openresearch-repository.anu.edu.au...United States and United Kingdom. When Lloyd George and his Treasury officials refused the request of the Vesteys that UK taxation not be extended

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Terry Dwyer is aVisiting Fellow at theNational Centre forDevelopment Studies,Asia Pacific School ofEconomics andManagement, TheAustralian NationalUniversity.

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History of tax havens

In 1970, the then British administrators ofthe Condominium of the New Hebridesintroduced Banking Regulation no. 4 of 1970.That regulation introduced offshore bankingto Vanuatu and led to the development ofVanuatu’s offshore financial centre. Laterlegislation provided for trust companies,insurance and exempt company laws. Thedevelopment of Vanuatu’s financial servicesindustry was not a casual decision onLondon’s part. Britain recognised that its

responsibilities to a post-colonial countryrequired it to think about what industriescould generate income for the Vanuatueconomy and its efforts met with theendorsement of its then French governmentpartner in the Condominium. In view of morerecent OECD and European Union views ontax havens, Vanuatu might find itworthwhile to remind the former colonialpowers of the parentage of its offshorefinancial sector.

Tourism and financial services arenatural complements for a small South

Offshore financial centres are coming under increasing pressurefrom both the OECD and the European Union. They are seen bymany bureaucrats and politicians in OECD countries as facilitatingcriminal activities such as laundering drug money as well as taxevasion and tax avoidance by residents of high-tax welfare states.While there are good reasons for nation states to cooperate tosuppress criminal activity, this is not true in relation to taxcompetition. The notion that by engaging in ‘harmful’ taxcompetition, offshore financial centres are damaging thelegitimate interests of OECD nations has no sound foundationin economic theory. Competition in tax matters is beneficial andworld welfare enhancing. Governments of offshore financialcentres serve their own and the world’s interests by providingzero or low tax environments for global business and investmentand they are right to insist that treaties on criminal matters notbe used to enforce other countries’ tax claims.

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Pacific economy as part of its developmentstrategy. A country’s development strategyhas to focus on attracting locationally mobileindustries to raise the productivity andwages of its people. In any case, a countrysuch as Vanuatu with pristine coral reefsmight be expected to prefer clean industrieslike financial services to dirty factories whichmight damage its tourism income (as well asthe environmental amenity enjoyed by itscitizens).

If you have a largely subsistenceagricultural sector and virtually all yourrevenue is raised by indirect taxes or resourcerents, you do not need income taxes, capitalgains taxes, withholding taxes or deathduties. If you do not have these taxes, there isno need to enter into tax treaties. Vanuatu isthus a natural tax haven. An absence of taxes,like an absence of war or internal violence, issomething a country can turn to itsadvantage. It is understandable that Vanuatucontinued the policy of developing itsfinancial sector after independence in 1980.The presence of an offshore financial sectorcan provide collateral spin-off benefits for therest of the economy. It may gradually lead tofunds being lent to or invested in developingthe domestic economy and it may assist indeveloping the legal expertise necessary fora market economy to work. These are nosmall things when one observes the problemsfaced by some Eastern European economiesin transition. Educating people on howmoney and finance work in a marketeconomy is an important part ofdevelopment.

Notwithstanding the logical reasonswhich might favour Vanuatu developing itsoffshore financial sector, Vanuatu’s existenceas a tax haven has not been welcomed by allpeople. In particular, it would be surprisingif the Australian Treasury welcomed itsemergence after closing down NorfolkIsland as a tax haven. It is therefore perhapsnot surprising that the OECD (in whoseCommittee on Fiscal Affairs Australia plays

an active role) has launched an attack on‘harmful’ tax competition from tax havens.

Indeed the history of offshore financialcentres reflects the historical evolution of thetax systems of major countries, notably theUnited States and United Kingdom. WhenLloyd George and his Treasury officialsrefused the request of the Vesteys that UKtaxation not be extended to overseas incomein World War I, the Vesteys decided on self-help. Their overseas income eventuallyflowed to the trustees of a settlement basedin Paris at a time when France did not seekto tax overseas gains. Given the currentattitude of France as an OECD member tooffshore financial centres, it is worth notingthat France was one of the first offshorefinancial centres.

After World War I, as tax rates rose in theUnited States and the United Kingdom, bothcountries sought in the 1930s to attack thetransfer of assets abroad. The UnitedKingdom legislated against offshore schemesbased in Canada and the United Stateslegislated against offshore pocketbookcompanies held by US millionaires in theBahamas.

For the vast majority of taxpayers inindustrial countries, tax havens held littleinterest. With onshore tax havens such aslife insurance, pension or superannuationfunds available, only the very wealthy foundmuch need to consider the use of offshoretax havens. In the United Kingdom, thecombination of a still-wealthy upper classfacing extraordinarily high marginal taxrates, a tradition of overseas investment andthe unique circumstances of offshore taxhavens within the then exchange control areameant the British were leaders in tax havendevelopment. To these were added afterWorld War II the multinational corporationswhich found that the services of tax havenswere essential in overcoming the problemscreated for international business byinconsistent tax treaties or dual claims toincome.

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It is not generally recognised by mosteconomists that without tax havens, multiplenational taxation would still exist and poseenormous difficulties for mutually beneficialtrade and commerce.

As public expenditure rose, notably onexpanding welfare states, and as onshore taxshelters or tax havens were attacked, one afterthe other, by treasuries in industrialcountries, the demand for the services ofoffshore tax havens rose. No longer wereoffshore tax havens merely of interest tomajor multinational corporations or thesuper-wealthy. With high postwar incometax rates and death duties and a widespreadlegacy of colonies which had inherited thecommon law and the law of trusts, the Britishled the offshore migration. The Americanswere not slow to patronise the British-developed Caribbean jurisdictions and totake advantage of common law legal systemswith which they were familiar.

The Europeans with a tradition ofterritorial taxation and civil law systems hadless need to patronise Anglo-Saxon taxhavens with whose legal systems they wereless familiar. However, as Europeancountries moved to wind back the scope ofexemptions for extra-territorial income, it wasno longer enough merely to haveundisclosed bank accounts in Switzerlandor Luxembourg. By the 1980s the gradualremoval of capital controls in the UnitedKingdom and the European countriesopened the way for further Europeanpatronage of places such as the ChannelIslands.

The consciousness of Europeantreasuries was raised after Germany failedin an attempt to impose an interestwithholding tax in the face of a flight ofcapital. It now seemed clear to the treasuriesof ageing welfare states that tax competition,when combined with freedom of capitalmovement, was a threat to their ability toraise further revenue. European writersincreasingly recognised that the emergence

of a global capital market set limits to theredistributive financing of welfare states(Frenkel, Razin and Sadka 1991:213:4;Schjelderup 1993:377).

Since the 1980s, there has been theadoption generally within Europe ofcontrolled foreign companies legislation aswell as other anti-avoidance legislation. Moresignificantly, the OECD report on harmfultax competition and its cognate report on taxsparing (OECD 1998), together with EUinitiatives, have seen the emergence of amultilateral attack on tax havens or offshorefinancial centres (OECD 1999).1 The OECDCouncil is expected to consider a list of taxhavens at its meeting in June 2000. Inparticular the United Kingdom has clearlycome under pressure from its Europeanpartners to ‘do something’ about itsdependent territories. The first example ofthis was the UK Edwards report (Edwards1998) which examined the Channel Islandsand the Isle of Man and which has now beenfollowed by the White Paper on the overseasterritories (UK 1999).

