For the last couple of months we have been bombarded with news stories about the action of the OECD countries vis-à-vis the offshore sector in the Caribbean. Essentially we have been told that the OECD is unhappy with the present legislative and administrative arrangements governing the offshore sector. The clear impression given is that the offshore financial sector in the Caribbean is a danger to the OECD economies (if not to the entire world economy) because the sector could easily be taken over by criminal elements, particularly the drug mafias, to launder their ill-gotten gains. The necessity to fight money laundering and other criminal activities is a goal we all subscribe to, and our government here in Dominica is hastening to beef up legislation and procedures in order to keep out "dirty-money". However it is our contention that money laundering is not the main or real concern of the OECD countries. Rather they are very concerned with what is euphemistically known as "harmful tax practices" or "unfair tax competition".
Offshore activities are not new by any means, but it is only recently that they have become a matter of controversy. Controversy has arisen now because the world economy is in the throes of a major realignment whereby the sources of wealth and income are moving away from material things; factories; farms etc. toward what is known as the weightless economy, which can be considered to comprise four elements:
All these elements of the weightless economy have knowledge and its applications at their core. Not only is most of this knowledge, and therefore value, produced and used in the OECD countries but the value of the weightless economy is already larger than what is referred to as the old economy: Agriculture, manufacturing and the traditional services. It is a well-known fact that the richest man in the world is Bill Gates founder of Microsoft who was reportedly worth US$46 billion in1998. The second richest man is reputedly the C.E.O of Oracle another producer of computer software. Both of these gentlemen and scores of other less well know companies and individuals own little physical property as such, but rather copyrights and patents – intellectual property. To give you an idea of the importance of the weightless economy consider these facts. In 1997 the Performing Right Society of the UK, a Performing Right Organisation concerned with the collection of royalties for Composers and Songwriters, collected 205 million pounds sterling in licence fees. This is quite a tidy sum, but the PRS (founded in 1914) took 76 years to reach a level of collections of 100 million pounds in 1990. The second 100 million pounds was achieved in only 8 years.
Similarly if we look at the macro picture in the United States the importance of the weightless economy will be demonstrated. In a study undertaken for the International Intellectual Property Alliance (IIPA) by Economists Incorporated it was shown that the Copyright industries are of great and growing importance to the US economy. In 1997 the core copyright industries – Movies, TV productions, home Video, the recording industry, music publishing, books, journals, newspapers, computer software, advertising, cable, radio and TV broadcasting – contributed $348.4 billion or 4.30% of US GDP. In the same year the total copyright industries (the core industries plus allied activities such as retailing and distribution of software, videos etc) contributed $529.3 billion or 6.53% of GDP. While these numbers are impressive the real rate of growth of the copyright industries vis-a-vis the rest of the economy is even more astounding. Over the period 1977 to 1997 the real rate of growth of the core copyright industries has grown at an annual compounded rate of 6.35% while the rate for the economy as a whole grew at only 2.7%. Copyright industries grew more than twice as fast as the economy as a whole!
As you would expect employment also followed a similar trend. In 1997 the core copyright industries employed 3.8 million workers, while the total copyright industries employed 6.9 million workers or 5.3% of total employment.
At US$66.85 billion in 1997 the export sales of the core copyright industries of the US was larger than the export of almost all other industries, larger even than the combined exports of automobiles and automobile parts or the agricultural sector.
Copyright Industries of course are only part of the weightless economy; you will notice that we have not mentioned the internet, patents, biotechnology etc. When all these activities are taken into account the true scope of the weightless economy in the OECD begins to emerge.
Tax liability for an individual or a company is determined essentially by two factors:
An offshore jurisdiction (tax haven) essentially allows an individual or company to transfer his (or its) legal domicile to some country where he (it) carries on no real business. In return for domiciliation the individual or company pays a very low or in some cases no tax on income or wealth except for an annual fee. While it is possible for firms in the old economy to take advantage of the low tax regimes, the offshore sector seems tailor-made for tax avoidance for businesses and individuals operating in the new weightless economy. E.g. because Microsoft’s assets are essentially in the form of copyright and some patents the ownership of Microsoft’s assets can literally be transferred to an IBC domiciled in Dominica with the stroke of a pen. The IBC located in Dominica, being the owner of the assets, could then license the copyrights and patents to all users anywhere in the world. The entity receiving the revenues would be the IBC domiciled in Dominica rather than Microsoft based in Washington State. Such a move would radically change Microsoft’s tax liability in the United States as well as in the other OECD countries (where the income really arises). Of course before they would dream of taking such a step our copyright and other intellectual property laws as well as the relevant international treaties would have to be up to date.
Globalisation, if it means anything specific, is the breaking down of trade barriers with the avowed aim of increasing efficiency of production in the world. It is not often stated explicitly, but it is accepted that the process of globalisation must involve increased specialisation and trade (WTO and all of that). Globalisation (specialisation and free trade) also implies that goods and services should be produced by those countries and firms that produce them at lowest cost (hence DCP should sell out to Colgate-Palmolive because this multinational is better able to market the company’s products). It is on these grounds of efficiency that the United States and the Latin American producers of bananas object to the EU’s banana regime. The logic of the argument says that if we in the Caribbean were to cease producing bananas the net benefit to European consumers and Latin American producers would outweigh the loss to Caribbean producers. Not only would there would be a net increase in world welfare, but the resources that would be freed up in the Caribbean could then be put to uses that would provide higher levels of welfare for Caribbean people.
