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OECD Project on Harmful Tax Competition

Written by: Samir Malik - Author is LLM from University of Warwick and is a practicing Advocate in India.
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Globalization has acted as a catalyst in integrating economies, dissolving political boundaries and changing system of governance, politics, finance, trade and investment. Now the World is witnessing reduced trade barriers, loosened exchange control, increased mobility of capital, skilled labor and other factors of production. This has led to increased competition amongst countries (similar to businesses competing domestically) to attract trade and investment.

There are many factors governing choice of the investors for e.g. stable currency, trustworthy legal system, transparent financial markets, infrastructure, skilled labor, tax incentives etc . Countries which are relatively less fortunate in terms of natural resources and geographical locations stands at a disadvantageous position to attract investment to boost their economies. Equity and fair competition demands that these countries should be provided with a level playing field and stronger economies should be discouraged from interfering with the capacity of these countries to pursue policies which are in their best interests.
It is widely accepted that with increased capital mobility tax considerations are playing a pivotal role in deciding business locations and making investment choices . There seems to be no justification in prohibiting countries (particularly the disadvantageous ones) to follow aggressive tax policies except for some plausible reason such as terrorism, money laundering etc.

It is completely with in sovereign realms of the countries to pursue such aggressive tax policies, suiting their own interests. Even otherwise tax competition promotes efficiency and innovation and therefore it should be encouraged. Gary Becker, Nobel Prize winner in Economics has supported tax competition in the following words:
“Competition among nations tends to produce a race to the top rather than to the bottom by limiting the ability of powerful and voracious groups and politicians in each nation to impose their will at the expense of the interests of the vast majority of their populations”.

In order to secure global welfare tax competition should be promoted rather than be discouraged. The rules regulating practices of countries to compete with each other should perpetuate global interests rather than interests of some powerful nations intending to bully weak nations and to grind their own axe. Any effort to regulate tax competition should be taken up by a forum representing diverse interests of the world and not merely a particular group of powerful nations like OECD, which has suo motto assumed the responsibility to correct the world.

In 1998 OECD made an endeavor to regulate international tax competition, which was very cleverly advertised as “OECD project on harmful tax competition” to promote “global welfare”, however the interestingly OECD did not clearly explained what it meant by “harmful tax competition” and “global welfare” . It is noteworthy that OECD has confused the fundamentals of the project; it neither stated its authority/jurisdiction for sitting upon judgment to determine global welfare nor clearly defined how the alleged harmful tax practices undermined global welfare. An analysis of highly technical, colored and vague language of the reports depicts suspicious intentions of OECD to monopolize global trade and investment . It has completely turned a blind eye towards the principle of fiscal sovereignty and diverse nature of the competing countries.

II. The OECD Project on Harmful Tax Competition: An Effort to Monopolize Global Trade and Investment

In 1996 upon request of ministers of member countries and with support of the G7 countries OECD started a project on harmful tax competition. Its objective was to counter distortionary effects of harmful tax competition and its consequence on national tax bases . It is not beyond a reasonable man’s understanding as to why a representative body of developed countries would worry about the tax bases of the other non member countries?

This project being a brain child of the developed countries facing stiff competition from the developing world casts serious aspersions on the alleged intentions of the OECD to promote global welfare . These aspersions are further strengthened by use of vague concepts and narrow approach adopted by OECD. Although the reports have laid down great emphasis on harmful nature of some international tax practices (characterizing tax havens and preferential tax regimes) however no research or empirical data on harmful nature of such practices has been provided . No concrete parameters are suggested to determine such harmful nature of these tax practices. It seems that OECD has left this judgment on its own sweet will.

The project appears to be centered on the interests its twenty nine members and it has been severely criticized for failure to effectively consult the non member tax jurisdictions and business community before drafting the reports . The project creates a catch twenty two situation for the non member countries, for if they decide to cooperate with OECD they will be required to modify their existing tax system according to the recommendations of OECD and if they opposite would likely face sanctions and other measures by the most powerful countries of the world (measures proposed by the OECD) , which is clearly a violation of their fiscal sovereignty.

OECD has alleged that the tax havens and preferential tax regimes are poaching tax bases of the other countries , however no evidences have been provided to support this allegation . The existing data does not support these allegations of OECD, there has been no decline of corporate and personal income tax revenues of OECD countries even OECD has also implicitly admitted this fact . Comparative tax revenue statistics of OECD countries clearly shows that tax revenues of all of these countries have been on the rise since 1995.

To illustrate a few, UK tax revenues have increased by almost 90%, US tax revenues by 81% and France tax revenues by 55% . Genshel’s analysis of OECD data has exposed the myth propagated by OECD that the global tax revenues are on decline (natural result of OECD concern about erosion of tax bases). His analysis has shown that “there is no sharp decline of global tax rates or tax revenues”.

