Oxfam is a British charity devoted to the reduction of global poverty. In early March, it published a report, Off the Hook: How the EU is about to Whitewash the Worst Tax Havens.
The report claims that international finance centres (IFCs) such as the Bahamas, which impose no tax on corporate profits, harm the world's poor. It therefore laments the expected removal of several IFCs - Bahamas, Bermuda, British Virgin Islands, Cayman Islands, Guernsey, Hong Kong, Isle of Man, Jersey, and Panama - from the EU's "grey list" of "non-cooperative tax jurisdictions" (none being on the blacklist) in its first annual review, which was published shortly after the Oxfam report. According to Oxfam, the EU should move in the opposite direction, changing the criteria for blacklisting to capture more IFCs and increasing the sanctions associated with being blacklisted.
The idea that IFCs have harmed the world's poor should startle anyone who knows even a little recent economic history. In 1980, more than 40% of the world's population lived in absolute poverty, defined as an income of less than $2 a day (in today's money). Today, that figure is 9%. This historically unprecedented rate of poverty reduction has occurred at precisely the same time that IFCs have assumed their significant role in the global economy.
The idea that IFCs have harmed the world's poor should startle anyone who knows even a little recent economic history"
It could be a mere coincidence, of course. But it isn't. The zero corporate tax policies of IFCs facilitate the efficient allocation of capital around the world. IFCs are an important part of the story of poverty reduction over the last 40 years.
The Oxfam report does not address this argument. Indeed, it does not even acknowledge that poverty has declined dramatically over the last 40 years. It simply assumes that if zero-corporate tax rates were eliminated, the extra tax revenues raised would be directed towards the poor, and that they would suffer no loses from the obstruction to global capital flows. As a result, the central claim of the report - that IFCs harm the world's poor - remains unjustified.
On top of this cavalier approach to economic analysis, the report displays a casual contempt for the sovereignty of IFCs. It claims that the tax policies of IFCs are a "political choice", meaning not that they are a choice for the IFCs themselves, but a choice for politicians in the EU. Most citizens of small island nations had believed such colonialist attitudes to be consigned to history. It is disturbing to see a British charity openly espousing them in 2019.
IFCs help to reduce global poverty
From the 1970s, governments around the world began to loosen controls that had restricted the flow of capital across borders. At the same time, tariff barriers to international trade continued to be reduced through the operations of the General Agreement on Trade and Tariffs (GATT) and then its successor, the World Trade Organisation (WTO). These two developments gave rise to the new era of "globalisation" that, despite a recent increase in trade tariffs, continues to this day.
The economic benefits of free trade have been familiar since the work of Adam Smith and David Ricardo. Put simply, by increasing the scope of trade it encourages greater specialisation and allows producers to take better advantage of their comparative advantages, arising from factors such as climate and human capital. Land, capital and labour become more productive.
The free movement of capital across borders has the same effect. By increasing the scope of investment, it increases the chance that savings will flow to the best investment opportunities, wherever they may happen to be in the world.
What makes an investment "best" varies with the preferences and circumstances of the saver. A Chinese businessman who has saved $100,000 may seek a secure investment that he can be confident he will be able to pass to his children. This may encourage him to invest his savings outside of China, in foreign assets facing less political and economic risk than offered by the investment opportunities within China. At the same time, a US business with a higher risk appetite may be keen to invest in China, keen to profit from the rapid economic growth occurring there.
Such variation in the preferences of savers and the investment opportunities available around the world explains why capital flows both into and out of the same country at the same time. For example, although the US is still the world's largest recipient of foreign direct investment, American individuals and firms invest heavily outside of the US.
This globalisation has helped to lift hundreds of millions of people out of poverty, most notably in Asia. Real GDP per capital has tripled in India since 1980 and increased eightfold in China. Over the same period, the percentage of the population living in poverty has declined from 88% to 7% in China and from around 50% to 24% in India.
International Finance Centres play a pivotal role in this globalised economy, acting as staging posts for global capital. Most savers lack the information or skill to make investment decisions for themselves, and their savings are often too small to buy the assets in which they might like to invest, Fund managers solve these problems by aggregating the funds of many savers and making investment decisions on their behalf. And the aggregation of these funds often takes place in IFCs - or, in other words, many funds management companies are registered in IFCs.
