate many cases progressed for reasons other than fraud. tax, though without beneficial tax regimes, But there seems to be an ulterior motive they may not have progressed at all. in this apparently beneficent activity. If Increasingly offshore financial centres are measures introduced to secure the integrity used for asset protection against the tort of the overseas territories’ financial sectors liability revolution.7 Liberalised no-fault have the effect, if not the stated purpose,3 of divorce laws which give spouses automatic ensuring that the financial affairs of OECD claims to assets regardless of adulterous investors in those territories are exposed to conduct do not meet with universal moral the gaze of OECD treasuries, then Britain will approval. In some countries, testators are have pleased not only its own treasury but denied freedom to dispose of their estates as those of its European neighbours. Certainly they think fit and, increasingly in common there is no reason to think that even a ‘Third law countries, legislation makes it easier for Way’ UK Labour government has much disappointed beneficiaries or others to sympathy for tax avoidance through the use challenge a will. Assets may be moved to of offshore havens. vehicles in offshore financial centres to defeat It is clear that a consensus is emerging such legislation.8 among many OECD countries that tax Sometimes governments themselves use competition is harmful4 and measures need offshore financial centres, for example, to to be taken collectively to eliminate tax trade with other countries when it is not havens. This is not a universal OECD view. politically correct to do so or to protect Switzerland and Luxembourg dissented themselves against the possibility of strongly from the report on harmful tax sanctions being imposed, as when Iranian competition (OECD 1998:73–81) while the assets were frozen in the United States. United States has its own views on foreign Individual investors, such as Taiwanese sales corporations.5 investing in mainland China, may have Tax havens face the following similar motives to use offshore centres. international agenda Offshore financial centres cater to • tax competition is harmful expatriate investors who may be working in • it should therefore be suppressed many countries over time and wish to • national sovereignty means it cannot be manage their investments or pension directly suppressed arrangements from one centre. Prospectus requirements may influence investment • therefore, financial threats or inducements or the use of ostensibly managers in choosing to locate their non-tax treaties must be employed for the operations in offshore financial centres. explicit or ulterior purpose of eliminating Onshore investors denied access to foreign tax havens. In the case of dependent company prospectuses or life insurance territories of OECD members, such products, may seek to invest via offshore measures may carry the implicit threat vehicles. Persons planning a company of the governing power to override takeover on a stockmarket may not wish to internal self-government.6 alert the market. Multinational groups

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seeking access to lower premiums through allow the purchase or sale of an the reinsurance markets may choose to increasing number of goods and operate captive insurance companies in services—including the provision of offshore financial centres. labour services—in a way which could render traditional tax collection Opinions may differ on the morality or mechanisms unworkable, posing a otherwise of the use of offshore centres but major challenge for tax system design. they do emphasise that tax is not the only, or The OECD is developing a taxation the most powerful, motivation for the use of framework to apply to electronic offshore centres. For that reason, the term commerce including ‘place of taxation’ ‘offshore financial centre’ is more accurate rules for consumption taxes and than ‘tax haven’ as there is often more than measures to strengthen international one kind of perceived legal inadequacy or cooperation in tax administration and repression in the investor’s home or target collection. Australia is contributing actively to this work. The ATO has jurisdiction providing the impetus to locate sought to raise awareness of the issue assets in an offshore vehicle. in its publication Tax and the Internet (Costello 1999:4–24) The theory of ‘harmful’ tax Before accepting that tax competition can competition ever be harmful, one might ask some questions. How does tax competition differ As the expertise of this writer is in economics, from other competition?10 What is wrong not international relations or political with general fiscal competition so that a low science, the rest of this paper addresses the spending country can pursue a low or zero OECD premise that tax competition is income ?11 What is wrong with not harmful. There is an assumption that the taxing income you would otherwise not answer is yes. I argue that economic theory gain?12 points to the opposite conclusion, namely Fear that tax competition will lead to a that tax competition is a healthy and natural loss of domestic revenue does not amount to economic process which weeds out stupid an argument that tax competition is harmful or inefficient taxes.9 either to one’s own or other countries, no If I am correct, then the governments of matter how unpleasant it may be for the offshore financial centres are entitled to take treasury concerned. the view that they are not being bad Competition among countries for international citizens in seeking to profit taxation revenue poses a significant from the stupidity of treasuries of high- threat to national revenue bases and income countries. They are entitled to take effective tax rates. The OECD has the view that any form of international legal recognised the danger that such assistance should not extend, directly or competition will simply see an erosion of tax revenues without any benefit to indirectly, to the enforcement of other individual countries in terms of greater countries’ tax laws, whether such assistance investment. The analogy with the is by sought by way of debt recovery, destructive competition of an insolvency proceedings, information earlier era is clear (Ralph 1998:25 para exchange or evidence for tax prosecutions. 2.36). The OECD fear is that Tax competition is seen as a ‘race to the [d]evelopments in communications bottom’ where there are no winners in the technology, such as the Internet, raise end. But the theory to support such a view is a general risk to the forward estimates not presented. The analogy that international of revenue. Such developments may tax competition is potentially harmful in the

