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Forum on International Tax Avoidance and Evasion
755
National Tax Journal
Vol. LXIl, No. 4
December 2009
Abstract – The recent uncovered cases of tax evasion in the Euro-
pean Union and the United States have revived the fi ght against
harmful tax practices and spurred impressive progress in the
adoption of international standards on information exchange. This
paper reviews the theoretical and empirical literature on harmful tax
practices and information exchange on the size and consequences of
the existence of tax havens and harmful tax regimes. The paper also
describes the multilateral approaches developed by the Organisa-
tion for Economic Co-operation and Development (OECD) and
the European Union and examines recent developments in fi ghting
harmful tax practices.
I. INTRODUCTION
The recent Liechtenstein and UBS tax affairs have put the
topic of harmful tax practices under the spotlight. In the
fi rst case, the German secret service secretly bought a compact
disc in 2006 containing information about hundreds of indi-
viduals evading taxes in Germany (and in other jurisdictions
it appears) through the use of anonymous Liechtenstein-
based trusts. This led in February 2008 to various raids—
publicized by the press—against a number of individuals
and, as a consequence, to a large number of confessions of
tax evasion to the German tax authorities. In the second case,
the U.S. Internal Revenue Service, aided by a whistleblower
investigated an alleged case of tax evasion facilitated by the
Swiss bank UBS that involves tens of thousands Swiss bank
accounts held by wealthy U.S. citizens. Facing the threat of
losing its charter to operate in the United States, in August
2009 UBS agreed to pay a fi ne of $789 million and to disclose
the identity of (some of) the incriminated account holders as
part of a settlement. In addition, these events have occurred
during a period of severe global economic crisis that is forcing
governments to seek additional revenues to ease their fi scal
problems. These events led politicians in many countries
to decide that “enough is enough” and that more political
pressure should be put on fi ghting tax evasion. Even if tax
havens are not at the root of the fi nancial crisis, dealing with
them is increasingly seen as part of the solution.
Toward this end, the leaders of the G-20 countries issued a
statement on April 2, 2009 declaring that they “agree to take
On Recent Developments in Fighting
Harmful Tax Practices
Gaëtan Nicodème
European
Commission and
Université Libre de
Bruxelles,
Brussels, Belgium
NATIONAL TAX JOURNAL
756
action against non-cooperative jurisdic-
tions [that they are ready] to deploy sanc-
tions [and that] the era of bank secrecy
is over” (Organisation for Economic Co-
operation and Development, 2009, 18).
This has led to astonishing developments
as many jurisdictions around the world
have adopted international standards
for information exchange, in particular
all “uncooperative” tax havens are now
committed to these standards. This paper
reviews these recent developments at the
OECD and EU levels and assesses them
in the light of the economic literature on
harmful tax practices.
The remainder of the paper is organized
as follows. Section II defi nes harmful tax
practices and reviews the rationales for
counteracting them. It also takes stock
of the existing theoretical and empirical
economic literature on the economic char-
acteristics and consequences of these prac-
tices. Section III examines the history and
the recent developments of policy actions
at both the OECD and EU levels, notably
the Harmful Tax Competition projects
and the EU code of conduct and other
initiatives. Conclusions are presented in
the fi nal section.
II. THE ECONOMIC LITERATURE
ON HARMFUL TAX PRACTICES
A. Harmful Tax Practices and Capital
Export Neutrality
The term “harmful tax practice” is
a loose and subjective concept. In this
paper, it is defi ned as setting tax policies
to intentionally try to attract a mobile tax
base, usually in a non-transparent way or
by using unusual tax regimes. Such poli-
cies usually contain no or low taxation but
this alone is not suffi cient; other features,
including non-transparency, ring-fencing
of mobile activities, or other unusual
features are also required. This covers,
for example, regimes that are only avail-
able to headquarters of large corporate
groups and which allow the application
of a notional tax base defi ned as a fraction
of specifi c costs instead of profi t. Harmful
tax practices also include tax practices that
have the intention or the potential to help
foreign taxpayers evade taxation in their
home country, including many practices of
so-called tax havens. For all such harmful
tax practices, the OECD and the EU have
introduced a formal defi nition, a topic that
will be discussed further in section III.
The focus on harmful tax practices in
policy discussions stems from the fear
that such practices will erode the mobile
portion of domestic tax bases. Mobility
of tax bases, in particular capital, has
increasingly become a feature of the
world economy, due to the removal of
trade barriers, technological progress, and
fi nancial integration that allows “banking
without borders” (Owens and Sanelli,
2007). There is also ample evidence that
various forms of capital are tax sensitive,
including international deposits, foreign
direct investment (FDI), and even busi-
ness location. For example, Huizinga and
Nicodeme (2004) report an elasticity of
international deposits with respect to net
rates of return of 2.4. In a meta-analysis,
de Mooij and Ederveen (2003) fi nd an
average semi-elasticity of FDI to taxes of
close to 3. A recent contribution by Barrios
et al. (2008) fi nds a signifi cant effect of host
and home country taxes on the location
of foreign subsidiaries and that the struc-
ture of the corporate group is designed
to be tax-minimizing. In addition, Voget
(2008) fi nds headquarters location to be
tax sensitive.
One economic rationale for fighting
harmful tax practices is that many of
these practices prevent the implementa-
tion of residence-based taxation, which
is desirable to attain the goal of capital
export neutrality (CEN), achieved when
investors from a specifi c country face the
same rate of return on their investments
Forum on International Tax Avoidance and Evasion
757
in all locations.1 Such a tax structure is
consistent with the concept of production
efficiency advocated by Diamond and
Mirrlees (1971) since it does not distort
the international allocation of investment.
