What if IFCs no longer existed? This is not a rhetorical question. There is a concerted campaign underway to eliminate international financial centres (IFCs). Consider the following recent tax policy proposals:
These examples do not include the usual suspects – I cite The Times’ editorial board, not Labour leader Jeremy Corbyn; the rich-country-dominated IMF rather than the broader-based United Nations; the wealthy-country bureaucracy of the Paris-based OECD instead of the openly anti-finance industry Tax Justice Network. That The Times, the voice of the British establishment, the IMF staff, whose official mission charges it with safeguarding the security of the international monetary system, and the OECD, founded to promote economic growth rather than to maximise tax revenue, all now oppose jurisdictional competition illustrates a major shift among elites. Rather than viewing economic growth as the engine of increased social welfare, they see firms and individuals as cows to be ever more efficiently milked by tax authorities.[i]
Suppose these efforts are successful, which is a real possibility. What will the world look like? Let’s consider two scenarios, one in which everything works out as envisioned by the opponents of competition and one in which their efforts to abolish IFCs fail.
Tax Monopoly World
Most opponents of regulatory and tax competition focus primarily on taxes. At the core is opposition to individuals’ and firms’ ability to shift income to jurisdictions charging lower tax rates. They want a world without such tax competition: ’Tax Monopoly World.’ What it will include begins with proposals for minimum levels of business and personal taxation’ global exchange of information; beneficial ownership registries that identify individual owners of all assets; and restrictions on the ability of people and firms to change tax domiciles.
The result, they argue, will be higher levels of tax revenue for virtually all governments. In particular, developing countries with natural resources where multinational firms operate are predicted to collect substantially increased tax revenue. In a conclusion worthy of Voltaire’s Pangloss, all that new money is assumed to be spent on health care, education, and other socially favoured pursuits. Tax Monopoly World will be a marvellous place.
But all that revenue has to come from somewhere. Firms will pay higher tax rates, reducing profits. What will that mean for the global economy? Even relatively obvious consequences should strain Panglossian forecasters’ optimism. Because most research and development (R&D) investment comes from retained profits, R&D expenditures will fall, slowing economic growth. Dividends too are funded from profits. Hence, institutional investors such as pension funds, charitable endowments, and university endowments, will have fewer resources. Companies’ cash reserves will shrink; as stocks reflect the value of claims on their assets, firms’ stock prices will also fall. That too will hit institutional investors and individual savers whose retirement funds will fall. Tax Monopoly World doesn’t appear to be quite so attractive.
We can debate the size of such negative impacts and whether or not the claimed benefits of particular measures are worth the cost. But one of the most striking features of the Panglossian literature promoting Tax Monopoly World is its failure to identify any negative economic impacts of shutting down regulatory and tax competition. The literature rarely concedes there are costs at all to establishing and maintaining complex bureaucracies necessary for something like a global public beneficial ownership register, let alone attempts to quantify and balance those costs against the purported benefits. Without an open debate about the costs and benefits of restrictions on global financial flows, we cannot know if anti-competition advocates’ ideas produce a benefit. This is a conversation they studiously avoid.
The other striking feature of the graduates of Dr. Pangloss’s Academy at the IMF, OECD, and The Times’ editorial board is the failure to recognise that IFCs do anything besides facilitate tax avoidance. This is odd. It is not hard to find evidence of broader beneficial impacts. For example, both Jersey Finance and Cayman Finance commissioned reports on the benefits of their jurisdictions. The 2016 estimate of Jersey’s impact on Britain was £14 billion, while Cayman estimated that it channelled $4.1 trillion of investment funds through Cayman-domiciled investment funds and banks into the United States.[ii] Would the UK or US get those investments if Jersey or Cayman didn’t facilitate them? If not, what funds would make up the difference for those economies? Perhaps these estimates are off, but we will not know without a careful examination of the evidence. That would be a useful task for the large staffs at the IMF and OECD.
