Harmful Tax Competition

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Harmful tax competition among regions and countries internationally has been of major concern to both governments and organizations. Where countries rely a lot on taxation income to fund social programs, the concept of harmful tax competition emerges from the idea that countries use lowered tax rates as a main means of increasing revenue by the implementation of special tax legislation.

But what is gained in another country through the application of harmful tax practices, results in loss, in one way or the other, for the country whose labor and capital is affected by the low tax jurisdiction. Tax competition is something that is almost inevitable due to the unevenness of tax structures and differences amongst countries in politics, economy and society. It is thus in fact challenging for one country to try to dictate or impose the tax structure of another, except probably in the case where an economic block is being constructed by a group of countries and uniformity is required at various levels for strengthening and making effective the union being formed. Such was the case during the formation of the European Union (EU) when lower tax rates within the region were deemed competitive and identified as harmful tax competition that impeded strides towards the creation of a European Single Market.

One of the major attempts at assuaging harmful tax competition between members of the EU was done by establishing agreements which sought to create uniformity in tax rates. For some countries, this meant lowering their taxes, which in turn for them signified losing vital revenue used for funding and maintaining social welfare and government facilities. However, harmful tax competition as a result of differences in tax rates still existed due to the varying dynamics of European countries. In the 1980s, Britain was considered a major pioneer of tax competition and its corporate tax was lowered from 52% to 35%, while, today, Ireland has taken lead with a 12.5% tax rate which is one of the lowest in Europe. France and Germany, on the other hand, are marked promoters of tax harmonization and share the view that harmful tax competition should be contained.

What is considered international harmful tax competition is a result of expanded capital markets and increased liberalized trade. This occurred as economies became increasingly intertwined, transnational corporations expanded to new borders and many small developing countries saw the need to encourage infrastructural development, invigorate job creation and keep abreast with global advancement both economically, politically and legally so as to mitigate the possible negative impacts of globalization. However, contrary to common belief, this was not achieved solely through harmful tax competition but by the mere existence of factors other than low taxes, such as cheaper skilled labor forces, emerging markets and new business opportunities.

As it relates to the international offshore sector and globalization, a country which has ideal up-to-date telecommunication systems and infrastructure, is socially, economically and politically stable, and has attractive taxes, is able to take a snatch at its fair share of the pie.

Harmful tax competition is said to have been bolstered by tax havens and offshore financial centres which exert a lot of influence on the international marketplace. But besides the preferential tax treatment that was meted out to foreign corporations and individuals by tax havens, the offshore financial services industry introduced an array of offshore banking, offshore funds and offshore company registration services, which very much triggered a new twist in the way in which business is conducted and transactions made. Largely dependent on advancement telecommunications and the internet, offshore services deepened tax competition.

Though viewed as harmful tax competition by OECD countries, lower taxes in the wider world became significant to the residents of OECD member states largely as a result of high taxes and restrictive corporate laws both within the EU and the US. Efforts to set benchmarks for tax bases and structures within the EU thus evolved into an increasing need to achieve international tax harmonization as their economies were no longer within the boundaries of Europe but had long expanded to the most remote of nations. The EU’s attention was diverted from Europe to tax havens which were accused of harmful tax competition.

Harmful tax competition, which became a characteristic of tax havens according to the EUs standards, was said to be a major promoter of the laundering of money derived from illegal activities and taxable corporate profits earned in the EU. Tax competition in tax havens was also closely linked with financial terrorism, whereby offshore banks were being used as vessels for transferring and safeguarding funds intended for terrorist activities. As a result of all of this, a report published by the OECD on harmful tax practices eventually led to the blacklisting and sanctioning of several small developing countries, which had over time become heavily or partially dependent on offshore services as a source of income.

To combat international tax competition, the Financial Action Task Force published 40 Recommendations to which tax havens were required to adhere in order to eliminate money laundering, the transfer of terrorist finance and abuse of offshore entities for fraudulent, free riding tax behaviors. Whilst the FATF battled with enforcing international financial regulations and Know Your Client Rules (KYC), the OECD kept busy with combating harmful tax competition and constructing a level playing field through international tax harmonization as its main agenda.

Tax competition is considered harmful by many developed countries which hold tax havens partly responsible for facilitating the withdrawal of funds and assets from their countries to offshore jurisdictions with obscure tax regimes designed specifically for offshore activities. For these countries, tax competition is unhealthy and a “no no”. According to the Tax Justice Network, a major portion of this argument is owed to the fact that in order to achieve sustainable modern economies, countries require sufficient revenue in order to fund physical and social infrastructure essential to welfare, and also to enable a degree of wealth distribution between rich and poor in order to promote equity and security. Harmful tax competition also touches on matters such as gender equity, sound investment management, international relationships, inequality of treatment, international trade and sustainable development.

Arguments against harmful tax competition often state that harmonizing taxes could lead to a ”race to the bottom”, whereby countries would be forced to reduce their taxes to such low levels that it would become difficult to maintain and fund social welfare programmes. From a macroeconomic point of view, the European Monetary Union raises the question of tax competition, stating that individual countries implement competitive tax structures in order to achieve budget equilibrium in the medium term and high employment or growth through a competitive tax policy. In contrast, tax harmonization could result in higher average taxes in the European Union (Boss, 1999).

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