The Diamond and Mirrlees (1971) produc-
tion effi ciency theorem, however, is not
exempt from criticism, both from theoreti-
cal and practical perspectives. Keen and
Piekkola (1997, 448–450) argue that the
theorem rests on the critical assumption
that “any pure profi t can be fully taxed
and that there are no restrictions on either
the distorting tax instruments that can be
deployed or the use of intergovernmental
transfers” and, when this is not the case,
the optimal system depends on elasticities
of demand and supply for capital and on
the tax rates at which pure profi t is taxed.
Keen and Wildasin (2004) show that the
Diamond and Mirrlees theorem rests on
the assumption that there is a single (joint)
budget constraint and that global welfare
is maximized. This condition, how-
ever, does not necessarily hold if every
country has its own domestic budget
constraint and if there are no lump sum
transfers between governments. More
recently, Devereux (2008, 3) states that in
a real-world situation, “… all traditional
forms of taxation would be distorting
unless they are completely harmonised.”
Nevertheless, capital export neutrality
remains a common benchmark against
which to assess the effi ciency aspects of
international tax systems. That said, a
residence-based tax system is considered
to be impractical by some authors because
it requires domestic tax authorities to
have information on revenues generated
abroad, and it is not in the interest of
countries practicing harmful tax practices
to provide such information (Tanzi and
Zee, 2001). Finally, it is equally interesting
to notice that while economists see the
problem of harmful tax practices through
its effi ciency aspects, policymakers seem
to be at least equally focused on equity
aspects.2 For example, the G-20 State-
ment on Transparency and Exchange
Information for Tax Purposes in Berlin
in November 2004 indicates that “… the
Finance Ministers … regard [information
exchange] as vital to enhance fairness and
equity in our societies and to promote
economic development” (Organisation
for Economic Co-Operation and Develop-
ment, 2009, 21). This concern has gained
importance at a time of increased revenue
needs following the fi nancial crisis.
B. Tax Havens and their Economic
Importance
Most harmful tax practices are closely
linked to the existence of so-called “tax
havens.” A formal defi nition of tax haven
that goes beyond a reputation test was
given by the Organisation for Economic
Co-Operation and Development (1998,
22), which defined a tax haven as a
jurisdiction that “… imposes no or only
nominal taxes (generally or in special
circumstances) and offers itself, or is
perceived to offer itself, as a place to be
used by non-residents to escape tax in
their country of residence.” The absence
of a signifi cant level of taxation is a nec-
essary but not a suffi cient condition, as
a jurisdiction must satisfy several other
criteria before it is black-listed as a tax
haven. These criteria include a lack of
effective exchange of information, a lack
of transparency in its provisions, and the
1 Alternatively, capital import neutrality ensures that the rates of return on all investment in the same location
are the same regardless of the country of origin of the investor. This corresponds to source-based taxation.
2 Actually, it is unclear whether capital export neutrality is always endorsed by policymakers. For example,
residence-based taxation is not actively promoted in the case of dividend taxation, for which withholding
taxes seem to be accepted instruments despite the potential double-taxation problems they create.
NATIONAL TAX JOURNAL
758
absence of a requirement that the activ-
ity of fi rms be substantial. Based on this
defi nition, the Organisation for Economic
Co-Operation and Development (2000)
issued a list of 35 jurisdictions classifi ed as
tax havens.3 Given the inherent subjectiv-
ity of criteria, several other authors have
come up with different defi nitions,4 but
the bottom line is that tax havens are juris-
dictions that offer favorable tax regimes
and a relatively high degree of secrecy for
investors.
The characteristics and economic effects
of tax havens have been studied by sev-
eral researchers.5 Dharmapala and Hines
(2006) analyze the 41 tax haven jurisdic-
tions listed in Hines and Rice (1994) and
fi nd that countries labeled as tax havens
are usually small in size and population,
are more likely to be islands and located
near large capital exporting countries,
have homogenous populations, are poor
in natural resource endowments, and are
likely to be of British legal origin and use
English as an offi cial language. Interest-
ingly, such countries are also likely to
have high levels of GDP per capita and,
even controlling for their wealth, to score
high on governance indicators (political
stability, rule of law, control of corrup-
tion, effectiveness of the government,
and accountability). It appears that good
governance is a necessary condition for
a favorable tax regime to be credible in
the eyes of capital exporters.6 Finally, the
authors fi nd that the levels of taxation
and government expenditure relative to
GDP are comparable to those of non-tax
havens.
Tax havens have also grown substan-
tially and represent non-negligible parts of
the world economy. Hines (2007) reports
that real GDP in tax havens grew at a 3.3
percent rate over the period 1982–1999,
compared to 1.4 percent for the rest of
the world. In 1999, tax havens’ combined
share of the non-U.S. world population
was only 0.8 percent, but their share of
GDP was 2.3 percent. Hines also fi nds that
while tax havens accounted for a relatively
modest share of foreign property, plant
and equipment and of foreign employees
of U.S. multinationals (about 6 percent
and 8.5 percent, respectively), their share
in foreign sales and net income were 15.7
percent and 30.0 percent, respectively. In
addition, 59 percent of U.S. multination-
als with significant foreign operations
had affi liates in tax havens (Desai, Foley
and Hines, 2004). Finally, the most recent
estimates put capital held offshore in the
range of $5–7 trillion; although not all of
this amount refl ects tax evasion, the large
revenue intakes from recent policy initia-
tives such as tax amnesties or measures
to uncover tax evasion suggests that tax
evasion in tax havens is far from negligible
(Owens, 2007).
