Topics in the Economics of International Taxation (2): Tax Havens and Tax Holidays

Transcription

1 Topics in the Economics of International Taxation (2): Tax Havens and Tax Holidays Center for Economic Studies Ludwig-Maximilians-Universität Munich 27 July, 2011 Dhammika Dharmapala University of Illinois at Urbana-Champaign

2 Tax Havens Based on: Which Countries Become Tax Havens? Journal of Public Economics, 93, (2009) Coauthored with James R. Hines, Jr., University of Michigan What Problems and Opportunities are Created by Tax Havens? Oxford Review of Economic Policy, 24, (2008) 2

3 What are Tax Havens? Tax havens are countries and territories that offer favorable tax regimes to foreign investors They play an important role in the world economy Havens attract a vastly disproportionate share of crossborder investment They are central to many current policy issues : International tax competition Tax avoidance by multinational firms 3

4 List of Tax Havens Classification of tax havens follows Dharmapala and Hines (2009) and OECD (2000) Andorra Grenada Nauru! Anguilla Hong Kong * Netherlands Antilles Antigua and Barbuda Ireland * Niue! Aruba! Isle of Man Panama Bahamas Jordan * Saint Kitts and Nevis Bahrain Lebanon * Saint Lucia Barbados Liberia Saint Vincent and the Grenadines Belize Liechtenstein Samoa! Bermuda Luxembourg * San Marino! British Virgin Islands Macao * Seychelles! Cayman Islands Maldives Singapore * Channel Islands Malta Switzerland * Cook Islands Marshall Islands Tonga! Cyprus Mauritius! Turks and Caicos Islands Dominica Monaco Vanuatu Gibraltar Montserrat Virgin Islands (U.S.)!! Not included in Dharmapala and Hines (2009) tax haven list * Not included in OECD tax haven list There are approximately 40 tax havens Tax haven status is very stable over time Most tax havens are small, relatively affluent countries 4

5 What Roles Do Tax Havens Play? The bank secrecy laws of some tax havens may facilitate (illegal) evasion of home country taxes by foreign individuals However, this role seems to have been eroded by the spread of tax treaties and information exchange agreements Perhaps a more important role is to facilitate (lawful) tax planning by multinational firms Strategic transfer pricing Strategic use of inter-affiliate debt 5

6 Direct v. Portfolio Investment Direct investment (FDI): undertaken by multinational firms acquiring controlling stakes in foreign entities A vastly disproportionate fraction of the world s FDI holdings are in tax havens Corporations use havens to engage in tax planning Transfer pricing Allocation of debt among affiliates 6

7 Transfer Pricing B: Affiliate in Ireland (low-tax) A: (Dutch Parent) Royalties C: Affiliate in Germany (high-tax) 7

8 Debt B: Affiliate in Ireland (low-tax) A: (Dutch Parent) Loans Interest C: Affiliate in Germany (high-tax) 8

9 Economic Characteristics of Tax Havens GDP pc (PPP; Havens=1) Population (Nonhavens=1) Distance by air (Nonhavens=1) Island (fraction) Coastal population (fraction) Nonhavens Havens Telephone Lines pc (Havens=1) Subsoil Assets pc (Nonhavens=1)

10 Theoretical Framework Optimal tax theory small open economies should impose a zero tax rate on foreign investors Caveats: Some countries enjoy locational advantages Govts ability to commit to tax rates may be greater in countries with stronger governance institutions Hypothesis: Among small countries that do not enjoy locational advantages, those with higher quality governance institutions are more likely to become tax havens 10

11 Institutional Characteristics of Tax Havens British legal origin (fraction) French legal origin (fraction) Ethnolinguistic Fractionalization English as an Official Language (=1) Parliamentary System (fraction) Nonhavens Havens UN Member (fraction) Governance Index

12 Institutional Characteristics of Tax Havens Mean of 5 governance measures from British the World legal origin Bank: (fraction) Voice and accountability French legal origin (fraction) Political Stability Government Effectiveness Ethnolinguistic Rule of Law Fractionalization Control English of as Corruption an Official Language (=1) (each normalized to have mean 0 Parliamentary and st. dev. System 1, with (fraction) higher values indicating better UN Member (fraction) governance) Governance Index Nonhavens Havens

13 Institutional Characteristics of Tax Havens British legal origin (fraction) Population < 1 million French legal origin (fraction) Ethnolinguistic Fractionalization English as an Official Language (=1) Parliamentary System (fraction) Small Nonhavens Small Havens UN Member (fraction) Governance Index

14 Characteristics of Tax Havens: Summary Tax havens are substantially better-governed than nonhavens; they are also: smaller more affluent more open (as measured by distance) more likely to have British legal origins, parliamentary systems, and to use English as an official language Moreover, the strength of tax havens governance does not simply reflect their higher GDP per capita 14

