The Moral Case for Tax Efficiency and Tax Havens

First Published: 2003-08-31

On October 23, 2002 the front page of the Royal Gazette, the main daily Bermuda newspaper, proudly recorded that local gangsters had been foiled by the legendary efficiency of the Bermuda Police.

Fifty-six boxes of eggs had been intercepted, allegedly planned to be thrown at the local constabulary during Halloween. By coincidence, it was also reported on the same page that Jesse Jackson (yes the US shakedown artist) had predictably failed to turn up for a local conference about women inbusiness. Bermuda, like other tax havens (a name that locals detest) was facing business as usual. Just another boring day for its 60,000 residents who enjoy live crime-free lives, nil unemployment, take the azure sea and delightful climate for granted, and do a million and one other things that peaceful happy people do in order to live a normal prosperous life.

Alas, Bermuda has a terrible reputation with foreign government elites. It is a mid-Atlantic affront to the American and European Governments who believe they have a right to tell the rest of the world how to live and what their tax laws should be. The guts of the problem is, that Bermudians do not pay income tax on their earnings, capital gains taxes, and even worse there are no corporate taxes on profits. This state of affairs is infinitely worse than throwing eggs at policemen, and is considered to be a greater menace to the financial well-being of Western civilisation than even Jesse Jackson.

Many politicians wish to close down, or at least hobble, the activities of pirate countries like Bermuda, The Bahamas, The Cook Islands, Switzerland, and about 35 other financial pygmies that are mere dots on the map of the world.

Over the past ten years or so, governments (and other quasi governmental organisations such as the OECD) in the United States and Western Europe have been throwing rotten eggs and rotten arguments at the so-called tax havens like Bermuda and the Cayman Islands on the grounds that they siphon off legitimate tax revenues. This has been described as “harmful tax competition” (an oxymoron), or has been categorised as illegal tax evasion. The clients of tax havens, wealthy individuals and multi-national corporations, are, it is said, dodging their legitimate tax obligations to their countries of domicile and as a result those who are left at home are unfairly compelled to pay higher taxes.

Spending on social programmes such as education and pensions is reduced and many high powered and high-paid lawyers, accountants expend time and effort in tax dodging when they could usefully be engaged in more productive tasks.

For years, orthodox economics has condemned tax avoidance as unproductive, as well as being unfair to other taxpayers. Yet public expenditures in almost every country one can name (including Bermuda) are unproductive and have risen steadily absorbing over 50% of GDP in many countries. Most thoughtful people now belatedly understand to their horror that government bureaucracies (often employing about a fifth of the labour force) are not staffed by disinterested philosopher kings who somehow and magically understand what the people want and impose taxes accordingly. It is not overstating the case, to say that many public employees arrived at their desks with the objective of doing good, but somewhere along the way, they ended up doing very well for themselves.

Why should the activities of tax havens be put in the spotlight of public distaste in North America and Europe? One reason is that the success of Bermuda and other tax efficient countries feed the fantasies of pro-government and anti-business fanatics – after all Enron established a few off balance sheet entities in the Cayman Islands, the fabled numbered bank accounts in Switzerland have long been accused of facilitating money-laundering and linked to drug trafficking, and, more recently, low-tax jurisdictions are a bogey-man of anti-terrorists. A more important reason is that high-spending Western governments desperately need lost revenues to keep the state machine ticking over whilst taxpayers resent the grasping mitt of government on their wallets. When governments grab over 40 percent of a country’s income in taxes a natural resistance to having incomes and wealth confiscated builds up in the minds of productive citizens.[1]

We need to remind ourselves that until the early 20th century, governments tended to restrict their activities to maintaining an army against foreign aggression, a police force to protect law-abiding citizens against robbers and thieves, and a limited number of social activities such as public health and education. In most countries, less than ten percent of incomes were taken in taxation. All of this changed because of the costs of fighting two world wars and innumerable other small conflicts, a desire to re-distribute incomes from the rich to the poor, and the recognition that governments by spending huge amounts on social programmes could effectively bribe voters with their own money to vote high spending politicians into office. Elections became in the words of H.L. Mencken “advance auctions of stolen goods.”

Perceptive voters recognised that government looting of their private property, incomes, and wealth impeded the production of goods and services, and was being abused by hyper-active and incompetent governments. From the end of the Second World War, in 1945, a few wealthy individuals and corporations decided to take remedial action to protect their assets from the plundering activities of government. They rested their case largely on the dictum of Judge Learned Hand who stated: “Anyone may arrange his affairs so that his taxes shall be as low as possible; he is not bound to choose that pattern which best pays the Treasury; there is not even a patriotic duty to increase one’s taxes…nobody owes any public duty to pay more than the law demands. Taxes are an enforceable extraction, and not a voluntary contribution.”

As the burden of taxation and other nefarious activities of governments increased, largely because of military spending and the creation of massive welfare states in Europe and the United States, the activities of a few tax freedom-fighters mushroomed into something of a major cottage industry. There are now something like 40 or so tax havens, and even countries like Hungary[2] are getting into the business of preserving the assets and incomes of those who find that tax authorities (representatives of the looting class) were penalising relatively minor economic figures like dentists in Belgium, tennis players in Germany, or movie stars and writers in UK. Such people, pilloried by politicians as being unpatriotic, were simply people who loved their countries but feared the plundering and economically counter-productive activities of their governments.

