Wednesday, July 14, 2010

Desperately Seeking Plan B: what are the development options for small island tax havens

The University of Kent Business School has just published this Working Paper on development prospects for small island tax havens. Co-authored by Mark Hampton and John Christensen, the paper explores how recent changes, including the emergence of strong civil society coalitions engaged in combating tax evasion and offshore secrecy, confronts small island tax havens with difficult decisions about their future.

The paper argues that the 2007/8 financial crisis has changed the nature of the external pressures on tax havens, especially since major political power blocs face unprecedented fiscal pressures which force them to confront their massive tax losses from tax evasion. Unlike the situation at the start of 2000, when the small islands were easily able to mobilise political support to resist the OECD's harmful tax competition initiative, the situation in 2010 requires them to seriously address the need for alternatives to the tax evasion industry:

"Unlike the multilateral initiative in the 1990s against tax havens, spearheaded by the OECD, which fizzled out when the US Bush Administration withdrew its support in 2001, the current initiatives are being driven by three power blocs, the Group of 20 countries, the EU and the US, all of which are confronted by the deepest recessions experienced since the 1930s. Domestic budgetary pressures within these economies have played an important part in swinging the pendulum away from tax havens. In this context, preparing development strategies that reduce dependence on rent incomes from what the OECD terms ‘the tax industry’ should be regarded as a priority for small islands."

But identifying a realistic Plan B will not be straightforward. Many small island tax havens have allowed their offshore finance sectors to crowd-out other industries, and their options are constrained by what economists term 'path dependency'. As the authors argued in an earlier paper in 2002:, many small island tax havens “have become locked into their relationships with the offshore finance industry by their dependence upon the earnings potential of predominantly imported skills and expertise, and their lack of skills and knowledge in alternative sectors. This means that any attempts at diversification into other sectors would be constrained by the need for wholesale re-skilling and the acquisition of new knowledge bases.”

The authors, both Jerseymen, cite that island as an example of how political short-sightedness and arrogance has locked Jersey's economy into a situation where its future prospects are almost entirely dependent upon decisions taken outside the island. This particularly applies to its ill-judged zero-ten corporate tax policy, which face scrutiny by the European Union's Code of Conduct Group on Business Taxation on the grounds that it harms the tax sovereignty of other countries:

"For many decades Jersey’s key politicians have assumed that the EU could not extend its powers to include Crown Dependencies and that the UK government would intervene to protect their autonomy on tax matters. This is clearly no longer the case: the powers of the EU Code of Conduct Group on Business Taxation extend to the Crown Dependencies and the Group has required their respective governments to remove “harmful tax practices” such as the ‘ring-fencing’ of tax exempt status to non-resident companies.

Despite clear evidence that their existing tax regimes constituted harmful tax practices as defined by the EU, Jersey officials are largely dismissive of efforts to strengthen international cooperation. For example, the Chief Executive Office of Jersey Finance, Geoffrey Cook (2009), commented that: “An unlikely alliance of tax hobbyists, left wing newspapers, trades unions, and development agencies has catalysed around calls for greater concentration of the means of wealth creation in the hands of governments, and implicitly greater taxation of business and wealthy individuals through the outlawing of wealth structuring and planning, together with restrictions on cross border capital flows. They hope that their own constituencies will be beneficiaries of this new ‘contract’, with the authors; the tax hobbyists, gaining fame and funding, and their supporters feeling validated in their enduring distrust of the wealthy and their advisers.

Despite having been warned in 2006 by a number of experts, including one of the authors of this paper, that proposed amendments to their corporate tax regime (the so-called Zero-Ten tax policy) would be rejected by the Code of Conduct Group, in 2007 the States of Jersey adopted measures that were indeed deemed unacceptable in 2009.

The paper's conclusions do not make for happy reading for small island tax havens. Their options for diversification are restricted by past decisions, and attempts to diversify face major structural barriers, including the high cost bases of their local economies and the lack of local skills base outside the finance sector:

"Some tax haven islands, including Jersey, are already facing unprecedented budgetary pressures. But they have limited scope for reducing their dependence on offshore financial services. With approximately one quarter of its economically active population directly employed in the OFC, and the majority of the remaining workforce employed in secondary sectors like construction, distributive trades and catering, there is virtually no alternative skills base on which new industries can draw. This path dependence has been reinforced by the extraordinary high costs of land and labour, which have crowded-out pre-existing industries. Taking measures to diversify the local economy will therefore require politically unpalatable steps to significantly reduce the domestic cost base."

You can download the Working Paper here, and as usual we would welcome your feedback.


Post a Comment

Links to this post:

Create a Link

<< Home