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Joel Slemrod
  Joel Slemrod

Elimination of Tax Havens Leaves Countries Better Off

7/14/2006 --

Research shows that tax havens may lead to a waste of resources.

ANN ARBOR, Mich.—Tax havens may lead to the wasteful expenditure of resources, both by tax-dodging firms and by governments bent on enforcing tax codes, according to a study from the University of Michigan's Ross School of Business.

It also suggests that tax havens may worsen tax-competition problems by causing countries to reduce their tax rates below efficient levels.

"Countries are, and should be, concerned about the detrimental effects of tax havens on their citizens' welfare," said Joel Slemrod, the Paul W. McCracken Collegiate Professor of Business Economics and Public Policy at the Ross School.

Slemrod and colleague John Wilson of Michigan State University found that either full or partial elimination of tax havens raises public-goods levels and improves welfare in non-haven countries. They say that initiatives to limit some, but not all, havens can leave all countries better off, including the remaining havens.

According to the researchers, recent policy actions by countries in the Organisation for Economic Co-operation and Development reflect concern over the erosion of home-country tax bases through the actions of tax-haven countries, which enable multinational firms to conceal taxable business income by shifting it to overseas jurisdictions where they pay no tax.

Slemrod and Wilson developed a stylized mathematical tax-competition model in which tax havens are "parasitic" on the revenues of other countries. These jurisdictions use real resources to help companies camouflage their home-country tax avoidance, and non-haven countries use resources to limit the transfer of tax revenues. The equilibrium price for this protection service depends on demand, which in turn depends on the tax system in use and the technology available to the parasitic havens.

The study shows that reducing or eliminating tax havens enables each country's residents to benefit directly from the productive use of resources that were previously employed for income shifting and tax-enforcement activities. Additionally, the marginal cost of providing public goods declines, inducing countries to increase their public-good levels, thus improving welfare.

"A sufficiently small reduction in the number of havens may make residents of all countries better off and nobody worse off, provided the large havens are eliminated first," Slemrod said. "The largest haven does not materially benefit from haven activities, so it will be better off when these activities are eliminated and it takes advantage of the welfare gain associated with the higher price for protection services charged by the remaining havens. These remaining havens also benefit from this higher price. Thus, everyone may be better off."

For more information, contact:
Bernie DeGroat
Phone: (734) 936-1015 or 647-1847