Recently, the issue of tax havens has risen to the fore of the fiscal policy debate, with tax havens being singled out as the root cause of many of the fiscal shortfalls plaguing the governments of the world. Surprisingly, however, although there has been a fair amount of literature on why tax havens are harmful to the modern international tax regime, which countries become tax havens, and what means are available to combat tax havens, there has been less written specifically on the underlying question of why, notwithstanding all these points, tax havens exist in the first place, or why they persist in the face of such overwhelming criticism. This Article will fill that gap by directly confronting the question: why are there tax havens?
To this end, this Article will propose for the first time that the focus of the international tax laws of wealthier countries, such as the United States, on capital neutrality---or making the flow of capital across borders easier and cheaper--can actually create or exacerbate the incentives necessary for poorer countries to act as tax havens. This can be thought of as a "capital neutrality paradox" in that it is the pursuit of capital neutrality--meant to increase worldwide efficiency--which leads to more countries acting as tax havens, effectively undermining worldwide efficiency. Consequently, punishing such countries in response would also prove counterproductive, because it would only exacerbate these incentives created by U.S. law in the first place. This "punishment paradox" in connection with the "capital neutrality paradox" can fundamentally alter the way in which the law should conceptualize and respond to the issue of tax havens. Rather than ask "why are there tax havens?" the question would become "why pursue capital neutrality?"Rather than ask "what can we do to punish tax havens?" the question would become "would punishment be effective?"Such an approach could not only lead to a more efficient international tax regime, but could also be the first step to finally answering the question of why there are tax havens.
INTRODUCTION I. THE INTERNATIONAL TAX REGIME: THE PROBLEMS OF DOUBLE TAXATION AND TAX COMPETITION II. DOUBLE TAXATION RELIEF AND TAX COMPETITION: THE TWO PARADOXES A. The Capital Neutrality Paradox B. The Punishment Paradox C. The International Tax Paradoxes Operationalized 1. Territorial Exemption and Tax Competition 2. Worldwide Tax Base, Credits, and Blending III. HOW DID WE GET HERE? THE MOVE TO NEUTRALITY AND THE RISE OF THE INTERNATIONAL TAX PARADOXES IV. TOWARD RESOLVING THE INTERNATIONAL TAX PARADOXES CONCLUSION INTRODUCTION
A raging debate on the perils of tax havens grips the nation. Unscrupulous taxpayers indefinitely defer paying their fair share of U.S. taxes by funneling their income through artificial companies in tax haven countries. Tax havens threaten the long-term fiscal health of the country, undermining the ability of the government to address the pressing economic and social emergencies of the day, and thus the integrity of the modern state itself. The alarm has been raised, the gauntlet has been thrown; leading academics have been decrying the use of tax havens as "tax witchcraft," (1) and even the President of the United States himself has been imploring Congress to act. (2) Is this a description of the state of U.S. tax policy in 2010? No--it describes international tax policy debate in the late 1950s and early 1960s. Yet, despite over fifty years of debate, scholarship, analysis, legislation, and regulation, if one simply listened to the modern debate over tax havens, it would appear that little progress has been made over that time. (3)
What can explain this lack of progress? (4) It cannot simply be attributable to myopia, inertia, or laziness; after all, the United States has enacted or fundamentally revised comprehensive antitax-haven legislation in 1962, (5) 1976, (6) 1986, (7) and 1993, (8) and it is currently the driving factor behind most international tax policy. (9) Nor can it be a problem unique to the idiosyncrasies of U.S. tax policy, since tax havens have plagued most of the developed countries of the world--as evidenced by the recent "name and shame" campaign against tax havens led by the Organisation for Economic Cooperation and Development (OECD). (10) Yet tax havens not only arise and persist in the face of such seemingly overwhelming attack and criticism, they seem to flourish. (11)
Accordingly, the issue of combating tax havens has once again risen to the fore of the fiscal policy debate, being singled out by institutions such as the OECD and G20 as the root cause of many of the fiscal shortfalls plaguing the governments of the world. (12) To this end, an otherwise unassuming five-story building located in Grand Cayman named Ugland House has found itself in the eye of the most recent tax haven storm. (13) What distinguishes Ugland House from other buildings is not its architecture or its name, but rather that it houses over 18,000 corporations, mostly owned by U.S. taxpayers. (14) Consequently, a renewed--and familiar chorus has arisen: Ugland House is a mere sham, aiding and abetting U.S. companies from paying their "fair share" of U.S. taxes. This obviously must be the case, the argument goes--after all, if 18,000 corporations truly were headquartered at Ugland House, wouldn't it need a bigger parking lot? (15)