The argument in general is correct and globalisation is indeed capable of producing higher levels of welfare. The problem for our economy arises because, for globalisation to be meaningful, pretty much all goods and services have to be globalised, including the domiciliation of wealth and income. In other words all aspects of economic life should be on the table and should be traded freely. Countries should not only be trading and competing in the provision of goods and traditional and new services, but taxation services should be also be freely tradable. The OECD however says that tax competition is not allowed in the globalisation game (or is allowed with so many restrictions as to nullifiy its effect ) because the countries that are tax competitive are small and unpowerful. Just consider this scenario; The US is badgering the EU to allow the importation of genetically engineered food under the guise that it is more efficient and economical for the European consumer and the American producer. However a goodly portion of the revenue from the genetically modified food belongs to patent holders, but the US tells the patent holder that he cannot domicile his patent in Dominica or any off-shore jurisdiction because the cost to him of doing so is too low. This argument of course flies in the face of common sense. An efficient economic agent is required to seek out the lowest cost supplier of any good or service and if Dominica and other off-shore jurisdictions can provide more tax efficient domiciles for mobile capital then the logic of globalisation dictates that the patent holder ought to utilize the tax advantages of off-shore jurisdictions.
The new international division of labour roughly allocates manufacturing to Asia and Latin America, knowledge industries (the weightless economy) to Europe and North America. Finance and the related domiciliation of capital and wealth are still not quite decided, but they seemed to be going to small island states via the offshore sector because these states are able to compete effectively on taxes with the rich countries. This move to small states is quite threatening to the OECD for among other things it threatens the hegemony of London and New York as "The" financial centres for the world.
The case of the Cayman Islands graphically illustrates the fact that the objective of the OECD’s name and shame campaign is not about money laundering. Over the last several years the Cayman Islands have quietly become one of the largest financial centres in the world and its offshore sector is considered one of the best regulated. They have signed agreements with both the UK and the US for exchange of information regarding criminal activities, but these agreements specifically excluded tax matters. Notwithstanding the fact that they had in place platinum level regulations and procedures against money laundering, in order to kept off the blacklist of tax havens they were forced to sign an "Advanced Commitment Letter" guaranteeing that they would commit "in particular to a programme of effective exchange of information in tax matters, transparency, and the elimination of any aspects of the regimes for financial and other services that attract business with no substantial domestic activities." The letter makes no mention of money laundering and only talks of "harmful tax practices".
The OECD itself clearly recognises that the offshore business is a natural concomitant of globalisation, but they are clearly not prepared to undergo the adjustment necessary with respect to the movement of wealth and capital to domiciles with preferential tax regimes.
In a paper entitled Globalisation: Benefits and Challenges for Governments The OECD lists one of globalisation’s challenges this way:
"But Globalisation has also raised challenges for governments: ……… how to ensure that governments maintain sufficient sovereignty to determine the revenue and expenditure structure that is best suited to their political, institutional and social conditions."They go on to say
"but it [globalisation] has also widened opportunities for tax evasion and avoidance. In this new environment, tax havens have thrived and some governments have adopted preferential tax regimes targeted at attracting mobile activities."According to them it will become difficult to collect taxes from mobile activities (the weightless economy blows across the globe on a faint wind). They foresee a "race to the bottom" where location and financing decisions become primarily tax driven. This means of course that offshore jurisdictions will have the edge, particularly in the weightless economy. The potential negative impact on the OECD of a large portion of the world’s wealth being outside of the control of the rich countries is real and they are determined not to lose control it, never mind their trumpeting of the benefits of globalisation.
Given the fact that the weightless economy is already so large and is expanding rapidly the taxman in the OECD countries, particularly where marginal tax rates are high, as in France, is justifiably concerned that a great number of business entities could legally use offshore mechanisms to escape large tax burdens. The countries (Dominica included) providing the offshore services benefit from the fees and other levies which the IBC’s, banks etc. pay and we wish it to continue because the revenue from more legal business would be more than sufficient to offset the decline in foreign exchange earnings from bananas and guarantee us a high standard of living.
In order to maintain an offshore sector we are more than willing to implement new measures to combat money laundering and other similar crimes; but if we think that the assault on the sector is really about money laundering we will be fooling ourselves because as we have tried to demonstrate our efforts to keep out dirty money will not ultimately satisfy the OECD as long as we continue to provide a legal means for high earners in the weightless economy to avoid taxes in their home countries. After all, the whole point of the offshore business is keeping one’s income and wealth out of the hands of the tax collector; the bankruptcy court; ex-spouses etc. The solution to the dilemma is neither easy nor obvious. It seems to me that we should agree on the one hand to modernise our laws to bring them up to date with modern business practice and the new tools available for fraud and other criminal activity, but on the other hand we should resist the attempt to whittle away the location advantages which our small size confers on us. Among other strategies I would advocate taking our case to the WTO on the grounds that the proposed actions of the OECD are in violation of WTO rules which essentially allows any business to set up shop anywhere and sell its goods and or services to any consumer anywhere in the world.
References.
Copyright Industries in the US Economy – The 1999 Report. Executive summary. Economists Incorporated
The weightless economy, Danny Quah
"Growth and Dematerialisation: Why Non-stick Frying Pans have lost the Edge," Danny Quah CEP’s Centrepiece, 1996 October
Performing Right Society Ltd Yearbook 1999. Performing Right Society Ltd.
Briefing Paper on Harmful tax practices, 17th October 2000, OECD
Towards Global Tax Co-operation: Report to the 2000 Ministerial Council Meeting and Recommendations by the Committee on Fiscal Affairs. Progress in Identifying and Eliminating Harmful Tax Practices : OECD
Globalisation: Benefits and Challenges for Governments, OECD
URL http://www.uwichill.edu.bb/bnccde/dominica/conference/papers/marie.html
© McCarthy Marie, 2001. HTML prepared using 1st Page 2000, revised February 12th, 2001.