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same manner as the tariff competition of an taxes. earlier era is false. Whereas tariff competition As regards the fairness and broad social involved putting up taxes and destroying acceptance of tax systems, it is curious that trade, tax competition involves driving down revenue collectors who traditionally insist tax rates on mobile factors of production in the Courts that taxes must be collected towards their optimal level. It is trade- according to law—without regard to facilitating rather than trade-destructive.13 fairness—should raise this issue. The obvious point is that many citizens in high- taxing countries do not accept their tax Defining ‘harmful’ tax competition systems as ‘fair’ and, failing to obtain A basic problem in defining ‘harmful’ tax from their political systems, do what they can competition is to define who wins and who to protect themselves and their families. Their loses. Are the losers governments? Or some responses can range from simple legal tax governments and not others? 14 Or are they planning such as deductible pension fund the citizens of countries? Or is the world at contributions, or geared investments or large a loser? income splitting to more complex tax The OECD Report argues that planning or avoidance and even to minor or 15 tax havens and harmful preferential massive unlawful evasion. tax regimes, collectively referred to as While one can understand why a high- harmful tax practices, affect the tax country’s tax administrators would view location of financial and other service all such responses by its citizens as ‘harmful’ activities, erode the tax bases of other to revenue collections, that does not mean countries, distort trade and investment taxpayer responses to high tax burdens are patterns and undermine the fairness, necessarily always harmful to the country neutrality and broad social acceptance itself. In the case of onshore havens such as of tax systems generally. Such harmful tax competition diminishes global pension funds, the capital accumulated may welfare (1998:8 para 4). increase investment and productivity while reducing future demands on the treasury This statement raises a multitude of from an ageing population. In the case of questions. Apart from the circularity of offshore havens, similar responses by referring to a harmful preferential tax regime citizens may have similar if more attenuated as harmful, in what sense is it harmful for benefits and may serve as an economic and another country to be a tax haven? If the 16 alleged harm is that tax havens affect the political safety valve, forestalling the location of financial and other service physical emigration of talented labour and industries, it needs to be observed that all capital or the emergence of violent minority 17 taxes affect location decisions, including the political movements. In an ideal society, taxes of the country allegedly harmed. If people would want to pay their taxes or be country A puts on taxes while country B does unable to avoid them, but only benefit taxes not, whose action causes financial and other or taxes on economic rent are likely to service activities to relocate? Are not country approach such an ideal. With other taxes, it is A’s taxes the ultimate reason for the erosion moderation in their levels and administration of its tax base? Is not the harm self-inflicted? which best promotes their acceptance and As for distortion of trade and investment mitigates avoidance and evasion. patterns, all taxes on labour and capital are It is therefore impossible to assume that distorting: only taxes on rent are non- tax competition harms the country losing distorting and there is no international law revenue. It is even more difficult to conclude which prohibits countries from adopting rent that ‘harmful’ tax competition diminishes

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global welfare, unless one can show that the distinguished from any other economic gains to the competing country and its clients decision. Nor is it satisfactory to define from the revenue-losing country plus gains ‘harmful’ tax competition as that which is to third countries are less than the losses to ‘designed’ or ‘intended’ as tax competition. the beneficiaries of the revenue-losing Is it harmful tax competition if you intend country’s taxes and the marginal deadweight to poach another country’s tax base but not losses of those taxes. Nowhere does the if you pursue a domestic policy which merely OECD Report attempt such a demonstration. has that effect? Such a definition is The difficulty of defining ‘harmful’ tax nonsensical.19 It would mean that Hong Kong, competition is further exemplified by the which pursues a low tax policy assisted by OECD concession (1998:8 para 6) that: ‘Tax land revenues, is a ‘non-harmful’ tax haven incentives designed to attract investment in competitor but Singapore, which is a higher plant, building and equipment have been tax jurisdiction, with specific incentives for excluded at this stage…’ The focus of the international business, is a ‘harmful’ tax OECD Report is on tax competition for mobile competitor. Curiously, it would also mean financial capital or services. It seems to be that the classical tax havens, Jersey, Guernsey assumed sometimes (or for the time being?) and the Isle of Man, were not engaging in that competition for financial capital is ‘harmful’ tax competition as their tax haven harmful but competition for physical capital features grew out of domestic policy is, so far, legitimate. decisions and long-established tax practice. But physical and financial capital are Many tax havens have evolved their own not so neatly distinguished and tax tax systems without any particular interest competition affects labour mobility as well. in the wider world, yet the OECD Report It seems odd to complain that tax competition recommendations clearly conclude by for location of financial capital or regional focusing on the effects of tax competition on headquarters is harmful while tax the revenue-losing countries more than any competition for factories and jobs is not. As intentions on the part of tax havens. In the Bracewell-Milnes (1980) and Keen (1993) end, the OECD sees all tax competition as have pointed out, paper tax avoidance, which harmful to the interests of revenue-losing tax means a factory continues to operate and authorities, regardless of whether it is create jobs in a high tax country, may be seen intended and whether it operates on physical as less harmful than the tax avoidance or financial capital or on labour. As Mason involved in closing down the factory, sacking Gaffney (1999) has pointed out, the OECD workers and setting up in a developing report has not been accurately titled. It should country which grants tax incentives for plant have been called ‘tax competition: a problem and equipment.18 for high tax countries’. The OECD (1998:17 para 34) recognises that some investors may seek to invest in a location with lower Defining ‘fair’ tax competition rates (and greater after tax return) even if only low public services are The difficulty of defining ‘harmful’ tax available…but these genuine location competition is paralleled by the difficulty of decisions have to be distinguished defining ‘fair’ tax competition. The OECD from the type of behaviour which is the argues that ‘the proposals set out in the focus of this Report. Report will reduce ‘the distortionary Again, the OECD Report gives no criterion influence of taxation on the location of mobile by which any such decisions can be financial and service activities, thereby

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promoting fair competition for real economic income redistribution, there are many activities. If governments can agree that these economists who would argue that both are location decisions should be driven by economically inefficient, especially when it economic considerations and not primarily is sought to finance redistribution by high by tax factors, this will help move towards marginal tax rates on labour and capital the ‘level playing field’ which is so essential incomes as opposed to land rents.20 It is also to the continued expansion of global odd that a report which complains (OECD (1998:9 para 8). 1998:15 para 25) that tax havens are ‘free What is a ‘real’ and ‘unreal’ economic riders’ accepts as given the ‘free riding’ activity. Is banking unreal? Is insurance implicit in redistributive taxation (OECD unreal? Is e-commerce unreal? Is the Internet 1998:14 para 23). unreal? And why is tax not an ‘economic’ consideration? The House of Lords, the Australian High Court and the United States Should tax systems be the same? Supreme Court have taken it as axiomatic that taxation is a normal part of any business Who is to define internationally accepted decision-making when dealing with cases standards? Should it be internationally of alleged tax avoidance. unacceptable for a country to raise its If the concern is with whether a country’s revenue entirely from land taxes or resource tax regime induces economic activity to shift, taxes (for example, oil royalties) and have no then all tax competition is necessarily taxes at all on capital or labour? If it is to be ‘harmful’. The only way to prevent tax- unacceptable, why should that be so, given induced changes of investment location the obvious efficiency benefits of such a tax would be for all countries to adopt the same regime and, if, on the other hand, it is to be tax system and the same tax rates. acceptable, how can one logically object to The inference from the OECD report is tax competition? If a zero on capital that all low tax countries are engaging in and labour income is acceptable to the OECD ‘harmful’ tax competition and the Report why does the OECD have any concerns about evinces in its recommendations an intention tax competition? The OECD report seems to eliminate all forms of tax competition as designed to dissemble the real objective of harmful, no matter how arising. an OECD-led global tax cartel with worldwide enforcement powers. The ‘harm’ caused by tax competition A global tax cartel?

