Friday, January 27, 2006

Does Global Tax Competition Increase Poverty?

Every year, the world's leaders meet in Davos, Switzerland, for the World Economic Forum. This convention is a highly exclusive– you have to be head of a major international corporation to participate. However, there is a parallel event taking place, the Open Forum, which is open to the public. I figured I might as well go.

There have been accusations in the past that Davos is turned into a fortress during the WEF. They are only partially true: Sure, the conference center is blocked off, and the police and security guard density is the highest I've even seen in Europe. But it all still looks very peaceful. As a side note, Davos had the highest concentration of black Audi sedans I've ever seen – Quattro for snow?

We all like lower taxes and corporations do too. But do countries that drop tax rates to spur the economy and attract foreign investment do this at the expense of the poor in other countries? Are nations that do not get foreign investments deprived of income needed to run their social system? This was the topic of Thursday evening's panel at the Open Forum.

The two sides of the issue were best played out by Youssuf Boutros-Ghali, Minister of Finance in Egypt, and Leonor Briones, former Treasurer of the Philippines.

Boutros-Ghali pulled off quite a coup when he dropped tax rates in Egypt from 42% to 20% last year and eliminated all tax loopholes and fiscal incentives for foreign investors. Even though this move was much, it actually increased tax income in his country!

One reason for this is that foreign investors prefer low, but predictable tax rates over having a 5-10 year "tax holiday" after first settling in, but later being taxed at 42%. Some even prefer investing in Egypt over places like Dubai and Kuwait, which basically have no taxes at all, but also don't have a cheap labor force and a only small home market.

For a country on the other side of the world, in the Philippines, Leonor Briones painted a different picture: High rates of poverty and the highest infant mortality rates in Asia are plaguing a country desperate to get foreign investment. Nearby neighbors - Hong Kong and Taiwan - are engaged in intense tax competition, in her view at the expense of the Philippines, which needs every penny it can get to solve its internal problems. Sheila Killian, a lecturer in economics at the University of Limerick seemed to share this view.

Overall, I found the Egyptian argument to be more persuasive: Drop taxes and clean up your system to encourage growth seems like the right way to go. As harsh as this sounds, competition is not an opt-in system. While many may sympathize with loud whining about the unfairness of your neighbors, that does not help solve your problem. Ireland, Egypt and almost all of Eastern Europe have profited greatly from becoming competitive. There is no reason why you can't follow their example.

For me, the answer to the question "Does global tax competition increase poverty?" is "Yes, unless you participate in it, which you should."

On the other side of the panel, a different fight was taking place: Brian Henderson of Merril Lynch and Peter Athanas, CEO of Ernst & Young Switzerland had to defend the perceived tax-evasive behavior of multinational corporations. They both denied that it still exists. In fact, according to Athanas, 'tax planning' in corporations is now much less aggressive than in the 1990s, and almost all companies pay their dues.

Much of the following Q&A was very disappointing: Instead of asking relevant questions, most audience members' contribution consisted of accusing multinational corporations of misbehavior: It ranged from a four-minute rant about Ernst & Young's role in the Enron scandal to basically asking the Merril Lynch guy about how much laundered money they have in their bank. I, too, believe that corporate responsibility is important. But I also think that it's very simple to equate big with bad.

One point that was lost completely in the panel is that the world is not made of huge corporations. It is made of small and medium-size enterprises. By lowering tax rates in your country, you're mainly supporting these companies and encouraging them to grow. The growth they deliver is much more sustainable than that of corporations who might leave the country in a moment's notice. But maybe thinking small is too much to ask of the WEF.

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