The Edwards report, which, in themethod of its inception, broke long-established constitutional usages governingthe relationship between the UnitedKingdom and the Crown’s offshore islands,did not recommend wholesale eliminationof the offshore tax havens. Indeed theEdwards report was surprisingly fair, givenits genesis, but it did foreshadow substantialinroads on client privacy in the interests ofoverseas regulators and tax collectors.

Since before the American revolution,the United Kingdom has had a practice thatBritish colonies with self government areentitled to administer their own taxationaffairs.2 No pressure from its Europeanpartners is likely to alter that position.Hence the UK government is proceeding toassuage its European partners by seekingmore subtle methods of removing theattractiveness of its overseas territories astax havens. The ostensible focus of its

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initiatives is to ensure credible regulation ofthe offshore financial industry in each of itsterritories. The overseas territories, on the faceof it, find it difficult to complain if the UKgovernment insists that they cooperate inmeasures to afford mutual legal assistanceto counter criminal activity and eliminatefraud.

But there seems to be an ulterior motivein this apparently beneficent activity. Ifmeasures introduced to secure the integrityof the overseas territories’ financial sectorshave the effect, if not the stated purpose,3 ofensuring that the financial affairs of OECDinvestors in those territories are exposed tothe gaze of OECD treasuries, then Britain willhave pleased not only its own treasury butthose of its European neighbours. Certainlythere is no reason to think that even a ‘ThirdWay’ UK Labour government has muchsympathy for tax avoidance through the useof offshore havens.

It is clear that a consensus is emergingamong many OECD countries that taxcompetition is harmful4 and measures needto be taken collectively to eliminate taxhavens. This is not a universal OECD view.Switzerland and Luxembourg dissentedstrongly from the report on harmful taxcompetition (OECD 1998:73–81) while theUnited States has its own views on foreignsales corporations.5

Tax havens face the followinginternational agenda• tax competition is harmful• it should therefore be suppressed• national sovereignty means it cannot be

directly suppressed• therefore, financial threats or

inducements or the use of ostensiblynon-tax treaties must be employed for theexplicit or ulterior purpose of eliminatingtax havens. In the case of dependentterritories of OECD members, suchmeasures may carry the implicit threatof the governing power to overrideinternal self-government.6

Are offshore financial centres ‘taxhavens’?

So far I have used the terms ‘tax haven’ and‘offshore financial centre’ interchangeably.In fact the offshore financial centres have inmany cases progressed for reasons other thantax, though without beneficial tax regimes,they may not have progressed at all.Increasingly offshore financial centres areused for asset protection against the tortliability revolution.7 Liberalised no-faultdivorce laws which give spouses automaticclaims to assets regardless of adulterousconduct do not meet with universal moralapproval. In some countries, testators aredenied freedom to dispose of their estates asthey think fit and, increasingly in commonlaw countries, legislation makes it easier fordisappointed beneficiaries or others tochallenge a will. Assets may be moved tovehicles in offshore financial centres to defeatsuch legislation.8

Sometimes governments themselves useoffshore financial centres, for example, totrade with other countries when it is notpolitically correct to do so or to protectthemselves against the possibility ofsanctions being imposed, as when Iranianassets were frozen in the United States.Individual investors, such as Taiwaneseinvesting in mainland China, may havesimilar motives to use offshore centres.

Offshore financial centres cater toexpatriate investors who may be working inmany countries over time and wish tomanage their investments or pensionarrangements from one centre. Prospectusrequirements may influence investmentmanagers in choosing to locate theiroperations in offshore financial centres.Onshore investors denied access to foreigncompany prospectuses or life insuranceproducts, may seek to invest via offshorevehicles. Persons planning a companytakeover on a stockmarket may not wish toalert the market. Multinational groups

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seeking access to lower premiums throughthe reinsurance markets may choose tooperate captive insurance companies inoffshore financial centres.

Opinions may differ on the morality orotherwise of the use of offshore centres butthey do emphasise that tax is not the only, orthe most powerful, motivation for the use ofoffshore centres. For that reason, the term‘offshore financial centre’ is more accuratethan ‘tax haven’ as there is often more thanone kind of perceived legal inadequacy orrepression in the investor’s home or targetjurisdiction providing the impetus to locateassets in an offshore vehicle.

The theory of ‘harmful’ taxcompetition

As the expertise of this writer is in economics,not international relations or politicalscience, the rest of this paper addresses theOECD premise that tax competition isharmful. There is an assumption that theanswer is yes. I argue that economic theorypoints to the opposite conclusion, namelythat tax competition is a healthy and naturaleconomic process which weeds out stupidor inefficient taxes.9

If I am correct, then the governments ofoffshore financial centres are entitled to takethe view that they are not being badinternational citizens in seeking to profitfrom the stupidity of treasuries of high-income countries. They are entitled to takethe view that any form of international legalassistance should not extend, directly orindirectly, to the enforcement of othercountries’ tax laws, whether such assistanceis by sought by way of debt recovery,insolvency proceedings, informationexchange or evidence for tax prosecutions.

The OECD fear is that

[d]evelopments in communicationstechnology, such as the Internet, raisea general risk to the forward estimatesof revenue. Such developments may

allow the purchase or sale of anincreasing number of goods andservices—including the provision oflabour services—in a way which couldrender traditional tax collectionmechanisms unworkable, posing amajor challenge for tax system design.The OECD is developing a taxationframework to apply to electroniccommerce including ‘place of taxation’rules for consumption taxes andmeasures to strengthen internationalcooperation in tax administration andcollection. Australia is contributingactively to this work. The ATO hassought to raise awareness of the issuein its publication Tax and the Internet(Costello 1999:4–24)Before accepting that tax competition can

ever be harmful, one might ask somequestions. How does tax competition differfrom other competition?10 What is wrongwith general fiscal competition so that a lowspending country can pursue a low or zeroincome tax policy?11 What is wrong with nottaxing income you would otherwise notgain?12

Fear that tax competition will lead to aloss of domestic revenue does not amount toan argument that tax competition is harmfuleither to one’s own or other countries, nomatter how unpleasant it may be for thetreasury concerned.

Competition among countries fortaxation revenue poses a significantthreat to national revenue bases andeffective tax rates. The OECD hasrecognised the danger that suchcompetition will simply see an erosionof tax revenues without any benefit toindividual countries in terms of greaterinvestment. The analogy with thedestructive tariff competition of anearlier era is clear (Ralph 1998:25 para2.36).Tax competition is seen as a ‘race to the

bottom’ where there are no winners in theend. But the theory to support such a view isnot presented. The analogy that internationaltax competition is potentially harmful in the

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same manner as the tariff competition of anearlier era is false. Whereas tariff competitioninvolved putting up taxes and destroyingtrade, tax competition involves driving downtax rates on mobile factors of productiontowards their optimal level. It is trade-facilitating rather than trade-destructive.13

Defining ‘harmful’ tax competition

A basic problem in defining ‘harmful’ taxcompetition is to define who wins and wholoses. Are the losers governments? Or somegovernments and not others? 14 Or are theythe citizens of countries? Or is the world atlarge a loser?