Moreover, IFCs provide multiple services unrelated to tax. For example, the top three IFC captive insurance jurisdictions (Bermuda, Cayman, and Guernsey) collectively were home to 1,750 captive insurers in 2017. Captives lower insurance costs and expand coverage for a wide range of industries, from health care to transportation. That captives are not tax-avoidance schemes is demonstrated by the election of many captives doing business in the United States to be taxed as a US insurer and the widespread use of captives by non-profit entities such as charity hospitals. The failure to recognise the diversity and innovation in more efficient forms of business strategies made possible by IFCs, leads the Panglossians to fail to value the services provided by IFCs.
Having taken the (apparently) radical step of actually talking to financial industry professionals and clients in these jurisdictions in my own research, I found that investors chose these IFCs as the basis for their investments elsewhere for three main reasons. First, they want well-developed legal rules to govern their investment vehicles. Second, they want high quality judges to handle any future disputes. Third, they want world class professional communities of service providers. To get these things, they are willing to pay – but like all consumers, they prefer to pay less if they can. Tax neutrality or low tax rates are thus critical to IFCs’ ability to attract business because using an IFC to get the benefits I mentioned is an additional cost for the investor. Eliminating IFCs’ ability to provide tax neutral platforms – the ultimate goal of the OECD/IMF efforts –raises the cost of investment, lowering returns, deters innovation, and slowing the creation of wealth. The stunning thing about the Tax Monopoly World promoters’ efforts is their failure to even acknowledge such economically destructive costs.
A Less Perfect World
A major goal of those advocating reducing regulatory and tax competition is to enable governments to impose and collect taxes on multinational enterprises operating in their country, particularly in the natural resource sector. For example, a regular feature of their critiques of IFCs is the lack of fiscal resources among developing country governments, even those with substantial natural resource endowments. By eliminating jurisdictional competition, critics contend that these governments would be able to impose higher taxes and then devote those new resources to education, health care, and infrastructure investment.
One flaw in these arguments is that they assume that, if denied foreign bank accounts or real estate investments, corrupt oligarchies would be transformed into enlightened rulers. This seems implausible in many instances. To take just one example, Angola (ranked 165 out of 180 by Transparency International in its 2018 Corruption Perceptions Index, with a score of just 19/100 on the perceived level of public sector corruption) seems more likely to have additional tax revenue stolen by corrupt officials than to spend it on public education.
Moreover, IFCs provide a vital service for facilitating investment into developing economies by giving investors a legal system that can handle disputes fairly and expeditiously. They also provide access to a domicile’s investment treaty network’s protections. An investment fund in an IFC can collect resources from investors in multiple jurisdictions because it provides the security of a well-developed body of law administered by expert, honest judges who will determine any future disputes among the investors. Through investment treaty networks, external investment structured through an IFC can protect itself from potentially corrupt local courts. Without the availability of such services, investment into developing economies would shrink. Sacrificing those benefits to funnel funds to corrupt governments would harm, not help, the poorest.
A Poorer World
What would Tax Monopoly World look like? It would have slower economic growth; higher transactions costs for cross-border investment; less financially robust pension funds; more expensive or non-existent insurance for critical areas from medical care to transportation; and lower investment in developed economies. In short it would be a much poorer world. Why would anyone want to us to live there?
[i] It is always worth noting the irony that the staffs of both the IMF and the OECD themselves are not troubled by the higher taxes they seek to impose on others – both pay their staff’s personal income taxes, justifying this as necessary to attract the most qualified.
[ii] Capital Economics, Jersey’s Value to Britain 2 (2nd ed., 2016); Cayman Finance, The Cayman Islands: An Extender of Value to the USA 1 (2018).
Andrew P. Morriss
Andrew Morriss is the Dean of Texas A&M University School of Innovation. Prior to this position, he was the Dean of the Texas A&M School of Law, the D. Paul Jones & Charlene A. Jones Chairholder in Law at the University of Alabama, the Ross & Helen Workman Professor of Law at the University of Illinois, and the Galen J. Roush Chair in Law at Case Western Reserve University.