Three characteristic features of IFCs explain why they play this role. The first is legal certainty. Investors must feel confident that contracts will be enforced and that their savings will not be subject to arbitrary or confiscatory governmental interventions into the funds management industry. This explains why IFCs are typically stable democracies with a strong commitment to the rule of law (with most being common law jurisdictions).
The second characteristic feature of IFCs is a well-developed network of supporting businesses - law firms, trust companies, fund administrators, etc. The Bahamas hosts many of the world's leading firms in these fields and has a highly educated domestic workforce.
The third important feature, and the one to which Oxfam objects, is not taxing corporate profits. Consider savings originating in Country A, being aggregated in Country B, and then being invested Country C. The destination enterprise will probably be subject to taxation in Country C and the investor will be taxed on his returns from the fund in Country A (as income or capital gains). If the returns to the fund were also taxed in Country B, the investor would be subject to triple taxation. This would reduce the post-tax return to investors, in many cases below the minimum rate of return at which the saver is willing to make the investment.
From an investors' point of view, taxation is simply another cost. The lower the cost, the more likely they are to make the investment. By imposing no tax on the returns of funds domiciled in them, IFCs reduce the cost of international investment and improve the efficiency of global capital allocation. They thereby play an important role in the economic globalisation that has so dramatically lifted living standards in many poor countries.
Oxfam's response to the globalisation argument
You might expect Oxfam to celebrate globalisation, and the role in it played by IFCs, given the great reduction in poverty that it has caused. In fact, however, Oxfam is consistently hostile to IFCs and even to globalisation itself. According to its 2019 report, "… globalisation and the greater mobility of capital … are harming citizens worldwide." (p6)
Globalisation may well have caused the incomes of low-skilled workers in advanced economies to stagnate over the last 20 years. But the tens of millions of workers who may have lost from globalisation in this way are relatively rich by global standards. The welfare gains to hundreds of millions of much poorer workers in developing economies surely swamp this effect. The idea that globalization has harmed poor people is extraordinary. What evidence or argument does the Oxfam report offer to support this contention?
The short answer is none. It is asserted without supporting evidence or even references to other publications where the thesis has been defended. The report does no more than reference estimates of how much tax revenue is forgone because IFCs do not levy corporation tax, assuming that these sums are the net loss to the poor. That is to say, the report assumes (again, without evidence) that these tax revenues would end up in the hands of the poor and that they can be raised at no cost to the poor, that taxes have no deadweight costs.
The first assumption is implausible, because government spending tends to be concentrated on electorally important groups (which the poor rarely are). The already well-off in poor countries capture the largest share of government spending on healthcare and education.
And the falsity of the second assumption is the very foundation of the "globalisation argument" of the previous section. It is precisely because IFCs do not tax corporate profits that IFCs help the world's poor. This policy holds down the cost of international investing and thereby spurs the rapid economic growth that has lifted hundreds of millions of people from poverty. Oxfam may disagree with this argument, but they must explain where it goes wrong. Instead, the report proceeds as if they had never encountered it.
The report is generally devoid of economic analysis. The economic concepts relevant to the topic - return on investment, efficient capital allocation, the deadweight costs of taxation and so on- are nowhere to be found in the report. Even more astonishingly, the report nowhere acknowledges that the increased role of IFCs has coincided with the most dramatic reduction in poverty in history. Coincidence is not causation, of course. But anyone claiming that the causation goes in the opposite direction, that IFCs cause poverty, must explain away the dramatic coincidence. They must explain why poverty has decreased so much while IFCs have become more prominent in the global economy. The Oxfam report doesn't even try to.
Rather than engaging in serious economic analysis, the report indulges in baseless accusations of immorality. According to Oxfam, IFCs with zero corporate tax rates "rob" other countries of the "resources needed for development" (p8). This exemplifies a muddle that occurs consistently through the report: namely, confounding governments with countries. When money is kept in private hands rather than being transferred to the government through taxation, the country has not been deprived of any resources. The private citizens of a country are as much part of that country as its government is. And those privately held resources may well be used in ways that promote development. This is precisely what happened in China. It was only when the control of many productive assets was shifted from the government to private profit-seekers that economic growth took off and incomes began to rise.
