International Tax Competition

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Taxes have been in existence for several centuries. They were imposed by the Pharaohs in Egypt, the Greeks, in the Roman Empire and as early as the 11th century in Great Britain. Taxes and tax structures evolved and multiplied as time went by and were established by governments in accordance with national dynamics, thus leading to unevenness in tax structures worldwide.

Taxes have always been regarded as a burden on the residents and businesses of a country, and the higher and more numerous they are, the more so. Despite development and wealth, in business where profit maximization is the primary objective, history shows that a country deficient in tax incentives and overwhelmed with elevated taxes is capable of driving away its capital and labor force to other territories where taxes are fewer and lower. This phenomenon has revealed the degree of sensitivity that individuals and businesses have towards taxation as well as the importance of fiscal regimes in impacting government social policies and programs based upon how much revenue is generated through the collection of taxes.

In the early 90s, the ways in which the forces of globalization and integration of financial markets created a global economic field where some tax structures appeared more attractive to businesses, especially multinational corporations with the resources to relocate and invest in cross-border operations, fiscal regimes and laws became competitive. But deciding whether tax competition is really about a) countries competing against each other in a subtle legislative warfare to allure foreign capital, or, b) whether tax regimes simply present differences and advantages that influence the flow of capital, seems to go unconsidered in dealing with concerns about tax havens and international tax competition.

This thought arises from grounds on which the notion of tax competition was built. A glance back into the early 80s shows that tax competition became a concern of European countries as efforts towards unifying the region to form a single economy and market intensified. Uneven tax structures within Europe was seen as one of the main hindrances to economic unification and stability as result of, as mentioned earlier, the tendency of labor forces and capital to emigrate to countries with more beneficial and advantageous tax systems.

Due to this, one of the main setbacks that the EU region faced was the changes made in the EU tax structure, which led to a progressive transfer of the fiscal burden away from mobile factors of production such as capital to non-mobile factors of production, in particular, labor. Studies also showed that there was an increase from 35% to 42% on the average effective rate on employed labour during the period between 1980 and 1997.

Meanwhile, on the other side of the hemisphere, corporate frustration was high in the United States due to the existence of the Glass-Steagall Act or Banking Act of 1933 under which broad banking, whereby combined commercial and investment banking – the mixing of banking with securities or insurance businesses – was prohibited. Broad banking was said to encourage conflicts of interest and fraudulent securities’ activities in some banks.

In light of these events, tax competition was intensified by lower taxes and incentives in territories outside of both the EU and the US. This led to the expansion of offshore financial centres, which were being used by Americans and Europeans in response to high taxes imposed because of fiscal deficits, capital controls that had been implemented from since the 1950s and 60s both in the U.S. and E.U. in order to reduce deficits in balance of payments, and tough corporate and banking regulations which created the need to increase business ventures and earnings in foreign currencies.

The EU’s attention was now turned to battling with what it termed “international tax competition” as the flight of capital and labor was no longer a matter that needed to be contained regionally, but internationally. In response to international tax competition, the OECD’s Report on Harmful Competition explicitly described and discussed cross-border tax competition as harmful to social welfare states whose tax bases were being eroded, while posing the threat of sanctions on countries which had embarked upon devising harmful tax competition schemes to attract foreign capital and resources, particularly those of affected EU member countries.

The momentous worth of the OECD’s Report is not solely based in its content and the sanctioning events that ensued, but on the classification and identification of countries with low or competitive tax regimes as ‘tax havens’. Tax havens were not only countries or territories engaged in harmful tax competition, but were especially classified for intentionally and deliberately implementing legislation to erode foreign tax bases; the fundamental factor upon which tax havens were blacklisted.

This factor greatly influenced the treatment that was meted out to harmful competitive tax havens in contrast to other countries owing to the fact that in its report on harmful tax competition, the OECD identified two other groups of countries – OECD member states and non-OECD member states and their dependencies, which like tax havens could be engaged in harmful taxation practices, possess legal or administrative laws allowing corporate secrecy that hinders the exchange of information and offer nominal or zero taxes to foreign juridical and natural persons from which local residents were excluded and; the three parameters originally established for classifying countries as tax havens.

Today, however, as the global financial crisis continues to affect economies, international tax competition has re emerged as one of the critical issues in national politics. As a result, tax havens in particular, are being looked at with a watchful eye by tax authorities that are looking at ways to recuperate tax revenue considered lost to tax competition. Several arguments against offshore tax havens suggest that tax competition is partially responsible for the fiscal deficits around the world. To counter this position, however, proponents of tax competition strongly indicate the need for governments to implement effective and sustainable banking and economic activities rather than stage a fully fledged attack on tax competition, which is capable of promoting better tax regimes and incentives for people and businesses.

Tax competition is often perceived as a concomitant of globalization, the integration of markets and increased mobility of capital, data, goods and services as a corollary of technological advancement. By being tax competitive, several countries are able to attract investors, create employment and foster development through increased earnings of foreign exchange and exports. The benefits of tax competition, particularly in offshore tax havens, have produced the spillover effect of better enabling governments of poorer countries to construct schools, upgrade and build roads, provide primary health care and better maintain social stability through a strengthened economy. Despite the unquestionable importance of taxation in national budget planning and social services, tax competition through lowered taxes and tax breaks may reduce government revenue, but provides for another means of generating income by dissuading tax bases from emigrating, whilst reducing unemployment and stimulating cash flow and enterprise.

By encouraging lowered taxation, tax competition has the potential of deterring the flight of capital and labor and stimulating domestic enterprise and spending power due to higher employment levels and cash circulation. Again, the need for balance and an integrated approach in confronting international tax competition is also seen in the importance of establishing sound banking and economic policies as many are of the opinion that the repeal of the Glass-Steagall Act, for example, which enabled commercial lenders to underwrite and trade instruments such as mortgage-backed securities and collaterized debt, as having an instrumental role in the current crisis. Equally important as competition among businesses, tax competition is necessary, effective and productive in stimulating governments to provide quality, affordable public services and programmes for the people by whom they were elected to serve.

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