The OECD Report argues thattax havens and harmful preferentialtax regimes, collectively referred to asharmful tax practices, affect thelocation of financial and other serviceactivities, erode the tax bases of othercountries, distort trade and investmentpatterns and undermine the fairness,neutrality and broad social acceptanceof tax systems generally. Such harmfultax competition diminishes globalwelfare (1998:8 para 4).This statement raises a multitude of

questions. Apart from the circularity ofreferring to a harmful preferential tax regimeas harmful, in what sense is it harmful foranother country to be a tax haven? If thealleged harm is that tax havens affect thelocation of financial and other serviceindustries, it needs to be observed that alltaxes affect location decisions, including thetaxes of the country allegedly harmed. Ifcountry A puts on taxes while country B doesnot, whose action causes financial and otherservice activities to relocate? Are not countryA’s taxes the ultimate reason for the erosionof its tax base? Is not the harm self-inflicted?As for distortion of trade and investmentpatterns, all taxes on labour and capital aredistorting: only taxes on rent are non-distorting and there is no international lawwhich prohibits countries from adopting rent

taxes.As regards the fairness and broad social

acceptance of tax systems, it is curious thatrevenue collectors who traditionally insistin the Courts that taxes must be collectedaccording to law—without regard tofairness—should raise this issue. Theobvious point is that many citizens in high-taxing countries do not accept their taxsystems as ‘fair’ and, failing to obtain equityfrom their political systems, do what they canto protect themselves and their families. Theirresponses can range from simple legal taxplanning such as deductible pension fundcontributions, or geared investments orincome splitting to more complex taxplanning or avoidance and even to minor ormassive 15 unlawful evasion.

While one can understand why a high-tax country’s tax administrators would viewall such responses by its citizens as ‘harmful’to revenue collections, that does not meantaxpayer responses to high tax burdens arenecessarily always harmful to the countryitself. In the case of onshore havens such aspension funds, the capital accumulated mayincrease investment and productivity whilereducing future demands on the treasuryfrom an ageing population. In the case ofoffshore havens, similar responses bycitizens may have similar if more attenuatedbenefits and may serve as an economic andpolitical safety valve,16 forestalling thephysical emigration of talented labour andcapital or the emergence of violent minoritypolitical movements.17 In an ideal society,people would want to pay their taxes or beunable to avoid them, but only benefit taxesor taxes on economic rent are likely toapproach such an ideal. With other taxes, it ismoderation in their levels and administrationwhich best promotes their acceptance andmitigates avoidance and evasion.

It is therefore impossible to assume thattax competition harms the country losingrevenue. It is even more difficult to concludethat ‘harmful’ tax competition diminishes

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global welfare, unless one can show that thegains to the competing country and its clientsfrom the revenue-losing country plus gainsto third countries are less than the losses tothe beneficiaries of the revenue-losingcountry’s taxes and the marginal deadweightlosses of those taxes. Nowhere does theOECD Report attempt such a demonstration.

The difficulty of defining ‘harmful’ taxcompetition is further exemplified by theOECD concession (1998:8 para 6) that: ‘Taxincentives designed to attract investment inplant, building and equipment have beenexcluded at this stage…’ The focus of theOECD Report is on tax competition for mobilefinancial capital or services. It seems to beassumed sometimes (or for the time being?)that competition for financial capital isharmful but competition for physical capitalis, so far, legitimate.

But physical and financial capital arenot so neatly distinguished and taxcompetition affects labour mobility as well.It seems odd to complain that tax competitionfor location of financial capital or regionalheadquarters is harmful while taxcompetition for factories and jobs is not. AsBracewell-Milnes (1980) and Keen (1993)have pointed out, paper tax avoidance, whichmeans a factory continues to operate andcreate jobs in a high tax country, may be seenas less harmful than the tax avoidanceinvolved in closing down the factory, sackingworkers and setting up in a developingcountry which grants tax incentives for plantand equipment.18

The OECD (1998:17 para 34)recognises that some investors mayseek to invest in a location with lowerrates (and greater after tax return) evenif only low public services areavailable…but these genuine locationdecisions have to be distinguishedfrom the type of behaviour which is thefocus of this Report.

Again, the OECD Report gives no criterionby which any such decisions can be

distinguished from any other economicdecision. Nor is it satisfactory to define‘harmful’ tax competition as that which is‘designed’ or ‘intended’ as tax competition.

Is it harmful tax competition if you intendto poach another country’s tax base but notif you pursue a domestic policy which merelyhas that effect? Such a definition isnonsensical.19 It would mean that Hong Kong,which pursues a low tax policy assisted byland revenues, is a ‘non-harmful’ tax havencompetitor but Singapore, which is a highertax jurisdiction, with specific incentives forinternational business, is a ‘harmful’ taxcompetitor. Curiously, it would also meanthat the classical tax havens, Jersey, Guernseyand the Isle of Man, were not engaging in‘harmful’ tax competition as their tax havenfeatures grew out of domestic policydecisions and long-established tax practice.

Many tax havens have evolved their owntax systems without any particular interestin the wider world, yet the OECD Reportrecommendations clearly conclude byfocusing on the effects of tax competition onthe revenue-losing countries more than anyintentions on the part of tax havens. In theend, the OECD sees all tax competition asharmful to the interests of revenue-losing taxauthorities, regardless of whether it isintended and whether it operates on physicalor financial capital or on labour. As MasonGaffney (1999) has pointed out, the OECDreport has not been accurately titled. It shouldhave been called ‘tax competition: a problemfor high tax countries’.

Defining ‘fair’ tax competition

The difficulty of defining ‘harmful’ taxcompetition is paralleled by the difficulty ofdefining ‘fair’ tax competition. The OECDargues that ‘the proposals set out in theReport will reduce ‘the distortionaryinfluence of taxation on the location of mobilefinancial and service activities, thereby

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promoting fair competition for real economicactivities. If governments can agree that theselocation decisions should be driven byeconomic considerations and not primarilyby tax factors, this will help move towardsthe ‘level playing field’ which is so essentialto the continued expansion of globaleconomic growth (1998:9 para 8).

What is a ‘real’ and ‘unreal’ economicactivity. Is banking unreal? Is insuranceunreal? Is e-commerce unreal? Is the Internetunreal? And why is tax not an ‘economic’consideration? The House of Lords, theAustralian High Court and the United StatesSupreme Court have taken it as axiomaticthat taxation is a normal part of any businessdecision-making when dealing with casesof alleged tax avoidance.

If the concern is with whether a country’stax regime induces economic activity to shift,then all tax competition is necessarily‘harmful’. The only way to prevent tax-induced changes of investment locationwould be for all countries to adopt the sametax system and the same tax rates.

The inference from the OECD report isthat all low tax countries are engaging in‘harmful’ tax competition and the Reportevinces in its recommendations an intentionto eliminate all forms of tax competition asharmful, no matter how arising.

The ‘harm’ caused by taxcompetition

More insight into what the OECD sees as‘harmful’ tax competition comes from itsdescription of the harm caused by taxcompetition. If tax competition shifts the taxburden from mobile to relatively immobilefactors, it is doing the world a service.Economic theory has always held that, froman efficiency point of view, taxes should belaid on things which are inelastic in supply(of which the prime example is land rents).As for progressive marginal tax rates and

income redistribution, there are manyeconomists who would argue that both areeconomically inefficient, especially when itis sought to finance redistribution by highmarginal tax rates on labour and capitalincomes as opposed to land rents.20 It is alsoodd that a report which complains (OECD1998:15 para 25) that tax havens are ‘freeriders’ accepts as given the ‘free riding’implicit in redistributive taxation (OECD1998:14 para 23).

Should tax systems be the same?

Who is to define internationally acceptedstandards? Should it be internationallyunacceptable for a country to raise itsrevenue entirely from land taxes or resourcetaxes (for example, oil royalties) and have notaxes at all on capital or labour? If it is to beunacceptable, why should that be so, giventhe obvious efficiency benefits of such a taxregime and, if, on the other hand, it is to beacceptable, how can one logically object totax competition? If a zero tax rate on capitaland labour income is acceptable to the OECDwhy does the OECD have any concerns abouttax competition? The OECD report seemsdesigned to dissemble the real objective ofan OECD-led global tax cartel withworldwide enforcement powers.

