A DRIVER FOR COMPETITION

Competition and capitalism have been proven as the best of all economic models tried so far, so unless the reader is interested in relocating to Cuba, rural China, or certain other parts of the world, we will assume competition is a good thing.

Competition is good because it promotes efficiency, innovation, and drives costs and prices down. The problem is that unless we embrace globalisation certain sectors of Governments around the world chose not to compete. In this context international financial centres (IFCs) like Cayman not only promote competition but limit excessive Government expansion and don’t take my word on this:

“ …the ability to choose the location of economic activity offsets shortcomings in Government budgeting processes,
limiting a tendency to spend and tax excessively…” [1]

and

“Evidence also suggests that tax autonomy may lead to a smaller and more efficient public sector, helping to limit the tax burden and improve tax compliance… Efficiency-raising effects of tax autonomy and tax competition on the public sector have also been reported in empirical research with Norwegian and German data… Tax autonomy generates opportunities to choose the level of public service provision and taxation, although in practice such “voting with your feet” seems mostly limited to young, highly educated and high income households. Decentralised tax setting also fosters benchmarking of the performance of jurisdictions belonging to the same Government level by voters, even in the absence of “voting with your feet”… [2]

One of the reasons IFCs continue to be successful is that many countries have developed overcomplicated tax systems. They also tax economic activity repeatedly throughout the production and commercialisation cycle with treaties and rebates that attempt to avoid double and triple taxation but fail miserably to do it in a viable way to promote international capital flows.

On the other hand, many IFCs have built their tax collection systems in a very simplified way that avoids these pitfalls and is centred around consumption, which is especially true in the case of the Cayman Islands; and while many countries complain and believe this is not a good idea, the Organisation of Economic Co-operation and Development (OECD) again said –

“Shifting the taxation of income to the taxation of consumption may be beneficial for boosting economic activity (Johansson et al., 2008 provide evidence across OECD economies). These benefits may be bigger if personal income taxes are lowered rather than social security contributions, because personal income tax also discourages entrepreneurial activity and investment more broadly.” [3]

This demonstrates what a simplified tax system based on simple economic theory could look like if legislators and regulators did not have a pervasive incentive to act in the opposite way.

Furthermore, progressive corporate taxes, which appear to be the most common approach taken in developed countries, are the most damaging to business growth. These taxes negatively harm the businesses that are likely to be most productive, hurting the economy in the worst possible place.

On the contrary, most IFCs have revenue systems that are based on effective use of Government services.

But competition is not limited to the area of taxes, and certainly not to the area of effective tax rates. Even though the effective tax rate may not in itself be excessive, the sheer difficulty of dealing with double taxation treaties and tax rebates can make many projects unviable.

In addition, unnecessary regulation can have a similar negative effect.

The enactment of regulation by separate states within a country is in many cases the biggest driver promoting the provision of certain services from IFCs — insurance being such an example of this influence.

One common argument against IFCs is that such regulatory competition promotes a “race to the bottom”, forcing Governments to adopt weaker legislation to compete with the IFCs.

However, this argument does not stand scrutiny when the reports from the FATF, general secretary of the OECD, or membership in IOSCO are perused objectively. Indeed, these reports show the Cayman Islands has a comparable and in many cases much stronger compliance with international standards and recommendations when compared to the major OECD countries.

The last report issued by the general secretary of the OECD to the leaders of the G20 during a September meeting in Russia, provided summary results of the compliance with FATF recommendations by 98 jurisdictions ranking them green, amber, or red across nine categories. While Cayman has a perfect score (green across all nine categories), the US has two ambers, the UK and Germany one, and the host of the meeting seven, leaving them green in just two of the nine categories.

Fortunately many economic studies have proven that tax competition creates economic benefits. At marginal tax rates that near or surpass half of gross income, many investment projects that would promote economic activity are no longer viable. Studies suggest every additional percentage point in the level of taxation as a share of GDP reduces growth in the economy by 0.15%, so the point that an oversized Government has a negative effect on economic growth, income per capita, and average living standards is not one of ideology but a factual conclusion proven repeatedly.

A smaller economy means less available resources as a whole and in the long run lower public spending. The key issue is in the short-term (certainly within an election cycle) discussions on Government spending and taxes tend to assume a stable economic output. While that may be an acceptable assumption in the election cycle, it is certainly not the case in our life cycle or that of our children’s.

Lastly, but certainly not less important, IFCs provide the ability to structure international investments within a recognised and proven legal framework without adding a layer of taxes. Many international investments, including those made by State funds in poorer countries, would not be possible if IFCs were unable to offer access to common law, and those investments had to be done within the laws of the country of destination of the investment. It is also important to note that contrary to popular belief, this structuring does not reduce the tax where the investment is made nor the tax to which the investor is liable. Instead, the benefit of the structuring is it ensures that in the case of multiple investors each one has to deal with the particulars of the tax code that regulates them instead of having to navigate through multiple
tax codes and double taxation treaties that would make the investment even less economically viable.