It's not all shady on the sunshine islands

BERMUDA - It has been bash-the-tax-haven week. On Tuesday in Paris the OECD countries, with two notable exceptions, agreed to a seven-year drive to try to stamp out tax havens. Thet have published a report, Harmful Tax Competition, an Emerging Global Issue, saying that unfair fiscal policies can distort international competition.

The exceptions were Switzerland and Luxembourg, surprise, surprise, and these two countries have warned that they may not co-operate with the project. But apparently they are not being targeted: according to the head of the project it is "islands in the sun" which are in the frame. It is an interesting issue because it goes to the heart of the question: what will be the nature of international competition in a world where financial businesses can locate more or less anywhere? Since I happen to be in Bermuda for a financial conference (and, yes, the sun is shining) it seems the appropriate place from which to respond.

Not that Bermuda is completely dependent on its tax haven status to attract money. It is not particularly attractive as a refuge from high personal taxation in the way that, say, the Channel Islands are. While it is a mere 90 minutes from the US east coast cities, Americans have to pay taxes wherever they live, so there's no advantage in locating here. Some Britons use Bermuda for tax purposes, but it is lot farther away than, say, Guernsey or Monaco. It is attractive to someone from the British Isles who has business interests in North America, but there are few such people.

The Bermuda economy is, however, doing well. The island has a GDP per head of more than $32,000, pretty much the same as Switzerland and Luxembourg and vastly higher than any of the Caribbean islands. How has it managed it? There is tourism, of course, and Bermuda has been successful in keeping its appeal towards the top of the market. But it is a seasonal business, and unlike the Caribbean, mainly in the summer.

The other big wealth generator is insurance and in particular reinsurance. It is, with London and New York, one of the three key reinsurance centres in the world. As a result, financial services in total generate about 20 per cent of GDP. This is not just driven by tax considerations, though of course the tax treatment is attractive. Where I am assured Bermuda has also scored has been the combination of a trusted legal system and effective regulation. The quality of regulation has become a competitive advantage. Regulation has to be light and cheap, but financial institutions do not want a free-for-all. But a reputation for effective regulation attracts business, and in particular quality business.

There is a second quality which distinguishes Bermuda from the name- plate tax havens. The business has to be done here: the offices, the staff, much of the decision-making, the board meetings and so on have to be located on the island. This places a constraint on the ability of countries to achieve tax-haven status: you have to be a place where professionals who work in financial services want to live.

Physical location matters. That is why Bermuda or the Channel Islands can carve out niches; it is also why St Helena or the Falklands cannot. You can establish a name-plate tax haven anywhere, but you will not generate $32,000 GDP per head out of it.

So, although in theory these booming high-added-value businesses can go anywhere, in practice they can't: it is not just a tax issue. So from the point of view of the aspirant tax haven, sustaining a comparative advantage is a much more complex and subtle process than just cutting taxes.

Of course tax is important, and will become more so. One of the effects of globalisation has been that taxation is moving towards a single global standard. This is happening particularly for companies, but also for individuals. The company point is widely accepted: do you remember how Gordon Brown, in both his Budget speeches, noted how Britain is towards the bottom of the corporate tax league? And he came close to saying that Britain was trying to achieve a taxation advantage over its European rivals. Whether the deed matches the word is another matter, but there is no doubt that one of the reasons why the UK has succeeded in attracting inward investment has been favourable tax treatment. Other European countries have used the tax weapon more aggressively to lure capital and arguably are more guilty of distortingcompetition than, say, Switzerland.

For individuals much the same thing is starting to happen, for on-screen workers are becoming the first generation who do not need to live in the same country in which they work. People living off investments can choose their location, but up to now those of us who have to work for a living have had to go where the jobs are. As telecommunications costs continue to fall to a level where they hardly exist, expect a growing proportion of the workforce to become outworkers. The proportion need not be large to start forcing tax convergence.

But if tax is becoming more important, so is good administration: simple but effective regulation, and an affordable and honest legal system. Three years ago Bermuda voted nearly three-to-one not to become independent but to remain a colony. Strange? It seems odd nowadays to see the Union Jack flying over a coral beach, but in business terms it makes sense. The island runs its own domestic affairs, but the umbrella of the UK, and UK law, offer a comfort factor for international businesses. It also makes Bermuda different. To Britons, Bermuda may seem a bit like Surrey in the sun, but to the half million American tourists it is exotic.

That combination - low taxes, efficient administration, and "safe and accessible differentness" - seems to be the key. Compare Monaco, the Channel Islands and Bermuda and they all exhibit similar characteristics. As a result they become very rich and other countries become rather jealous.

There will be some sort of inter-national drive to curb tax havens. That is right because there are clear abuses, or at any rate activities which make the world's big developed countries feel uncomfortable. The Netherlands Antilles has become not only a name-plate financial tax haven, but also a key offshore centre of the US telephone sex industry. Guyana paid for the rebuilding of a phone system from the same abundant source of funds.

But the OECD countries surely also have something to learn from the up- market tax havens. Why should their citizens have to go offshore to get lean administration and low taxes? Why can little countries sometimes do things better than big ones? Should not OECD countries try to learn as well as criticise? If you drive both businesses and people offshore, maybe you are being just a little arrogant in the way you have been treating them. It does large countries no harm at all just occasionally to have the sand kicked in their face by small ones.