A global tax cartel?

The OECD response to tax competition is totry to organise a tax cartel.21 The OECDargues that all countries can benefit byjoining a global tax cartel.

The assumption that all countries couldbe better off by joining a tax cartel depends,first, on all countries joining the cartel and,second, on a fixed worldwide supply of thefactor sought to be taxed. While somecountries may be tempted to join such a cartelif promised a share of the tax revenue, others

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will observe that, the larger the cartel, thegreater the profits to be secured by thoseremaining outside it. Apart from theimprobability of all countries joining a taxcartel, since the rewards for staying out areincreased as more join, the key assumptionis that the worldwide supply of capital orlabour would not be reduced if allgovernments colluded to increase tax rates.That this assumption is false is suggested bydeclining savings rates, labour forceparticipation and birth rates in high taxcountries. Even in a closed economy, hightaxes on labour and capital have negativeconsequences.

Such considerations do not appear todeter the OECD from planning the means toenforce a tax cartel. The OECD notes ‘Someprogress has been made in the area of accessto information, in that certain tax havenjurisdictions have entered into mutual legalassistance treaties in criminal matters withnon-tax havens that permit exchange ofinformation on criminal tax matters relatedto certain other crimes (for example, narcoticstrafficking) or to exchange information whencriminal tax fraud is at issue. Nevertheless,these tax haven jurisdictions do not allow[other countries’] tax administrations accessto bank information for the critical purposesof detecting and preventing tax avoidancewhich, from the perspectives of raisingrevenue and controlling base erosion fromfinancial and other service activities, are asimportant as curbing tax fraud’ (1998:24 para54). The OECD goes on to assert ‘In an era ofglobalisation and increased mobility fortaxpayers, traditional attitudes towardsassistance in the collection of taxes may needto change. The purpose…is to encouragecountries to review the current rules…witha view to encouraging the enforcement of taxclaims of other countries’ (1998:52 para 137).

The implications of this OECDbureaucratic view for both OECD and non-OECD countries are that there is to be nodistinction drawn between legal tax

avoidance and illegal evasion.22 It meansinternational crime fighting is being used asa stalking horse to attack so-called taxcrimes.23 It means the destruction ofsovereignty and the principle of no extra-territorial enforcement of other countries’taxes. It means the complete destruction ofprivacy as a social value in OECD societies,notwithstanding its status as a human rightunder some Constitutions, for example in theUnited States.24 Non-OECD countries areexpected to legislate to force their citizens todivulge information to OECD authorities notmerely for the purpose of prosecutingcommon criminals but for the purpose ofpreventing both evasion and avoidance ofOECD countries’ taxes.25 No decent personwishes to support drug cartels but manywould feel that the loss of all personalfinancial privacy is too high a price to payfor their elimination.

Just as modern Western states areimitating the later Roman Empire in theirpopulation decline, so they are imitating itin their increasingly punitive approach totaxation enforcement as their labour taxbases shrink. Tax defaults are increasinglybeing criminalised and attempts are beingmade successfully to prosecute tax evasionas if it were common law fraud (even thoughtaxes—originally called aids or subsidies—are a creature of statute alone and not knownto the common law). The great tacticaladvantage of this confusion of the sources oflegal obligation is that the authorities in theOECD country can then seek to use treatieson mutual legal assistance to pursue taxcollection outside their borders by claimingthey are pursuing criminal acts rather thanseeking extra-territorial tax enforcement.There is little point to offshore financialcentres saying they will cooperate withOECD measures against illegal tax evasionbut not against lawful tax avoidance, if theOECD countries are determined to confoundthe two: offshore centres have in effect onlyone choice regarding exchange of tax

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information—to force their citizens toprovide information to OECD countries forall tax purposes or for none. Governmentsof offshore financial centres will doubtlessstudy more closely the precise wording oflegal assistance treaties to ensure suchindirect attempts to erode their sovereigntydo not seriously undermine their ownrevenues.

In essence, the OECD is arguing that therest of the world should be forced to designtheir legal and administrative systems tofacilitate the application of residence-basedincome taxation by OECD countries. Evenin the heyday of colonialism, imperialpowers tended not to make such demandsof their colonies. Faced with the prospect ofsuch drastic abuse of legal assistancetreaties, one suspects that some non-OECDcountries will reach the view that legalassistance treaties are not in their nationalinterest and should be denounced oramended. It would be unfortunate if theunbridled demands of OECD taxbureaucrats were to trigger a decline ininternational cooperation against realcriminality, under which tax offences are notnecessarily included by most of humanity.26

Just why some countries should be madeto enforce other countries’ tax laws when it isnot in their interests to do so, nor in theinterests of world economic growth, is notexplained. The radical assault on sovereigntyimplicit in such sentiments should causeobservers to ask what is wrong with the OECDtax systems that they need such drasticextraterritorial enforcement.27 Territorialincome tax systems, or land taxes, do notrequire such extraterritorial assistance.

The problem of trying to taxmobile factors of production

The real problem the OECD is grapplingwith is trying to tax what can run away. Taxpolicy is really quite simple. There are onlythree sources of income to tax—land, labour

and capital—and only one of them cannotflee. Capital can flee at the speed of light todayand it can stop replenishing itself as peopleeither stop saving or investing. Like water,capital can evaporate or leak away from anopen economy. Labour has a harder jobescaping tax burdens, but it can stop working,shift to the black economy, emigrate(especially if it is skilled)28 or stop breeding.Only land (which includes all scarce naturalresources) can command a true economic rentwhich cannot be diminished by taxation.29

There is no reason why reduced taxes onmobile capital could not be financed byincreased land taxes within the OECDcountries.30 If they choose to tax their workersmore rather than land, that is their domesticpolitical decision, just as it was a domesticpolitical decision for many OECD countries,notably in Europe, to embark on high welfarespending programmes which necessitatedhigh taxes on labour and made theminternationally uncompetitive. Having madethose decisions, they should not blame therest of the world for the logical economicconsequences.

Just why small countries, for example thePacific island countries, should be expectedto provide a ‘level playing field’ for OECDcountries by embarking on similar high-tax,high-spending, policies is not explained.Why should places such as Vanuata with fewresources be expected to forgo any chance ofmaintaining the living standards of theirpeople by imposing OECD tax rates whichwould drive away business and employment?To blame emerging economies in the AsiaPacific for the economic woes of Europeanwelfare states may be good domestic politicsin Europe but it is bad economics, both forEurope and the world at large.

The argument that tax competition isharmful, implicitly rests on the assumptionthat there are only two factors of production,labour and capital, and these are fixed in theirtotal worldwide supply. Both assumptionsare quite false.

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From the point of view of nationaleconomic welfare, the view that taxcompetition is harmful is correct only if thereare no immobile tax bases available. Wherethere are mobile tax bases (for example,capital) and immobile tax bases (for example,land), tax competition can force a country toshift its tax base from mobile capital toimmobile land. Such a shift is, in fact, a shiftto a more efficient tax base, one conformingto the general Ramsey efficiency rule of taxingmore those things which are less elastic insupply. Tax competition may thus beefficiency enhancing and no bad thing for acountry, even if its tax administrators orpoliticians find it uncomfortable.