More insight into what the OECD sees as The OECD response to tax competition is to ‘harmful’ tax competition comes from its try to organise a tax cartel.21 The OECD description of the harm caused by tax argues that all countries can benefit by competition. If tax competition shifts the tax joining a global tax cartel. burden from mobile to relatively immobile The assumption that all countries could factors, it is doing the world a service. be better off by joining a tax cartel depends, Economic theory has always held that, from first, on all countries joining the cartel and, an efficiency point of view, taxes should be second, on a fixed worldwide supply of the laid on things which are inelastic in supply factor sought to be taxed. While some (of which the prime example is land rents). countries may be tempted to join such a cartel As for progressive marginal tax rates and if promised a share of the , others

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will observe that, the larger the cartel, the avoidance and illegal evasion.22 It means greater the profits to be secured by those international crime fighting is being used as remaining outside it. Apart from the a stalking horse to attack so-called tax improbability of all countries joining a tax crimes.23 It means the destruction of cartel, since the rewards for staying out are sovereignty and the principle of no extra- increased as more join, the key assumption territorial enforcement of other countries’ is that the worldwide supply of capital or taxes. It means the complete destruction of labour would not be reduced if all privacy as a social value in OECD societies, governments colluded to increase tax rates. notwithstanding its status as a human right That this assumption is false is suggested by under some Constitutions, for example in the declining savings rates, labour force United States.24 Non-OECD countries are participation and birth rates in high tax expected to legislate to force their citizens to countries. Even in a closed economy, high divulge information to OECD authorities not taxes on labour and capital have negative merely for the purpose of prosecuting consequences. common criminals but for the purpose of Such considerations do not appear to preventing both evasion and avoidance of deter the OECD from planning the means to OECD countries’ taxes.25 No decent person enforce a tax cartel. The OECD notes ‘Some wishes to support drug cartels but many progress has been made in the area of access would feel that the loss of all personal to information, in that certain tax haven financial privacy is too high a price to pay jurisdictions have entered into mutual legal for their elimination. assistance treaties in criminal matters with Just as modern Western states are non-tax havens that permit exchange of imitating the later Roman Empire in their information on criminal tax matters related population decline, so they are imitating it to certain other crimes (for example, narcotics in their increasingly punitive approach to trafficking) or to exchange information when taxation enforcement as their labour tax criminal tax fraud is at issue. Nevertheless, bases shrink. Tax defaults are increasingly these tax haven jurisdictions do not allow being criminalised and attempts are being [other countries’] tax administrations access made successfully to prosecute to bank information for the critical purposes as if it were common law fraud (even though of detecting and preventing tax avoidance taxes—originally called aids or subsidies— which, from the perspectives of raising are a creature of statute alone and not known revenue and controlling base erosion from to the common law). The great tactical financial and other service activities, are as advantage of this confusion of the sources of important as curbing tax fraud’ (1998:24 para legal obligation is that the authorities in the 54). The OECD goes on to assert ‘In an era of OECD country can then seek to use treaties globalisation and increased mobility for on mutual legal assistance to pursue tax taxpayers, traditional attitudes towards collection outside their borders by claiming assistance in the collection of taxes may need they are pursuing criminal acts rather than to change. The purpose…is to encourage seeking extra-territorial tax enforcement. countries to review the current rules…with There is little point to offshore financial a view to encouraging the enforcement of tax centres saying they will cooperate with claims of other countries’ (1998:52 para 137). OECD measures against illegal tax evasion The implications of this OECD but not against lawful tax avoidance, if the bureaucratic view for both OECD and non- OECD countries are determined to confound OECD countries are that there is to be no the two: offshore centres have in effect only distinction drawn between legal tax one choice regarding exchange of tax

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information—to force their citizens to and capital—and only one of them cannot provide information to OECD countries for flee. Capital can flee at the speed of light today all tax purposes or for none. Governments and it can stop replenishing itself as people of offshore financial centres will doubtless either stop saving or investing. Like water, study more closely the precise wording of capital can evaporate or leak away from an legal assistance treaties to ensure such open economy. Labour has a harder job indirect attempts to erode their sovereignty escaping tax burdens, but it can stop working, do not seriously undermine their own shift to the black economy, emigrate revenues. (especially if it is skilled)28 or stop breeding. In essence, the OECD is arguing that the Only land (which includes all scarce natural rest of the world should be forced to design resources) can command a true economic rent their legal and administrative systems to which cannot be diminished by taxation.29 facilitate the application of residence-based There is no reason why reduced taxes on income taxation by OECD countries. Even mobile capital could not be financed by in the heyday of colonialism, imperial increased land taxes within the OECD powers tended not to make such demands countries.30 If they choose to tax their workers of their colonies. Faced with the prospect of more rather than land, that is their domestic such drastic abuse of legal assistance political decision, just as it was a domestic treaties, one suspects that some non-OECD political decision for many OECD countries, countries will reach the view that legal notably in Europe, to embark on high welfare assistance treaties are not in their national spending programmes which necessitated interest and should be denounced or high taxes on labour and made them amended. It would be unfortunate if the internationally uncompetitive. Having made unbridled demands of OECD tax those decisions, they should not blame the bureaucrats were to trigger a decline in rest of the world for the logical economic international cooperation against real consequences. criminality, under which tax offences are not Just why small countries, for example the necessarily included by most of humanity.26 Pacific island countries, should be expected Just why some countries should be made to provide a ‘level playing field’ for OECD to enforce other countries’ tax laws when it is countries by embarking on similar high-tax, not in their interests to do so, nor in the high-spending, policies is not explained. interests of world economic growth, is not Why should places such as Vanuata with few explained. The radical assault on sovereignty resources be expected to forgo any chance of implicit in such sentiments should cause maintaining the living standards of their observers to ask what is wrong with the OECD people by imposing OECD tax rates which tax systems that they need such drastic would drive away business and employment? extraterritorial enforcement.27 Territorial To blame emerging economies in the Asia systems, or land taxes, do not Pacific for the economic woes of European require such extraterritorial assistance. welfare states may be good domestic politics in Europe but it is bad economics, both for The problem of trying to tax Europe and the world at large. mobile factors of production The argument that tax competition is harmful, implicitly rests on the assumption The real problem the OECD is grappling that there are only two factors of production, with is trying to tax what can run away. Tax labour and capital, and these are fixed in their policy is really quite simple. There are only total worldwide supply. Both assumptions three sources of income to tax—land, labour are quite false.

