Tax havens, often referred to as “offshore financial centers” or “international financial centers,” offer companies and individuals low to no tax rates and often, as importantly, anonymity. Such centers have come under increasing scrutiny — particularly since OECD’s 1998 Harmful Tax Competition initiative — as the international community evaluates their potential negative effects on domestic taxation globally and the loss of legitimate public revenues. In the United States, reining in tax havens is a simmering political issue; a Senate subcommittee estimated in 2008 that the U.S. loses some $100 billion a year because of their use.

Such criticisms of tax havens are well known and find corroboration in some academic research. A 2009 study from Michigan State and the University of Michigan published in the Journal of Public Economics, “Tax Competition with Parasitic Tax Havens,” creates statistical models that demonstrate the challenges for many countries in this area. The authors state that “the elimination of havens makes all non-haven countries better off,” though they allow that their “analysis points to the potential difficulties involved in eliminating large numbers of havens, including small ones.”

A 2013 report from the U.S. Congressional Research Service, “Tax Havens: International Tax Avoidance and Evasion” (PDF), notes that “multinational firms can artificially shift profits from high-tax to low-tax jurisdictions using a variety of techniques, such as shifting debt to high-tax jurisdictions…. On average very little tax is paid on the foreign source income of U.S. firms. Ample evidence of a significant amount of profit shifting exists, but the revenue cost estimates vary from about $10 billion to $60 billion per year.” Further, “Individuals can evade taxes on passive income, such as interest, dividends, and capital gains, by not reporting income earned abroad. In addition, since interest paid to foreign recipients is not taxed, individuals can also evade taxes on U.S. source income by setting up shell corporations and trusts in foreign haven countries to channel funds…. Estimates of the cost of individual evasion have ranged from $40 billion to $70 billion.” (Also see the CRS report “An Analysis of Where American Companies Report Profits: Indications of Profit Shifting” (PDF).)

However, a 2010 paper from the University of Michigan published in the Journal of Economic Perspectives, “Treasure Islands,” examines the relevant scholarly literature on the topic with a view toward less well-known aspects of tax havens that may be positive in terms of market efficiency and growth.

Key points in the paper include:

• Combined, the 52 tax havens in 2004 had 0.84% of the non-U.S. world population and 2.3% of non-U.S. world GDP.
• American multinationals hold 6% of their property in tax havens, but locate 27% of their foreign assets there. Additionally 42% of their foreign income is earned in tax havens. This is primarily because American firms use tax havens as conduits for their investments into foreign firms.
• Contrary to popular belief, some recent studies show that increased foreign investment drives increased domestic production as well. A previous study estimates that for every additional 10% of foreign investment a firm makes, it increases domestic production by 2.6% concurrently.
• Because tax havens eschew domestic taxes and stamp duty, they are excellent environments for pass-through transactions (investment from a firm in one country to a firm in another).
• Though havens are believed to create competition among governments, “a more likely possibility is that the tax avoidance opportunities presented by tax havens allow other countries to maintain high capital tax rates without suffering dramatic reductions in foreign direct investment.”

The author concludes that “few countries can lay claim to having perfectly designed taxes or regulations, so the relevant question is the effect of tax havens in the world in which we live. The evidence indicates that tax havens contribute to financial market competition, encourage investment in high-tax countries, and may ultimately, in their little island ways, promote economic growth elsewhere in the world.”

A 2013 report in The Economist, “Onshore Financial Centres: Not a Palm Tree in Sight,” examines the variation in this area and seeks to debunk some conventional wisdom about tax havens.

Tags: crime

By John Wihbey | May 23, 2013