3 Those jurisdictions were Andorra, Anguilla, Antigua and Barbuda, Aruba, The Bahamas, Bahrain, Barbados,
Belize, British Virgin Island, Cook Islands, Dominica, Gibraltar, Grenada, Guernsey, Isle of Man, Jersey, Libe-
ria, Liechtenstein, the Maldives, Marshall Islands, Monaco, Montserrat, Nauru, Netherlands Antilles, Niue,
Panama, Samoa, Seychelles, St Lucia, St Kitts and Nevis, St Vincent and the Grenadines, Tonga, Turks and
Caicos, US Virgin Islands, and Vanuatu. Six additional jurisdictions fulfi lled the criteria but were not included
in the list because they committed to eliminating their harmful practices before publication of the list. Those
six jurisdictions are Bermuda, Cayman Islands, Cyprus, Malta, Mauritius and San Marino (Owens and Sanelli,
2007). Note that the OECD list was reduced to seven “uncooperative” tax havens in 2002 and eventually to
zero in May 2009.
4 Such alternative classifi cations can be found in Hines and Rice (1994), Zoromé (2007) or Tax Justice Network
(2007). The two latter papers broaden the defi nition of tax havens to include jurisdictions with offshore fi nancial
centers whose activities are large compared to the domestic economy.
5 Dharmapala (2008) provides an excellent survey of this literature.
6 Note that the Diamond and Mirrlees (1971) theorem also explains why small open economies may become tax
havens in the absence of economic rents as it is optimal for them not to tax foreign investors, a point stressed
by Gordon (1986) and Dharmapala and Hines (2006).
Forum on International Tax Avoidance and Evasion
759
C. Harmful Tax Practices Involve the
Establishment
Harmful tax practices that involve the
establishment by some countries of pref-
erential tax regimes designed to attract
footloose companies, passive investments,
or paper profi ts. Those measures are the
target of both the OECD work on harm-
ful preferential tax regimes and of the EU
code of conduct on business taxation. The
OECD applies four key factors to identify
such practices (Organisation for Economic
Co-Operation and Development, 1998):
(1) a low or zero effective tax rate on such
income, (2) a tax regime that is “ring-
fenced,” that is, at least partly insulated
from domestic markets, (3) a tax regime
that is non-transparent, and (4) a lack of
effective exchange of information. In addi-
tion, the OECD also uses an array of other
criteria such as whether the tax base is
artifi cially defi ned, the country adheres to
commonly accepted transfer pricing rules,
full exemption is applied to foreign-source
profi t, the tax base or tax rate is negotiable,
there are secrecy provisions, there is a wide
network of tax treaties allowing treaty-
shopping, and the regime is fl agged as
tax minimizing or encourage operations
that are purely tax-driven.
7
Based on these
criteria, the Organisation for Economic
Co-Operation and Development (2000)
identifi ed 47 regimes that were potentially
harmful.
The European Union has a similar
approach, characterizing as harmful tax
regimes that offer low or zero taxation and
satisfy at least one of fi ve criteria (Council
of the European Union, 1999): (1) the tax
advantages are for non-residents only, (2)
the regime is ring-fenced, (3) the advan-
tages are granted despite the absence of
real economic activity, (4) the rules for
computing the tax base depart from gen-
erally accepted practices, and (5) a lack
of transparency. The European Council
(1999) identifi ed 66 measures that were
potentially most harmful. Both institu-
tions work exclusively on the tax systems
of their Member States but whereas the
OECD focuses on internationally mobile
activities, the EU code of conduct in prin-
ciple covers all economic activities.
D. Economic Effects of Harmful Tax
Practices
The economic effects of tax havens and
of preferential regimes for mobile income
are the subject of an intellectual debate
in the literature between the partisans of
the thesis that tax havens are parasitic
and detrimental because they increase tax
competition and incur enforcement costs
for other countries, and the disciples of the
thesis that tax havens may tame tax compe-
tition and increase effi ciency by allowing
non-tax havens to keep high tax rates on
immobile firms while allowing mobile
fi rms to benefi t from preferential regimes.
8
Slemrod and Wilson (2006) construct a
model of tax competition with parasitic
tax havens and show that removing pref-
erential tax regimes increases welfare. In
their model, the presence of tax havens
increases tax competition and leads to
a decrease in corporate tax revenues in
non-tax havens. In contrast, Keen (2001)
constructs a similar model but introduces
two types of fi rms: mobile or immobile.
Because countries cannot tax discrimi-
nate between these two types of fi rms,
tax competition would drive tax rates
down to suboptimal levels. The pres-
ence of preferential tax regimes targeted
to mobile fi rms allows them to decrease
their tax burden and permits countries
to maintain high tax rates on immobile
fi rms. This form of Ramsey-type taxation
implies that tax competition applies only
to mobile companies, leaving countries
7 OECD (1998) provides a detailed description of these factors.
8 Dharmapala (2008) provides a thorough description of the arguments.
NATIONAL TAX JOURNAL
760
with more tax revenues than under “ordi-
nary” tax competition. Note that Keen’s
results differ from those of Janeba and
Peters (1999) who fi nd that tax revenues
are lower when preferential regimes are
allowed. This result obtains because their
model includes differences in the share of
the immobile sector in each country, which
implies that the country with the higher
share decides not to compete on tax rates
and lets the other country impose prefer-
ential regimes to attract the mobile fi rms.9
Hong and Smart (2007) provide a slightly
different model that allows for shifting
of the incidence of the tax to wages and
for redistributive policies and comes to
similar conclusions: tax havens are used
by mobile companies to lower their tax
liability, which in turn increase their abil-
ity to invest in the non-tax haven country,
increasing the welfare of domestic work-
ers and allowing for higher corporate
tax rates on immobile capital and more
redistribution to workers. These results
complement some other papers using
the same type of model to examine the
complementarities between tax havens
and non-tax havens. In particular, Desai,
Foley and Hines (2006a, 2006b) fi nd that
the presence of tax havens stimulates
investment in non-tax havens because it
allows companies to decrease their overall
cost of capital.