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From the point of view of national growth will slow. Once this fundamental economic welfare, the view that tax error of the harmful tax competition model is competition is harmful is correct only if there grasped, the concept collapses. are no immobile tax bases available. Where there are mobile tax bases (for example, The zero rate on capital capital) and immobile tax bases (for example, land), tax competition can force a country to A key question is whether all forms of income shift its tax base from mobile capital to should be taxed equally. Leaving aside immobile land. Such a shift is, in fact, a shift ethical views in favour of graduated income to a more efficient tax base, one conforming taxes,31 the answer depends on how to the general Ramsey efficiency rule of taxing responsive different parts of the tax base are. more those things which are less elastic in Income is not a homogeneous tax base.32 It is supply. Tax competition may thus be not sensible to tax all forms of income at the efficiency enhancing and no bad thing for a same rate if the factors of production country, even if its tax administrators or generating the income are not all equally politicians find it uncomfortable. mobile. In particular, it does not make sense The economic theory underpinning the to tax mobile capital, especially capital concept of ‘harmful’ tax competition is supplied by foreigners, at the same tax rate essentially non-existent. The theoretical as income arising from land or immobile models employed in the economic literature labour tied to the jurisdiction. Though not to show harmful effects from tax competition essential to the case against the OECD’s and a loss of collective revenue are essentially views on harmful tax competition, it is based upon models which assume a fixed reasonable to suggest that the optimal tax worldwide supply of capital. In those rate on capital income is zero.33 models, tax competition is a ‘beggar thy The fundamental Ramsey principle of neighbour’ policy whereby the gains of taxation is that taxes should be levied on financial centres or tax havens must be at those activities which are least responsive. the expense of tax revenue in the capital One would not tax a factor of production exporting countries. Obviously, if the world which was in perfectly elastic supply. This conformed to such models, if there were a has profound implications for internationally fixed world stock of capital, governments mobile capital. Theoretical models of optimal could collect more tax by operating a tax taxation produce three broadbrush results cartel. It would be in their collective interest (Frenkel and Razin 1996:chap 14). to eliminate tax competition. In such models, • the optimal principle of international it would make sense for a UK government to taxation is the residence principle; that pressure its dependent territory governments is, non-residents should not be taxed on to put up their tax rates and compensate their capital income from a country them for any revenue lost by paying subsidies • the optimal tax rate on capital income (increased foreign aid) out of the increased from all sources is zero revenue generated by driving capital back to • the optimal tax rule for a country that the United Kingdom. cannot enforce taxes on foreign source However, the implicit assumption of the capital income is to abstain entirely from OECD model is wrong. The world supply of taxation of domestic source capital capital is not fixed and depends on the net income as well. rate of return. If all governments increase the Even in a closed economy, it may be tax burden on capital income, world capital efficient to exempt capital income from tax accumulation slows down and economic in the long run (Chamley 1986; Correia 1996).

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The intuition behind these conclusions (land) revenue base—a virtuous economic is not difficult to understand, even though cycle. There is nothing to stop developed the policy implications are dramatic. countries such as the United Kingdom, the One would not tax non-residents on their United States or Australia pursuing similar capital income because that drives up the cost policies if they wish. Rather than of capital to the local economy—non- complaining about ‘harmful tax competition’ residents can take their mobile capital and they would do better to emulate Hong Kong. invest it elsewhere. By driving away mobile For example, the United States economic capital, the tax becomes an inefficient tax on revival owes much to President Reagan’s tax immobile factors of production, such as cuts and it is notable that the United States is immobile labour or land (Kopits 1992:5, 15; somewhat more comfortable than the Head 1997:86). One should not tax the capital European Union with economic competition income of non-residents just as one does not (and internally has long lived with State tax outlaw foreign investment. One wants competition). foreign capital to increase the productivity Indeed, this leads to the logical point that and wages of the local population. international tax competition, by forcing Just as capital can flow across borders, governments to reduce tax rates on mobile so capital can evaporate over time. Hence, in capital income or mobile labour, is directing the long run, the optimal tax rule is not to tax governments’ attention to the desirability of capital income at all. Taxing the return on shifting the tax base towards immobile capital lowers the capital intensity of the factors (which includes full licence fees for economy and reduces the productivity and natural monopolies such as the broadcast wages of labour. This is one of the major spectrum). Economic theory declares that the arguments for shifting from an income to a most desirable tax base is a tax on base (although that can be unimproved land values because it cannot done just as—or more—easily by exempting be shifted and has no distorting effects on capital income from tax). investment in physical capital or labour The third principle states that if capital supply. The beauty of such territorial-based income is to be taxed without distorting the taxation is that it also solves the allocation of investment then, other things issue—international being equal, it is desirable to tax income from becomes a non-issue and the OECD tax domestic and foreign investments equally. treaty network becomes unnecessary. But if one cannot tax foreign income As countries have reduced their equally—and even with the most company tax and top marginal personal sophisticated legislation that is likely—then income tax rates, they have turned to value one should cut the rate of tax on domestic added taxes, user charges, expenditure capital income. copayments, social security levies and mandated social insurance because there is less incentive or ability for such tax bases to Territorial revenues from land rents leave the jurisdiction. Thanks to tax competition, tax policies are de jure shifting Hong Kong has made a policy of raising taxes from capital towards labour income, much of its public revenue from land rents, from the more mobile towards the less mobile which has enabled it to keep its tax rates on factor. This could be to labour’s advantage capital and labour comparatively low. That as de facto shifting is eliminated and jobs and policy attracts capital investment which in wages are nourished by increased turn pushes up land rents and enhances the investment.

