The Role of Tax Havens

February 26, 2008

A commentary on the Cato Institute website and in the Wall Street Journal Europe today responds to the controversy over the stolen data that Germany purchased from a Liechtenstein bank. The author, Daniel J. Mitchell, argues that tax havens such as Liechtenstein play an important role.

Wealthy tax evaders may not be sympathetic figures, especially to those of us who meekly comply with the law. But low-tax jurisdictions serve a valuable role in the world economy. Simply stated, they keep other governments honest. Globalization makes it easier for labor and capital to cross national borders, forcing governments to improve tax policy to keep the geese with the golden eggs from flying away.

Tax competition first became a big issue following the Thatcher and Reagan tax cuts in the 1980s. Responding to the increased attractiveness of the U.K. and U.S. economies, every single industrialized nation has been forced to lower personal tax rates in an effort to stay competitive. The average top tax rate in the developed world has dropped from more than 67% in 1980 to barely 40% today.

The same thing is happening to corporate tax rates. Back in 1980, corporate tax rates averaged nearly 50%. Today, led by Ireland’s 12.5% corporate tax, the average corporate rate in the industrialized world is less than 27%. As the World Bank explained in its recent “Paying Taxes” report, these lower rates create incentives for more investment, which leads to faster growth, more jobs, higher incomes and what Berlin seems to be most concerned about: better compliance. …

Liechtenstein has a tax code that rewards productive behavior, and it is now the world’s third-richest jurisdiction according to the World Bank. German tax laws, by contrast, are rated among the world’s worst by the World Economic Forum’s Global Competitiveness Report. … Perhaps most interesting, Liechtenstein scores highly on the World Bank’s six governance indicators, beating out nations such as—you guessed it—Germany.

Click here for more on international tax competition.

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