Abstracts

TAX HAVENS AND TAX COMPETITION
June 18 -19, 2007

In June of 2007 the Office of Tax Policy Research co-sponsored a conference with the Asset Management Forum and Econpubblica at Bocconi University entitled “Tax Havens and Tax Competition.”

Thirty of the world’s experts -- academics and policymakers -- in economics, law, and accounting convened on June 18-19 in Milan, Italy to discuss empirical facts, theoretical models and empirical analysis of tax havens, tax competition modeling, the response of corporations and governments to the changing environment, and setting the future research agenda.

Major tax havens have less than 1 percent of the world’s population, but they host 5.7 percent of the foreign employment and 8.4 percent of foreign property, plant, and equipment of American firms. Per capita real GDP in tax haven countries grew at an average annual rate of 3.3 percent between 1982 and 1999, which compares favorably to the world average of 1.4 percent. Whether the economic prosperity of tax haven countries comes at the expense of higher tax countries is unclear. Better-governed countries are much more likely than others to become tax havens. Using a variety of empirical approaches, and controlling for other relevant factors, governance quality has a statistically significant and quantitatively large impact on the probability of a small country being a tax haven. Low tax rates offer much more powerful inducements to foreign investments in well-governed countries than elsewhere, which may explain why poorly governed countries do not generally attempt to become tax havens.

This paper reviews the empirical literature on competition in source-based taxes on corporate income. We identify and discuss conceptual issues in empirically identifying tax competition and in inferring the presence of competition from a correlation with openness of the economy. The empirical literature finds evidence of competition in the statutory tax rates, but this is typically not found when using measures based on tax revenues.

The authors consider optimal tax enforcement policy in the presence of profit shifting towards tax havens. This paper shows that, under separate accounting, tax enforcement levels may be too high due to negative fiscal externalities. In contrast, under formula apportionment, tax enforcement is likely to be too low due to positive externalities of tax enforcement. Our results challenge recent contributions arguing that, under formula apportionment, there is a tendency towards inefficiently high levels of (effective) tax rates.

 

The authors develop a model of tax competition in which tax havens are parasitic on the revenues of other countries. The havens use real resources to help companies camouflage their home-country tax avoidance, and countries use resources in an attempt to limit the transfer of tax revenues to the havens. In this model the full or partial elimination of tax havens would improve welfare in (non-haven) countries, in part because countries would be induced to increase their tax rates, which they have set at inefficiently low levels in an attempt to attract mobile capital. We also demonstrate that the smaller countries choose to become tax havens, and that the abolition of a sufficiently small number of the relatively large havens leaves residents of all countries better off, including residents of the remaining havens.
 

The author presents a simple, partial equilibrium model of the supply of offshore tax havens, when MNCsare capable of sheltering some of their worldwide income. It provides a few contrasting predictions to those in the Slemrod and Wilson model (discussed previously) in which tax sheltering is a production process that uses up scarce resources in the tax haven providing it. Here, MNCs can transfer some of their income costlessly to an offshore tax haven, which charges a fee for this privilege (so there are no real resource costs to tax sheltering activity in this model); however, the tax havens must commit credibly to honor their implicit promise to keep tax rates low. The cost of sheltering income, the number of tax havens, and the extent to which MNCs shelter income there are all determined by this credibility requirement. In this model, although the tax rates in non-haven countries will affect the number of tax havens, they will have little or no effect on the amount of income which MNCs choose to shelter.
 

The authors consider tax competition in a world with mobile and immobile capital. An agreement among countries not to give preferential treatment to mobile capital results in an equilibrium where mobile capital is nevertheless taxed relatively lightly. In particular, one or two of the smallest countries choose relatively low tax rates, thereby attracting mobile capital away from the other countries. In contrast, unrestricted competition for mobile capital results in the preferential treatment of mobile capital by all countries, without cross-country differences in the taxation of mobile capital. The non-preferential regime generates larger global tax revenue, despite the sizable revenue loss from the emergence of low-tax countries. With cross-country differences in productivities, a case for preferential regimes may be made, but only if the productivity differences are sufficiently large.
 

The authors analyze a sequential game between two symmetric countries when firms can invest in a multinational structure that confers tax savings. Governments are able to commit to long-run tax discrimination policies before firms’ decisions are made and before statutory capital tax rates are chosen non-cooperatively. Whether a coordinated reduction in the tax preferences granted to mobile firms is beneficial or harmful for the competing countries depends critically on the elasticity with which the firms’ organizational structure responds to tax discrimination incentives. A model extension with countries of different size shows that small countries are likely to grant more tax preferences than larger ones, along with having lower effective tax rates.
 

This paper empirically investigates the determinants of corporate tax rates and corporate tax revenues, focusing on the influence of increasing economic integration and the case of European Union member and applicant countries. An analysis of 36 OECD and European countries over the period 1979 to 2002 suggests that more integrated countries chose lower corporate tax rates, while larger countries, those with bigger governments, and those with higher individual income tax rates chose higher rates. Corporate tax revenues are found to be parabolically related to tax rates, the more so as economies are more integrated, implying a lower revenue-maximizing tax rate for such countries.
 

Analysis of affiliate-level data for American firms indicates that larger, more international firms, and those with extensive intrafirm trade and high R & D intensities, are the most likely to use tax havens. Tax haven operations facilitate tax avoidance both by permitting firms to allocate taxable income away from high-tax jurisdictions and by reducing the burden of home country taxation of foreign income. The evidence suggests that the primary use of affiliates in larger tax haven countries is to reallocate taxable income, whereas the primary use of affiliates in smaller tax haven countries is to facilitate deferral of U.S. taxation of foreign income. Furthermore, when multinational firms expand their operations in tax havens, on average they do not divert activity from non-havens. Much of the debate on tax competition presumes that the answer to this question is yes. Instead, the evidence suggests that tax haven activity enhances activity in nearby non-havens.
 

Most studies of tax competition neglect the role of corporate tax planning and of home governments that facilitate this planning. In fact, high-tax host governments can permit income to be shifted out to tax havens as a way of attracting mobile companies, and that home country governments may cooperate in this shift if they think the benefit to their companies is greater than any reduction in the domestic tax base. Analysis of U.S. data, including firm-level tax files, from 1992 to 2002 suggests that, in the latter half of this period U.S. policy changes are the most important factor in explaining the reduction in effective tax rates faced by U.S. MNCs. This period is of particular interest because the United States introduced regulations in 1997 that greatly simplified the use of more aggressive tax planning techniques.