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But the process can—and should—go example, New Zealand has not taken the further than simply shifting taxes from view that insider trading should be a criminal capital to labour.34 As Kopits (1992:5) notes, matter but treated as a civil law matter a country can use its resource rents to between a company, its employees and respond successfully to tax competition for others having a fiduciary . mobile capital. Although there does not seem The reality is that, while comparative to have been an international trend to shift advantage is a basic source of gains from taxes from capital income to land (as opposed international trade and commerce, to labour, which raises its own problems), may be largely man- some observers have noted that Hong Kong made. It may depend substantially on how and Singapore have been able to compete on countries tax and spend (for example, their company tax rates because they have whether they spend on infrastructure or age placed heavier reliance on taxing land.35 pensions) and how they regulate or tax Professor , former Chairman mobile business. Countries which are of the US Council of Economic Advisers, resource-rich are sometimes poor because of acknowledges a tax on unimproved land oppressive government and oppressive values ‘involves no distortion’ and is clearly taxation while countries which have little by efficient (Feldstein 1976:96). way of natural resources (for example, So, economic freedom and international Switzerland, Singapore and Hong Kong) tax competition are world welfare enhancing. have sometimes become rich by pursuing Far from hurting the OECD, it is nudging policies of good government and lower OECD countries towards optimal tax policies business taxation. A perfect identity of which are in the best interests of their regulatory systems in search of a level citizens. playing field can destroy the gains from trade and deny the world the beneficial Who says what is a ‘level playing demonstration effects of genuine field’? economies. The offshore financial centres could do worse than remind Europeans and Another key theoretical defect of the OECD Americans that European civilization rose report lies in its concept of the ‘level playing to greatness not from the slavish Imperial field’. It appears to be assumed that the uniformity of the later Roman Empire but optimal approach to maximising world from the competition between the nation economic growth consists of identical tax and states which succeeded it.37 It was the ability regulatory systems. But why should this be to cross a frontier or cross the Atlantic and so?36 The absurdity of the proposition is escape from tyranny which protected the immediately obvious if it were suggested to vitality of Western culture and enterprise. OECD countries that they should now The Anglo-American tradition is one of harmonise on a Soviet style command liberty rather than uniformity. economy system. If the countries of the world The offshore financial centres might also cannot all agree on the first-best taxation point out that federations such as the United system of taxing land rents, is that any States and Australia have lived with tax reason why some countries should not do so competition for decades without and become tax havens for the avoidance of disintegration. A New Hampshire or a other countries’ less efficient taxes? It might Queensland has not only served its own also be pointed out that OECD countries often interests by following a low tax policy but cannot agree themselves on what the also, by putting pressure on the tax policies regulatory level playing field shall be. For of neighbouring states, has helped to keep

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economic activity within the federation as a of tax competition lies in the hands of OECD whole. countries themselves. No offshore financial In the international sphere, the United centre is preventing any OECD country from States and the United Kingdom have long privatising or implementing ‘user pays’ for engaged in tax competition. The United States social insurance. No offshore centre is is an offshore banking tax haven38 while the forcing any OECD country to have a bloated United Kingdom rules granting the or impose high taxes on labour remittance system to non-domiciled residents and capital. No offshore financial centre is has meant that London has been a tax haven preventing any OECD country from taxing for many wealthy expatriates.38 immobile land and resource rents which are Without a refund system for embedded immune to tax competition. State indirect taxes on and with a Vanuatu and other offshore financial system of taxing worldwide income, the US centres have no reason to cut their own stands to disadvantage itself uniquely by incomes by winding back their services. As continuing to endorse the OECD attack on parts of ’s ‘’ they ‘harmful’ tax competition. Having felt the serve not only their own, but the world’s sting of international tax conformity in the interests, by facilitating the freedom of trade form of the adverse World Trade and investment and the protection of Organization ruling on its foreign sales property. Those who seek to eliminate corporations, the US would do well to offshore financial centres might do damage reconsider its support for the OECD and EU to their own countries were they to succeed. attacks on tax competition. The US Congress No doubt, offshore financial centres is starting to ask itself the right questions by should cooperate as good international examining a bill to implement a territorial citizens in combating common criminality. system for taxing business income.40 But they should politely decline any suggestions to harmonise taxes or to assist OECD tax enforcement directly or indirectly Conclusion through any exchange of information. Perhaps some offshore financial centres may Because mistaken and unexamined OECD be coerced or bribed by the OECD to join its nostrums on tax competition are affecting tax cartel, but, as with all cartels, the fewer world economic policies by appealing to the there are outside the cartel the greater the prejudices of EU and other politicians, profits to be had by them. Notwithstanding offshore financial centres should undertake the current clouds over offshore financial their own research to examine the ‘harmful’ centres, it is hard to see anything but tax competition issue so that the implicit increased demand for their services so long errors of OECD policy reasoning can be as there is scorn elsewhere for ‘the obvious debated openly and flushed out. They need and simple system of natural liberty’ which to enter the global economic policy debate. commended itself to the Physiocrats and Ideas matter! Adam Smith (1776:687). The governments and citizens of offshore financial centres are entitled to resent Notes strongly a situation in which they are being pressured (or pilloried) by the OECD on the 1 These have included the United Nations basis of wholly incomplete economic report on Financial Havens, Secrecy and Money theorising. They need to point out to the Laundering, the EU Code of Conduct on OECD that the remedy for the alleged ‘harm’ business taxation and the G7 initiatives