The economic theory underpinning theconcept of ‘harmful’ tax competition isessentially non-existent. The theoreticalmodels employed in the economic literatureto show harmful effects from tax competitionand a loss of collective revenue are essentiallybased upon models which assume a fixedworldwide supply of capital. In thosemodels, tax competition is a ‘beggar thyneighbour’ policy whereby the gains offinancial centres or tax havens must be atthe expense of tax revenue in the capitalexporting countries. Obviously, if the worldconformed to such models, if there were afixed world stock of capital, governmentscould collect more tax by operating a taxcartel. It would be in their collective interestto eliminate tax competition. In such models,it would make sense for a UK government topressure its dependent territory governmentsto put up their tax rates and compensatethem for any revenue lost by paying subsidies(increased foreign aid) out of the increasedrevenue generated by driving capital back tothe United Kingdom.

However, the implicit assumption of theOECD model is wrong. The world supply ofcapital is not fixed and depends on the netrate of return. If all governments increase thetax burden on capital income, world capitalaccumulation slows down and economic

growth will slow. Once this fundamentalerror of the harmful tax competition model isgrasped, the concept collapses.

The zero optimal tax rate on capital

A key question is whether all forms of incomeshould be taxed equally. Leaving asideethical views in favour of graduated incometaxes,31 the answer depends on howresponsive different parts of the tax base are.Income is not a homogeneous tax base.32 It isnot sensible to tax all forms of income at thesame rate if the factors of productiongenerating the income are not all equallymobile. In particular, it does not make senseto tax mobile capital, especially capitalsupplied by foreigners, at the same tax rateas income arising from land or immobilelabour tied to the jurisdiction. Though notessential to the case against the OECD’sviews on harmful tax competition, it isreasonable to suggest that the optimal taxrate on capital income is zero.33

The fundamental Ramsey principle oftaxation is that taxes should be levied onthose activities which are least responsive.One would not tax a factor of productionwhich was in perfectly elastic supply. Thishas profound implications for internationallymobile capital. Theoretical models of optimaltaxation produce three broadbrush results(Frenkel and Razin 1996:chap 14).• the optimal principle of international

taxation is the residence principle; thatis, non-residents should not be taxed ontheir capital income from a country

• the optimal tax rate on capital incomefrom all sources is zero

• the optimal tax rule for a country thatcannot enforce taxes on foreign sourcecapital income is to abstain entirely fromtaxation of domestic source capitalincome as well.Even in a closed economy, it may be

efficient to exempt capital income from taxin the long run (Chamley 1986; Correia 1996).

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The intuition behind these conclusionsis not difficult to understand, even thoughthe policy implications are dramatic.

One would not tax non-residents on theircapital income because that drives up the costof capital to the local economy—non-residents can take their mobile capital andinvest it elsewhere. By driving away mobilecapital, the tax becomes an inefficient tax onimmobile factors of production, such asimmobile labour or land (Kopits 1992:5, 15;Head 1997:86). One should not tax the capitalincome of non-residents just as one does notoutlaw foreign investment. One wantsforeign capital to increase the productivityand wages of the local population.

Just as capital can flow across borders,so capital can evaporate over time. Hence, inthe long run, the optimal tax rule is not to taxcapital income at all. Taxing the return oncapital lowers the capital intensity of theeconomy and reduces the productivity andwages of labour. This is one of the majorarguments for shifting from an income to aconsumption tax base (although that can bedone just as—or more—easily by exemptingcapital income from tax).

The third principle states that if capitalincome is to be taxed without distorting theallocation of investment then, other thingsbeing equal, it is desirable to tax income fromdomestic and foreign investments equally.But if one cannot tax foreign incomeequally—and even with the mostsophisticated legislation that is likely—thenone should cut the rate of tax on domesticcapital income.

Territorial revenues from land rents

Hong Kong has made a policy of raisingmuch of its public revenue from land rents,which has enabled it to keep its tax rates oncapital and labour comparatively low. Thatpolicy attracts capital investment which inturn pushes up land rents and enhances the

(land) revenue base—a virtuous economiccycle. There is nothing to stop developedcountries such as the United Kingdom, theUnited States or Australia pursuing similarpolicies if they wish. Rather thancomplaining about ‘harmful tax competition’they would do better to emulate Hong Kong.For example, the United States economicrevival owes much to President Reagan’s taxcuts and it is notable that the United States issomewhat more comfortable than theEuropean Union with economic competition(and internally has long lived with State taxcompetition).

Indeed, this leads to the logical point thatinternational tax competition, by forcinggovernments to reduce tax rates on mobilecapital income or mobile labour, is directinggovernments’ attention to the desirability ofshifting the tax base towards immobilefactors (which includes full licence fees fornatural monopolies such as the broadcastspectrum). Economic theory declares that themost desirable tax base is a tax onunimproved land values because it cannotbe shifted and has no distorting effects oninvestment in physical capital or laboursupply. The beauty of such territorial-basedtaxation is that it also solves the tax treatyissue—international double taxationbecomes a non-issue and the OECD taxtreaty network becomes unnecessary.

As countries have reduced theircompany tax and top marginal personalincome tax rates, they have turned to valueadded taxes, user charges, expenditurecopayments, social security levies andmandated social insurance because there isless incentive or ability for such tax bases toleave the jurisdiction. Thanks to taxcompetition, tax policies are de jure shiftingtaxes from capital towards labour income,from the more mobile towards the less mobilefactor. This could be to labour’s advantageas de facto shifting is eliminated and jobs andwages are nourished by increasedinvestment.

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But the process can—and should—gofurther than simply shifting taxes fromcapital to labour.34 As Kopits (1992:5) notes,a country can use its resource rents torespond successfully to tax competition formobile capital. Although there does not seemto have been an international trend to shifttaxes from capital income to land (as opposedto labour, which raises its own problems),some observers have noted that Hong Kongand Singapore have been able to compete ontheir company tax rates because they haveplaced heavier reliance on taxing land.35

Professor Martin Feldstein, former Chairmanof the US Council of Economic Advisers,acknowledges a tax on unimproved landvalues ‘involves no distortion’ and is clearlyefficient (Feldstein 1976:96).

So, economic freedom and internationaltax competition are world welfare enhancing.Far from hurting the OECD, it is nudgingOECD countries towards optimal tax policieswhich are in the best interests of theircitizens.

Who says what is a ‘level playingfield’?

Another key theoretical defect of the OECDreport lies in its concept of the ‘level playingfield’. It appears to be assumed that theoptimal approach to maximising worldeconomic growth consists of identical tax andregulatory systems. But why should this beso?36 The absurdity of the proposition isimmediately obvious if it were suggested toOECD countries that they should nowharmonise on a Soviet style commandeconomy system. If the countries of the worldcannot all agree on the first-best taxationsystem of taxing land rents, is that anyreason why some countries should not do soand become tax havens for the avoidance ofother countries’ less efficient taxes? It mightalso be pointed out that OECD countries oftencannot agree themselves on what theregulatory level playing field shall be. For

example, New Zealand has not taken theview that insider trading should be a criminalmatter but treated as a civil law matterbetween a company, its employees andothers having a fiduciary duty.

The reality is that, while comparativeadvantage is a basic source of gains frominternational trade and commerce,comparative advantage may be largely man-made. It may depend substantially on howcountries tax and spend (for example,whether they spend on infrastructure or agepensions) and how they regulate or taxmobile business. Countries which areresource-rich are sometimes poor because ofoppressive government and oppressivetaxation while countries which have little byway of natural resources (for example,Switzerland, Singapore and Hong Kong)have sometimes become rich by pursuingpolicies of good government and lowerbusiness taxation. A perfect identity ofregulatory systems in search of a levelplaying field can destroy the gains from tradeand deny the world the beneficialdemonstration effects of genuine free marketeconomies. The offshore financial centrescould do worse than remind Europeans andAmericans that European civilization roseto greatness not from the slavish Imperialuniformity of the later Roman Empire butfrom the competition between the nationstates which succeeded it.37 It was the abilityto cross a frontier or cross the Atlantic andescape from tyranny which protected thevitality of Western culture and enterprise.The Anglo-American tradition is one ofliberty rather than uniformity.

