During the first few months of every year, US citizens and residents become preoccupied with the ritual of collecting W-2 forms from employers (indicating how much income tax was withheld from their paychecks during the year) and 1099 forms from banks and other payors (indicating how much non-salary income was received by the resident during the year on which tax must be reported and paid). We grouse about the time we spend preparing federal, state and local tax returns or the money we pay an accountant or professional tax preparer if we choose not to prepare them ourselves. Then, once we’ve calculated the tax due on our income for the year, we either enthusiastically plan how we’ll spend the refund we’re due if too much tax was withheld or complain bitterly if too little tax was withheld and we have to write a check for the balance owed to the US Treasury. 

Given the prominent place of the income tax in US culture, it’s not surprising that law students in my OFC courses find the absence of income taxation in offshore jurisdictions to be so . . . well, foreign. Perhaps it’s also why they are prepared to buy into the OECD’s portrayal of OFCs as parasitic regimes engaged in a tax competition “race to the bottom”. There is a common misperception in the United States that OFCs intentionally abandon income (or “direct”) taxation in order to poach tax revenue from onshore jurisdictions. In fact, the development of any country’s tax system is influenced by a combination of factors including its political system, its economy and even its geography. For example, in terms of territory, population and economic activity, OFCs are relatively small.

The combined landmass of the 41 countries the OECD identified as tax havens in 2000 is less than that of New Zealand – as is their combined gross domestic product. Thus, OFCs need relatively less tax revenue to fund government operations. In addition, because most OFCs are located on islands or are otherwise geographically isolated, they are able to effectively patrol their territorial borders. This means that for most OFCs, import duties and similar levies are a far more efficient means of extracting the fiscal resources necessary for government than a system of income taxation, with its printing, reporting, auditing, recordkeeping and enforcement requirements. 

Although income taxation is anathema in most OFCs, it is the value-added tax that is abhorred in the United States. At first glance, opposition in the United States to implementing a VAT is puzzling. In the European Union, the VAT has generated something like 30 per cent of total tax revenues, and most other developed countries around the world rely on the VAT for a substantial portion of their tax revenues. But just as most OFCs have rejected income taxation for practical reasons relating to their unique circumstances, US reluctance to adopt a VAT may be similarly explained. Like an income tax, a VAT requires significant administrative and enforcement resources. Installing a VAT in addition to the existing US income tax would substantially expand a tax system that many view as too large already. Moreover, in many respects a VAT replicates a retail sales tax. Under the US’s federal system of government, sales taxes historically have only been imposed by state and local governments.  

Despite its discomfort with the VAT, the United States may be forced to seriously consider implementing one in order to raise revenues to offset the trillion-dollar annual budget deficits projected for the next several years. By the same token, despite their discomfort with direct taxation, some OFCs may be forced to seriously consider adopting an income tax in order to deal with their own revenue shortfalls. The two-island federation of St Kitts and Nevis (which already has the highest VAT in the region) reportedly is contemplating the reintroduction of a personal income tax in order to reduce a ballooning national debt that has drawn the attention of the International Monetary Fund. Similarly, the recently installed British-led government in the Turks and Caicos proposes to replace that country’s work permit fees with an income tax on wages that will be paid by employers. 

The point here is that taxes are taxes – whether of the income, duty, or VAT variety. Countries impose the forms of taxation that work best given their unique circumstances and may adopt different forms when faced with fiscal crisis. However, a choice to forego a particular form of taxation should never be met with condemnation from other countries.