Bucovetsky and Haufl er (2008) extend
the Hong and Smart (2007) model by
allowing fi rms to choose whether to stay
domestic or become multinationals, and
fi nd that the tax elasticity of this deci-
sion is crucial for assessing whether or
not preferential regimes are benefi cial. If
fi rms’ decisions on whether to become a
multinational are inelastic to the presence
of preferential regimes, non-cooperative
countries will choose to deploy extensive
preferential regimes to attract mobile
fi rms and set high tax rates on immobile
fi rms, and the optimal coordinated policy
is to try to curb such preferential regimes.
If, however, fi rms’ decisions are elastic,
non-cooperative countries will choose
minimal preferential tax regimes and
tax competition in rates will reduce tax
rates to suboptimal levels. The optimal
coordinated policy in this case is to try
to increase the number of preferential
regimes to reduce competition in tax
rates.10
E. The Choice of Instruments to Fight
Tax Evasion
As exemplifi ed by the various proposals
to deal with the taxation of savings instru-
ments (discussed below), European Union
policy making has always been a struggle
between using a system of exchange of
information between tax authorities to
ensure a fair level of tax burden and using
a system of withholding taxes to simply
avoid the diffi culties of implementing effi -
cient information exchange (although the
two systems need not be mutually exclu-
sive). In particular, the goal of achieving
capital export neutrality is made diffi cult
by the fact that information exchange is
not necessarily in the interest of low tax
jurisdictions which can use secrecy as a
strategic variable.
9
Janeba and Smart (2003) endogenize the size of the tax base to make it dependent on the level of tax rates
in the two countries. They fi nd that Keen’s result is less likely to occur under this assumption. Haupt and
Peters (2005) also dispute Keen’s result if investors have a home bias and if preferential tax regimes can be
partly restricted (as opposed to a dichotomous choice assumed by Keen); they show that full tax competition
is always inferior to moderate restrictions on preferential regimes. Marceau, Mongrain and Wilson (2007)
also fi nd that non-preferential regimes generate larger global tax revenues, unless cross-country differences
in productivity are suffi ciently large. Finally, Wilson (2006) assumes highly mobile tax bases, which allows
countries to undercut each other’s rate and get all revenues. This implies tax revenues are no longer a concave
function of the rate, so that preferential regimes are desirable.
10 Bucovetsky and Haufl er (2008) also fi nd that small countries are more likely to utilize preferential regimes.
Forum on International Tax Avoidance and Evasion
761
This issue has been investigated in game
theory settings. Bacchetta and Espinosa
(1995) use a two-stage non-cooperative
game in which each country fi rst decides
on the level of information exchange they
will provide to the other country, and then
decides on the level of the withholding tax
rate applied to non-residents. They show
that the equilibrium is a partial informa-
tion exchange, as the countries face oppos-
ing effects from information exchange. On
the one hand, exchanging information
may make a country less attractive for
foreign investors but, on the other hand,
exchanging information allows the other
country to maintain higher levels of
taxation, which in turn also allows the
fi rst country to maintain high tax rates.
Eggert and Kolmar (2002) modify the
assumptions of the model to show that
when investment decisions in physical
capital can be separated from investment
decisions in fi nancial capital—therefore
removing the tax-base effects of informa-
tion exchange—countries no longer have
incentives to use information exchange as
a strategic variable and should engage in
full cooperation.
Turning to a repeated game setting,
Bacchetta and Espinosa (2000) show that
countries might engage in cooperative
behavior because they know that deviat-
ing from exchange of information will
lead other countries to apply the same
(harmful) policy. The possibility of such
punishment is suffi cient for exchanges of
information to become equilibrium poli-
cies. The same repeated game framework
is used by Huizinga and Nielsen (2003)
who construct a model in which countries
choose between the mutually exclusive
alternatives of exchanging information
or imposing a withholding tax. In such
a setting, mixed regimes can arise with
some countries exchanging information
(usually large countries) and other coun-
tries (usually small ones) using withhold-
ing taxes. Finally, considering the case
of perfectly mobile capital, Eggert and
Kolmar (2004) fi nd a “tax competition
paradox,” as increasing capital market
integration and capital mobility eventu-
ally makes source-based withholding
taxes unsustainable and leads countries
to opt for information exchange. That is,
somewhat paradoxically, greater capital
mobility enables residence-based taxation.
Keen and Ligthart (2006b) provide
another important contribution to the
literature by allowing countries to opt
for both a withholding tax or informa-
tion exchange but also giving them the
option to use the revenues collected from
either approach to be transferred to the
other country. The paper derives three
key results. First, when only withhold-
ing taxes are used and a share of the
proceeds is returned to the country of
the investor (such as in the EU savings
directive), the level of withholding tax
rates in equilibrium is independent of
the share of proceeds transferred. Second,
allowing transfers of part of the revenues
collected due to information exchange
back to the country providing the infor-
mation increases equilibrium withholding
tax rates and the total sum of revenues
collected. Finally, while large countries
would prefer information exchange, small
countries could also choose this system,
provided that they are not too small rela-
tive to the large country.