The offshore financial centres might alsopoint out that federations such as the UnitedStates and Australia have lived with taxcompetition for decades withoutdisintegration. A New Hampshire or aQueensland has not only served its owninterests by following a low tax policy butalso, by putting pressure on the tax policiesof neighbouring states, has helped to keep

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economic activity within the federation as awhole.

In the international sphere, the UnitedStates and the United Kingdom have longengaged in tax competition. The United Statesis an offshore banking tax haven38 while theUnited Kingdom rules granting theremittance system to non-domiciled residentshas meant that London has been a tax havenfor many wealthy expatriates.38

Without a refund system for embeddedState indirect taxes on exports and with asystem of taxing worldwide income, the USstands to disadvantage itself uniquely bycontinuing to endorse the OECD attack on‘harmful’ tax competition. Having felt thesting of international tax conformity in theform of the adverse World TradeOrganization ruling on its foreign salescorporations, the US would do well toreconsider its support for the OECD and EUattacks on tax competition. The US Congressis starting to ask itself the right questions byexamining a bill to implement a territorialsystem for taxing business income.40

Conclusion

Because mistaken and unexamined OECDnostrums on tax competition are affectingworld economic policies by appealing to theprejudices of EU and other politicians,offshore financial centres should undertaketheir own research to examine the ‘harmful’tax competition issue so that the impliciterrors of OECD policy reasoning can bedebated openly and flushed out. They needto enter the global economic policy debate.Ideas matter!

The governments and citizens of offshorefinancial centres are entitled to resentstrongly a situation in which they are beingpressured (or pilloried) by the OECD on thebasis of wholly incomplete economictheorising. They need to point out to theOECD that the remedy for the alleged ‘harm’

of tax competition lies in the hands of OECDcountries themselves. No offshore financialcentre is preventing any OECD country fromprivatising or implementing ‘user pays’ forsocial insurance. No offshore centre isforcing any OECD country to have a bloatedwelfare state or impose high taxes on labourand capital. No offshore financial centre ispreventing any OECD country from taxingimmobile land and resource rents which areimmune to tax competition.

Vanuatu and other offshore financialcentres have no reason to cut their ownincomes by winding back their services. Asparts of Adam Smith’s ‘invisible hand’ theyserve not only their own, but the world’sinterests, by facilitating the freedom of tradeand investment and the protection ofproperty. Those who seek to eliminateoffshore financial centres might do damageto their own countries were they to succeed.

No doubt, offshore financial centresshould cooperate as good internationalcitizens in combating common criminality.But they should politely decline anysuggestions to harmonise taxes or to assistOECD tax enforcement directly or indirectlythrough any exchange of information.Perhaps some offshore financial centres maybe coerced or bribed by the OECD to join itstax cartel, but, as with all cartels, the fewerthere are outside the cartel the greater theprofits to be had by them. Notwithstandingthe current clouds over offshore financialcentres, it is hard to see anything butincreased demand for their services so longas there is scorn elsewhere for ‘the obviousand simple system of natural liberty’ whichcommended itself to the Physiocrats andAdam Smith (1776:687).

Notes1 These have included the United Nations

report on Financial Havens, Secrecy and MoneyLaundering, the EU Code of Conduct onbusiness taxation and the G7 initiatives

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including the Financial Action Task Force(FATF). Money laundering legislation hasmoved well past drug trafficking to all kindsof ‘economic crime’ such as tax avoidance orevasion as well as securities law evasion oravoidance.

2 See the Parliamentary speeches of WilliamPitt, 1st Earl of Chatham, 14 January 1766and 20 January 1775.

3 The metaphysical subtleties in distinguishingbetween ‘purpose’ and ‘effect’ is wellunderstood by lawyers dealing with generalanti-avoidance statutes.

4 Curiously, Treasury officials have oftendownplayed the influence of taxation oninvestment decisions when arguing againstthe need for industrial countries to cut taxrates in order to compete on tax. Yet that hasnot stopped them from arguing that taxcompetition is a major concern (see Griffiths1994). One might have thought that the twopropositions were mutually inconsistent. Thereality, and the commonsense, of the matterappears to be that taxation is a major, but notthe only, influence on investment locationdecisions. It is generally agreed that taxationdoes affect business location (Papke 1987,1991; Devereux 1992; Industry Commission1996). Tax may not be the most importantdeterminant—factories are not built onremote tax-free islands with no infrastructureand no workers—but tax will always be animportant influence. As David Williamswrites: ‘Tax systems used once almost to besolely decided by a nation. Now even thebiggest economies have tax systems whichare part of the same world economy, andthey are in competition together (1991:34).’There is increasing competition forinternational investment and, with improvedreal time communications and lower tariffs,an increasing ability to move operationsoffshore.

5 The World Trade Organization has ruled thata US policy of granting special tax preferencesto companies that export (foreign salescorporations or FSCs) is a violation of WTOrules. The United States has until 1 October2000 to either change its tax laws or faceretaliatory sanctions that could reach US$6billion annually. Daniel J. Mitchell, a senior

fellow at the Heritage Foundation, aWashington-based public policy researchinstitute has written in the Washington Times(3 January 2000) that the United States couldbest respond to the WTO by repealing theUS tax code’s onerous foreign incomeprovisions and instead shifting to a territorialtax system which would only tax incomeearned inside its borders, making UScompanies more internationally competitive.

6 The threat is clear in Robin Cook’s statementof 17 March 1999 to Parliament introducingthe UK White Paper Partnership for Progress.He said ‘we have to insist on the governmentsof the Overseas Territories fulfilling their [sic]obligations to meet the standards ofinternational organisations in which theUnited Kingdom represents them. There aretwo issues which are of priority in meetingthose obligations. The first is to match thebest international standards in financialregulation…We will therefore be requiringall Overseas Territories, by the end of thisyear, to meet in full international standardson money laundering, transparency,cooperation with law enforcement authorities,and independent financial regulation. Theglobalisation of international finance meansthat we cannot tolerate a weak link anywherein the chain without exposing investorseverywhere to risk. The second area ofpriority is in human rights…Specifically, werequire changes in the law in a minority ofOverseas Territories which retain corporalpunishment and criminalise consensualhomosexual acts in private. Our strongpreference is that the Overseas Territoriesshould enact the necessary reformsthemselves, but we are ready to make suchreforms by Order in Council if they fail to doso.’ It seems the EU view is that there is ahuman right to privacy in sexual, but notfinancial, affairs. It is also interesting that inthe Foreword to the White Paper, Mr Cookstates ‘It will ensure that we put up a commonfront against fraudsters, tax evaders, moneylaunderers, regulatory abuse and the drugstrade. ’The order of listing seems to confirmmore cynical views that, while drug traffickinghas been a convenient excuse to elicitoverseas cooperation, the emerging OECD

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agenda is more tax-driven. Cynics will alsonote: ‘In a recent communiqué, the G7 urgedthe OECD to give particular attention to thedevelopment of a comprehensive programto improve the availability of information totax authorities to curb international taxevasion and avoidance through tax havensand preferential regimes. It also encouragedaction to ensure that suspicious transactionreporting requirements apply to tax offencesand for money laundering authorities to passinformation to tax authorities in support ofthe investigation of tax related crimes in wayswhich would allow it to be sharedinternationally’ (UK 1999:para 5.26).

