The world will be one big tax haven

Tax has become a global issue. Powerful forces are driving rates on savings down towards zero.

IT IS AN overworked cliche to say that business is becoming increasingly global these days. There is nothing particularly new about this. Some businesses have always been global - shipping was a big global business a century ago. Some can never be because we all spend a lot on services - haircuts, housing, restaurant meals, taxis - that can only be provided locally. But in between there are some interesting industries that clearly are becoming more global. The most important of these is probably financial services. And as financial services have become a global industry, tax has become a global issue.

For a large part of the post-war period, people's savings were invested mainly, if not entirely, in their own country. What kept the money at home was exchange controls. As soon as these were abolished, and fund managers were free to seek the highest returns in whatever far-flung location took their fancy, they proved more than willing to do so.

International capital flows have grown to enormous proportions because capital - especially financial capital - is incredibly mobile. It can move across national boundaries in a split second and at very low cost. It will move quickly, anywhere in the globe, to find the highest returns.

This brings us to the issue of tax. because what interests the provider of capital is the post-tax return. In a world of highly mobile global savings, the jurisdiction with the lowest tax rate is an attractive place to be.

By cutting tax rates on savings, a country can attract more than its share of world savings. Lower tax rates thus lead to higher tax revenue - until competing jurisdictions react by cutting their own rates.

Hoping to get an unfair share of the world supply of savings by cutting tax rates on savings is a bit like standing up at an all-seater football match. You'll get a good view for a while, but if you persist eventually everybody else stands up and all are worse off - same view, aching feet.

Tax competition between jurisdictions has been driving down tax rates on capital around the world from the early 1980s. The two most important taxes on the returns to capital are corporation tax, which taxes profits, and the income tax which bears on dividends and interest.

International organisations, such as the European Commission and the OECD, worry about the loss of revenue from these taxes because the lower the taxes on capital income, the higher the taxes have to be on employment and consumption.

This concern of the EU and the OECD reflects a very respectable strand in tax thinking: it is better to tax many things lightly than a few things heavily owing to the distortion to economic activity being less. This laudable concern for tax neutrality also fits in very well with the natural desire of finance ministries around the world to get in revenue from every possible source. So it is not at all surprising that the OECD has, with their blessing, launched an inquiry into "harmful tax competition" and is looking particularly closely at the so-called tax havens.

There is no official definition of a tax haven, though the large accounting firms produce lists of countries which have two key characteristics: low rates of tax on residents and a willingness to pay dividends and interest to non-residents free of tax. Nothing wrong with that. It is incumbent on the non-resident to declare the income from another jurisdiction in his or her own jurisdiction - and there are many large and respectable countries that do not apply withholding taxes to non-residents. If you want to avoid tax by getting paid interest gross and not declaring the income, you can achieve this result as easily by opening a bank account in Germany as in Guernsey.

Global industries, like financial services, which do not have to be close to their customers, find it very attractive to locate themselves in these low-tax jurisdictions, and finance ministries in other jurisdictions are becoming increasingly concerned about the resulting revenue loss.

However it must be said that the official word is somewhat schizophrenic on this issue. For there is another respectable strand of tax theory which says the returns on savings (out of income which has already been taxed) should not be taxed at all. That line of thinking has long governed the tax treatment of pensions. More recently, we have witnessed the invention of new savings instruments such as PEPs and Tessas, which offer tax-exempt savings opportunities.

So it is far from clear that the authorities, who have been busy inventing tax havens inside their own jurisdiction, are in a strong position to attack the tax havens in other jurisdictions. The really interesting question to ask about any tax jurisdiction is whether it is engaging in fair or unfair competition. Low tax rates do not constitute unfair competition. Helping people in other jurisdictions to evade tax, or outright money laundering, does.

Do the Channel Islands, for example, engage in unfair competition? Certainly their tax rates are much lower than in the UK, but this is because public spending takes a much lower share of GDP. There are three main reasons for this: the islanders have run their affairs extremely prudently in the past, so that taxpayers are not lumbered, as they are in the UK, with a debt interest burden. Secondly, pensions are all fully funded and the islands enjoy full employment, so there is no need for a huge social security budget. And thirdly, because the islanders shelter under the UK defences, there is no defence burden on the taxpayer.

For all these eminently respectable reasons, the Channel Islands have been able to impose low rates of tax. As a result they have attracted a large financial services industry to their shores. But in the process they have also attracted the attentions of those intent upon evading tax in their own jurisdiction. That is why the Islands are perceived, potentially to their detriment, as centres of tax evasion rather than successful low- tax economies in the Hong Kong or Singapore mould.

Where will the OECD inquiry lead? It is far too early to say, but the global forces driving taxes on savings down towards zero are extremely powerful. In the future there will be no tax havens because the world will be one big tax haven for the saver. The other side of the coin is that we will all have to get used to higher taxes on labour and consumption - or find some way of getting our levels of spending down. The Islanders have shown us it can be done.

Bill Robinson is a director of the consultancy London Economics.