“Tax Information Agreements Reduce the Shady Parts of Tax Havens’ Business”
(The interview appeared in SAFE Newsletter Q3 2015)
Alfons Weichenrieder is Professor of Economics and Public Finance at Goethe University, Principal Investigator in SAFE and a Member of the SAFE Policy Center Core Team. His research interests comprise fiscal policy in Europe, sovereign debt and taxation. Before joining Goethe University in 2002, he held academic positions at the University of Vienna, the LMU Munich and Princeton University. Weichenrieder is a Member of the Scientific Research Council of the German Federal Ministry of Finance.
Which research questions are you currently focusing on?
An important topic at the moment is whether we need new fiscal institutions in Europe given that we have a monetary union without a fiscal union. There are many related research questions that are of interest to me. Another longstanding research interest of mine is international taxation, in particular of multinational firms. Here, tax havens have attracted much attention since the financial crisis. Low regulations in tax havens may have contributed to the crisis by offering an unregulated place for all kinds of special vehicles. A related issue, more on the public finance side, is the question to what extent tax havens make it more difficult for high tax countries to secure their tax revenues.
In a recent paper (Braun/Weichenrieder, 2015), you look at the question of how multinational firms use tax havens.
There is a lot of research and public talk on the aspect of private bank accounts in tax haven countries. Research shows that exchange of tax information reduces the willingness of investors to shift money into a “cooperative” tax haven. I was wondering whether similar behavior can be observed for multinational firms. There were two hypotheses: first, as it is more difficult for firms, as compared to individuals, to hide funds, information exchanges could have rather little impact on multinationals’ use of tax havens. On the other hand, we know from anecdotal evidence that firms sometimes do shady things, e.g. they give bribes to get procurement projects in corrupt countries or they set up tax saving arrangements and do not want tax authorities to figure out how they do it. So, I was interested in whether all these factors lead to a situation where tax information exchange agreements would change the interest of firms to have an affiliate in tax haven countries.
And what are your findings?
We used Bundesbank data for German parent firms to detect whether a given parent has an operation going on in a particular tax haven country in a given year. Germany has tax information exchange agreements with some tax havens but not with all, which allowed us to examine how many affiliates cooperative tax havens have lost, as compared to those that were not cooperative. What we find is that German parent firms indeed seem to have a preference for tax havens that have not signed a tax information exchange agreement with Germany: the number of affiliates in countries that became cooperative slightly went down whereas the number of affiliates in non-cooperative tax havens went up quite steeply (see Figure 1). In sum, affiliates in cooperative tax havens decreased by 46% compared to the control group. So, it is not only a demand for tax advantages that leads to firms’ investments in tax havens but also a demand for secrecy. However, it may be that only a part of the activities has been given up completely whereas a considerable amount may have been shifted towards the remaining non-cooperative tax havens.
Do your results also provide information about the activities of shadow banks?
Unfortunately, the number of banks in our data base was too small to concentrate on banks. So, we had to merge all kinds of businesses. But when you look at the most complicated ownership structures of affiliates that use several countries, you will mainly find banks. This may be telling.
In a second paper (Weichenrieder/Xu, 2015), you evaluate the consequences of tax havens for higher tax countries. One would expect these to be negative, right?
Interestingly, this is not clear. A couple of North American scholars in public finance tend to hold the seemingly paradoxical view that tax havens have positive effects on high tax countries. The explanation is that countries can benefit from the fact that immobile domestic firms have to pay the higher national corporate tax rate, while highly mobile international firms can make use of tax havens without having to leave the country. The underlying assumption is that an outright differentiation of corporate tax rates is not possible in most countries. Therefore, according to this view, tax havens provide an indirect service to high tax countries by allowing international firms to reduce their tax rates. This way, high tax countries lose tax income but they do not lose the mobile firms altogether with all the valuable jobs they provide.
In our paper, we suggest that rather the opposite is plausible: tax-haven secrecy makes it harder to differentiate between domestic and foreign firms. An example is China which, indeed, in the past had a split corporate tax and imposed 15% on foreign owned firms, which by definition are mobile, and 25% on domestic firms. When you now look at the main investor countries in China you surprisingly find that the largest investor – behind Hong Kong – is not Japan or the U.S. but the British Virgin Islands. Same picture in India where the biggest foreign investor is Mauritius. The explanation is that the intransparency offered by tax havens allows firms to circumvent their home country’s legislation and, thus, to get advantages in tax rates and other policy areas by pretending to be foreign. These results are quite contrary to what some proponents of tax havens want to make us believe.
So, both of your papers suggest that tax information agreements could be an efficient policy tool to avoid undesired behavior of multinational firms.
This is true. Tax information agreements would probably also reduce this inefficient roundtripping. So, altogether, these agreements are a good move forward. An OECD initiative has already resulted in 61 countries signing a multilateral treaty. The shady parts of tax havens’ business may be reduced by this. On the other hand, with every agreement the remaining uncooperative tax havens are gaining more and more profits which will make it increasingly difficult to persuade them to cooperate.
Could a further policy implication be to change the tax base, e.g. instead of taxing corporates based on where their headquarters is located, to tax them based on where their employees work?
There are efforts in this direction. In 2011, the EU Commission has published a draft directive on formulary apportionment whose idea is to calculate the profits of European company groups as a whole and then provide each of the hosting countries with a part of the tax revenue depending on how many workers, tangible capital and sales to unrelated parties are connected to this country. However, there are several problems with this concept: first, the EU Commission suggested to make this approach elective; groups can opt into this system but can also stay in the old system. Second, it would be only valid in Europe. Third, and most importantly, it might lead to more distorted results than we have now. A firm which wants to save on taxes in the old system, uses highly distorted transfer prices between affiliates in different countries to push profits to where the tax rates are lowest. In the new system, the firm would need to push workers and capital to achieve this effect. This would lead to distortion which should affect the real economy more than this is currently the case. So, as long as the EU does not dare to set a minimum corporate tax rate in Europe, there is tax competition and firms will react to that with all kinds of creative activities.
Braun, J., Weichenrieder, A. (2015)
“Does Exchange of Information between Tax Authorities Influence Multinationals’ Use of Tax Havens?”,
SAFE Working Paper No. 89.
Weichenrieder, A., Xu, F. (2015)
“Are Tax Havens Good? Implications of the Crackdown on Secrecy”,
SAFE Working Paper No. 111.
Selected Publications by Alfons Weichenrieder
Bursian, D., Weichenrieder, A., Zimmer, J. (2015)
“Trust in government and fiscal adjustments”,
International Tax and Public Finance, DOI 10.1007/s10797-015-9363-2.
Lipatov, V., Weichenrieder, A. (2015)
“Welfare and labor supply implications of tax competition for mobile labor”,
Social Choice and Welfare, DOI 10.1007/s00355-015-0898-z.
Weichenrieder, A., Zimmer, J. (2013)
“Euro membership and fiscal reaction functions”,
International Tax and Public Finance, Vol. 21, Issue 4, pp. 598-613.
Ruf, M., Weichenrieder, A. (2012)
“The taxation of passive foreign investment: Lessons from German experience”
Canadian Journal of Economics, Vol. 45, Issue 4, pp. 1504-528.