Keen and Ligthart (2006a) provide
an interesting summary of the possible
theoretical and practical arrangements
for international information exchange.
Interestingly, information exchange and
withholding taxes appear to be substitutes
in the real world. Huizinga and Nicodeme
(2004) review the arrangements in place
for the member countries of the Bank for
International Settlements and fi nd that,
with the exception of Australia which
adopts both policies, the two instruments
appear to be substitutes. They also fi nd
that information exchange is generally
a reciprocal arrangement. Ligthart and
Voget (2009) come to the same conclusion
NATIONAL TAX JOURNAL
762
on reciprocity,11 and also fi nd that informa-
tion is more likely to be exchanged when
the domestic income tax rate is high, the
marginal cost of public funds is high, and
the country has sizeable interest-bearing
deposits that are held abroad. Empiri-
cally, Huizinga and Nicodeme (2004) fi nd
that for the sub-category of international
deposits, a 1 percent increase in the
domestic interest tax burden increases
deposits held abroad by about 2.4 percent,
and that having a domestic exchange
of information between banks and tax
authorities increases deposits held abroad
by 28 percent on average. However, they
fail to fi nd a signifi cant impact of interna-
tional information exchange on deposits
held abroad.
III. OECD AND EU INITIATIVES
IN FIGHTING HARMFUL TAX
PRACTICES
The attempts to curb harmful tax com-
petition practices at a multilateral level
have so far been led by the OECD and
the European Union, with numerous
political interactions involving the G-20
countries.12 This section will review these
efforts and comment on the very latest
developments.
A. The OECD Work on Harmful Tax
Competition
The OECD work on harmful tax compe-
tition accelerated in 199613 when the G-7
countries called for the OECD to pursue
its work on establishing a multilateral
approach to limit tax schemes aimed
at attracting mobile activities, as these
“… can create harmful tax competition
between States, carrying risks of distorting
trade and investment and could lead to
the erosion of national tax base.” (Weiner
and Ault, 1998, 602). This led to the report
on harmful tax competition (Organisation
for Economic Co-Operation and Develop-
ment, 1998) that established the criteria
for identifying tax havens and harmful
tax practices discussed above, as well
as a set of recommendations on possible
counteracting measures against countries
engaged in harmful tax competition. A
follow-up report issued a list of coun-
tries and measures that met the criteria
(Organisation for Economic Co-Operation
and Development, 2000). This list was not
intended to name and shame countries.
Nevertheless, a majority of countries
rapidly made commitments to implement
transparent practices and allow exchange
of information, leaving only seven juris-
dictions—Andorra, Liberia, Liechtenstein,
Monaco, the Marshall Islands, Nauru and
Vanuatu—on the list of uncooperative tax
havens by April 2002 (Owens, 2007). In
2003, Nauru and Vanuatu issued similar
commitments and were removed from the
list. The same commitments were made
by Liberia and the Marshall Islands in
2007 and, following the recent increase
in political pressure, the remaining three
countries followed suit in May 2009, leav-
ing no countries classifi ed as uncoopera-
tive tax havens.
11 Based on Dutch data, they fi nd that on average 85.4 percent of information exchanges are made on an automatic
basis.
12 There are also some initiatives, not discussed in this paper, at the level of the United Nations, such as the work
of the Committee of Experts on International Cooperation in Tax Matters (http://www.un.org/esa/ffd/tax/
overview.htm). Initially, the group’s mandate was to fi nd ways to facilitate the adoption of tax treaties, but
it has been broadened to include issues of transfer pricing, mutual assistance, interaction of tax, trade and
investment, tax treatment of cross-border interest income and capital fl ight, etc. Some initiatives are also taken
at the level of individual countries by ways of Controlled Foreign Corporations rules and other instruments.
Those are also not reviewed here.
13 Previous initiatives include the Draft Double Taxation on Income and Capital in 1963 and the Model Conven-
tion and Commentaries in 1977 (Jackson, 2009).
Forum on International Tax Avoidance and Evasion
763
Following the publication of the OECD
list of tax havens in 2000, a group of 32
cooperative countries was invited to
participate in the OECD’s Global Forum
on Transparency and Exchange of Infor-
mation. The goal of the forum was to
encourage fair competition between the
jurisdictions involved by achieving high
levels of transparency and exchange of
information based mainly on five key
principles: (1) an agreement to deliver
information upon request if it is “fore-
seeably relevant” to the Treaty partner,
(2) no restrictions on transparency or
information exchange due to domestic
bank secrecy laws or domestic tax interest
requirements (which allow information
to be obtained only if it serves a domestic
tax interest), (3) making available relevant
information and granting the powers
needed to obtain it, (4) respect of taxpay-
ers’ rights, and (5) strict confi dentiality of
the information exchanged. Those stan-
dards have been successfully elaborated
in both article 26 of the OECD Model Tax
Convention on Income and Capital,14
and in the 2002 Model Agreement on
Exchange of Information on Tax Matters,
which was released in April 2002 by the
Working Group on Effective Exchange
of Information and became the basis for
subsequent Tax Information Exchange
Agreements (TIEAs).
