Tax Haven Myths vs. Facts

Tax Haven Myths vs. Facts

Politicians from high-tax nations as well as international bureaucracies such as the Organization for Economic Cooperation and Development (OECD) want to stamp out low-tax jurisdictions.

Today, we’re going to puncture some anti-tax-haven myths.

Myth #1: Tax havens result in $100 billion of unpaid taxes.

In short, this is a phony number.

Some politicians in Washington want to dramatically increase the power of the IRS, claiming that this is the only way to collect the $100 billion that supposedly is hiding in low-tax jurisdictions.

Now, a few American taxpayers doubtlessly have some money hidden offshore, but the IRS, which has a big incentive to bash tax havens, estimates that the overwhelming share of the so-called tax gap is the result of what happens in the United States.

Part of that $100 billion make-believe number apparently comes from a former John Kerry staffer who concocted an estimate of $70 billion in unpaid individual income taxes, but when the Congressional Research Service (CRS) asked for the methodology used to generate the number, the former Kerry staffer confessed that he basically made it up. According to the CRS memo, he wasn’t able to send a written discussion of his estimating procedure, and he indicated that the estimate was an uncertain one. That’s the understatement of the century.

Myth #2: Cracking down on tax havens is the best way to improve compliance.

Politicians from high-tax nations and bureaucrats at the OECD claim that offshore jurisdictions deprive politicians of much-needed tax revenue. This assertion is rather strange, since tax receipts have been near record levels in OECD nations, but let’s directly address the issue of how best to improve tax compliance.

Academic research strongly indicates that the biggest factor in tax compliance is tax rates. When tax rates are excessive, people are less likely to obey the law, and if they can’t protect their income using tax havens, they will utilize the domestic underground economy—or they will be less productive and earn less income.

The world’s leading expert on the issue, Friedrich Schneider at the Johannes Kepler University in Austria, explains that income taxes and payroll taxes are the main causes for the existence of the shadow economy. The bigger the difference between the total cost of labor in the official economy and the after-tax earnings from work, the greater the incentive to avoid this difference and to work in the shadow economy. If politicians really want to improve tax compliance, they should lower tax rates.

Myth #3: Tax havens lead to higher taxes for ordinary people.

This is the notion that low-tax jurisdictions reduce taxes on sneaky people, and this causes politicians to raise taxes on other people to make up the difference. But if this were true, increases in the amount of money flowing to tax havens should be accompanied by higher tax rates, yet the evidence shows just the opposite.

As cross-border financial flows have skyrocketed, tax rates on both personal and corporate income have dropped significantly.

Here’s an analogy that shows why this just makes sense. Imagine that there’s one gas station in a town, and it charges high prices. But then a new gas station opens up. It charges lower prices and attracts customers from the other gas station. Would it make sense for the other gas station to raise prices even further to make up for the lost customers? The answer, of course, is no. Higher prices would simply cause more customers to shift to the new gas station. The same thing is true for governments. Politicians are lowering tax rates because of competition from tax havens. So tax havens lead to lower tax rates for the average person because of tax competition.

Myth #4: Tax havens promote bad tax policy.

If there were a prize for the most absurd myth, it would certainly be this argument from the OECD.

The Paris-based bureaucracy has asserted that tax havens and tax competition distort the location of capital and services and that they induce potential distortions in the patterns of trade and investment and reduce global welfare.

Now, not surprisingly, the OECD offers zero evidence of any kind for this laughable assertion.

In reality, tax competition improves global welfare in two ways.

First, the shift of economic activity to low-tax countries keeps resources in the productive sector of the economy rather than under the control of politicians; this means that those resources are allocated on the basis of market forces instead of special-interest deal-making.

Second, and perhaps more important, tax havens and tax competition lead to lower tax rates, which unambiguously boosts economic performance, according to almost all research.

Myth #5: Tax havens are rogue regimes.

If you listen to politicians and bureaucrats, you would think that low-tax jurisdictions are lawless places… the fiscal equivalent of the Wild West.

But are tax havens unstable rogue regimes?

A bit of common sense exposes the silliness of this assertion. If you had a lot of money, would you invest it someplace that was poorly governed? Of course, the answer is no.

Academic research shows that low-tax jurisdictions are among the best-governed and most honest places on the planet. But let’s not rely on academic research. Let’s go straight to the World Bank’s governance indicators.

Now, nobody has ever accused the World Bank of being a hotbed of free-market thinking, so we can safely assume these governance indicators were not rigged to paint tax havens in a positive light.

Yet from the World Bank’s data, the world’s leading havens have extremely high ratings on government effectiveness, regulatory quality, rule of law, and control of corruption. Indeed, they generally score higher than the big nations in Europe that are leading the OECD campaign. They usually even get better scores than the United States.

Myth #6: Tax havens are money-laundering centers.

Critics of low-tax jurisdictions routinely smear them as being hotbeds of dirty money, yet all the objective evidence shows that they have the toughest rules against money laundering.

Not a single tax haven, for instance, is on the black list of the Financial Action Task Force.

Now, a few tax havens are considered money-laundering centers, according to the Central Intelligence Agency (CIA), but there are far more non-tax havens on the CIA list. Likewise, the State Department says that a handful of havens are jurisdictions of primary concern for money laundering, but once again, there are many, many more non-tax havens on the list.

It is also worth noting that every major tax haven has been cleared by the IRS for having good “know your customer” laws to hinder dirty money; all the major havens also are members of the Egmont Group, which is only open to jurisdictions that have effective financial intelligence units to fight money laundering.

None of this should be a surprise. Tax havens are very sensitive to reputation risk. If it’s discovered that a drug dealer or terrorist used a bank in New York or London, that doesn’t really hurt the image of the US or the UK, but such a revelation would be crippling to a tax haven’s reputation, so they have a big incentive to keep their financial centers clean.

Moreover, the notion that bad guys would seek out tax havens is a bit fanciful. Dirty money generally is laundered where it’s obtained, and criminals avoid taking it offshore since that creates a trail for investigators. Indeed, even the United Nations—which is on the wrong side of all these issues—acknowledged that going offshore doesn’t make sense for crooks since it raises a red flag.

Dan Mitchell is an economist and senior fellow at the Cato Institute. He’s a strong proponent of tax competition, financial privacy, and fiscal sovereignty. You can read his blog here.

Tags: tax haven, austrian economics,