15 Governance and GDP (All Countries) Governance Index Log of GDP per capita Nonhavens Fitted values Havens 15

16 Governance and GDP (Small Countries) Governance Index Log of GDP per capita Nonhavens Fitted values Havens 16

17 Regression Analysis There is no variation over time in tax haven status restricted to cross-sectional analysis Basic approach: Probit regression of an indicator variable for tax haven status on: Governance measure Various controls Note: results are robust to using logit or linear probability models 17

18 Table 2: Determinants of Tax Haven Status Probit Estimates (1) All Countries and Territories (2) UN Members (3) Non-African Countries and Territories (4) Countries and Territories with GDP per capita $1000 (5) Small Countries and Territories Dependent Variable: Indicator for Tax Haven Status (= 1 for Tax Havens) Governance Index (0.275)** (0.303)** (0.325)** (0.283)** (0.513)* Log of GDP per capita (0.174) (0.186) (0.233) (0.194) (0.217) Log of Population (0.064)*** (0.069)*** (0.067)*** (0.064)*** (0.158) UN member (=1) (0.455) (0.445) (0.458) (0.506) Landlocked (=1) (0.396) (0.425) (0.460) (0.395) (0.777) Distance by air (0.077)** (0.087)** (0.075)* (0.076)** (0.117) Regional Y Y Y Y Y Dummies? Observations Maximized Log Pseudo Likelihood Pseudo R

19 Results: Dharmapala and Hines (2009) The results show a strong association between good governance and tax haven status These results are robust to including additional control variables and using alternative specifications But, does good governance cause countries to be tax havens? or, Is the association due to some omitted correlated variable, or to reverse causality? 19

20 Table 3: Determinants of Tax Haven Status Robustness Checks (1) (2) (3) (4) (5) (6) Dependent Variable: Indicator for Tax Haven Status (= 1 for Tax Havens) Governance Index (0.230)*** (0.311)*** (0.492)** (0.588)*** Governance Index for 2002 (0.294)** Bur. Efficiency (early 1980 s) (0.404)*** Political Stability (early 1980 s) (0.672) Log of GDP per capita (40.594)** (0.771) (1.051) (0.201) (0.810)** Log of Population (0.063)*** (0.075)*** (0.224)*** (0.541)*** (0.066)*** (1.403)* UN member (=1) (0.447) (0.461) (0.541) (1.335) Landlocked (=1) (0.371) (0.457) (1.187) (1.309) (0.433) (0.995)** Distance by air (0.076)** (0.089)*** (0.0001)*** (0.290)*** (0.081)*** (0.390)*** Coastal Population Mauro s (1995) measure of bureaucratic efficiency in the early (1.174) (1.309) British Legal Origins (=1) 1980 s: (0.675) (1.229)** English as Official Language (=1) Judicial efficiency, absence (0.970) of red tape, absence (1.404)** of corruption Parliamentary System (=1) strongly predicts current tax (0.635) haven status, (0.688) suggesting that Log of Telephone Mainlines p. c. (0.698) (0.820) long-run governance characteristics are crucial Corporate Tax Rate (0.048)*** Regional Y Y Y Y Y Y Dummies?

21 Table 4: Governance and the Tax Elasticity of FDI by US Firms (1) All Countries and Territories (2) Well- Governed Countries (3) Less Well- Governed Countries (4) All Countries and Territories (5) All Countries and Territories Dependent Variable: Log of US FDI Tax Rate faced by US Firms (0.018)** (0.017)*** (0.019) (0.023) (0.031) Governance Index (0.412) (0.534) (0.543) (0.429)*** (0.587)** Tax Rate* Governance Index (0.016)*** (0.022)** Log of GDP per capita (0.418)*** (0.754)*** (0.408)** (0.351)*** (0.524)*** Log of Population (0.153)*** (0.149)*** (0.167)*** (0.141)*** (0.151)*** Coastal Population Why are tax havens well-governed? (0.537) British Legal Origins (=1) (0.401) English as Official Limited commitment view: Language (=1) (0.372) Log of Telephone Only countries with stronger governance institutions can Mainlines p. c. (0.444) Subsoil Assets credibly commit to low future tax rates, market institutions etc ( )* Contiguous to US Poorly governed countries would have difficulty attracting (=1) (0.493) Distance from US foreign investment even if they significantly reduced their ( ) tax Regional Y Y Y Y Y Dummies? rates Observations R

22 Ratio of US FDI to GDP for 4 Groups of Countries Ratio of Total FDI to Total GDP Poorly-Governed, Low Tax Poorly-Governed, High Tax Well-Governed, Low Tax Well-Governed, High Tax

23 The Consequences of Tax Havens (1) Tax evasion (by individuals) is unambiguously harmful to nonhavens However, the consequences of corporate tax planning activity for the welfare of nonhaven countries are less clear Negative view: havens are parasitic and erode the tax base of nonhaven countries 23

24 The Consequences of Tax Havens (2) Positive view: havens mitigate tax competition and enable nonhavens to tax mobile and immobile capital more efficiently Keen (2001) Desai, Foley and Hines (2006) Hong and Smart (2010) Example: Assume 2 countries: Canada and the USA Assume 2 firms: GM is mobile and Ford is not, but the governments cannot observe this difference 24