Although in1998 report OECD has admitted its disability to quantify loss of revenues suffered in consequence of alleged harmful tax practices but it has specifically mentioned its concern about high rate of foreign direct investment (FDI) in low tax jurisdictions (all of them are small countries) . It seems OECD is more perturbed by the relatively higher rate of foreign direct investment in some countries rather than the alleged harmful tax practices. This higher rate of FDI can not be relied upon to propose or justify any action against these countries.

Even if for the sake of the arguments, this phenomenon is considered as suspicious an analysis of United Nations Committee on Trade and Development’s (UNCTAD) world investment report would expose the misconception of OECD. According to this report aggregate flow of FDI to developed countries is much higher than that of tax havens . A.Almeida upon his analysis has found that “FDI inflow to tax havens is just 2.1% of the level in developed countries and 1.4% of the world” . Efforts of OECD to unreasonably put restriction to free flow of trade and investment will in fact lead to monopoly of OECD countries which are better equipped than the developing countries.

III. A fabricated Illusion of Level Playing field

One of the main arguments of OECD for taking up this initiative to correct the alleged distortionary effects of harmful tax practices is to provide a level playing field for global competition amongst all countries . It is agreed that there should exist a level playing field but before beginning to build any methodology to create such a level playing field all relevant factors should be taken into account. Although OECD has recognized different factors affecting competitive position of a country however it has categorically mentioned that it will not consider these factors for the purpose of its study . Moreover no justification or rational has been proposed by OECD for exclusion of these factors. Exclusion of these important factors has made the conclusions drawn by OECD more questionable because until and unless diverse factors affecting tax competition are accommodated no accurate principles can be formulated to identify the grey areas to work upon and reach to an effective solution.

This perhaps suggests that while conducting the study a presumption was made that countries competing with each other are in similar circumstances to make decisions about their tax policies, which is grossly incorrect. All countries do not posses similar natural resources, infrastructure and level of economic development to compete with each other. The countries which are located in the remotest or disadvantageous parts of the world and which are suffering from different economic, social and political problems have very little to offer to attract trade and investment. They have nothing better to offer except tax incentives, which can immensely help them in overcoming their problems.

Some of the important policy questions arising here are: Why such countries should not be allowed to attract trade and investment to alleviate themselves from the curse of all these problems? Why only developed countries should have right to better standard of living? Why developed countries should be allowed to compete beneficially with their immense infrastructure and superior economic social and political conditions?

On one hand the 1998 report states that this work only focuses on geographically mobile activities and excludes capital and manufacturing activities while on the other hand it states that it is very difficult to make a difference between the two . Moreover no description of geographically mobile activities covered under the scope of the study is specified. Business and Industrial Advisory Committee to OECD (BIAC) has shown its disappointment over lack of clarity on this issue.

Such an ambiguous approach about these key aspects is creating a stronger suspicion against the OECD project. Otherwise also focusing only on geographically mobile activities would lead to incorrect criterion to judge the alleged harmfulness of a particular tax regime thereby because this approach would completely ignore the other aspects like attractiveness for manufacturing and capital industries etc. This restricted methodology is perhaps adopted to impart a favorable color to the project so as to present an exaggerated version of dangers of alleged harmful tax practices.

In these circumstances OECD project seems to be self contradictory. Its incorrect presumptions and subjective approach favoring powerful nations professes to distort the existing tax competition and seeks to create a global tax cartel

IV. Lack of Business Perspective

Apart from completely ignoring other fronts of global tax competition OECD also failed to consider the consequences of unreasonable control of international tax competition on global business environment. Any deviation from a balanced and healthy international tax competition would seriously undermine global business activities. While overregulation may affect access to new markets, under regulation may result in unacceptable business practices, thus an agreement between the two extremes is must. A company before making a decision to choose a particular location considers varied factors which bear effect on its business prospects and an insight into such factors would have fine tuned the criterion adopted by OECD to identify harmful tax practices. It is not arguable that tax considerations plays an important role in making business decisions, however the issue remains, are these tax considerations capable of surpassing every other considerations (even for geographically mobile activities)?.

BIAC has criticized this approach of OECD, focusing only on tax basis for business decisions . Upon analysis of UNCTAD data on FDI, A.Almeida while studying higher investment flow to China compared to tax havens, has concluded that there are other considerations influencing investment and business decisions that made China even more attractive than tax havens.

There are other factors which are far more important than the tax considerations such as political stability, size of market, quality of legal framework, infrastructure, availability of skilled labor etc. which no business can afford to ignore. Failure to consider these important factors has created serious flaws in OECD conclusions. OECD should have consulted business community before proceeding with the project however it failed to do so , which spurs a suspicion that the reports does not adequately represent the views of all affected.