The work of the Global Forum subse-
quently grew in geographical scope, as
it now includes close to 90 jurisdictions,
including OECD members, observer
countries, cooperative tax havens and
other fi nancial centers. The Forum has
been relatively successful during its fi rst
few years. By early 2004, 18 of the 47 harm-
ful tax regimes identifi ed in 2000 had been
abolished or were in the process of being
abolished, the harmful features of an
additional 14 regimes had been removed,
13 regimes had been considered as not
harmful after further analysis, and by
2006 only the Luxembourg 1929 holding
company regime remained on the list of
harmful tax practices15 (Organisation for
Economic Co-Operation and Develop-
ment, 2004, 2006).
The Bush administration, however,
marked a turning point for the OECD in
two respects. First, U.S. Treasury Secre-
tary O’Neill expressed the administra-
tion’s view that no country or group of
countries should dictate the features of
other countries’ tax systems. This led the
OECD to divert its efforts from harmful
tax practices to focus on exchange of
information (Jackson, 2009). Second, the
terrorist attacks of September 11, 2001
caused a profound shock and led the
U.S. to link exchange of information and
tax transparency with the issue of terror-
ist fi nancing. Accordingly, the Financial
Action Task Force on Money Laundering
(FATF), a body created in 1989 by the G-7
countries and whose secretariat is hosted
by the OECD, refocused its efforts from
money laundering to terrorist fi nancing.
Both activities are still being pursued by
the task force.
Between January 2000 and January 2008,
only 23 Tax Information Exchange Agree-
ments were signed, 17 of them involving
the U.S. or the Isle of Man. The revelation
of the Lichtenstein affair in February 2008
and the strong political condemnation of
tax evasion practices that followed pro-
voked an impressive reaction in many
countries. Between February, 2008 and
April 2009, an additional 41 agreements
were signed. The G-20 Communiqué of
April 2, 2009 left no doubt regarding the
willingness of the member countries to
take tax haven issues seriously, includ-
ing a commitment to develop a set of
countermeasures that would be utilized
14 The OECD Model Tax Convention on Income and Capital is available at http://www.oecd.org/document/
53/0,3343,en_2649_33747_33614197_1_1_1_1,00.html.
15 Luxembourg eventually passed legislation in 2006 to remove the regime by 2010 (OECD, 2009).
NATIONAL TAX JOURNAL
764
against non-cooperative countries.16 On
the same day the OECD published a
progress report on the implementation
of the tax standards regarding transpar-
ency and information exchange. The
report contains three lists. The “white list”
initially included 40 countries that have
substantially implemented the OECD tax
standards. Specifi cally, the progress indi-
cator used by the OECD is whether the
jurisdiction has signed at least 12 TIEAs
that meet the OECD standards, taking into
account the identity of the treaty partner,
the willingness to sign additional agree-
ments in the future, and the effectiveness
of implementation (Organisation for
Economic Co-Operation and Develop-
ment, 2009). The “grey list” included 31
tax havens and eight financial centers
that have committed to implementing the
standards but had not yet done so. Finally,
four jurisdictions—Costa Rica, Malaysia,
the Philippines and Uruguay—were
on the “black list” of countries that had
not agreed to the standards. This “name
and shame” exercise had immediate and
signifi cant consequences. By April 7, all
four jurisdictions had agreed to commit to
the standards and could be moved to the
“grey list.” Over the next six months, more
than 150 TIEAs were signed and 12 juris-
dictions17 had signed a suffi cient number
to be moved to the “white list.” The
challenging task of the Global Tax Forum
will now be to maintain the momentum
of the new agreements and to effectively
organize peer monitoring of progress in
the participating countries.
B. The EU Work on Harmful Tax
Competition
The European Union has been closely
associated with the OECD initiatives from
the outset. Nevertheless, the presence of
an internal market with free movements
of goods, services, people and capital
required additional measures. Coop-
eration in tax matters in the European
Union has traditionally been organized
under the auspices of the 1977 Direc-
tive on Mutual Assistance (Commission
of the European Communities, 1977).
Under this directive, EU Member States
are required to exchange any informa-
tion that appears relevant for the correct
assessment of taxes due. It covers value-
added taxes, excise duties on alcohol and
alcoholic beverages and on manufactured
tobacco, and all taxes on income or
capital.
In the early 1990’s, the European Union
faced two problems. First, several Member
States had developed specifi c tax regimes
with a goal to lure business and fi nancial
activities. Second, while the taxation of
dividends received by non-resident indi-
viduals was generally effected with fi nal
withholding taxes in many countries, the
situation was different for interest-bearing
instruments, as little or no taxation was
the general rule and each Member State
in effect acted as a tax haven for residents
of other Member States. Because of the
unanimity rule regarding issues of EU
taxation, little progress could be made. At
the informal council of Finance Ministers
in Verona in April 1996, the Commission,
under the leadership of Commissioner for
Taxation Mario Monti, presented a new
strategy to make sure that tax policies
would be better directed to achieve the
objectives of growth and employment
and to fight harmful tax competition.
The Council agreed to consider these
issues in a high-level discussion group,
and the end result was the so-called “tax
package.” The idea for this tax package
16 These include additional disclosure requirements, withholding taxes, revision of treaties, revision of investment
and development policies, and more focus on tax transparency and information exchange in aid programmes.
17 These countries were Aruba, Austria, Belgium, Bermuda, British Virgin Islands, Bahrain, Cayman Islands,
Luxembourg, Monaco, The Netherlands Antilles, San Marino, and Switzerland.
