"....a race to the bottom is evident among special regimes, most notably in the case of Africa, creating effectively a parallel tax system where rates have fallen to almost zero" - Abbas and Klemm, IMF Working Papers:
Capital is now extremely mobile and the international community, through the IMF and the World Bank and the OECD, has moved to make it more mobile over time by pressing countries to eliminate their remaining restrictions on capital flows. As this capital is both mobile and very scarce countries, desperate for investment which will create jobs, will often compete with each other by lowering taxes in special incentive schemes that make countries that are otherwise unattractive look fairly good. For the Europeans and the Americans this has been a real issue that is undermining their revenues and social model. In 1983, the average statutory corporate tax rate of 13 Western European countries accounted to 49.2%. As of 2008, the average tax rate of these countries had eroded to 27.2%.
But the lowering of the statutory tax rates are just the tip of the tax-free iceberg as many of the large European countries, like the UK have also provided all sorts of other legal tax incentives and provisions that have permitted companies to avoid paying local taxes. Corporate tax revenues on both sides of the North Atlantic have not been expanding in proportion of corporate profits as governments began competing with each other for scarce investments by competitively lowering effective tax rates.
As the tax revenues did not rise as needed governments simply cut back expenditure or shifted the tax burden to other taxes, more inequitable taxes, like VAT which falls on consumers i.e. workers who are not mobile and do not have the IMF, World Bank or OECD arguing for their rights to move to another location where they could earn higher wages and pay less taxes. In the 2000's, in response to the squeeze on the taxation revenues caused by this competition the OECD found an appropriate and easy target in its Harmful Tax Initiative which pinpointed a large number of small developing states which have tried to copy Switzerland's prosperity by establishing tax secrecy laws and tax havens.
Supply Side economics and Irish predators The tax competition faced by the rich countries was coming from several sources. First, OECD countries increasingly bought into the 'supply-side' economics of President Regan which just said if you lower taxes on companies and the rich you will stimulate investment which started an unavoidable trend of lowering tax rates.
The pressure on the tax revenue in developed countries also came from countries like Ireland which sought to transform itself from a butter-exporting backwater in the 1970's to the industrial powerhouse it became. Ireland was so effective in its industrial and tax policy of poaching investment from its older and richer EU neighbors, that just prior to its recent collapse during the international economic crisis in 2008 it was the second richest country in the EU after the real culprit, Luxembourg.
Ireland conducted a predatory tax policy by lowering its effective tax rate i.e. what companies actually paid to about 5.5% in the 1990's. What Ireland learned in the 1980's and 1990's the new east European member states of the EU have simply copied since they acceded and have continued poaching investors from the old industrial powers.
Switzerland and Luxembourg - the Real culprits? But the real long term culprit were super-rich countries like Luxemburg and Switzerland which, depending on the oil price, normally rank amongst the two richest countries on earth. They prospered greatly by providing honest, hard working but tax avoiding (and often evading) EU citizens along with many international criminals, safe places to hide their ill-gotten gains. By 2005 Switzerland reportedly had Euro 3 trillion of bank deposits by EU citizens alone. Even to this day Luxemburg remains the tax haven of choice of companies operating in Europe. Countries like the UK could shut off the tax havens with appropriate anti tax avoidance legislation, but instead London has preferred to complain of others while using this a source of advantage to get new corporate headquarter such as the recent AON Insurance relocation into the City.
Luxemburg and Switzerland are members of the OECD and hence the OECD Secretariat always had a more difficult time picking on them as well as US tax havens like the state of Delaware. So when in doubt pick on the small, weak and poor and whereas the OECD has been really successful in getting poor but largely irrelevant tax havens in the Caribbean and Pacific into line with their Harmful Tax Initiative, the policies of OECD members Luxemburg and Switzerland continue to put downward pressure on effective tax rates all over the developed world.
Africa leads the way to the bottom! In Africa countries also bought into the' lower taxes will bring in new investments' argument and started by the 1990's to lower corporate tax rates through the use of special incentive schemes. In fact all the evidence suggests they were right to try but not if their house was not in order and investors saw a country as profoundly uncompetitive. In this case the incentives did almost nothing.
According to a recent IMF working paper Africa has now finally won the race to the bottom and effective tax rates i.e. what companies pay after all the special incentives they get from governments is just about zero. The authors Abbas and Klemm conclude '....a race to the bottom is evident among special regimes, most notably in the case of Africa, creating effectively a parallel tax system where rates have fallen to almost zero'
South Africa has maintained something above a zero effective corporate tax rate because it is the economic epicenter of Southern Africa. But in neighboring countries like Namibia rates under tax incentives are in effect zero. Over the last decade effective rates for Egypt, Mozambique, Uganda have all been pretty close to zero.
Others like Tanzania, Mauritius and Nigeria have has negative effective tax rates at times! As African economies start to really recover from the civil wars and liberation struggles of the 1990's they will increasingly compete with South Africa as centres for investment and then even Pretoria will have to rush to the bottom to maintain its position.
Ramatex Rules- OK!
Once classic example of how company tax incentives are used and abused from earlier in the decade exemplifies how damaging these incentives are to countries. At the beginning of the last decade a Malaysian company called Ramatex proposed to build a huge textile plant in Southern Africa which would employ 10,000 workers to process African cotton for export to the American market.
Ramatex had four countries, SA, Botswana, Namibia and Swaziland competing over who would offer more for the factory. Unfortunately for Namibia it won after not only providing the company with subsidies of over ZAR 60 million to build the plant as well as a totally tax free environment.
There could not have been a worse time to build a textile plant following the phase out of the Multi-fibre agreement (2005) and after several years the company shut down leaving Namibia to deal with the mess and the unemployed. Namibia has received precious few investments despite a zero tax regime in its export processing zones.
As the recent Euro crisis has shown even very rich countries jealously protect their sovereign right to tax. Small African developing countries, desperate for investment will not abandon these rights easily and so this race to the bottom will continue even 'below ground', and as Ramatex shows, to get worse with desperate countries being willing to offer large subsidies to attract investments.
The real danger of this race to the bottom and its continuation below ground through ever more state subsidies is that African countries may conclude that state ownership is a cheaper option.
* These are the views of Professor Roman Grynberg and not necessarily those of the Botswana Institute for Development Policy Analysis where he is employed.