V. Race to the Bottom and Global Welfare

One of the main arguments put forth by OECD is that tax practices of tax havens and preferential tax regimes will lead to race to the bottom and would ultimately undermine global welfare . The concept of race to the bottom means that the countries in order to remain attractive for investment would keep on reducing tax rates and in this race they would end up reducing the tax rates to unsustainable levels thereby derailing the global welfare , however this would only happen if it is presumed that all other factors affecting competitive advantages of the countries and investment choices becomes inelastic and tax remains only elastic factor which is quite impractical. The countries would keep on reducing their tax rates only if they have nothing else to thrust their attractiveness and businesses have nothing else to seek except tax advantages. The situation contemplated here is perhaps a hyperbole and the possibilities of such situation are almost zero. The available data shows that despite existence of tax havens and preferential tax regimes world has not witnessed any sharp decline in business income tax rates thereby negating the argument of race to the bottom.

The possibilities of tax levels reaching unsustainable levels are also dimmed by the fact that while deciding tax levels countries apart from considering international tax competition also takes note of many domestic social and political compulsions. Any fall in tax rates beyond sustainable levels would result in lesser funds available for public spending and welfare measures, which would upset the citizens and would ultimately, lead to downfall of the government. No government wants to annoy its citizens and face this wrath. This fear ties hands of all governments to madly participate in race to the bottom
OECD has asserted that the alleged harmful tax competition negatively affects global welfare.

However global welfare is a subjective term and there can be no straight jacket formula to asses its magnitude. Data shows that despite globalization and liberalization the world is facing the same problem of poverty and hunger . Yoram Margolith has noted that the poor nations today are still having similar position as they had two centuries ago . In these circumstances Global welfare should perhaps be used in the context of helping poor nations to develop their economies so that they can overcome the problems of poverty and unemployment. Tax incentives can play a very important role in helping these countries to attract investment which brings with it new technology, skills, and jobs. This is the reason why some economists have supported tax incentives to promote development in developing countries . This aspect remains completely ignored in the reports. Townsend has rightly argued that the long term benefits of economic growth of these countries would be in the benefit of all and will eventually result is higher fiscal revenues to the developed countries which would offset any loss suffered by them.

VI. Tax Havens and Preferential Tax Regimes

OECD considers tax havens and preferential tax regimes as a threat to tax bases of all countries and 1998 report has enumerated factors to identify them viz. :-
• No or only nominal taxes
• Lack of effective exchange of information
• Lack of transparency
• No substantial activity

Here also the OECD did not fail to maintain its theme of leaving fundamental aspects ambiguous, no criterion to determine no or nominal taxes was provided and that too when it considered it to be the most important factor . In 2000 and 2001 reports OECD tried to explain this first factor by emphasizing that this factor is not sufficient by itself and other three factors should be conjunctively considered.

In defence of its criticism of violation of fiscal sovereignty it was stated that “The OECD recognizes that every jurisdiction has a right to determine whether to impose direct taxes and, if so, to determine the appropriate tax rate” , however still this factor was not satisfactorily explained and no tax range was specified for this purpose. Import of the last factor is also not clear. The 2000 report rephrased this factor but still the meaning remained obscure . This issue as to real import of requirement of no substantial activity made OECD to give it a second thought and in 2001 report OECD excluded this factor and rather focused on requirements of transparency and exchange of information.

The criterion adopted by the OECD has not helped in identifying all tax havens of the world and even today there are some countries (including those which agreed to cooperate with OECD) which continue to work as tax havens for e.g. well known Switzerland (OECD member but abstained from the project) , Hong Kong, Dubai and Singapore . The proceedings of OECD suffer from lack of transparency. The 2001 report excluded six jurisdictions from its criterion of tax jurisdiction without explaining reasons . OECD has simply identified jurisdictions as tax havens and has not made public the issues it has with each of the jurisdiction so identified and how each of the criterion was applied to them.

Four key factors were laid down for identification of harmful preferential tax regimes:
• No or low effective tax rates on the relevant income
• Ring fencing
• Lack of transparency
• Lack of effective exchange of information

Along with this other eight factors and three questions were also mentioned . An analysis of these factors does not help in understanding the actual criterion adopted by the OECD. Many aspects of these factors are either subjective or have been left ambiguous. Although no clear difference have been made between harmless and harmful preferential tax regimes yet on some undisclosed considerations some preferential regimes existing in member countries have been declared harmless . The factors enumerated are so broad that any tax regimes can easily fit in one or the other criterion . First of all no threshold figure is provided which can be regarded as low and no explanation of “relevant income” is provided. The importance of each factor as against other is also not clear and the three questions are quite subjective.

