G20 crackdown on tax havens is bad for economic growth

High-tax countries unable to compete with tax havens have instead opted to subjugate them

Rivalry between governments to attract capital and labour can lead to pro-growth policies. That this comes from the power of people to “vote with their feet” has been known for long. For instance, it was the palpable threat of workers and investors deserting them to choose more hospitable economies like the US and Europe that led countries like India to lower economic barriers. Yet public intellectuals have preferred to uphold governments’ supposed “right to tax” over citizens’ right to keep what they earn. Today, to compete with economies like the US and Europe, there are a number of low-tax countries, called tax havens, like Switzerland, Singapore, Ireland, among others, offering better conditions for labour and capital to create wealth for all. Thus, it is increasingly common to see American companies move their addresses (through the process of tax inversion) to tax havens and retain more of their profits. Quite ironically, this has allowed American companies to serve domestic customers well despite high US corporate tax rates. This is largely the result of international competition between governments to attract foreign capital by offering attractive tax rates. The US, in other words, remains a low-tax nation for foreign investors causing American companies to masquerade as foreign ones. While this may be viewed as fraud and depriving governments of precious tax revenues, it has helped many innovative companies like Apple Inc., Amazon.com Inc., Google Inc., Starbucks Corp. etc. to serve millions of customers while escaping draconian taxes. Indeed, such tax competition is doubly bad for governments that wish to tax citizens without any sense of accountability. Thus, like many western governments today, high-tax countries tend to form tax cartels to prevent any competition from rivals (tax havens). The decision of G20 finance ministers on Sunday to take further steps towards curbing corporate tax avoidance should be seen in this context. According to the OECD, G20 countries have come together to establish “coherence of corporate income taxation at the international level”. This is another way of saying that governments will now cooperate rather than compete in their tax policies, which can only mean bad news for businesses and workers—and thus for world economic growth. Whether this is brought about through bullying of tax havens to raise tax rates or pushing them to share more information on foreign companies remains to be seen. But both these steps would simply mean a compromise in international tax competition through prevention of tax havens from attracting capital through competitive tax rates—which has forced high-tax countries to follow suit in order to compete. If things do go according to plan and tax cooperation between countries becomes an actual reality, the choice for investors and workers to choose between good and bad would be severely limited. It is true that individual governments can still achieve growth through domestic reforms, irrespective of external conditions. In fact, if more countries choose to do so, resources could be much more fully exploited than today. But quite often, countries are more likely to reform when threatened with the drain of resources; particularly in a globalized world where capital can move swiftly. The ideal solution to this problem would be market-based, explored by many including economist David Friedman in his famous work “The Machinery of Freedom” (http://bit.ly/1uft8B3). But even decentralization of state power at the international level would be a tremendous improvement from an international tax cartel that governments currently want to establish. For such an arrangement will only retard growth by preventing the movement of resources in search of better pastures. Since the tax cuts initiated by former British prime minister Margaret Thatcher and former US president Ronald Reagan in the 1980s, the average tax rate across over the world has decreased considerably. Tax competition, in other words, has helped keep tax rates under control by checking the power of greedy politicians. But today, on the back of huge fiscal burdens, many governments want to reverse the progress made over the past two decades. This will not bode well for a world already deep in crisis.