Contrary to this popular sentiment that Ugland House represents a den of tax iniquity for dishonest taxpayers to evade their fair share of U.S. taxes, this Article will contend that it can more properly be thought of as a symptom of the unintentional incentives created and perpetuated by the modern international tax regime embodied in the laws of countries such as the United States. How can this be the case? Surprisingly, although there has been a fair amount of literature on why tax havens are harmful to the modern international tax regime, (16) which countries become tax havens, (17) and what means are available to combat tax havens, (18) there has been little written in the legal literature specifically on the underlying theoretical question of why, notwithstanding all these points, tax havens exist in the first place, or why they persist in the face of such overwhelming criticism. (19) This Article will begin to fill that gap by directly confronting the question: why are there tax havens?
At first this seems like an exceedingly obvious question--tax havens exist because countries use their tax laws to attract business, either as a means to increase economic growth or to maximize tax revenue, or both. (20) The problem with this answer is that the literature has fairly well established that it must either be incorrect or irrational: first, using taxes as a means to compete with other countries over business investment generally does not benefit a country's long-term economic growth, (21) and second, tax havens generally have not adopted revenue-maximizing rates or otherwise engaged in theoretically revenue-maximizing behavior. (22) So are tax havens merely acting irrationally and contrary to their own long-term economic and fiscal interests, perhaps captured by special interest groups indifferent to the harms they are imposing on the world, or is some other underlying phenomenon at play?
This Article proposes the latter, focusing on the role that the fundamental policy superstructure of the international tax laws of countries such as the United States can play in creating or exacerbating all or part of the incentives necessary for countries to act as tax havens. In other words, what has been missing from the tax haven debate is the observation that the focus of most developed countries' international tax law on "capital neutrality"--in essence minimizing double taxation on cross-border business and investment (23)--can itself create or exacerbate incentives for other countries to engage in tax competition.
At first this appears counterintuitive: if U.S. law is truly neutral as to capital, how can it shape incentives for other countries to compete against the United States over capital? Answering this question requires revisiting some of the normative arguments supporting capital neutrality in the first place, primarily the concern with mitigating double taxation, that is, two countries imposing tax on the same item of income. By doing so, the theory goes, capital will more easily cross borders, increasing gains from trade and making every country better off. (24) The problem is that there is a cost to making capital more mobile in addition to a benefit: the more mobile capital becomes, the more easily countries can use tax incentives to attract such capital. (25) In other words, one country focusing on double taxation relief can make tax competition a cheaper and more readily available instrument for other countries to attract capital. (26)
This could be thought of as a form of"capital neutrality paradox" in that it is precisely the pursuit of capital neutrality by a country such as the United States--intended to increase worldwide efficiency-which could lead to greater incentives for other countries to engage in tax competition, effectively undermining worldwide efficiency. (27) This does not mean that the costs of capital neutrality will outweigh the benefits, or that all countries will act on the incentive to engage in tax competition. Rather, the capital neutrality paradox suggests that there are incentives within the international tax regime toward tax competition which have until now not been taken into account.
Even taking the incentives of the capital neutrality paradox as true, however, they would be irrelevant to the analysis of why there are tax havens if the benefits of capital mobility, such as gains from trade, were always greater than the benefits from tax competition for all countries involved. Accordingly, analyzing why there are tax havens necessitates...