Forum on International Tax Avoidance and Evasion
765
was to manage the diverse interests of
the different Member States by offer-
ing more avenues for compromise. The
package was formally accepted by the
ECOFIN on December 1, 1997. Following
this agreement, three main developments
took place in 1998: a new proposal for
the taxation of savings, a proposal on
interest and royalties payments, and a
code of conduct on business taxation (see
below).
This was not the fi rst attempt by the
EU to fi ght harmful tax practices. The
fi rst proposal linked to taxation of sav-
ings dates to 1975 with a proposal for a
directive that concerned both the har-
monization of corporate taxation with a
single corporate tax rate between 45–55
percent and a 25 percent withholding tax
on dividends (Commission of the Euro-
pean Communities, 1975). This proposal
was rejected by the European Parliament
in 1977 since the Parliament’s agenda
was to harmonize the tax base prior to
the tax rate. In 1977, the Council adopted
the directive on mutual assistance which
could have been a major breakthrough
in terms of exchange of tax information,
but it was limited dramatically by provi-
sions that authorized Member States to
withhold information if domestic law
or administrative practices prevented
its exchange. The fi rst proposal on taxa-
tion of interest payments was issued in
1989 under Commissioner for Taxation
Christiane Scrivener. The proposal was
to establish a common regime of a 15
percent withholding tax rate on interest
for both residents and non-residents in the
EU (Commission of the European Com-
munities, 1989). The proposal was never
discussed by the Council, practically
blocking its adoption, and it was eventu-
ally removed in 1998 when a new proposal
for a directive was issued introducing
the “coexistence principle.” Under this
principle, Member States could choose
between a system of exchange of informa-
tion and a minimum 20 percent withhold-
ing tax on non-residents (Commission of
the European Communities, 1998).
No progress was made until the Feira
European Council in June 2000. At that
meeting, the Council agreed on the ele-
ments of the tax package, and in particular
on the contents of a new proposal for a
directive on taxation of savings. Moving
away from the coexistence principle, the
new proposal was designed to implement
a fi nal system based on the exchange of
tax information, with a transitional period
of seven years for Austria, Belgium and
Luxembourg. However, some Member
States, fearing the loss of competitiveness
of European fi nancial centers, made the
agreement conditional on the adoption
of equivalent measures by important
third countries (e.g., the United States,
Switzerland, Liechtenstein, Monaco,
San Marino, and Andorra) as well as the
adoption of similar measures by Mem-
ber States’ dependent territories (e.g.,
Netherlands Antilles, Jersey, Guernsey,
Island of Man, etc.). The Commission
started to negotiate with these countries
hoping to fi nalize an agreement in the
Council.
Rapid agreement was not possible,
essentially because Switzerland did not
offer to implement measures that were
considered as “equivalent” to those con-
tained in the EU agreement. Switzerland
instead proposed to levy a withholding
tax, called an “EU retention tax,” and
to exchange tax information on request
in the case of “fraud or similar misbehav-
ior.” This created an important stumbling
block for several Member States, as the
Swiss penal code is more restrictive in
what it considers fraud. Finally, following
further negotiation, the Council reached
a new political agreement on the tax
package on January 22, 2003 (Council
of the European Union, 2003). Although
the Council offi cially maintains an ulti-
mate objective of requiring exchange of
information, it allows Austria, Belgium,
and Luxembourg to levy a withhold-
NATIONAL TAX JOURNAL
766
ing tax18 until the Council unanimously
agrees that third countries also exchange
information as defi ned in the 2002 OECD
agreement.19 It actually reverts to the
“coexistence principle” for an open-
ended transitional period, allowing the
three mentioned Member States to retain
a withholding tax system as long as (1)
Monaco, San Marino, Andorra, Lichten-
stein and Switzerland do not exchange
information upon request as required in
the OECD Model Agreement on Exchange
of Information on Tax Matters, and (2)
there is confi rmation that the U.S. is com-
mitted to exchange of information upon
request as defined in the 2002 OECD
Model Agreement with all EU Member
States in relation to interest payments.
The Directive went into effect on July 1,
2005.
After three years of implementa-
tion, the European Commission in 2008
reviewed the operation of the Directive
on Savings and found several important
potential loopholes, such as the use of
legal persons to circumvent the Directive,
the use of tax-exempt structures such as
trusts to channel interest payments, and
the development of innovative fi nancial
products that have the characteristics
of interest-bearing products but are not
offi cially covered by the Directive. The
existence of these loopholes could explain
why many studies have so far failed to
detect an effect of the introduction of the
Directive on fi nancial markets (Hemmel-
garn and Nicodeme, 2009; Klautke and
Weichenrieder, 2008).
The European Union has also made
progress on the removal of harmful
tax regimes. In March, 1998, a working
group composed of Member States and
chaired by UK Paymaster Primarolo was
established to identify and examine tax
measures in the Member States that might
reflect harmful tax competition. This
group published a report in which 280
tax measures were declared as potentially
harmful, with 66 identifi ed as most harm-
ful (according to the criteria described
above). The resulting “code of conduct” in
the fi eld of business taxation adopted the
principles of “standstill” (i.e., refraining
from introducing new harmful measures)
and of “rollback” (i.e., removing exist-
ing harmful measures). In addition, the
offending measures had to be dismantled
by January 1, 2003, although their benefi ts
could remain until the end of 2005.20 The
code of conduct was a non-binding peer
review exercise and the report was not
unanimously adopted, as some countries
expressed reservations regarding specifi c
elements. However, peer pressure was
sufficient that all regimes have either
been dismantled or are currently being
removed.21
In April 2009, the European Commis-
sion issued an important communication
on good governance in tax matters, which
defi nes the EU approach for the imple-
mentation of the G-20 decisions (Com-
18 Austria, Belgium and Luxembourg are allowed to levy a withholding tax with a rate of 15 percent for the fi rst
three years, 20 percent for the following three years, and 35 percent thereafter, with 75 percent of revenues
collected redistributed to the country of the recipient of the interest payment.
