The Never-Ending Assault on International Financial Centres

International Funds ConferenceCayman Islands, January 14, 2010

Issues to Discuss

Why is the “offshore” world being attacked?Why do the goal posts keep moving?The “practical” reason the attacks will never end.The “ideological” reason the attacks will never end.

There Is a Simple Explanation

Asked why he robbed banks, Willie Sutton remarked, “that’s where the money is.”Some – if not most – politicians have the same attitude about “tax havens.”

America’s Dismal Fiscal Situation

In just eight years, President Bush increased the budget from $1.8 trillion to $3.5 trillion.President Obama promised “hope and change,” but is doing the same thing.In his first few months, $800 billion of so-called stimulus.Hundreds of $billions of new spending in his first budget.Government-run health care?!?

Catching Up to Europe?Today, the burden of the federal government is about 26 percent of GDP, up from 18.5 percent of GDP when Clinton left office.The “good news” is that spending is artificially high because of financial sector bailouts and the recession, meaning the “baseline” level of federal government spending is about 23 percent of GDP. The depressing news is the long-run budget outlook.

The Federal Government Has Been Growing...

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The Calm Before the Storm

Because of Social Security, Medicare, and Medicaid, federal spending is projected to jump from 22 percent-plus of GDP today to 45 percent-67 percent of GDP after the baby boom generation is fully retired. State and local governments will consume – at a minimum – another 15 percent of GDP.America’s welfare state will be bigger than what France has today.

…But Soon Will Explode

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Battling the CEN IdeologyOpponents of tax competition and “tax havens” are motivated by an ideological belief in the theory of capital export neutrality (CEN), which holds that all tax planning (avoidance or evasion) must be eliminated. According to the theory, economic efficiency is maximized when people make decisions in a world of identical tax rates.At the very least, this requires worldwide taxation.

The Added Problem of Haig-Simons

The Haig-Simons theory of taxation presumes it is good to double tax income that is saved and invested. In other words, tax both income and changes in net worth.This requires tracking capital, not only domestically but also internationally.To be comprehensive, the Haig-Simons system requires worldwide taxation.

Threats from the United StatesA rejuvenated OECD anti-tax competition campaign, particularly with Democrats controlling Congress and the White House.American support for expanded savings tax directive.Anti-tax haven legislation in the US, such as the Levin/Obama proposal and Dorgan/Obama proposal.

Obama’s Demagoguery

More than 12,000 companies are registered at Ugland House, and Obama says it is “either the biggest building in the world or biggest tax scam in the world.”

Cayman Islands vs. Delaware

The OECD’s New Offensive

At the recent Global Tax Forum in Mexico, the OECD rejuvenated its campaign against tax avoidance and other forms of legal tax planning.Opponents of tax competition generally have claimed that the goal is to eliminate tax evasion, but the theory used by the OECD – capital export neutrality – ultimately leads to full tax harmonization.

The Mexico City SurpriseAt the recent Global Tax Forum in Mexico, the OECD tried to insert report language broadening its supposed mandate.

They sought to add the following clause: “In the context of the broader effort to fight tax evasion and avoidance and to remove harmful tax practices that facilitate such activities, the main objectives of the meeting are…”

The bureaucrats were unsuccessful, but they will not give up.

The Next Steps for the StatistsThe OECD also has announced steps to persecute high-net-worth individuals with greater monitoring and demands for advance reporting of activities.The European Commission is proposing to dramatically expand the savings tax directive, with a goal of automatic information sharing for all forms of capital income .The expanded EUSTD would apply to individuals and entities.

The Next Steps for the StatistsThe European Commission is pushing to harmonize the definition of corporate taxable income – the so-called CCCTB, and the left more broadly wants worldwide formula apportionment.The OECD is expanding the so-called Global Tax Forum to include more anti-tax competition jurisdictions.We also can expect renewed efforts to curtail international company formation and open shipping registries.

How Should Cayman Protect Itself?

First, realize that you are in a protracted battle for survival.Second, realize that you wear the white hats and Sarkozy, Merkel, Brown, and Obama wear the black hats.Third, understand that every concession you make simply whets the appetite of your enemies.

Don’t Feed an Alligator

He’ll Want Another Meal Tomorrow…and Bring a Friend

Curtailing the Welfare State

How do we stop these terrible predictions from becoming a reality?“Public Choice” makes spending restraint a political challenge.At a minimum, spending should grow slower than GDP, causing the burden of government to fall over time.Some nations have been successful with dramatic spending restraint.

Can We Elect Good People?

How often is there a Ronald Reagan – or even a Bill Clinton – in the White House?How often are there people like Phil Gramm and Dick Armey in the House and Senate?Will good people ever have a controlling majority?And if good people get power, how do we avoid Lord Acton’s dilemma?

Washington Is a Cesspool…

…that Becomes a Hot Tub

(accessories not included)

The Solution Is Tax Competition

When taxpayers have the ability to shift economic activity to lower-tax jurisdictions – and benefit from the better policy in those jurisdictions.This forces governments to lower tax rates and reform tax regimes to attract (or prevent the loss of) economic activity.Globalization is closely linked to tax competition.

The Reason Tax Rates Have Fallen

Even though the political system encourages bad policy, politicians are moving tax law in the right direction.26 flat tax nations.Top income tax rates have dropped 26 percentage points.Corporate tax rates have dropped by more than 20 percentage points.Significant reductions in double taxation.

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Falling Corporate Tax Rates

Average corporate tax rate in 1980 = 48 percent.Average corporate tax rate in 1990 = 42 percent.Average corporate tax rate in 2000 = 34 percent.Average corporate tax rate today = 26 percent.America is now an outlier on corporate tax.

