Tax havens, income shifting, and redistributive taxation

• DOI: http://doi.org/10.1111/jpet.12335
• Author: Yu‐Bong Lai
• Published date: 01 February 2019
• Date: 01 February 2019

Received: 23 November 2017

|

Accepted: 27 August 2018

DOI: 10.1111/jpet.12335

Tax havens, income shifting, and redistributive

taxation

Yu‐Bong Lai

Department of Public Finance, National

Chengchi University, Taipei, Taiwan, ROC

Correspondence

Yu‐Bong Lai, Department of Public Finance,

National Chengchi University, No. 64, Sec. 2,

ZhiNan Road, Taipei 11605, Taiwan, ROC.

Email: yblai@nccu.edu.tw

Funding information

Ministry of Science and Technology (Taiwan,

ROC), Grant/Award Number: 107‐2410‐H‐

004 ‐013

Abstract

This paper investigates the effects of tax havens on

nonhaven countries’redistributive policies. We consider

that a nonhaven country contains individuals with different

labor productivities. A tax is imposed on the income, and the

revenues are evenly distributed. The tax rate is determined

by majority voting, which reflects the median voter’s

preferences. The presence of havens gives rise to the

mobility of tax bases, which may increase the nonhaven

country’s tax rate in two ways. First, it leads to a median

voter with a lower productivity; second, it may enlarge the

marginal tax revenue from raising the tax rate. In addition,

we find that a stricter antihavens regulation may lower the

tax rate. We further show that income shifting is likely to

reduce the amount of the transfers. The case of tax evasion

is also taken into consideration.

1

|

INTRODUCTION

The issue of tax havens has been the focus of much attention and debate. A number of studies have discussed the

impacts of havens on the tax policies of nonhaven countries, and most of them have been directed at efficiency

topics. The redistributive problems, however, have been overlooked. According to Zucman (2014), about 8% of

global household net financial wealth is held in tax havens, which amounted to about $7.6 trillion at the end of

2013. In a more recent study, Alstadsæter, Johannesen, and Zucman (2017a) found that the amount of global

offshore wealth is equivalent to about 10% of world gross domestic product (GDP). Zucman (2014, p. 140) claims

that “the world’s offshore wealth is large enough to significantly affect measure of the inequality of

wealth.”Moreover, the higher mobility of tax bases has significantly restricted the scope for redistribution

through taxation. People are concerned that the presence of tax havens will erode the foundation of the

redistribution policy, or the welfare state (Avi‐Yonah, 2000; Steinmo, 1994). It is thus necessary to investigate the

effects of tax havens on nonhaven countries’redistributive policies.

J Public Econ Theory. 2019;21:81–97. wileyonlinelibrary.com/journal/jpet © 2018 Wiley Periodicals, Inc.

|

81

ARTICLE

This paper focuses on general redistributive programs, which affect almost all members of a society. Such

programs are likely to reflect the preferences of the majority (Persson & Tabellini, 2000). To characterize this

feature, we allow the redistributive program to be determined through a political process. Two political

candidates compete f or office, and they commi t to their announced pro gram once they are in offi ce. The

equilibrium tax rate reflects the preferences of the median voter.

1

This setting is differ ent from that in the

existing literature, in which governments seek to maximize social welfare or to maximize tax revenues.

Redistributive con cerns usually do not play an impor tant role in the related literatur e, whereas they are essential

in determining the ta x rate in this paper.

Moreover, the literature regarding tax havens focuses on capital income or profit income. However, according

to Atkinson, Piketty, and Saez (2011), over the past 30 years top income shares have increased substantially. They

argue that this result is due in part to an unprecedented increase in top wage incomes. Thus, wage income

constitutes a larger fraction of top incomes than in the past. Smith, Yagan, Zidar, and Zwick (2017) also confirm this

view. They find that most top earners are working rich, not passive owners of accumulated capital. They also show

that 61% of top S‐corporation income is wage income in disguise. To characterize these features, we deal with labor

income and personal taxation.

We aim to address how shifting income to havens affects the nonhaven country’s redistributive policy. To this end,

we consider a small open economy, in which live a large number of people endowed with different labor productivities.

A tax is imposed on the income, and all of the proceeds are evenly distributed among the people. We first consider a

case without havens, in which individuals’ideal tax rates decrease with their productivities, and the median vo ter is the

individual with the median productivity. Then, we introduce tax havens, through which rich people can dodge the local

taxes. Shifting income to havens requires a fixed cost, which is regarded as a social waste.

The standard tax‐competition model shows that the mobility of tax bases tends to reduce the tax rates in the

high‐tax countries, because when tax bases are interjurisdictionally mobile, an increase in the tax rate generates

less revenue. This result does not necessarily hold in the presence of havens, which give rise to the mobility of tax

bases. We find that the mobility of tax bases may increase the marginal tax revenues from raising the tax rate,

inducing the median voter to choose a higher tax rate.

Moreover, the presence of havens can raise the tax rate in the nonhaven country in a second way. When income

shifting is possible, the income shifters can avoid domestic taxes, and they will endorse the highest tax rate to

receive the largest amount in terms of a transfer payment. Recall that they prefer lower tax rates when income

shifting is not allowed. The change in their stance on the tax rate results in a different median voter with a lower

productivity, who prefers a higher tax rate.

Since the financial crisis of 2008–2009, progress has been made in reducing bank secrecy, including the Foreign

Account Tax Compliance Act (FATCA) in the United States, and the new global standard on the Automatic

Exchange of Information (AEOI) of the Organisation for Economic Cooperation and Development (OECD).

Although such policies are probably unable to eliminate income shifting behavior (Johannesen & Zucman, 2014;

Zucman, 2014), they raise the costs of using the offshore banking service.

2

The impacts of these antihaven

regulations on the tax rate in the nonhaven countries are another concern of this paper.

We find that the effects of a higher cost of shifting income, denoted by

c

, on the tax rate are ambiguous. On the

one hand, a higher

c

gives rise to a median voter with a larger productivity, and thus he endorses a lower tax rate.

On the other hand, the marginal tax revenues from raising the tax rate either increase or decrease with

c

. When the

labor productivities follow a Pareto distribution, a reverse relationship between

c

and the tax rate is more likely to

occur when the initial tax rate is higher, or the distribution of productivities is more unequal.

1

Here, we assume that voters’policy preferences are shaped by their economic situation. Such self‐interested policy preferences have been empirically

confirmed by, for example, Alesina and La Ferrara (2005), Kau and Rubin (1979), Lupu and Pontusson (2011), and Margalit (2013).

2

According to Zucman (2014), those regulations would make it more difficult for fairly wealthy individuals to avoid or evade taxes through offshore banks.

However, ultra‐rich individuals are still able to use the more sophisticated services provided by offshore banks to dodge taxes.

82

|

LAI