19 Importantly, while third countries would need to comply with the 2002 OECD agreement that foresees exchange
of information on request, Member States need to automatically exchange information with each other under
the EU Savings Tax Directive (except for those applying the withholding tax). EU tax authorities therefore
exchange information on amounts of interest paid to non-resident EU individuals.
20 The code of conduct included the provision that, on a case by case basis, certain measures may be extended
beyond December 31, 2005. This provision applies to fi ve regimes for which the deadline was set to end of
2010 or 2011.
21 Some of the measures covered by the code of conduct could fall within the scope of the provisions on State
aid contained in the EU Treaty, so that the European Commission could therefore take action to force Member
States to remove them.
Forum on International Tax Avoidance and Evasion
767
mission of the European Communities,
2009). The communication recommends
the rapid adoption of two pieces of legisla-
tion. First, the European Commission sup-
ports the adoption of amendments to the
1977 Mutual Assistance Directive. These
amendments, in addition to improving
the tools of cooperation (e.g., requiring
common administrative forms), would
introduce a most favored nation clause
whereby Member States would need to
provide other Member States with at least
the same level of cooperation that they
provide to any third country. It would
also prohibit Member States from invok-
ing domestic bank secrecy laws to refuse
to exchange information. The European
Commission hopes that this proposal will
be adopted before the end of 2009. Second,
the communication calls for amendments
to the Savings Directive to make fraud
more diffi cult.
IV. CONCLUDING REMARKS
A remarkable lesson from the recent
developments at the OECD and Euro-
pean Union is that obstacles that were
considered insurmountable for many
years can quickly vanish when there is
political will. Sustained pressure from the
G-20 countries has the potential to end tax
havens. However, the dramatic changes
experienced over the last two years owe a
lot to the conjunction of various favorable
elements: increased scrutiny of tax eva-
sion problems following cases of fraud,
the belief that all potential sources of tax
revenue should be used in the current
economic crisis, and increased emphasis
on dealing with tax evasion problems
in many administrations. However, it is
important to note that the sustainability
of current efforts against harmful tax prac-
tices still depend on future circumstances.
Some key elements also remain uncer-
tain. First, commitments to accept the
OECD standards of exchange of informa-
tion still need to be put into practice by
many jurisdictions. The progress indicator
used by the OECD (i.e., the signing of at
least 12 TIEAs that meet the OECD stan-
dards) is arbitrary and may not be viewed
by all as suffi cient to add a country to the
white list of jurisdictions having imple-
mented the standards. In this respect, the
follow-up peer review exercise under-
taken by the Global Forum will be crucial
in delivering real progress. Second, real
progress has been made as these standards
imply that a state cannot refuse a request
for information solely because it has no
domestic tax interest in the information
or solely because the information is held
by a bank or other fi nancial institution.
Nevertheless, requests for exchange of
information as foreseen by the OECD
standards are at present rare and irregular
events (Ligthart and Voget, 2009), most
notably because they require suspicion of
fraud.
For the European Union, the ultimate
goal of automatic exchange of information
in the context of the Savings Directive is
nearly attained as the transition regime is
close to an end with the adoption of the
OECD standards on information exchange
by Andorra, San Marino, Monaco, Lich-
tenstein, and Switzerland. Belgium has
already announced that it will adopt
the information exchange rules in 2010
and the Isle of Man will do so in 2011.22
22 Dependent territories are bound by the Savings Directive and, although they can benefi t from the transition
regime, they will have to switch to information exchange as soon as the transition regime ends. The British
Virgin Islands, Guernsey, the Isle of Man, Jersey, the Netherlands Antilles, and the Turks and Caicos Islands
apply a withholding tax. Anguilla, Aruba, the Cayman Islands and Montserrat provide automatic exchange of
information. In turn, EU Member States have to provide information or levy a withholding tax on the interest
income from savings of residents from these dependent territories in the Member States, except for Anguilla,
Cayman Islands and the Turks and Caicos Islands which do not tax residents’ savings income.
NATIONAL TAX JOURNAL
768
Interestingly, this shows the important
linkages between the EU project and
the OECD work to curb harmful tax
competition. Pressure from the Global
Forum on Transparency and Exchange
of Information may convince countries
to adopt the international standards
for information exchange and therefore
fulfi ll the conditions required to end the
transition period under the EU Savings
Directive.
Recent progress toward accepting
international standards on information
exchange has been impressive and might
curb the activities of tax havens. It does
not necessarily follow that tax evasion
will disappear, because implementing
the standards is a necessary but not suf-
ficient condition as these standards at
the present time only contain provisions
on information exchange. However, the
current developments mark an unprec-
edented and crucial step in the effort to
fi ght harmful tax practices.
ACKNOWLEDGMENTS
I thank Jean-Pierre De Laet, John Dia-
mond, Philip Kermode, Germano Mirabile
and George Zodrow for valuable com-
ments. All errors and omissions are mine.
The views expressed in this article are
those of the author and do not necessarily
refl ect the offi cial position of the European
Commission.
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