Malo periculosam, libertatem quam quietam servitutem.



January 2012



The Future of Offshore Financial Services

Written by , Posted in Taxes
Coauthor(s): Dan Mitchell
Originally published in Business BVI

A dramatic transformation has swept the globe over the last three decades. Despite the best efforts of politicians to follow their worst intentions, worldwide tax rates have dropped and fiscal policy has grown considerably more pro-growth. Responsible for this remarkable phenomenon is a process known as tax competition, whereby nations compete to attract labor and capital.

The Benefits of Tax Competition

The importance of good tax policy on prosperity and living standards is increasingly clear. Low marginal rates reward productive behavior, encouraging people to work more, save more, and invest more. Taxes on capital – such as taxes on capital gains, dividends, interest and inheritances – are particularly destructive because they inhibit a process – capital formation – that all economic theories agree is necessary for economic growth.

Economic growth is truly the key to human prosperity. Even slight differences in growth rates can have a significant impact over time thanks to compounding. A seven percent growth rate can double economic output every 10 years, but a one percent growth rate can only do so every 70 years. Even smaller differences can be profound. Even a modest three percent growth rate can double economic output in less than 24 years, or every generation or so.

Unfortunately, politicians don’t necessarily care about promoting growth. They care about raising tax revenues, which can then be spent in the quest to acquire votes and enhance the power of the political class. Tax competition is the mechanism by which the interests of politicians are forced – at least to some degree – into alignment with those of taxpayers and the economy. As a result, despite the fact that the political system encourages bad policy, tax law has moved in the right direction. Beginning with the Reagan and Thatcher cuts of the 1980s, the number of flat tax nations has increased from 3 to 30, corporate tax rates have dropped by more than 20 percentage points, top income rates have dropped 26 percentage points, and the destructive practice of double taxing dividends and capital gains has been reduced.

The Political Class Reacts

The bad news is that politicians have figured out that tax competition is a threat to excessive taxing and spending. In response, politicians have drawn on a theory known as capital export neutrality (CEN), and sought to create a global tax cartel – essentially an “OPEC for politicians”. The CEN theory is based on the notion that all differences in tax rates should be eliminated, leaving taxpayers no ability to protect themselves by shifting economic activity to jurisdictions with better tax law. Tax and spend politicians love CEN because when there are no jurisdictions with better tax law, they cannot be punished for their bad policies.

The campaign against low-tax jurisdictions began in the mid-1990s, entering the public realm with the release of a 1998 OECD report entitled, “Harmful Tax Competition: An Emerging Global Issue.” The Organization for Economic Cooperation and Development (OECD) had by that time become the preferred vehicle for anti-tax competition campaigners to advance their scheme.

Their adherence to CEN theory has been notably revealed on several occasions. One such instance occurred at the Mexico City meeting of the Global Forum on Transparency and Exchange of Information for Tax Purposes, where the OECD attempted a power grab by unilaterally asserting that it had the ability to impose rules to restrict tax avoidance and other forms of legal tax planning. To the uninitiated this sounds absurd, but it comes straight from the CEN theory. According to this ideological view, tax avoidance is just as bad as tax evasion.

What was particularly noteworthy in Mexico City was how they attempted to spring the effort unannounced on attendees. During the first day of the two-day conference, there was no mention of any campaign against tax avoidance and legal tax planning. The OECD even circulated a draft “summary of outcomes” after the dinner that evening, and the document began, “The main objectives of the meeting are…” Yet by the next morning, the version that was used as the working document included a dramatic change.

Delegates from low-tax jurisdictions were shocked the next day to see a significant new clause, and the summary now read, “In the context of the broader effort to fight tax evasion and avoidance and to remove harmful tax practices that facilitate such activities, the main objectives of the meeting are…” Many of the low-tax jurisdictions understandably objected to the underhanded addition.

Despite the efforts of high-tax jurisdictions to stall or move on to other topics, opponents kept up the fight long enough to force removal of the new language. Most remarkable, the nation that was instrumental in stopping the OECD was China. As hard as it is to believe, a nation governed by a nominal communist party played a key role in blocking a statist tax scheme pushed by supposedly capitalist nations.

While this particular power grab failed, the OECD’s anti-tax competition campaign has had successes over the years. Low-tax jurisdictions have been pressured, harangued and cajoled into abandoning financial privacy protections, and into signing one-sided information sharing agreements designed to conscript low-tax jurisdictions as deputy tax collectors for high-tax welfare states.

With each concession, low-tax jurisdictions have hoped that they may have finally satisfied the OECD. But feeding a tiger a bunch of steaks won’t turn it into a vegetarian. Every concession has simply become the new starting point, as the bureaucrats at the Paris-based OECD concoct new hoops for low-tax jurisdictions to jump through.

Dark Clouds on the Horizon

Despite their successes to date, the real danger from the international tax bureaucrats likely lies ahead.

The ultimate goal of CEN remains complete tax harmonization. One back door method of achieving this goal is worldwide taxation. Under worldwide taxation, an individual or company is taxed by its home nation on all income regardless of where it is earned. The U.S. is currently one of the few nations with a comprehensive worldwide tax system applying to capital income, corporate income, and labor income. Should it be utilized by other nations, the impact of a worldwide tax system would be exactly what CEN adherents want – no ability to benefit from better policy in other jurisdictions.

Another deeply troubling development comes from a TIEA-on-steroids unveiled by the OECD at the 2011 Global Forum in Bermuda. The Multilateral Convention of Administrative Assistance in Tax Matters presented at the meeting isn’t actually new, but was radically altered in 2010 and recently unveiled again. The Convention would obligate signatories to become deputy tax collectors for every other nation that joins. Even worse, it puts the OECD in charge of the “co-ordinating body,” granting it enormous powers to interpret the agreement and resolve disputes. They are essentially granting themselves the ability to serve as judge, jury and executioner.

Under the guidance of OECD bureaucrats, the scheme would result in the creation of something akin to a World Tax Organization. As a new potential blow to tax competition, the Multilateral Convention would likely lead to higher tax burdens. It would also increase the risk to human rights by undermining the financial privacy laws that protect individuals living under repressive regimes or in countries with high levels of crime and corruption. Already, the thuggish dictatorship of Azerbaijan has signed up, as well as the unstable nation of Moldova and the corrupt government of Mexico. And just like the Mexico City Surprise, the Multilateral Convention contains another attempt at “combating tax avoidance.” This shouldn’t come as much surprise given the tenets of CEN theory.

Currently it’s only possible to speculate on how the Multilateral convention will evolve, but there are three reasons to be concerned. First, the high-tax nations that control the OECD want an aggressive, multilateral approach, and the Convention creates a tool that presumably can be used to bully low-tax jurisdictions into acting as deputy tax collectors. Second, the OECD is doubtlessly excited by the Convention since it expands the power and budget of the Paris-based bureaucracy.

As noted above, the OECD will staff this new entity, giving the bureaucracy new authority and prestige. Finally, it satisfies the long held desire by ideological advocates of bigger government for some sort of international tax organizations, which the left-wing law professors and statist NGOs doubtlessly will use the Convention as a starting point for even further demands.

The one unknown in the process is the degree to which other nations will sign on to the pact. The Convention currently has two dozen signatories, mostly OECD countries. No “tax haven” is on the list. But given the OECD’s pressure for TIEAs, the Convention may be a tempting option. For all intents and purposes, signing the Convention could be seen as a one-stop way of dealing with demands and getting on the OECD’s so-called white list of compliant jurisdictions. But as history has demonstrated, this is a foolish notion.