Tax Havens,Growth, and Welfare

This paper develops an endogenous growth model featuring tax havens, and uses it to examine how the existence of tax havens affects the economic growth rate and social welfare in high‐tax countries. We show that the presence of tax havens generates two conflicting channels in determining the growth effect. First, the public investment effect states that tax havens may erode tax revenues and in turn decrease the government's infrastructure expenditure, thereby reducing growth. Second, the tax planning effect of tax havens reduces marginal cost of capital and hence encourages capital accumulation so as to spur economic growth. The overall growth effect is ambiguous and is determined by the extent of these two effects. The welfare analysis shows that tax havens are more likely to be welfare‐enhancing if the government expenditure share in production is low, or the initial income tax rate is high. Moreover, the welfare‐maximizing income tax rate is lower than the growth‐maximizing income tax rate if tax havens are present.     

The demand for tax haven operations

What types of firms establish tax haven operations, and what purposes do these operations serve? Analysis of affiliate-level data for American firms indicates that larger, more international firms, and those with extensive intrafirm trade and high R and D intensities, are the most likely to use tax havens. Tax haven operations facilitate tax avoidance both by permitting firms to allocate taxable income away from high-tax jurisdictions and by reducing the burden of home country taxation of foreign income. The evidence suggests that the primary use of affiliates in larger tax haven countries is to reallocate taxable income, whereas the primary use of affiliates in smaller tax haven countries is to facilitate deferral of U.S. taxation of foreign income. Firms with sizeable foreign operations benefit the most from using tax havens, an effect that can be evaluated by using foreign economic growth rates as instruments for firm-level growth of foreign investment outside of tax havens. One percent greater sales and investment growth in nearby non-haven countries is associated with a 1.5 to 2% greater likelihood of establishing a tax haven operation.     

Tax competition with parasitic tax havens

We develop a tax competition framework in which some jurisdictions, called tax havens, are parasitic on the revenues of other countries, and these countries use resources in an attempt to limit the transfer of tax revenue from capital taxation to the havens. We demonstrate that the full or partial elimination of tax havens would improve welfare in non-haven countries. We also demonstrate that the smaller countries choose to become tax havens, and we show that the abolition of a sufficiently small number of the relatively large havens leaves all countries better off, including the remaining havens. We argue that these results extend to the case where there are also taxes on wage income that involve administrative and compliance costs.     

A journey from a corruption port to a tax haven

We sketch a model according to which tax havens attract corporate income generated in corrupted countries. We consider the choice of optimal bribes by corrupt officials and the share of the proceeds of corruption that will be concealed in tax havens. Our framework provides novel welfare implications of tax havens. First, tax havens’ services have a positive effect on welfare through encouraging investment by firms fearing expropriation and bribes in corrupt countries. Second, by supporting corruption and the concealment of officials’ bribes, tax havens discourage the provision of public goods and hence have also a negative effect on welfare. The net welfare effect depends on the specified preferences and parameters. One source of this ambiguity is that the presence of multinational firms in corrupted countries is positively associated with demanding tax havens’ operations. Using firm-level data, we provide new empirical results supporting this hypothesis.     

Taxing multinationals: The scope for enforcement cooperation

Policymakers seeking to raise more tax revenues from multinational enterprises have two alternatives: to raise tax rates or to devote more resources to improve tax compliance. Tougher tax enforcement increases the cost of profit shifting, and thus mitigates tax competition. We present a tax-competition model with two policy instruments (the corporate tax rate and the tightness of tax enforcement). In line with the Organisation for Economic Cooperation and Development's Base Erosion and Profit Shifting project, we analyze the scope for enforcement cooperation among asymmetric countries, considering that taxes are set noncooperatively. We show that the low-tax country may fail to cooperate if asymmetry is large enough and that tax havens would never agree to cooperate. Then we identify two drivers for enforcement cooperation. The first driver of cooperation is the complementarity of enforcement actions across countries. This is because the efficiency loss from enforcement dispersion is greater under complementarity. The second driver of cooperation is tax leadership by the high-tax country, which acts as a level-playing field in the tax competition and reduces the extent of disagreement on enforcement.     

