America’s war on tax havens – what’s the real issue?

The U.S. government aims to outlaw offshore-tax savings strategies to collect billions of dollars lost in foreign jurisdictions. While the proposal threatens competitiveness of American corporations, the real issue is that the country’s high tax code fails to attract investment from nationals.

President Obama declared war on tax havens the very moment he took office in January 2009.

His opposition to offshore-tax savings strategies is like an iceberg. The tip we see is an attempt to overcome the worst economic meltdown in American history. Hidden underwater, however, lies a structural issue: a high tax code that forces U.S. companies and investors alike to allocate their capital into more competitive, lower tax jurisdictions.

America’s government is struggling to balance an ever-increasing budget deficit. A tax reform is one of the measures sought by the White House to tackle this crisis. The first proposal, as reported by Bloomberg in 2009, aimed to “end tax breaks for U.S.-based multinational companies”. Moreover, it wanted to “outlaw three offshore tax-saving strategies commonly used by American companies”. Obama’s plan, however, was shelved until 2010, when he announced a retooled scheme.

Obama’s second attempt to reform the tax code wanted “to collect $970 billion tax revenue in 10 years from Americans earning more than $200,000”, Bloomberg told. Moreover, he targeted “an additional $400 billion from businesses”. His proposals are yet pending agreement at the U.S. Congress.

Earlier this year, President Obama unveiled the budget for 2012 and reignited his war on tax havens at a press conference. His approach to tax reforms was criticised as of hampering American companies’ competitiveness in world markets if they have to pay billions of dollars in taxes on foreign profits.

Despite debate is grounded on the need for helping America’s economic crisis, U.S politicians are yet to discuss whether having a high tax system hinders the chance to race in a global economy where tax competition rules.

Who’s to blame?

Just as consumers benefit when grocery stores compete for their businesses, taxpayers benefit when governments compete. Investors play within the framework of a global tax competition and hence it’s legit to allocate their capital in the most tax-efficient jurisdiction.

Economist Daniel Mitchell, senior fellow at Cato Institute, argues that politicians from high tax nations, like the U.S., shouldn’t be allowed to undermine global tax competition. He said: “Some policymakers resent being force to lower tax rates. Like a town with only one gas station, these governments want captive customers with no choices.”

Countries like Ireland and Switzerland are in the race for lowering tax rates to attract savings, investments and jobs. The U.S., however, runs against the tide. Not only has one of the world’s highest corporate tax rates, the American government blames investors for hiding their assets in tax havens.

“Finding somebody to blame gives temporary relief and probably more votes for politicians that claim to fight the war on behalf of its people,” said Daniel Zurbrügg, managing partner of Alpine Atlantic Global Asset Management.

The greatest of all

The U.S. war against tax havens contains an element of contradiction. In 2007, speaking at a meeting of the Asia Offshore Association in Saigon, tax lawyer Marshall Langer said: “Some of the countries whose politicians complain the most about tax havens are in fact themselves significant tax havens.”

Langer lectures international tax law on a number of European universities. He told students of an online class: “No one is surprised when I tell the most important tax haven in the world is an island. They are surprised when I tell them that the name of that island is Manhattan. There is one big problem, however. The  U.S. is a tax haven only for foreigners who invest in the U.S. Most of its best tax haven attributes don’t work for you if you are either a U.S. citizen or U.S. resident.”

The case of the U.S. as a tax haven is rather unique. While it welcomes foreign investors applying competitive tax rate on their productivity, American counterparts bear a burden of 35% levy on profits, which is indeed one of the highest tax rates in the industrialised world.

Many supporters to this warfare claim companies are taking advantage of the system. Swiss tax lawyer Thierry Boitelle said: “I think many companies in the U.S. would like to keep the jobs in the U.S. if they could, but they also need to keep their shareholders happy. And they are in the U.S. in a corporate tax nightmare.”

A clampdown on tax havens might seem a solution today, but it doesn’t work if pursuing economic efficiency in the long-term. Encouraging investment is a must for America, but its high tax rate scares investors away, decreases competitiveness and hence worsens the deficit of the country.