Turn down the heat, switch on the light: a rational analysis of tax havens, tax policy and tax politics

Tax havens are essential to maintain a healthy economy, limit the overall tax burden and improve efficiency in financial markets.

Turn down the heat, switch on the light, published today by the Institute of Economic Affairs, highlights the benefits of tax havens globally. The author argues that political pronouncements vilifying companies for avoiding tax lack any honesty – or understanding – that the issue at the heart of the current debate, tax competition, results from the actions of governments and not corporations.

This is unacceptable hypocrisy on the part of politicians. The government must recognise the importance of tax havens and stop simultaneously talking about the need to encourage business whilst also deriding tax havens and companies that use existing tax rules to minimise their tax bill.

The importance of tax havens for the economy:

• Punitive action on tax competition would damage growth.Without tax havens, big businesses would move away from the UK. If tax havens could not be used by multinational corporations in the UK, then a single rate of corporate tax would have to be set. If set too low, then corporations’ contribution to the overall tax take would fall. If too high, then business would move overseas, damaging the overall economy.
• Tax havens play a key role in limiting the tax burden. The existence of tax havens, coupled with high mobility of capital, means governments are constrained in the tax rates they could otherwise apply – crucial for both wealth and job creation.
• Tax havens improve efficiency and liquidity in financial markets.Without tax havens, many innovative products would be stifled by punitive tax regimes. Offshore tax havens allow the UK to make the most of its comparative advantage in financial services and avoid potentially damaging double or triple taxation on investment returns.
• The levels of tax paid by multinationals currently are a direct consequence of the way the government’s own tax rules:
• The target of attracting mobile capital into the UK has been a constant tax policy of successive Chancellors. In the next two years corporate tax receipts will fall to their lowest level since 1984/85.
• The UK government has not only reined in the impacts of its own anti-tax haven rules, but also introduced a special regime for the taxation of income from patents – the ‘Patent Box’ – to allow mobile forms of income to be taxed more lightly. This will reduce tax revenue by £720 million in 2014-15. There are also other special allowances designed to reduce taxes for certain types of business.
• Politicians either do not understand that corporate tax policy in the UK is part of process of tax competition – meaning a worrying lack of grasp of sound economics – or they are displaying an astounding level of hypocrisy, heaping blame on corporations to score political points.

Commenting on the research, Professor Philip Booth, Editorial Director at the Institute of Economic Affairs, said:

"The present furore about tax havens has generated more heat than light. Politicians of all stripes are playing a dangerous game vilifying businesses for taking advantage of the tax systems that they themselves designed. British politicians can therefore hardly complain when other countries do the same and when businesses take advantage of those rules.”

Summary

• Tax havens have existed for many centuries and are certainly not limited to ‘sunny places for shady people’ as suggested by Vince Cable.
• The Netherlands, Luxembourg, Belgium and Switzerland all have some of the characteristics of tax havens.
• There are many senses in which the UK has become a leading tax haven given the effect of government’s policy in recent years, and particularly over the last ten years or so. Criticism by UK politicians of tax havens in the context of the UK’s own declared policy is hypocrisy.
• Much of the recent controversy has surrounded payments for intellectual property. There are some important issues here which require serious attention. Much of the value in modern companies is added by intellectual property, patented processes and brands. The profits generated by such brands do not necessarily belong in the countries in which sales take place. Given their nature, there is always going to be room for dispute as to how payments out of the UK for intellectual property should be determined; however, there would be little change in the UK tax base if such intellectual property were not located in tax havens.
• International action on tax havens is bound to be influenced by political rather than economic criteria and is therefore likely to be extremely unsatisfactory.
• In fact, tax havens bring many benefits to countries – including to high-tax countries. High-tax countries can attract mobile capital if tax havens can be used to reduce the overall rate of tax paid by those who control that capital. Without tax havens, high-tax countries would have to either lower the tax charged on all capital (mobile and immobile) with the subsequent loss of revenue or put themselves in a position where they could not attract any mobile capital which would flow to low-tax countries.
• Tax havens facilitate international fund management business - particularly in the form of collective investment vehicles (used to pool and invest the capital of investors) which could otherwise be subject to  tax at the level of the pooling vehicle (even though the investors themselves may be subject to tax on the income derived in their home jurisdiction). As such, tax havens allow the financial services industry - including that of the UK - to provide services globally without triggering unintended and potentially penal rates of taxation.
• Tax havens facilitate the creation of financial products that improve efficiency and liquidity in financial markets, including for retail investors. Without tax havens, many innovative products might be stifled by penal tax regimes.