Optimal Thin Capitalisation Rule in a Simple Endogenous Growth Model with Tax Havens

In this paper we study the optimal thin capitalisation rules by developing a simple dynamic general‐equilibrium growth model incorporating tax havens. It is found that a stricter thin capitalisation rule will reduce the incentive to invest, and is therefore harmful to growth. This effect is ignored in previous static studies on the welfare analysis of tax havens. Accordingly, when taking the growth effect into consideration, reducing the utilisation of tax havens has ambiguous effects on social welfare. We also show that a looser thin capitalisation rule could be favourable for the policymakers if (i) the production technology is high; (ii) the existing income tax rate is high; (iii) the rate of time preference is low; or (iv) the weight factor of public consumption in utility is small.     

Fairness in tax compliance: A political competition model

This paper analyzes the political economy of income redistribution when voters are concerned about fairness in tax compliance. We consider a two‐stage model where there is a two‐party competition over the tax rate and over the intensity of the tax enforcement policy in the first stage, and voters decide about their level of tax compliance in the second stage. We find that if the concern about fairness in tax compliance is high enough, a liberal middle‐income majority of voters may block any income redistribution policy. Alternatively, we find an equilibrium in which the preferences of the median voter are ignored in favor of a coalition formed by a group of relatively poor voters and the richest voters. In this equilibrium income redistribution prevails with no tax enforcement.     

Political economy of cross-border income shifting: A protection racket approach

Multinational firms often shift their incomes to low-tax jurisdictions, thus robbing host states of tax revenue. I offer a new theory to explain why some firms do this while others do not. I argue that firms that are more vulnerable to government expropriation are, counterintuitively, less likely to shift income offshore, since complying fully with tax law gives the government a greater stake in their survival. Analyzing a registry-based panel data on multinational firms, their tax burdens, and a cross-sectional information of the firms’ connections to tax havens, l find that, other things equal, firms with more concentrated fixed assets are less likely to use havens. These results challenge existing theories of the political economy of development. Whereas the “Pillars of Prosperity” theory suggests that successful states simultaneously develop protection of property rights and fiscal capacity, my results show that perfect property rights protection can actually undermine the state’s ability to tax.     

Profit-shifting from Czech multinational companies to European tax havens

Although tax havens have been affecting other countries for decades, only in recent years have the associated challenges been subject to intensive scrutiny in both research and policy areas. We contribute to the growing evidence of corporate tax base erosion and profit-shifting by testing multinational companies’ ownership links to individual tax havens rather than to groups of them, as is the case with most previous research. Our company-level analysis suggests that profit shifts through debt financing from the Czech Republic to Luxembourg, Switzerland and, to a lesser extent, the Netherlands. We have ascertained that tax havens are not limited to tiny islands and may actually be found among European countries. We also provide rough estimates of the impact of this profit-shifting on tax revenues as well as a policy recommendation.     

How much profit shifting do European banks do?

This paper studies whether and to what extent the largest and systemically relevant European multinational banks engage in profit shifting to lower their tax burden. We exploit unique data on bank operations reported on a country-by-country basis since 2015 in compliance with European legislation. The dataset contains information on profits, turnover, taxes paid and employment of bank affiliates worldwide, including tax and regulatory havens. In our empirical model, profits shifting incentives are captured through a weighted average of international tax rate differences between all countries where the bank is active. We find that international tax differences trigger the geographical distribution of profits within multinational banks, and that low tax jurisdictions, notably tax havens, attract disproportionately high profits. Our results suggest that, overall, 21% of profits is shifted. Moreover, profits in tax havens are 51% higher than they would be without tax-motivated profit shifting, pointing to a significant reduction of tax bases in high-tax countries.     

Tax Enforcement Policy and the Provision of Public Goods with the Presence of Tax Havens

A tax competition model is presented to investigate the effects of tax havens on the public good provision. We show that when countries facing a rise in tax havens change their tax enforcement strategies in response, the existence of tax havens may result in a higher level of equilibrium public good provision as compared to the case with no tax havens. Accordingly, tax havens could be welfare enhancing for non‐haven countries. This result offers a possible explanation for the recent empirical evidence that the corporate tax revenues in high‐tax countries have actually increased with the growth in the flow of foreign direct investment to tax havens.     