Growing List of Flat Tax Nations

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The Expanding Flat Tax Club

Jersey 1940 20 Percent Hong Kong 1947 15 PercentGuernsey 1960 20 Percent Jamaica 1985 25 PercentEstonia 1994 21 Percent Latvia 1995 25 PercentLithuania 1996 24 Percent Russia 2001 13 PercentSlovakia 2004 19 Percent Ukraine 2004 15 PercentIraq 2005 15 Percent Romania 2005 16 PercentGeorgia 2005 12 Percent Trinidad & Tobago 2006 25 Percent

Pridnestrovie 2006 10 PercentKazakhstan 2007 10 Percent Mongolia 2007 10 Percent Kyrgyzstan 2007 10 PercentMacedonia 2007 10 Percent Montenegro 2007 15 PercentMauritius 2007 15 Percent Bulgaria 2008 10 PercentAlbania 2008 10 Percent Czech Republic 2008 15 PercentFed. B&H 2009 10 Percent Belarus 2009 12 Percent

Policy Now Moving the Other Way

Obama has proposed higher income taxes, payroll taxes, death taxes, and increased double taxation of dividends and capital gains.He also has proposed a big energy tax.And taxes to finance government-run healthcare.The long-term threat is a value-added tax.Will Obama give us tax reform?

The Barack Obama Flat Tax

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Higher Tax Rates Will BackfireHigh tax rates reduce incentives to engage in productive behavior, meaning less work, saving, investment, and entrepreneurship.This means less taxable income.To determine the impact of a tax policy change on tax revenue, which effect dominates: The rate change or the change in taxable income.Obama will experience revenge of the Laffer Curve.

Tax Rates, the Rich, and RevenueIn 1980, there were 116,800 rich people.Those rich people reported $36.2 billion of income to the IRS.They paid $19.0 billion of income tax to the federal government.

Tax Rates, the Rich, and RevenueIn 1980, there were 116,800 rich people.Those rich people reported $36.2 billion of income to the IRS.They paid $19.0 billion of income tax to the federal government.

By 1988, there were 723,700 rich people.Those rich people reported $353.0 billion of income to the IRS.They paid $99.7 billion of income tax to the federal government.

George Stigler and Gary BeckerStigler: “Competition among communities offers not obstacles but opportunities to various communities to choose the type and scale of government functions they wish.”Gary Becker: "...competition among nations tends to produce a race to the top rather than to the bottom by limiting the ability of powerful and voracious groups and politicians in each nation to impose their will at the expense of the interests of the vast majority of their populations.“

James Buchanan and Milton FriedmanJames Buchanan: "...tax competition among separate units...is an objective to be sought in its own right.“Milton Friedman: "Competition among national governments in the public services they provide and in the taxes they impose is every bit as productive as competition among individuals or enterprises in the goods and services they offer for sale and the prices at which they offer them."

Vernon Smith “[Tax competition] is a very good thing. …Competition in all forms of government policy is important. That is really the great strength of globalization …tending to force change on the part of the countries that have higher tax and also regulatory and other policies than some of the more innovative countries. …The way to get revenue is doing all you can to encourage growth and wealth creation and then that gives you more income to tax at the lower rate down the road.”

Edward Prescott

“With apologies to Adam Smith, it’s fair to say that politicians of like mind seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise taxes. This is why international bureaucracies should not be allowed to create tax cartels, which benefit governments at the expense of the people.”

Edmund Phelps“[I]t’s kind of a shame that there seems to be developing a kind of tendency for Western Europe to envelope Eastern Europe and require of Eastern Europe that they adopt the same economic institutions and regulations and everything.  …We want to have some role models... If all these countries to the East are brought in and homogenized with the Western European members then that opportunity will be lost.

What Does Adam Smith Say?An inquisition into every man’s private circumstances, and an inquisition which, in order to accommodate the tax to them, watched over all the fluctuations of his fortunes, would be a source of such continual and endless vexation as no people could support…. The proprietor of stock is properly a citizen of the world, and is not necessarily attached to any particular country. He would be apt to abandon the country in which he was exposed to a vexatious inquisition, in order to be assessed to a burdensome tax, and would remove his stock to some other country where he could…

Adam Smith…Continued…either carry on his business, or enjoy his fortune more at his ease. By removing his stock he would put an end to all the industry which it had maintained in the country which he left. Stock cultivates land; stock employs labour. A tax which tended to drive away stock from any particular country would so far tend to dry up every source of revenue both to the sovereign and to the society. Not only the profits of stock, but the rent of land and the wages of labour would necessarily be more or less diminished by its removal. —Adam Smith, An Inquiry into the Nature & Causes of the Wealth of Nations, 1776.

Even OECD Economists Admit…OECD economists have written that “the ability to choose the location of economic activity offsets shortcomings in government budgeting processes, limiting a tendency to spend and tax excessively.”OECD economists note that “legal tax avoidance can be reduced by closing loopholes and illegal tax evasion can be contained by better enforcement of tax codes. But the root of the problem appears in many cases to be high tax rates.”

So Where’s the Harmful Part?

The OECD, European Commission, UN, and allies are motivated by greed for more tax revenue – meaning more power, which is why they want an OPEC for politicians.This is unseemly, so they claim their real interest is stopping “harmful” tax competition – but have never offered any evidence.Empirical and theoretical data supports tax competition.

ConclusionTax competition should be celebrated rather than persecuted.In the real world, truth takes a back seat and “might makes right.”The Cayman Islands and other international financial centres need to be aggressive as possible given their constraints.Make the moral case, citing rampant corruption and human rights abuses around the world.