7 This certainly seems true of many Americanswho suffer from a system of elected judgesand tort juries plus a lot of lawyers searchingfor ‘deep pocket’ defendants.

8 Contrary to David Ricardo’s expectations,many British subjects have moved assets tooffshore havens to escape new laws (whetherarising from law reform or judicial activism)and enjoy old and familiar laws in presentand former British possessions.

9 I am not alone in this view. Sinn (1993:43–44,70) also argues that tax competition isbeneficial for the citizens of the ‘losing’ hightax country. It forces Leviathan governmentsto put their houses in order by cuttingwasteful spending and shifting taxes frommobile to immobile factors of production.Breton (1996) explores how the collusivesuppression of intergovernmental or politicalcompetition tends to make citizens worse offwithout making anyone better off, except thecolluding politicians and bureaucrats.

1 0 One can think of a sovereign competing forsubjects and investment like any othereconomic agent maximising wealth, or of ademocratic government maximising thewealth of its people. In either case, what is tobe maximised is the country’s welfare notsome abstract concept of world welfare. Ifeconomists believe free competitionmaximises group welfare among self-interested individuals, one might expect asimilar result in similar competitive processes.

1 1 For example, it would be strange if a well-run country with no corruption, lowspending and low taxes were seen as a more

‘anti-social’ world citizen than another withcorruption, bloated spending and high taxes.

1 2 From an individual nation’s viewpoint, it isclearly welfare-improving to have somethingrather than nothing. Even Australia exemptsbank interest derived through offshorebanking units by non-residents and is, to thatextent, a tax haven, though the policyamounts to little more than not taxing foreignsource income of non-residents. What thecritics of tax competition have to prove isthat such actions are collectively welfare-reducing and that all nations could do betterby not competing.

1 3 Critics of tax competition may argue another,apparently, closer analogy: that taxcompetition is like competitive exchange ratedevaluation. But tax rates distort the marketequilibrium in the real economy and thereduction of tax wedges between pre andpost tax rates of return on mobile capitalreduces, rather than increases, distortions.

1 4 Even from a narrow nation-state point ofview, tax havens can be beneficial to a largepower. For example, Hines and Rice (1994)point out that tax havens help USmultinationals move profits back into USjurisdiction and the United States collectsmore tax in the end (at the expense of thesource countries).

1 5 Those who stripped companies with inchoatetax liabilities of their assets in the 1970s andsank documents into ‘the bottom of theharbour’ were the most extreme exampleAustralia has seen of large-scale tax evasion.

1 6 The late Professor Wheatcroft, an expert onthe UK capital gains tax, is said to haveremarked that: ‘A tax system breathesthrough its loopholes’. That remarkrecognizes that all taxes on labour and capitalare distorting and, if they can ameliorate theeconomic distortions created by taxation,taxpayers may be contributing to a moreproductive economy, for example, taxpayerself-help before imputation ameliorated thedefects of Australian double taxation ofincome (Head 1997: 65).

1 7 Note that this is only looking at someeconomic benefits from citizens’ tax reductionactivities. The economic benefits to a countryfrom a citizen’s ‘tax reduction fund’ may

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depend more on such factors as whether it isonshore and invested domestically(Australian superannuation funds in the1960s) or offshore and invested in anothereconomy (Latin American flight capital inNew York banks in the 1950s lent to UScompanies) than on whether the ‘taxreduction’ was obtained through legal taxavoidance or illegal evasion. That does notmean the distinction between legal or illegalactivity is irrelevant, since increasing evasionmay have a contaminating effect on publicmorals and respect for the rule of law, withoutwhich no economic activity is possible.

1 8 Bracewell-Milnes neatly controverts severalconventional wisdoms, including the legalversus economic tax avoidance issue. Afterall, which is worse—the oft-deplored legal‘paper’ avoidance which means a factory stilloperates, employing workers andgenerating PAYE and so on, or economic taxavoidance—closing down the factory andrelocating in China? Why is the formerdenounced so strongly and the latterrecognised as a legitimate business decision?And if both forms of avoidance aredenounced with equal force, when will China,Hong Kong, Singapore and dozens of othercountries be seen as anti-social economicthreats to prosperity?

1 9 As equally illogical as to say that taxcompetition which poaches a tax base butnot physical investment is ‘harmful’ yet taxcompetition which snares both is acceptable.

2 0 If a government wants to see income redistri-buted, a global graduated income tax is notnecessary. A government can distribute theproceeds of resource revenues and can allowtax deductions for income transferred to lowincome relatives or to charity. Hong Konghas used low flat-rate taxes and land revenuesto provide large subsidies to public housing.

2 1 The EU has tried to counter tax competitionby prescribing minimum levels of corporateor value-added tax. Minimum withholdingtax rates are under consideration. This is theaction of a tax cartel and the OECD is clearlyheading in the same direction.

2 2 The distinction between lawful tax avoidanceand illegal tax evasion is basic to the rule oflaw. One of the most depressing features of

modern taxation systems is their tendencyto corrupt basic legal principles. The Britishlegal tradition held that all tax legislation is ofits nature penal legislation which takes awaycommon law rights. Since taxes werevoluntary grants by Parliament to the Crownwhich derogated from common law rights,taxing statutes had to receive a strictconstruction. Increasingly, OECD countrieshave tended to rely upon statutory or judicialanti-avoidance doctrines which overturn theprinciple that the subject is not to be deprivedof his property except by clear words (seeCooper 1997). The rule against self-incrimination is routinely ousted in taxadministration. Retrospective tax liabilities areoften created and the onus of proofincreasingly reversed not only in civil taxcollection but also in criminal prosecutions fortax fraud. Lawyer-client privilege is attackedand assets are seized without due process oflaw under a presumption of guilt. Even taxadministrators themselves have sometimesanguished over the legal problems createdby criminalising what was in the past a civildefault (see Howard 1982). More recently,the US House Judiciary Committee andothers have expressed concern over theabuse of forfeiture laws and asset freezingor confiscation ahead of conviction. The merefact that OECD countries have increasinglyabandoned basic legal principles and vitaldistinctions between legal and illegal or civilversus criminal acts is no reason why offshorefinancial centres should follow suit byallowing tax matters to come under treatiesdealing with mutual assistance in criminalmatters. On the contrary, this is a reason forstronger adherence to the traditionalcircumspection on enforcing foreign revenuelaws (a circumspection which can also applyin federations—State death duties could notbe enforced against executors in other Statesin Australia). Offshore financial centres andtheir citizens are simply not subject to the taxlaws of the OECD countries, just as Americansare no longer subject to UK revenue lawsnor under any legal or moral obligation toassist the UK Treasury.

2 3 This is particularly obvious in the UnitedNations Political Declaration and Action Plan

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against Money Laundering adopted at theTwentieth Special Session of the UnitedNations General Assembly devoted to‘countering the world drug problemtogether’ New York, 10 June 1998. Drugs arethe ostensible focus of concern but theproposals on money laundering go muchfurther. Offshore financial centres may rightlyinsist that any financial regulation orreporting they choose to implement belimited to international drug traffickingmatters.

2 4 Some (perhaps many) would argue thatprivacy, including bank secrecy orconfidentiality of personal or business affairs,should given way to the need to investigatecriminal activity.

2 5 Australia pioneered instantaneous electronicreporting of financial transactions as part oflaw enforcement and made this facilityavailable not just to police combating thedrug trade but also to taxation officials.Several hundred public servants now haveonline access to the financial data ofAustralian residents. One suspects thatallegations of Internet crime are going to beused (conveniently) to facilitate a furtherenhancement of bureaucratic powers inmany countries.