The costs of tax havens: evidence from industry-level data

ABSTRACT

Multinational enterprises make use of tax havens to avoid paying corporate income taxes and this costs 100 billion USD and more in lost government revenue worldwide according to an increasing number of recent studies. None of those studies assigns these costs to industries. I aim to shed more light on this gap by using some of the best available industry-level US data to determine to what extent the location of the MNEs’ profit is aligned with the location of their economic activities. My first finding is that the most important tax havens for US multinational enterprises are the Netherlands, Ireland and Luxembourg (all EU member states). Second, I systematically identify the specific industries in specific tax havens responsible for the costs, which should be useful information for tax authorities aiming to reduce tax avoidance. Finally, I argue that the current data are not detailed enough to provide a reliable industry breakdown of the costs, but the prospect of combining input-output tables with forthcoming country-by-country data seems more promising.     

税收、收入不平等和内生经济增长

企业家(通过金融中介)从家庭借贷来支撑创新。二者在企业家的努力不为外人所见的情形下双方签订信用合同分享创新带来的垄断利润(即蛋糕)。两个有代表性经济人(企业家和家庭)的存在允许人们在内生经济增长模型里研究收入不平等。本文研究发现,企业家分配份额的增加一开始会提升增长速度,但是过了一定值后会拉低增长速度;而该份额的增加一直拉大企业家和工人间的收入差距。所以降低企业家获得的蛋糕的份额的分配改革可缩小收入差距。提高企业家来自创新的收入的税率将降低他们的努力程度,从而降低增长速度,但是该税率的提高有助于降低收入不平等程度。存款收入的税率提高尽管不会改变企业家的努力程度,但是也会降低经济增长速度,而且不会降低收入不平等(如果工人有一定比例的存款)。对于劳动收入(工人工资)的税率增加会加剧工人和企业家间的收入不平等,但对经济增长速度没有影响。     

Which countries become tax havens?

This paper analyzes the factors influencing whether countries become tax havens. Roughly 15% of countries are tax havens; as has been widely observed, these countries tend to be small and affluent. This paper documents another robust empirical regularity: better-governed countries are much more likely than others to become tax havens. Controlling for other relevant factors, governance quality has a statistically significant and quantitatively large association with the probability of being a tax haven. For a typical country with a population under one million, the likelihood of a becoming a tax haven rises from 26% to 61% as governance quality improves from the level of Brazil to that of Portugal. Evidence from US firms suggests that low tax rates offer much more powerful inducements to foreign investment in well-governed countries than do low tax rates elsewhere. This may explain why poorly-governed countries do not generally attempt to become tax havens, and suggests that the range of sensible tax policy options is constrained by the quality of governance.     

Lobbying and the international fight against tax havens

Despite a variety of measures taken by high‐tax countries, the international fight against tax havens so far remains rather ineffective. This paper introduces offshore lobbying as a possible explanation for this observation. The author analyzes the international fight against tax havens in a two‐country model, in which the onshore country exerts pressure on domestic profit‐shifting firms and the tax haven's government lobbies against this measure. In this framework, he finds that pressure and lobbying are strategic substitutes and that there is an extensive margin incentive for offshore lobbying. Furthermore, when starting at initially high costs for profit shifting, a reduction in these costs leads to fewer profit‐shifting firms. Finally, when allowing for a second low‐tax jurisdiction, the overall level of lobbying increases, but less than proportionally.     

