Year of grant:
Why No Tax Haven in the Faroe Islands? A Comparative Investigation of Tax Systems in Micro States
Copenhagen Business School
Leonard Seabrooke, Jason Sharman, Juanna S. Joensen og Árni Johan Petersen
Grant from the FRC in DKK:
Original: Micro-states require a steady fiscal revenue base to successfully integrate into a globalised world economy and to provide welfare to their citizens. typically micro-states have relied on taxing a) either their own population through indirect taxes b) on taxing foreigners through administrative charges on the passage of goods, or c) have relied on dependent relationships with colonial powers. In the late twentieth century many micro-states in dependent relationships with colonial powers gained fiscal autonomy and/or sovereign independence by deciding to become an “offshore tax haven”. Such havens provide foreign wealthy individuals and corporation a low tax environment, while providing the micro-state with a stable income and a greater capacity to mitigate economic risks, such as a high dependence on select agricultural resources (such as fishing).
This project investigates why some micro-states have chosen to become “offshore tax havens” while others have not. The research team will investigate policy reasoning in the Faroe Islands and compare its policy strategies with a range of other cases. National and international experts and policy-makers in a range of cases will be interviewed. In doing so the projects asks: “why is there no tax haven in the Faroe Islands?” and “what influence would a tax haven strategy have on the Faroese economy if pursued by the Faroese Government?”
Final: Several factors driving a countries or jurisdictions tax haven status have been identified in the literature. As noted earlier, previous research on the determinants of tax havens suggests that tax havens are:
- unlikely to be landlocked,
- likely to be islands
- large proportions of their populations live close to coasts,
- they have open economies,
- are physically close to major capital exporters
- are less likely to have Scandinavian and Socialist origins,
- are more likely to have British legal origins and parliamentary systems,
- are more likely to use English as an official language,
- are more likely to have substantially smaller natural resources than non-havens,
- are usually small countries with a population below one million, and
- are more prosperous than other countries, and
- are more likely to have high governance quality (see Dharmapala and Hines 2006, 2008, 2009).
Adding to this list, our research suggests that social capital, measured as interpersonal trust, is another important factor influencing the likelihood of a country to become a tax haven. The statistical analysis documents that the positive impact of high governance quality on the probability of being a tax haven is counteracted by high levels of trust. The interaction between the governance and the trust index thus decreases the likelihood of a country of to be a tax haven. This is shown for the Faroese case as well as a sample of 116 countries with non-missing trust index data (Weihe og Joensen 2013). Thus adding to the list above, we argue that:
• countries with high levels of trust are less likely to be tax havens
The fact that social capital counteracts the positive impact of high governance quality on the probability of being a tax haven suggests that intangible features such as norms and culture may be important factors influencing a country’s or jurisdictions propensity to become a tax haven. This is further corroborated by the finding that the region in which a country is located is an important predictive variable with respect to tax haven status.
Our project reveals that the predicted probability of being a tax haven is quite similar for the Faroe Islands, the Cook Islands and the Netherland Antilles. These three cases have quite similar observable characteristics.
Based on these observable characteristics, none of the three countries should be tax havens. However, we find that the unobservable characteristics left in the residuals of the statistical models are very different for the three countries, and that the Faroe Islands have unobserved characteristics making them less likely to be a tax haven, while Cook Islands and the Netherlands Antilles have unobserved characteristics making them more likely to be a tax haven. The observable characteristics can only explain 30 % of variation in tax havens, thus rendering the unobservable factors important in explaining a countries tax haven choice.
Unobservable characteristics are difficult to capture in the statistical model, and the quantitative analysis sheds light on only a few variables for many countries. The qualitative case analysis can shed further light on which factors may be important for a country’s or jurisdictions propensity to become a tax haven as a wider range of factors can be included in the analysis.
