In defence of tax havens

Taxing secret Swiss bank accounts held by British citizens is an easy win, and a helpful contribution to reducing the budget deficit, right?

Well, perhaps. But I find it hard to muster much enthusiasm for the agreement announced by the Treasury today. In reality, this is just one part of a concerted and ongoing effort by big, high-tax governments around the world to clamp down on international tax competition – a process by which other governments use low effective tax rates to attract capital and business activity to their country.

Put simply, the fiscal incontinents of the Western World – with the help of the EU and the OECD – are doing their best to form a politicians’ cartel, and rig tax rates internationally.

This is problematic because tax competition is a very good thing. Firstly, the existence of low tax jurisdictions gives people and companies an exit option – sometimes legal, sometimes not – through which they can escape from unfair and punitive rates of taxation. High-tax governments know this: they realize that if they raise taxes too much, wealth creators will just take their money elsewhere. The result is that those high-tax governments do not raise taxes as much as they otherwise would.

This is welcome in terms of its results – lower taxes boost economic growth – and as a matter of principle – lowers taxes mean more money left in the hands of those who have earned it, and less being forcibly confiscated by the state. To put it another way, given the inescapable tendency of government to grow ever larger and more intrusive, tax competition provides that all-too-rare thing: a check on the state’s rapacious ambitions.

Secondly, the existence of low tax jurisdictions plays an important role in making international capital markets work properly. The fact is that national tax systems do not cope well with international investment. When investors, fund mangers, operating companies, and holding companies are all based in different countries with different tax regimes, the same profits often get taxed several times as they are passed up the chain. The result is that profits get swallowed by governments, and international investment becomes uneconomic. Ultimately, that makes us all poorer.

Low tax jurisdictions help us to overcome this problem: their tax-free vehicles minimize the problems of multiple taxation that can occur with cross-border investment and allow for greater international pooling of capital. This does not mean that tax havens “poach” international capital – very often they merely act as conduits for investment back into industrialized countries. And in the long run, more international investment capital and less tax distortions means greater increases in wealth and faster rises in living standards.

The other point to make about low tax jurisdictions is that we shouldn’t be trying to eliminate them: we should be trying to learn from them. We would be far more prosperous if we stopped punishing saving and investment and started encouraging it instead. In an ideal tax system, we would simply tax all UK income once at its source – be it an individual’s wages or a company’s profits – and then leave well alone. In this time of economic uncertainty, it’s hard to think of a more pro-growth policy than that.

Read on ConservativeHome here.

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25 August 2011

Tom writes on the importance of low tax jurisdictions and why tax competition is a good thing on ConservativeHome.