Nor is "rob" an accurate description of the way IFCs acquire company registrations. As noted above, many companies register in IFCs because doing so reduces their legal risks and their costs of doing business, including their tax costs. The jurisdictions who impose higher costs on companies, and therefore attract fewer registrations, have not been robbed - neither by the IFC nor by the company. You might as well argue that a supermarket that charges low prices and therefore attracts many customers has robbed competitors who charge higher prices. When those who choose to register companies in IFCs are well-informed and acting voluntarily, it is scurrilous to accuse IFCs of robbing anyone.
The report also accuses the beneficiaries of firms registered in IFCs of acting unjustly by failing to "pay their fair share of taxes" (p.6). This accusation is baseless, for at least two reasons.
The first is that it relies on confusing the "legal incidence" of a tax (that is, the name on the account from which the taxes are paid) and the "economic incidence" of a tax (the person who bears the cost of the tax). These are sometimes the same, but they need not be. And they clearly are not in the case of corporation tax, because corporations are legal fictions which cannot bear economic costs; only real flesh and blood people can bear costs or enjoy benefits. The real, economic cost of corporation tax falls on its owners (through lower returns), its workers (through lower wages) and its customers (through higher prices), in varying proportions, depending on factors that need not detain us here.
Since it is only people who bear the cost of taxation, it is only people who can sensibly be accused of not bearing their fair share of the tax burden. But Oxfam does not know what share of a country's tax burden is borne by those who benefit from a company's registration in an IFC.
Consider just a shareholder of a company registered in an IFC (or someone whose money is invested by a fund registered in one). The untaxed returns will be taxed as income when they are repatriated to his country of domicile. And he will also pay income tax on his other income, if he has any. His spending in his home country is likely to be taxed by a VAT or GST and by excise duties and tariffs on some imported goods. He is also likely to pay local taxes. In short, the fact that his investments are not taxed in the IFC provides no information about what share of his country's tax burden he is bearing. But if Oxfam does not know what share of taxes someone pays, it cannot know whether it is a fair or unfair share.
Nor would it help much if Oxfam did know the share of their country's total tax burden was being paid by each beneficiary of IFC registration. For Oxfam does not know what "fair" means in this context. This is not surprising, because no one knows what it means. Imagine a society of six people. Five each earn 10% of the total income and the sixth earns the remaining 50%. What is the fair tax contribution of each? The only obvious answer is that they should pay in proportion to their incomes. But this is to recommend a flat rate of income tax - a policy that Oxfam would surely reject. But if strict proportionality is rejected, how will the fair share be determined? Any answer is sure to be arbitrary. And, certainly, Oxfam offers no answer, either in this report or any previous report.
Oxfam does not know what share of total taxes are paid by the beneficiaries of companies registered in IFCs and, even if it did, it would not know if those shares were fair. In other words, the accusation of wrong doing by these beneficiaries and those who act for them is a mere fabrication.
A New Colonialism
Having made the implausible claim that globalisation and IFCs harm the world's poor, and the baseless claim that IFCs and those who use them behave unjustly, Oxfam suggests the EU do more to discourage IFCs from maintaining zero-corporate tax policies. More specifically, they recommend (among other things) that low or zero corporate tax rates be an independent criterion for inclusion on the EU's blacklist and that the sanctions applied to blacklisted countries be made tougher (though the report is not very clear about what these sanctions should be).
Insofar as the report's claims about the harm done by IFCs are unfounded, so are its calls for this tougher regime. But Oxfam's call for action against IFCs has another serious defect. They recommend that the European Union, with its population of 500 million and GDP of over $18trn, penalise small peaceful countries unless they adopt the tax policies favoured by Oxfam.
In a revealing passage, the report claims that "tax havens are not inevitable - they are a political choice" (p.7). Most IFCs, such as the Bahamas, Jersey and Singapore, are stable and well-established democracies. But, when Oxfam says that the tax policies of IFCs are a political choice, it does not mean that they are a choice for their own democratically elected politicians. It means that they are a choice for European politicians.
The idea that the populations of small, island nations should do what their supposed betters in Europe tell them to do was once popular. Over the last century, however, the idea has fallen from favour. The people of all peaceful countries are now viewed as having a right to democratic self-rule. It is surprising to see Oxfam, a charity usually keen to brandish its progressive credentials, rejecting this modern idea in favour of the old colonialist attitude.
This article is sponsored by the Bahamas Financial Services Board (BFSB)
Rising incomes in Asia will probably be the most important investment story of the 2020s. Asia is home to 60% of the world's population, with both China and India each accounting for about 18% of the global total.