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The other day I read somewhere (yet again) that low tax rates encourage development. Which got me to thinking about tax havens. I’ve noticed that places like the Cayman Islands, for instance, seem to be magnets for hedge funds, but rarely if ever do countries which are mainly known as tax havens become industrial or technological powerhouses. What gives?

Here’s my thought… a hedge fund can buy and sell assets in country A from anywhere in the world, provided that it knows that country A has strong property rights, infrastructure, and legal institutions. If it can take advantage of those property rights, that infrastructure, and those legal institutions without paying for them (i.e., if it can free-ride), it can increase its private profits by having others pay for some of its costs.

Of course, a manufacturing, tech, or creative firm can also increase its profits by exporting its costs onto third parties (think externalities) which would make a tax haven ideal for such firms too. And yet, except for some transfer pricing games, for the most part, tax havens simply don’t attract or internally generate such firms in large numbers. My theory – it takes something else for that. It takes actually having a sound infrastructure (legal and physical), an educated populace, and a mindset, and these are things which tend to be generated by a not extremely incompetent government.

Your thoughts?

PS. Before the inevitable mention of Hong Kong, construct a Venn diagram of a) former British colonies and b) tax havens.

 

8 Responses to “Why Don’t Tax Havens Become Economic Powerhouses?”

  1. Steve Roth says:

    Beating my current-favorite spoon on my current-favorite highchair yet again some more:

    Stocks of financial assets are not real assets. It doesn’t matter where financial assets reside. It very much matters where real assets reside.

    The widespread confutation of the two — as if they were somehow synonymous — creates massive misunderstandings.

    Real assets constitute our true national wealth — our capacity to produce in the future. Financial assets are just storage containers for potential future spending (investment and consumption), like cookie jars full of money.

    Example of the confusion: “We can’t tax financial assets because they’ll just move elsewhere and we won’t have investment here!” (Again, confusing investment spending with so-called “investment” in financial assets, properly known as “saving” but perhaps better understood as “storage.”)

    1. Who cares? If there are attractive/lucrative domestic real-investment opportunities, then financial assets, in the form of money, will flow in from wherever.

    2. We tax worldwide income (well, at least of natural humans), why not worldwide holdings of financial assets?

    Just a reminder, btw, that real assets do not only include NIPA’s structures, equipment, and software. They also include (at least): 1. infinite varieties of human, cultural, and organizational capital: ideas, knowledge, methods, techniques, business processes, skills, character, beliefs, trust, etc. 2. natural resources.

    It takes both effort and money (the latter flowing out of financial assets) to create/develop all those different forms of capital.

    But that money can flow from anywhere.

  2. Kaleberg says:

    Nations need different capabilities to be a manufacturing powerhouse as opposed to a money laundering center. The only place that does both that I can think of is Switzerland. Becoming a manufacturing powerhouse requires a lot of government investment, tariff walls, loose IP rules and so on. (No nation has ever industrialized without these, though 19th century Britain avoided tariff walls by its government investment in its merchant marine.) Becoming a tax shelter requires being small, relatively stable and conveniently located. Historical trade connections can help.

  3. Sandi Saunders says:

    Mr. Kimel, thank you so much for this blog and the information you impart. I am just a working stiff with no formal education and I very much appreciate that unlike some, you do not make a habit of showing your intellect above making your point. Thank you for a great place for the truth and real, useful and needed information!

  4. Sandi Saunders says:

    Mr. Kimel, thank you so much for this blog and the information you impart. I am just a working stiff with no formal education and I very much appreciate that unlike some, you do not make a habit of showing your intellect above making your point. Thank you for a great place for the truth and real, useful and needed information!

  5. Mike Kimel says:

    Sandi,

    Thanks for the kind words.

  6. Mike Kimel says:

    Sandi,

    Thanks for the kind words.

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