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including the Financial Action Task Force fellow at the Heritage Foundation, a (FATF). Money laundering legislation has Washington-based public policy research moved well past drug trafficking to all kinds institute has written in the Washington Times of ‘economic crime’ such as tax avoidance or (3 January 2000) that the United States could evasion as well as securities law evasion or best respond to the WTO by repealing the avoidance. US tax code’s onerous foreign income 2 See the Parliamentary speeches of William provisions and instead shifting to a territorial Pitt, 1st Earl of Chatham, 14 January 1766 tax system which would only tax income and 20 January 1775. earned inside its borders, making US 3 The metaphysical subtleties in distinguishing companies more internationally competitive. between ‘purpose’ and ‘effect’ is well 6 The threat is clear in Robin Cook’s statement understood by lawyers dealing with general of 17 March 1999 to Parliament introducing anti-avoidance statutes. the UK White Paper Partnership for Progress. 4 Curiously, Treasury officials have often He said ‘we have to insist on the governments downplayed the influence of taxation on of the Overseas Territories fulfilling their [sic] investment decisions when arguing against obligations to meet the standards of the need for industrial countries to cut tax international organisations in which the rates in order to compete on tax. Yet that has United Kingdom represents them. There are not stopped them from arguing that tax two issues which are of priority in meeting competition is a major concern (see Griffiths those obligations. The first is to match the 1994). One might have thought that the two best international standards in financial propositions were mutually inconsistent. The regulation…We will therefore be requiring reality, and the commonsense, of the matter all Overseas Territories, by the end of this appears to be that taxation is a major, but not year, to meet in full international standards the only, influence on investment location on money laundering, transparency, decisions. It is generally agreed that taxation cooperation with law enforcement authorities, does affect business location (Papke 1987, and independent financial regulation. The 1991; Devereux 1992; Industry Commission globalisation of international finance means 1996). Tax may not be the most important that we cannot tolerate a weak link anywhere determinant—factories are not built on in the chain without exposing investors remote tax-free islands with no infrastructure everywhere to risk. The second area of and no workers—but tax will always be an priority is in human rights…Specifically, we important influence. As David Williams require changes in the law in a minority of writes: ‘Tax systems used once almost to be Overseas Territories which retain corporal solely decided by a nation. Now even the punishment and criminalise consensual biggest economies have tax systems which homosexual acts in private. Our strong are part of the same world economy, and preference is that the Overseas Territories they are in competition together (1991:34).’ should enact the necessary reforms There is increasing competition for themselves, but we are ready to make such international investment and, with improved reforms by Order in Council if they fail to do real time communications and lower tariffs, so.’ It seems the EU view is that there is a an increasing ability to move operations human right to privacy in sexual, but not offshore. financial, affairs. It is also interesting that in 5 The World Trade Organization has ruled that the Foreword to the White Paper, Mr Cook a US policy of granting special tax preferences states ‘It will ensure that we put up a common to companies that (foreign sales front against fraudsters, tax evaders, money corporations or FSCs) is a violation of WTO launderers, regulatory abuse and the drugs rules. The United States has until 1 October trade. ’The order of listing seems to confirm 2000 to either change its tax laws or face more cynical views that, while drug trafficking retaliatory sanctions that could reach US$6 has been a convenient excuse to elicit billion annually. Daniel J. Mitchell, a senior overseas cooperation, the emerging OECD

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agenda is more tax-driven. Cynics will also ‘anti-social’ world citizen than another with note: ‘In a recent communiqué, the G7 urged corruption, bloated spending and high taxes. the OECD to give particular attention to the 12 From an individual nation’s viewpoint, it is development of a comprehensive program clearly welfare-improving to have something to improve the availability of information to rather than nothing. Even Australia exempts tax authorities to curb international tax bank interest derived through offshore evasion and avoidance through tax havens banking units by non-residents and is, to that and preferential regimes. It also encouraged extent, a tax haven, though the policy action to ensure that suspicious transaction amounts to little more than not taxing foreign reporting requirements apply to tax offences source income of non-residents. What the and for money laundering authorities to pass critics of tax competition have to prove is information to tax authorities in support of that such actions are collectively welfare- the investigation of tax related crimes in ways reducing and that all nations could do better which would allow it to be shared by not competing. internationally’ (UK 1999:para 5.26). 13 Critics of tax competition may argue another, 7 This certainly seems true of many Americans apparently, closer analogy: that tax who suffer from a system of elected judges competition is like competitive exchange rate and tort juries plus a lot of lawyers searching devaluation. But tax rates distort the market for ‘deep pocket’ defendants. equilibrium in the real economy and the 8 Contrary to David Ricardo’s expectations, reduction of tax wedges between pre and many British subjects have moved assets to post tax rates of return on mobile capital offshore havens to escape new laws (whether reduces, rather than increases, distortions. arising from law reform or judicial activism) 14 Even from a narrow nation-state point of and enjoy old and familiar laws in present view, tax havens can be beneficial to a large and former British possessions. power. For example, Hines and Rice (1994) 9 I am not alone in this view. Sinn (1993:43–44, point out that tax havens help US 70) also argues that tax competition is multinationals move profits back into US beneficial for the citizens of the ‘losing’ high jurisdiction and the United States collects tax country. It forces Leviathan governments more tax in the end (at the expense of the to put their houses in order by cutting source countries). wasteful spending and shifting taxes from 15 Those who stripped companies with inchoate mobile to immobile factors of production. tax liabilities of their assets in the 1970s and Breton (1996) explores how the collusive sank documents into ‘the bottom of the suppression of intergovernmental or political harbour’ were the most extreme example competition tends to make citizens worse off Australia has seen of large-scale tax evasion. without making anyone better off, except the 16 The late Professor Wheatcroft, an expert on colluding politicians and bureaucrats. the UK , is said to have 10 One can think of a sovereign competing for remarked that: ‘A tax system breathes subjects and investment like any other through its loopholes’. That remark economic agent maximising wealth, or of a recognizes that all taxes on labour and capital democratic government maximising the are distorting and, if they can ameliorate the wealth of its people. In either case, what is to economic distortions created by taxation, be maximised is the country’s welfare not taxpayers may be contributing to a more some abstract concept of world welfare. If productive economy, for example, taxpayer economists believe free competition self-help before imputation ameliorated the maximises group welfare among self- defects of Australian double taxation of interested individuals, one might expect a income (Head 1997: 65). similar result in similar competitive processes. 17 Note that this is only looking at some 11 For example, it would be strange if a well- economic benefits from citizens’ tax reduction run country with no corruption, low activities. The economic benefits to a country spending and low taxes were seen as a more from a citizen’s ‘tax reduction fund’ may

