Make South Africa a tax haven to promote economic growth

Next week, SA’s Minister of Finance, Trevor Manuel, will be giving his annual budget speech in Parliament. Although his initial plans to deal with the world economic crisis will be incorporated in the budget speech, his staff will already be working on longer term plans to try and give SA’s citizens a comparative advantage in coping with the crisis. Their plans should include the benefits of making SA a tax haven.

Tax havens have existed for thousands of years: some earliest known examples date back to Ancient Greece, when sea traders used coastal islands as depositories to avoid import taxes in Athens. In medieval Europe jurisdictions competed by creating tax havens. Switzerland established itself as one of the first modern tax havens, attracting investors to Swiss banks and maintaining low taxes while other European governments raised rates to pay for reconstruction following WWI.

Although there are many definitions, a common definition refers to tax havens as locations with low taxes and other tax attributes designed to encourage foreign investment. More broadly defined, they are jurisdictions with preferential rules for foreign investors. Lowering taxes is only one component of government strategy to attract foreign investment and promote economic growth: as the World Bank’s Doing Business project outlines, governments should also reduce regulations on labour, protect investors and enforce contracts.

Today, the Cayman Islands, the British Virgin Islands and Switzerland are often cited as examples of tax havens. The US, however, could be the largest. Its government does not tax interest or capital gains made by foreigners who invest in the US. Some individual states are considered to be tax havens. Delaware is a known corporate tax haven while seven states – Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming – exact no income tax from residents.

The Organisation for Economic Co-operation and Development (OECD), along with many EU governments, has censured tax havens for providing “harmful tax competition”. They claim that tax havens are eroding tax bases. As part of the Harmful Tax Competition initiative, the OECD has pressured identified tax havens to provide confidential information about private investors and investments. Thirty-five jurisdictions have given way to the demands; three have not.

Cato’s Daniel Mitchell explains in his articles on the subject that competition from tax havens has in fact lowered tax rates around the world: in 1980 top personal income tax in OECD countries was 67 per cent and corporate tax was almost 50 per cent. Today personal income taxes are 40 per cent and corporate tax around 27 per cent. Governments of high-tax countries have been forced to lower tax rates in order to keep investors from moving to other countries with lower tax.

The OECD and EU governments oppose tax havens because they threaten their revenue, and in turn, their livelihoods. In an attempt to preserve large government in wealthy countries, the OECD and EU governments are ignoring positive benefits for the global economy. Lower taxes allow businesses to reinvest more money into technology, new products and services and additional workers. Businesses can also undertake investments with lower expected returns because less of the profit is consumed by tax.

In a 2004 study, James Hines of the US National Bureau of Economic Research finds that during the period from 1982 to 1999, GNP in 17 tax haven countries grew on average 3 per cent every year compared to world GNP growth, which was 1.4 per cent.

Tax competition is not a zero sum game: tax havens are not simply diverting revenue away from governments; they are contributing to real economic growth. Businesses make different decisions – to invest in technology, new products and services and additional workers – depending on the tax incentives.

Tax havens are not recent phenomena, and the number of tax havens is likely to increase as governments try to attract foreign investors in the global economy. OECD governments may have to cut taxes further, but the outcome will be greater economic growth and more efficient government spending.

Mauritius is the only country in the African region that qualifies as a tax haven. On 1 July 2009, the corporate and top individual tax rate will reduce to 15 per cent. Through low tax policies and other business-friendly reforms the Mauritian government seeks to attract entrepreneurs and investors, one of the primary objectives being to create more employment opportunities for the island’s citizens.

SA’s unemployment rate of 23 per cent is among the highest in the world. By lowering taxes, the South African government could attract investment, promote economic growth and create more jobs.

Author: Laura Grube, a graduate of Beloit College, is a Fulbright U.S. Student Programme member who is studying and participating in Free Market Foundation projects. This article may be republished without prior consent but with acknowledgement to the author. The views expressed in the article are the author’s and are not necessarily shared by the Foundation.

FMF Feature Article / 03 February 2009