The case analysis identifies some further factors that seem to have been influential for the policy route in the three investigated cases. First, the state of the economy seems to play an important role. If a microstate already has a steady fiscal revenue base and is capable of providing welfare to its citizens, it may be less inclined to consider / opt for a tax haven route. This seems to be the case for the Faroe Islands, which experienced a period of economic boom at the point when the tax haven strategy appeared as a conscious economical survival strategy elsewhere in the world. It was only later, during severe economic crisis years that the tax haven issue briefly emerged on the Faroese policy agenda. Correspondingly, in the two positive cases, the tax haven strategy was pursued on the background of weak economies. The economic motive behind tax haven strategies is also highlighted elsewhere. Palin et al., for example, suggest that tax haven legislation can be viewed "as a conscious, intentional, and long-term development strategy" (2010: 22). The fact that extant research suggests that tax havens are more likely to have substantially smaller natural resources than non-havens further supports this argument.
Second, as already indicated in the statistical analysis, intangible factors such as norms and values seem to be variables of some importance. A recurrent theme in the interview data for the negative case (i.e. the Faroese case) was that being a tax haven was affiliated with something “bad” or “inappropriate”. The national self-perception or identity somehow seemed inconsistent with the idea of being a tax haven. This finding fits well with the finding that the region in which a country is located is an important predictive variable with respect to tax haven propensity. It also fits well with the fact that previous research has documented, that tax havens are less likely to have Scandinavian and Socialist origins. The Scandinavian welfare model, with its “universalist” welfare state and taxation levels that are among the world’s highest, can be argued to stand in contrast with the general idea of having low rates of taxes or no taxes at all. The fact that previous research has documented that tax havens are more likely to have British legal origins and parliamentary systems, and are more likely to use English as an official language, further support the perspective that “ideas” play a role, and that economic calculation alone cannot explain policy outcomes.
A third factor, which seems to have some importance, is the stance of the metropole towards the tax haven strategy. In both the positive cases (The Cook Islands and the Netherland Antilles), the former colonizer originally positively encouraged these jurisdictions to adopt a tax haven strategy, the motive being making them more economically independent. In the negative case, the stance of the metropole is unclear since the tax haven issue never formally emerged on the Faroese policy agenda. However, it seems fair to suspect that a Faroese tax haven strategy would create some opposition from the neighboring Scandinavian countries, including the metropole.
The answer to the posed research question on what determines whether or not a micro-state chooses to become tax haven is, in conclusion, neither simple nor straight forward. Whether or not a country or jurisdiction opts for a tax haven strategy is contingent on a range of factors varying from factors based on rational choice calculations of economic benefit, factors based on power politics (i.e. the stance of the metropole towards the tax haven strategy), as well as factors based on norms and values, including national identity and self-perception. This suggests that a comprehensive and satisfactory understanding of the chosen policy routes can only be achieved by adopting a mix of theoretical perspectives, including rationalist as well as constructivist accounts of social action.
- International Hierarchies and Contemporary Imperial Governance: A Tale of Three Kingdoms. European Journal of International Relations (EJIR), Published 6 February 2012 - Governance, Institutions and Taxes: On the determinants of tax havens. Working paper in the working paper series of Department of Business and Politics, Copenhagen Business School, 2013. To be published as a journal article. - Delegation, Hierarchy, and Kingdoms in International Economic Organizations. Internasjonal Politikk. Currently being translated. The editorial board welcomes the submission. - Which Countries (Do not) Become Tax Havens? A comparative investigation of the (non)tax haven strategies in the Faroe Islands, the Cook Islands, and the Netherlands Antilles. Case report. Copenhagen Business School.
Publications (dissemination) outside the scientific community - Article in the Faroese newspaper Dimmalætting. The Faroe Islands as a tax haven. 26 July 2012. No. 143, week 30. By Sveinur Tróndarson. - Radio broadcast with Juanna S. Joensen and Guðrið Weihe in the Faroese radio station Kringvarpið: on the main results of the project. 25 July 2012. - The project results were prestented at public seminar in Torshavn on the 25th of July 2012.