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depend more on such factors as whether it is modern taxation systems is their tendency onshore and invested domestically to corrupt basic legal principles. The British (Australian superannuation funds in the legal tradition held that all tax legislation is of 1960s) or offshore and invested in another its nature penal legislation which takes away economy (Latin American flight capital in common law rights. Since taxes were New York banks in the 1950s lent to US voluntary grants by Parliament to the Crown companies) than on whether the ‘tax which derogated from common law rights, reduction’ was obtained through legal tax taxing statutes had to receive a strict avoidance or illegal evasion. That does not construction. Increasingly, OECD countries mean the distinction between legal or illegal have tended to rely upon statutory or judicial activity is irrelevant, since increasing evasion anti-avoidance doctrines which overturn the may have a contaminating effect on public principle that the subject is not to be deprived morals and respect for the rule of law, without of his property except by clear words (see which no economic activity is possible. Cooper 1997). The rule against self- 18 Bracewell-Milnes neatly controverts several incrimination is routinely ousted in tax conventional wisdoms, including the legal administration. Retrospective tax liabilities are versus economic tax avoidance issue. After often created and the onus of proof all, which is worse—the oft-deplored legal increasingly reversed not only in civil tax ‘paper’ avoidance which means a factory still collection but also in criminal prosecutions for operates, employing workers and tax fraud. Lawyer-client privilege is attacked generating PAYE and so on, or economic tax and assets are seized without due process of avoidance—closing down the factory and law under a presumption of guilt. Even tax relocating in China? Why is the former administrators themselves have sometimes denounced so strongly and the latter anguished over the legal problems created recognised as a legitimate business decision? by criminalising what was in the past a civil And if both forms of avoidance are default (see Howard 1982). More recently, denounced with equal force, when will China, the US House Judiciary Committee and Hong Kong, Singapore and dozens of other others have expressed concern over the countries be seen as anti-social economic abuse of forfeiture laws and asset freezing threats to prosperity? or confiscation ahead of conviction. The mere 19 As equally illogical as to say that tax fact that OECD countries have increasingly competition which poaches a tax base but abandoned basic legal principles and vital not physical investment is ‘harmful’ yet tax distinctions between legal and illegal or civil competition which snares both is acceptable. versus criminal acts is no reason why offshore 20 If a government wants to see income redistri- financial centres should follow suit by buted, a global graduated income tax is not allowing tax matters to come under treaties necessary. A government can distribute the dealing with mutual assistance in criminal proceeds of resource revenues and can allow matters. On the contrary, this is a reason for tax deductions for income transferred to low stronger adherence to the traditional income relatives or to charity. Hong Kong circumspection on enforcing foreign revenue has used low flat-rate taxes and land revenues laws (a circumspection which can also apply to provide large subsidies to public housing. in federations—State death duties could not 21 The EU has tried to counter tax competition be enforced against executors in other States by prescribing minimum levels of corporate in Australia). Offshore financial centres and or value-added tax. Minimum withholding their citizens are simply not subject to the tax tax rates are under consideration. This is the laws of the OECD countries, just as Americans action of a tax cartel and the OECD is clearly are no longer subject to UK revenue laws heading in the same direction. nor under any legal or moral obligation to 22 The distinction between lawful tax avoidance assist the UK Treasury. and illegal tax evasion is basic to the rule of 23 This is particularly obvious in the United law. One of the most depressing features of Nations Political Declaration and Action Plan

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against Money Laundering adopted at the legal which used to be proscribed (adultery) Twentieth Special Session of the United and vice versa. The real reason for obeying Nations General Assembly devoted to positive law is often more a sense of moral ‘countering the world drug problem self-respect, see Adam Smith’s Theory of Moral together’ New York, 10 June 1998. Drugs are Sentiments. the ostensible focus of concern but the 27 A question not asked by Jeffery (1999). proposals on money laundering go much 28 The post-War ‘brain drain’ to the United further. Offshore financial centres may rightly States from the United Kingdom cost the insist that any financial regulation or United Kingdom dearly. reporting they choose to implement be 29 That economic rent can even be increased by limited to international drug trafficking taxation if the proceeds are spent on useful matters. public works or to remove taxes on labour 24 Some (perhaps many) would argue that or capital which will move in to use the land. privacy, including bank secrecy or See Mieskowski and Zodrow (1989) on this confidentiality of personal or business affairs, ‘’ theorem, of which Hong should given way to the need to investigate Kong has afforded some demonstration (see criminal activity. Rabushka 1979:62). 25 Australia pioneered instantaneous electronic 30 Australia and New Zealand pioneered taxes reporting of financial transactions as part of on unimproved land values. New South law enforcement and made this facility Wales shifted to unimproved land rating in available not just to police combating the 1906 and gradually overtook Victoria (which drug trade but also to taxation officials. did not) in population and wealth. The Several hundred public servants now have Australian Capital Territory was established online access to the financial data of on a leasehold tenure basis so that it would Australian residents. One suspects that be self-financing without taxes. But both allegations of Internet crime are going to be countries have forgotten their history and used (conveniently) to facilitate a further their land taxes have been wound back in enhancement of bureaucratic powers in favour of higher income and consumption many countries. taxes. In the ACT, leases have been renewed 26 The attitude of most people may be close to for trivial payments and taxes put up instead. Will Rogers’ remark that the income tax has Australians never ask themselves why, with made more liars out of the American people a resource endowment per capita among the than golf. There is a certain inconsistency highest in the world, they cannot successfully sometimes observed in the attitudes of compete internationally on business taxes by ordinary people. Small scale tax evasion shifting to land and resource taxes. through false declarations by ordinary 31 The view that all income should be taxed at people is commonly condoned while legal, graduated rates regardless of its source is a but large scale, tax avoidance is commonly common, if not the prevailing, view among condemned. The inconsistency of moral economists. Despite its popularity, it is judgment seems only explicable by the fact essentially an ethical, not an economic, view that most people consider taxation itself as and only one of several possible ethical often arbitrary, unjust and immoral. As views. At bottom it rests on utilitarian Coffield (1970) points out, the growth of concepts, whether expressed through social taxation tends to corrupt public morals, welfare functions, including Rawlsian inflame envy and bring the law into maximin functions or through older ideas of disrepute. Nor does it seem to make much diminishing marginal sacrifice. As an ethical difference whether the tax laws are enacted view, countries and individuals are free to by a monarchy or a democracy. No one who reject it in favour of what they might consider has taken notes of Cabinet deliberations more compelling ethical views. For example, would pretend that laws always reflect many offshore financial centres rely on wisdom or justice. There are actions now import duties and tourist luxury taxes as a

