To Tackle Inequality, We Need New Thinking on Tax Havens

Demonstrators in fancy costume tossing play money in the air
A protestor throws fake money during a demonstration against tax havens in London, the United Kingdom, on May 12, 2016. © Neil Hall/Anadolu/Getty

What do tax havens have to do with inequality? Everything. That’s not to claim that getting rid of tax havens will solve inequality by itself, but until we address the challenge of tax havens, tackling inequality will only get harder in the coming years, as structural trends make it more pronounced and entrenched.

There may be no agreed definition or list of tax havens, but the common theme is that they invite mobile capital and help it avoid taxation in other countries.

Some havens help the ultra-wealthy hide their fortunes from tax authorities or creditors in their home countries (sometimes called secrecy jurisdictions). Other tax havens help large companies artificially shift profits from out of the countries where their real economic activity took place and into a low-tax jurisdiction. (For example, does anyone really believe that U.S. multinationals made more profit in Bermuda than in France, Germany, Japan, and China combined?) Some tax havens have gone further and help companies make it look as though their profits are generated nowhere—stateless income that no country can tax.

Most people sense that allowing big corporations and the ultra-wealthy to avoid taxes must play some part in inequality. But when it’s seen in light of the convergence of three trends, the impact is even deeper—and more troubling—than it first appears.

The first trend is the precipitous decline in corporate tax globally, both nominal and effective rates. This is partly due to the profit shifting and tax avoidance which tax havens enable. It is also caused by tax competition, in which jurisdictions feel pressure to reduce their corporate income tax rate or offer incentives such as tax holidays. But many argue that countries are lowering their corporate tax rates in part to compete with those tax havens.

The second trend is that this reduction in taxation of corporate income has taken place against a shift in economic returns from labor to capital—a trend which is only likely to be amplified by accelerating technological developments. The share of national income going to labor has hit a record low, as the benefits of economic growth in recent decades have gone disproportionately to a small fraction of the wealthiest citizens, while the post-2008 recovery has been characterized by a marked stagnation of wages for the vast majority of workers.

This transfer of income from labor to capital while the tax burden shifts away from capital—and therefore onto labor and consumption—is concerning in its own right. However, the need to address barriers to effective taxation of capital becomes more urgent in light of the role technology is playing in displacing labor. As technology displaces more workers in more sectors of the economy, it seems inevitable that the balance of return will shift further from increasingly-replaceable labor to capital (i.e., those who can invest in, and own, the technologies in question).

Remember that it is the income generated from mobile capital (whether profits of multinational corporate groups or investments of high-net-worth individuals), rather than immobile labor or consumption, that tax havens help avoid taxation in home countries. Uber could set up a subsidiary in the Bahamas and attempt to shift its income there through intellectual property rights and licensing fees, avoiding paying taxes in other countries. The people driving for Uber, however, cannot. And if its self-driving car initiative succeeds, then there will not even be that tax base of local labor for domestic governments.

Tax havens will thus exacerbate the social dislocation that increased automation will inevitably bring, and they may put at risk the social safety nets required to mitigate that dislocation. If we should, as the economist Richard Freeman argues, “worry less about the potential displacement of human labor by robots than about how to share fairly across society the prosperity that the robots produce,” then we must recognize that that is impossible in a world where tax havens run amok.

In short, the effective taxation of capital, in the face of increased automation, will increasingly become necessary for a sustainable social contract. But unless tax havens are addressed, effective taxation will remain a major challenge. You might say that tax havens are emblematic of a “rigged” economy, where the wealthy and powerful play by an entirely different set of rules, gathering disproportionate benefits, while it is increasingly hard for ordinary people to get ahead.

This leaves a pressing need for new thinking on how to view and address the role tax havens play in a rapidly evolving global economy. Some advocates are already taking up this challenge, arguing, for example, that the spillover effects of national tax policies should be assessed under the extraterritorial application of human rights obligations.

However, other opportunities exist to use other bodies such as international trade law. The link between international trade law and the role that tax havens play in promoting tax avoidance may seem a stretch at first. But international tax avoidance is possible on the massive scale that we see because of the growth in international trade.

Indeed, the way that trade is distorted, and that wealth is extracted from developing countries, now relies on complex corporate structures and the massive rise in intra-party transactions (where goods or services are “bought” and “sold” between two subsidiaries of the same corporate group, in reality two parts of the same company). The question is whether existing tax and international trade law systems are adequate to deal with this new reality.

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