Plundering and looting are strong words but they accurately describe many modern governments. Such words were used to great effect by the famous French economist and pamphleteer Frederic Bastiat (1801-1850) who wrote of the French Government: “If you make of the law the palladium of the freedom and the property rights of all citizens, and if it is nothing but the organisation of their individual rights to legitimate self-defence, you will establish on a just foundation a rational, simple, economical government, understood by all, loved by all, useful to all, supported by all, entrusted with a perfectly definite and very limited responsibility, and endowed with an unshakeable solidarity.

If, on the contrary, you make of the law an instrument of plunder for the benefit of particular individuals or classes, first everyone will try to make the law; then everyone will try to make it for his own profit.”[3]

Bastiat could have gone on and said that ultimately many citizens will decide that they do not like the law and will take actions to avoid its unpleasant plundering activities. Once the government bite on individual incomes reaches 30 percent or thereabouts a silent tax revolt takes place. People either stop working (hence the huge numbers of the underclass that simply mooch around most of the day), they cheat on their tax returns, or they shift assets and commercial activities abroad to countries where the tax regime is less hostile to earnings and the preservation of capital. Just as the exploited and victimised left Europe in the 18th and 19th centuries for the freedom of the United States and elsewhere, the wealthy also vote, not with their feet as did “the huddled masses yearning to breathe free” but with their bank balances and intellectual capital. They are heirs to a time-honoured custom of free people of telling overbearing government to take a hike. There is no Statue of Liberty in the harbour of Hamilton, Bermuda but on Front Street there are two banks, and two blocks away are legions of lawyers, accountants, and other financial professionals willing to assist in the freedom to keep private property out of the grasping hand of free-spending foreign governments.

Confiscatory taxes force otherwise law-abiding citizens into revolutionary action called tax avoidance by its supporters and tax evasion by its critics.

There is a huge morally important point at stake. Government taking is usually justified by the fact that it performs good works and provides endless benefits to its citizens. The State is somehow more important than the individual, and he should willingly stump up his share because of all the benefits showered on him by benevolent rulers. Others, like the American Founding Fathers, argue that the individual takes precedence over government and there are inalienable rights to privacy, life, liberty, and property and that the compulsory sequestration of the individual’s property through taxation makes the rights of man dependent on the goodwill of the state.

As Frank Chodorov stated: “If the State has a prior right to the products of one’s labour, his right to existence is qualified.” Once income taxes were imposed on the citizen, the level of earnings he was allowed to keep became dependent on the goodwill of the government; and how much he was allowed to keep varied with the size of the government jackboot.

Those who value individual freedom over government benevolence (or should that be malevolence) seek to protect their assets and their privacy from prying eyes, but they are usually portrayed as greedy selfish barons who neglect their responsibilities to those at home. Whilst most of the tax avoiders do not act from altruistic motives, it is relevant to recall that Joseph Schumpeter in his essay “The Fiscal State” pointed out that one of the consequences of the unlimited power of governments to tax their citizens would be a misallocation of resources away from wealth producing investments and into largely non-productive public spending designed to redistribute income or the building of public monuments. The Declaration of Independence put it more succinctly when it said of King George III that: “He has erected a multitude of new offices, and sent hither swarms of officers to harass our people and eat out their substance.”

The most important activity of the misnamed tax havens is to avoid governmental unproductive spending and to allow entrepreneurs freely to invest and produce the goods and services needed for the world to prosper. Tax efficient countries like Bermuda therefore enable resources to be used for the purposes of increasing the standard of living of everyone including the poor. Left to politicians, assets would be used for non-productive purposes and living standards would improve less rapidly. Time and time again, it has been shown that much of government expenditure is wasted on such things as huge public buildings, subsidies, national airlines, futile redistribution of wealth programmes, armaments, or just simple corruption of public officials. Modern government has become a gigantic slot-machine that uses the political process to take from everyone and give to some, the major objective being its own preservation.

Tax-efficient countries provide a mechanism for restricting the ability of governments to impose onerous tax burdens on their citizens, and assist in compelling governments to provide an economic climate more receptive to the peaceful activities of business. Without the safety valve of tax havens, taxpayers in North America and Europe would be milked even more vigorously by the looting class than they are at present. Far from cheating citizens of North America and Europe tax havens provide an essential escape route that enables capital to be preserved for productive purposes. In addition, it buttresses what is a core value of the West, namely freedom.

The utility of tax efficient countries will end when taxation levels become less onerous, but with Tax Freedom Day[4] getting later each year, and the US tax code at 45,663 pages[5], don’t bet the farm on that happening soon.

Can there be a more moral case for tax havens, than tax efficiency, restraints on government power to grab the income of its citizens, the preservation of capital to increase prosperity, and freedom to enjoy private property? I think not.

Robert Stewart has lived in Bermuda all of his adult life, and has degrees in economics and law from the University of London. He was chief executive of the Royal/Dutch Shell Group of Companies in Bermuda until his retirement in 1998. Subsequently, he was President of Old Mutual Asset Managers, Bermuda and retired from there at the end of 2002. He is a director of several Bermuda companies and investment funds. He is a director and Vice-Chairman of the Bank of Butterfield, Bermuda’s oldest bank. He is the author of “A Guide to the Economy of Bermuda.”

[1] Medieval serfs lost around 30%.

[2] See The Economist October, 19th 2002 page 93.

[3] Selected Essays on Political Economy” by Frederic Bastiat, pages 238 and 239.

[4] May 3rd in the United States, June 10th in UK, in 2002.

[5] New York Times August 12, 2002.

Help support The Nassau Institute