Information-eliciting compensation schemes

This paper examines the implications of the ‘residence’ approach to taxing foreign source income such as employed by the United States. It is argued that, because the repatriation of earnings to the home country investor and not the earnings themselves are typically the source of tax liability, the foreign source income tax should affect foreign investment differently depending on the required transfers of funds within the firm.One implication of viewing the tax in this way is that in order to maximize after-tax profits, a firm should finance its foreign investment out of foreign earnings to the greatest extent possible. That is, a firm's required foreign return jumps at the point at which desired foreign investment just exhausts foreign earnings. This allows us to draw a distinction between ‘mature’ foreign operations, which are at any point in time financed at the margin by investing earnings (and perhaps also pay dividends to their parent firm in the home country), and ‘immature’ foreign affiliates, which rely on funding from their parents (and should not be paying dividends). It is noted that survey evidence on multinational firm behavior is consistent with this distinction. Direct investment data indicate that mature foreign operations probably account for nearly 90 percent of U.S. foreign direct investment.The discussion then turns to investment incentives. It is shown that the home country's rate of tax on foreign source income and the presence or absence of a foreign tax credit should be irrelevant to a mature foreign operations's investment and dividend decisions. This conclusion, which conflicts sharply with the conventional wisdom, follows because the home country tax acts as an unavoidable cost. New firms' investment decisions are, on the other hand, influenced by home country taxes.     

VOTER PREFERENCES FOR TRADE POLICY INSTRUMENTS*

We analyze voter preferences for tariffs and production subsidies. The distribution of tax revenues argument shows that voters with high direct tax burdens prefer tariffs to subsidies. The uncertainty argument demonstrates that if actual tariff and subsidy rates are chosen from the set of individually optimal rates then the range of tariff rates is smaller than the range of subsidy rates. Thus, tariffs might be preferred even though they are less efficient. Finally, the large country argument shows that if a country is large then voters whose income shares decline with more protection prefer tariffs to subsidies.     

Company tax reform with a water's edge

This paper analyzes the effects of switching from a corporate tax system based on separate accounting (SA) towards a system in which two countries form a formula apportionment (FA) union while a third country sticks to SA (water's edge). Our analysis draws a positive picture on the water's edge regulation. In the short-run, for given tax rates, the transition from SA to FA is likely to reduce profit shifting from the FA union to non-FA tax havens. In a long-run tax competition analysis, we find a negative water's edge externality under FA that tends to be less detrimental than the profit shifting externality under SA and may offset other externalities under FA.     

A positive model of overlapping income taxation in a federation of states

This paper develops a positive theory of overlapping income taxation in a federation of states. The analysis provides a complete characterization of the equilibrium federal and states tax rates as functions of the level of total productivity dispersion between the states. The federal rate is increasing in the level of total productivity dispersion between the states, even if the income of the decisive voter at the federal level is above the mean income. Given that the individuals' income is endogenously determined there exists a negative trade-off between the implemented federal tax rate and the resulting states' tax rates, regardless of the pre-tax income of the decisive voter at the state level. Thus, high levels of productivity dispersion between the states cause a higher than optimal federal tax rate together with low states' tax rates. It is also shown that a system of overlapping income taxation is not efficient. The resulting inefficiency might be exacerbated by the implementation of a federal matching grants program, contradicting previous results in the related normative literature.     

Impact of electoral competition,swing voters and interest groups on equilibrium policy platforms: Exploring the strategic forces at work

This paper constructs a stylized model of election between two opportunistic candidates who can influence equilibrium policy platforms in exchange for monetary contributions provided by two distinct lobby groups. Two key features are embedded which give rise to a dual uncertainty in the model: the existence of partisan spread across voter groups as well as the embezzlement of campaign funds received by the electoral candidates from the interest groups. We derive and compare the equilibrium platforms of the two office-seeking candidates in three scenarios: none of the above uncertainties exist (benchmark case), only uncertainty about voters’ preferences exist (swing-voter case), and both the uncertainties exist (swing voters and lobby groups case). We find that an opportunistic candidate’s swing-voter tax platform is always lower than the benchmark tax platform. Additionally, the equilibrium tax choice of electoral contenders in the swing voters and opposing lobby groups case is found to be greater than the tax level chosen under the swing-voter case if the lobby group advocating a greater level of tax is sufficiently well-organized such that it outweighs the relative swing-voter effect in that group. Furthermore, we find that when an electoral candidate transitions from being highly corrupt to becoming relatively more honest, the equilibrium level of public good provision adjusts in conformity with the well-organized group’s economic preferences. Finally, if the strength of relative lobbying effect is weaker, a lower partisan bias within that group induces an electoral candidate to choose a tax platform closer to that group’s policy bliss point.