25 The Consequences of Tax Havens (3) In the absence of havens, tax competition is severe Both governments set low taxes on both firms to attract (physical) investment When havens exist, both governments can set high tax rates GM will use its haven operations to lower its effective rate, without significantly affecting the location of its physical activities Ford will be taxed more heavily 25

26 Implications Negative view growing FDI in havens will erode the corporate tax base of nonhavens Positive view: consistent with stable or growing corporate tax revenue Growing FDI in havens may be offset by higher taxation of immobile firms 26

27 US FDI in Havens and Corporate Tax Revenue % of US FDI in Tax Havens % of US Federal Tax Revenue from Corporate Taxes

28 The Consequences of Tax Havens (4) Large (and growing) FDI in havens does not seem to have eroded the tax base of large nonhaven economies There is also some evidence suggesting that havens may have a positive impact on nearby nonhavens Desai, Foley and Hines (2006): US multinational firms use of havens seems to increase their activity in nearby nonhavens Hines (2010): Nonhavens that are geographically closer to havens seem to experience faster economic growth The result that havens are well-governed does not settle this debate, but adds a new perspective 28

29 US International Tax System US MNC Controlling stake Repatriates $80 Owes US tax of $35, with foreign tax credit of $20 additional US tax = $15 F Sub Earns $100 Pays $20 to F Assume tax rates are: t F C = 20%; t US C = 35% Deferral: US taxes on active foreign income are deferred until repatriation Subpart F: US taxes on passive foreign income are imposed immediately 29

30 Effects of the US Repatriation Tax Sinn-Hartman Neutrality Theorem Sinn (1984), Hartman (1985): If the only available choices are to: Repatriate foreign earnings to the parent Reinvest in active foreign operations the US repatriation tax does not affect the repatriation decision or the level of foreign investment for a mature foreign affiliate Why? Reinvestment abroad defers the repatriation tax, but the tax liability grows in proportion to the growth of the investment 30

31 Effects of the US Repatriation Tax But, this does not take into account another possible choice: Invest in passive assets (cash) through the foreign affiliate Weichenrieder (1996): Firms have an incentive to delay repatriation by accumulating passive assets in affiliates located in low-tax foreign countries Note: there is a deferral advantage even though the interest earned abroad is taxed immediately by the US under Subpart F 31

32 Example: Accumulating Cash Abroad Time 0: Sub has generated $1 in earnings Time 1: Assume t F C = 0 and t US C = t > 0 After-tax return on passive assets = r (whether held in the US or F) Sub faces a choice between: Repatriating its earnings to US Reinvesting the funds in F Holding passive assets in F 32

33 Example: Accumulating Cash Abroad Time 0: Sub has generated $1 in earnings Time 1: Sub faces a choice between: Repatriating its earnings to US Reinvesting the funds in F Holding passive assets in F (1 t)(1 + r) at time 1 33

34 Example: Accumulating Cash Abroad Time 0: Sub has generated $1 in earnings Time 1: Sub faces a choice between: Repatriating its earnings to US Reinvesting the funds in F Holding passive assets in F (1 t)(1 + r) at time 1 (1 + r t) at time 1 34

35 US International Tax System Consistent with these incentives, US MNCs accumulated substantial cash holdings overseas prior to the HIA Assets of US Firms in 2004 Other Assets 89.5% Cash 10.5% Foley et al. (2007) show that firms facing higher repatriation tax burdens hold more cash overseas Cash trapped abroad appears to have motivated US MNCs to lobby Congress for the Homeland Investment Act of

36 Homeland Investment Act (HIA) The HIA (enacted in 2004 as part of the American Job Creation Act (AJCA)) created a temporary (1-year) tax holiday for repatriations made in % of repatriated foreign earnings were exempt from tax during 2005 Ostensibly, the HIA required that repatriated funds be used for US capital expenditures (or certain other permitted uses ) and was intended to raise US employment ( create jobs ) 36

37 Homeland Investment Act (HIA) Permitted uses incl. US investment Debt US MNC Prohibited uses incl. Payout Exec. comp. Controlling stake Repatriates $80 US taxable income = $15 (15% of $100) Owes US tax of $5.25 (35% of $15) with foreign tax credit of $3 (20% of $15) additional US tax = $2.25 F Sub Earns $100 Pays $20 to F Assume tax rates are: t F C = 20%; t US C = 35% HIA: 85% of foreign earnings exempt from US tax in

38 Firms Responses to the HIA US MNCs dramatically increased repatriations in 2005 $300 Figure 1 Total Repatriations by U.S. Multinational Companies $250 $200 Billions $150 $100 $50 $ Notes: Data from Bureau of Economic Analysis, U.S. International Transactions Accounts Data, Table 7b, line 3 for distributed earnings. Repatriations are payments to U.S. multinational entities from their foreign affiliates. 38