2 6 The attitude of most people may be close toWill Rogers’ remark that the income tax hasmade more liars out of the American peoplethan golf. There is a certain inconsistencysometimes observed in the attitudes ofordinary people. Small scale tax evasionthrough false declarations by ordinarypeople is commonly condoned while legal,but large scale, tax avoidance is commonlycondemned. The inconsistency of moraljudgment seems only explicable by the factthat most people consider taxation itself asoften arbitrary, unjust and immoral. AsCoffield (1970) points out, the growth oftaxation tends to corrupt public morals,inflame envy and bring the law intodisrepute. Nor does it seem to make muchdifference whether the tax laws are enactedby a monarchy or a democracy. No one whohas taken notes of Cabinet deliberationswould pretend that laws always reflectwisdom or justice. There are actions now

legal which used to be proscribed (adultery)and vice versa. The real reason for obeyingpositive law is often more a sense of moralself-respect, see Adam Smith’s Theory of MoralSentiments.

2 7 A question not asked by Jeffery (1999).2 8 The post-War ‘brain drain’ to the United

States from the United Kingdom cost theUnited Kingdom dearly.

2 9 That economic rent can even be increased bytaxation if the proceeds are spent on usefulpublic works or to remove taxes on labouror capital which will move in to use the land.See Mieskowski and Zodrow (1989) on this‘Henry George’ theorem, of which HongKong has afforded some demonstration (seeRabushka 1979:62).

3 0 Australia and New Zealand pioneered taxeson unimproved land values. New SouthWales shifted to unimproved land rating in1906 and gradually overtook Victoria (whichdid not) in population and wealth. TheAustralian Capital Territory was establishedon a leasehold tenure basis so that it wouldbe self-financing without taxes. But bothcountries have forgotten their history andtheir land taxes have been wound back infavour of higher income and consumptiontaxes. In the ACT, leases have been renewedfor trivial payments and taxes put up instead.Australians never ask themselves why, witha resource endowment per capita among thehighest in the world, they cannot successfullycompete internationally on business taxes byshifting to land and resource taxes.

3 1 The view that all income should be taxed atgraduated rates regardless of its source is acommon, if not the prevailing, view amongeconomists. Despite its popularity, it isessentially an ethical, not an economic, viewand only one of several possible ethicalviews. At bottom it rests on utilitarianconcepts, whether expressed through socialwelfare functions, including Rawlsianmaximin functions or through older ideas ofdiminishing marginal sacrifice. As an ethicalview, countries and individuals are free toreject it in favour of what they might considermore compelling ethical views. For example,many offshore financial centres rely onimport duties and tourist luxury taxes as a

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mix of a basic flat rate tax on inhabitants plusa windfall from foreigners. But other ethicalviews are possible. One could, for example,take a natural rights view of revenue raisingas did the French Physiocrats: one could arguethat the sovereign should collect the rent ofland as a method of discharging the Lockeanproviso that land can only be appropriatedby one man against another so long as theother is compensated. Thus a Henry Georgeor even a John Stuart Mill might argue thathe has no objection to media tycoonsminimising their tax payments according tolaw but he would rather condemn anypolitician who chooses to endow any personwith valuable common property such asspectrum rights without charging full marketrental annually. A fair price, not a tax, wouldbe the cry of such a natural rights theorist,and he would have the support of ancientParliamentary tradition. But one does nothave to agree with this ethical view, to realizethat a Brunei or a Saudi Arabia is quite withinits sovereign rights in raising revenue solelyfrom selling or leasing its natural resources(after all, Adam Smith started his discussionof the sovereign’s revenues with land). Apolicy of looking first to resources forrevenue also happens to allow reduction ofeconomic distortions since one can reducelabour and capital taxation: Hong Kong’s lowtax rates would not have been possiblewithout its land revenues. But whateverethical view one takes, the OECD cannotlegitimately complain about countries whichtake a differentiated or schedular approachto income taxation (as have the Scandinaviancountries). If, for example, Brunei does notcollect a personal income tax for itself whyshould it be expected to assist other countriesenforce their residence-based income taxeswithin Brunei’s territory?

3 2 In reality, there is no such thing as an incometax. As Adam Smith recognised, a tax onincome is three taxes—a tax on the wages oflabour, a tax on the rent of land and a tax onthe profits of capital.

3 3 By having a zero tax rate on interest income,Hong Kong to a large extent exempts thatpart of capital income which represents ariskless rate of return.

3 4 The OECD complaint that tax competitionforces a shift in tax burden from (mobile)capital to (immobile) labour not only ignoresthe possibility of taxing land or other naturalresources but it also sounds rather oddcoming from European countries which havewillingly raised social security payroll taxesand value-added taxes to extremely highlevels.

3 5 Australian Financial Review editorial 30 June1997.

3 6 ‘Arguments for creating a level playing fieldare troublesome at best. International tradeoccurs precisely because of differencesamong nations—in resource endowments,labour skills and consumer tastes. Nationsspecialize in producing goods and services inwhich they are relatively most efficient. In afundamental sense, cross border trade isvaluable because the playing field is notlevel…Taken to its logical extreme, the notionof leveling the playing field implies thatnations should become homogeneous in allmajor respects…[but the] core of the idea ofpolitical sovereignty is to permit nationalresidents to order their lives and property inaccord with their own preferences. ‘ Tanzi(1995, preface pxvii)

3 7 Douglass North (1995:32) also argues thatEuropean development profited frominstitutional competition between competingnation states.

3 8 The US exempts interest on bank deposits ofnon-resident aliens. Indeed, the US has servedas a tax haven for capital from Latin America,see McLure (1989).

3 9 For its part, Australia acknowledges that itcannot necessarily tax foreigners on theircapital income and imposes no interestwithholding tax on widespread foreignborrowings such as Eurobonds.

4 0 Although it is treated as axiomatic by manywriters that foreign income should be taxed,it is not clear that this is so. Suppose, forexample, another country raises all its taxrevenue through consumption or payrolltaxes. The idea that a dividend from thatcountry represents untaxed income issomewhat naive. Further, unless that foreigncountry supplies the same level of publicservices to an investor in return for low or

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no taxes, one cannot assume that taxing theinvestor at home produces a neutral result.For example, a company operating in Liberiamay pay no tax but would be spendingconsiderable amounts of money onproviding the sort of physical protectionwhich home taxes would provide. There isthus both pragmatic and theoreticaljustification for the policy adopted by morethan a few Asian, European and LatinAmerican countries of excluding foreignincome from the tax base. Interestingly, theUS has spent the most effort over the yearstrying to tax foreign income, but at the sametime invented foreign sales corporations totry to mitigate the adverse effects onAmerican exports! The US may get no taxrevenue from its foreign tax regime becausethe US credits foreign taxes and allows activeincome of subsidiaries to remain untaxed(Grubert and Mutti 1995). The use by UScompanies of low rate havens may evenenhance US tax collections (Hines and Rice1994). A territorial system of internationaltaxation of business income has beensuggested for the US (Hufbauer 1992:135–136). The tax-writing committee in the Houseof Representatives is considering a Bill toreplace the corporate income tax (and thebusiness parts of the personal income tax)with a business transfer tax that would beterritorial. This may not happen, but theWorld Trade Organization decision that theUS Foreign Sales Corporations were inbreach of WTO rules has created a new USappreciation for territoriality (though part ofthe motive for the Bill is border-adjustabilityfor indirect taxes).

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Acknowledgements

The author wishes to thank those from privatesector, academic and government sectorswho have commented on an earlier draft butaccepts sole responsibility for errors whichreaders may draw to his attention.