The first question as to determination of significant nature of the activity shifted from one country to another is difficult and subjective. One country may consider an activity as substantial but the other may not and moreover an activity may be relatively more substantial and important for one country than other. This issue of relative substantiality is also bewildering. Although these difficulties have been acknowledged but nothing has been mentioned about principles to determine the significant nature of these activities . This actually results in apprehension that any shifting of activity will have to first face and answer the charge of being motivated by pure tax considerations which is not good for healthy business environment.

The second and third questions deal with determination of commensurateness of an activity with amount of investment or income generated in the host country and primary motivation for location of the activity. OECD has itself admitted that determination of these questions depends on subjective evaluation . In these circumstances when these questions can not be satisfactorily determined is it possible to adequately consider the interests of all in a balanced way? The answer seems to be in negative raising serious issues of arbitrariness.

Political considerations are definitely involved in identification of preferential tax regimes; abstentions of Switzerland, Luxembourg Portugal and Belgium are highlighting this. Switzerland and Luxembourg could have vetoed the recommendations of OECD which would have adversely affected the project and perhaps in exchange of not opting to exercise veto nothing substantial has been done against Switzerland except that it has been persuaded to agree for exchange of information with respect to holding companies but noteworthy thing is this that the agreement is only in respect of bilateral tax treaties and nothing more than this.

Politics has also played a major role in identification of tax havens and preferential tax regimes in non member countries. Tax havens identified are comparatively smaller and weak countries as compared to the non member countries operating preferential tax regimes like China and India . These countries are having greater international influence and are difficult targets to deal with and thus till today such preferential tax regimes have not been identified even.

VII. Conclusion
OECD project on harmful tax competition does not adequately represent concerns of both developing and developed countries. The ambiguity and vagueness in its scheme coupled with the highlighted political considerations and opacity spells serious suspicion on its objective to promote global welfare. The reports seem to be centered on the interests of the member countries and have completely ignored the factors affecting competitiveness of targeted nations. OECD has in fact presumed that global welfare lies with the welfare of its members, this argument perhaps provide reason for stronger inclination of OECD towards prevention of erosion of tax bases of its members rather than properly considering more critical issues of eradication of global inequalities and development of developing countries. OECD has completely failed to strike a balance between the two.

These efforts to undermine global tax competition and ultimately global welfare are completely unwarranted particularly in view of the fact that such efforts are directing the world towards formation of a cartel of developed countries interested in keeping the tax rates high and harmonious so as to maintain their superior position in their global share of trade and investment.

The projects also raise serious issues of fiscal sovereignty and privacy. OECD through this project is dictating economic policies to other countries to secure their own welfare and welfare of the world (hypocrisy of OECD) that too on arbitrary and vague principles. The criterion to identify tax havens and preferential tax regimes is full of such arbitrary and vague principles , even fundamental aspects like harmful nature of concerned activities has not been sufficiently explained and no analysis of their harmful effects have been made. For the above analysis the OECD project on harmful tax practices seems to be flawed.

1. Angharad Miller and Lynne Oats, Principles of International Taxation, Tottel Publishing, 2006
2. Andrea Amatucci, International Tax Law, Kluwer Law International
OECD documents
1. OECD 1998 Report “ Harmful tax competition; An emerging global issue”, available at <>,
2. OECD 2000 Report available at <>
3. OECD 2001 Report available at <>
4. OECD 2004 Report available at <>
5. Business and Industrial Advisory Committee to OECD, A Business View On Tax Competition, June 1999 available at
6. OECD Revenue Statistics-Comparative tables available at

Journals and Articles
1. Alexander Townsend Jr., The Global Schoolyard Bully: The Organisation Of Economic Development’s coercive efforts to control tax competition, 25 Fordham Int’l L.J 215 (2001-2002)
2. Michael Littlewood, Tax competition: Harmful to whom?, 26 Mich. J. Int’l L. 411 (2004-2005),
3. Mitchel B. Weiss, International Tax Competition; An efficient or inefficient phenomenon?, 16 Akron J. 99 (2001)
4. Javier G. Salinas, The OECD tax competition initiative: A critique of its merits in the global market place, 25 Hous. J. Int’l L. 531 (2002-2003)
5. Kimberley Carlson, When Cows have wings: An analysis of OECD’s tax haven work as it relates to Globalization, Sovereignty and Privacy, 35 J. Marshall L. Rev. 163 (2001-2002)
6. Julie Roin, Competition and evasion: Another perspective on International tax competition, 89 Geo L.J 543 (2000-2001)
7. Yoram Margolith, Tax competition, foreign direct investment and growth: Using tax system in promoting developing countries, 23 Va. Tax Rev. 161 (2003-2004)
8. Almeida, Tax Havens: An Analysis of the OECD work with policy recommendations, available at:
9. Chris Edwards and Veronique de Rugy, Chapter 3, Economic Freedom Of World: 2002 Annual Report available at <

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