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mix of a basic flat rate tax on inhabitants plus 34 The OECD complaint that tax competition a windfall from foreigners. But other ethical forces a shift in tax burden from (mobile) views are possible. One could, for example, capital to (immobile) labour not only ignores take a natural rights view of revenue raising the possibility of taxing land or other natural as did the French Physiocrats: one could argue resources but it also sounds rather odd that the sovereign should collect the rent of coming from European countries which have land as a method of discharging the Lockean willingly raised social security payroll taxes proviso that land can only be appropriated and value-added taxes to extremely high by one man against another so long as the levels. other is compensated. Thus a Henry George 35 Australian Financial Review editorial 30 June or even a John Stuart Mill might argue that 1997. he has no objection to media tycoons 36 ‘Arguments for creating a level playing field minimising their tax payments according to are troublesome at best. International trade law but he would rather condemn any occurs precisely because of differences politician who chooses to endow any person among nations—in resource endowments, with valuable common property such as labour skills and consumer tastes. Nations spectrum rights without charging full market specialize in producing goods and services in rental annually. A fair price, not a tax, would which they are relatively most efficient. In a be the cry of such a natural rights theorist, fundamental sense, cross border trade is and he would have the support of ancient valuable because the playing field is not Parliamentary tradition. But one does not level…Taken to its logical extreme, the notion have to agree with this ethical view, to realize of leveling the playing field implies that that a Brunei or a Saudi Arabia is quite within nations should become homogeneous in all its sovereign rights in raising revenue solely major respects…[but the] core of the idea of from selling or leasing its natural resources political sovereignty is to permit national (after all, Adam Smith started his discussion residents to order their lives and property in of the sovereign’s revenues with land). A accord with their own preferences. ‘ Tanzi policy of looking first to resources for (1995, preface pxvii) revenue also happens to allow reduction of 37 Douglass North (1995:32) also argues that economic distortions since one can reduce European development profited from labour and capital taxation: Hong Kong’s low institutional competition between competing tax rates would not have been possible nation states. without its land revenues. But whatever 38 The US exempts interest on bank deposits of ethical view one takes, the OECD cannot non-resident aliens. Indeed, the US has served legitimately complain about countries which as a tax haven for capital from Latin America, take a differentiated or schedular approach see McLure (1989). to income taxation (as have the Scandinavian 39 For its part, Australia acknowledges that it countries). If, for example, Brunei does not cannot necessarily tax foreigners on their collect a personal income tax for itself why capital income and imposes no interest should it be expected to assist other countries withholding tax on widespread foreign enforce their residence-based income taxes borrowings such as Eurobonds. within Brunei’s territory? 40 Although it is treated as axiomatic by many 32 In reality, there is no such thing as an income writers that foreign income should be taxed, tax. As Adam Smith recognised, a tax on it is not clear that this is so. Suppose, for income is three taxes—a tax on the wages of example, another country raises all its tax labour, a tax on the rent of land and a tax on revenue through consumption or payroll the profits of capital. taxes. The idea that a dividend from that 33 By having a zero tax rate on interest income, country represents untaxed income is Hong Kong to a large extent exempts that somewhat naive. Further, unless that foreign part of capital income which represents a country supplies the same level of public riskless rate of return. services to an investor in return for low or

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no taxes, one cannot assume that taxing the Chamley, C., 1986. Optimal taxation of investor at home produces a neutral result. capital income in general equilibrium with For example, a company operating in Liberia infinite lives, Econometrica, 54:607–622. may pay no tax but would be spending Correia, Isabel H., 1996. Should capital considerable amounts of money on income be taxed in the steady state? Journal providing the sort of physical protection of , 60:147–151. which home taxes would provide. There is Coffield, James, 1970. A Popular History of thus both pragmatic and theoretical Taxation: From Ancient to Modern Times, justification for the policy adopted by more Longman, London. than a few Asian, European and Latin American countries of excluding foreign Cooper, Graeme, S., (ed.) 1997. Tax Avoidance income from the tax base. Interestingly, the and the Rule of Law, International Bureau US has spent the most effort over the years of Fiscal Documentation, Amsterdam. trying to tax foreign income, but at the same Costello, Peter, 1999. Budget Strategy and time invented foreign sales corporations to Outlook 1999–2000: Budget Paper No. 1, try to mitigate the adverse effects on Parliament House, Canberra. American exports! The US may get no tax De Jouvenal, Bertrand, 1952. The Ethics of revenue from its foreign tax regime because Redistribution, Cambridge, (reprinted the US credits foreign taxes and allows active Indianapolis, 1990):61–62, Cambridge income of subsidiaries to remain untaxed University Press, Cambridge. (Grubert and Mutti 1995). The use by US Devereux, Michael, 1992. The Impact of companies of low rate havens may even Taxation on International Business: enhance US tax collections (Hines and Rice Evidence From the Ruding Committee 1994). A territorial system of international Surve, EC Tax Review, 2:105–117. taxation of business income has been suggested for the US (Hufbauer 1992:135– Frenkel, Jacob A. and Razin, Assaf, 1996. 136). The tax-writing committee in the House Fiscal Policies and Growth in the World of Representatives is considering a Bill to Economy, (Third edition), MIT Press, replace the corporate income tax (and the Cambridge, Massachusetts. business parts of the personal income tax) Dowell, Stephen, 1965. A History of Taxation with a business that would be and Taxes in England: from the earliest territorial. This may not happen, but the times to the present day, 2nd edition, World Trade Organization decision that the reprinted by A.M. Kelley, New York. US Foreign Sales Corporations were in Dwyer, T.M. and Larkin, J.T., 1997. A Tax breach of WTO rules has created a new US Rebate System for Australian Exports: appreciation for territoriality (though part of Towards a Level Playing Field, the motive for the Bill is border-adjustability Consultants’ Report to the Mortimer for indirect taxes). Review of Business Programmes, June, Department of Industry, Science and References Tourism, Canberra. Dwyer, T.M., 1997. An Internationally Bracewell-Milnes, Barry, 1980. The Economics Competitive Australian Business Tax of International Tax Avoidance: Political Policy, ASX Perspectives, 4th quarter, Power versus Economic Law, Kluwer, October:4–10 Amsterdam. —— and Larkin, J.T., 1995. The Taxation of Breton, Albert, 1996. Competitive Governments: Company and Business Income, An economic theory of politics and public Australian Tax Research Foundation finance, Cambridge University Press. Study, No 25, Sydney.

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Acknowledgements

The author wishes to thank those from private sector, academic and government sectors who have commented on an earlier draft but accepts sole responsibility for errors which readers may draw to his attention.

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