Part 1 - AL-Tax

Chapter 10AbstractThe deepening globalization and increased capital mobility, facilitated by advancements intechnology and the elimination of exchange controls, have affected countries’ ability to effectivelytax cross-border savings deposits and more generally portfolio investments. Due tothe ready access to foreign financial markets – often located in offshore financial centerslevying no or low tax rates – investors can more easily than before conceal capital incomefrom their domestic tax authorities. While the literature has paid much attention to the institutionalarrangements and practicalities of tax information sharing, the economics of theissue has hardly been analyzed. Many questions arise. Why would source countries (thatis, those in which the savings income arises) voluntarily choose to provide information toresidence countries and thereby make themselves less attractive places to foreign investors?Does self-interest induce countries to provide an appropriate amount of information? Whyis it – as the experience in the European Union has been – that small countries prefer tolevy withholding taxes, whereas (relatively) large countries favor information sharing?This overview article presents what is known about these questions with a view to provideinsights into the economics of tax information exchange.10.1 IntroductionThe increased mobility of capital flows, facilitated by advancements in technologyand the elimination of foreign exchange controls, has negatively affected countries’ability to tax income from cross-border savings. 1 Due to the ready access toforeign financial markets – often located in tax havens, levying little or no tax 2 –private investors can easily conceal capital income from their domestic taxauthorities. As a result, tax authorities of the investor’s country of residence arefaced with an increasing number of ‘disappearing’ taxpayers. No reliable estimatesexist of the scope of international tax evasion. Evidently, if we could measure it, wecould tax it too! Nevertheless, most experts agree that the tax evasion problem issubstantial and growing rapidly. Indeed, external bank deposits of nonbankinvestors for a group of 24 countries 3 have grown on average by 123% during1995–2004. It is likely that part of this sizeable growth is attributable to increasednoncompliance with national tax laws. Consequently, national governments arelosing public revenue at a time when their public finances are already overstretched4 and their banking sectors are suffering from (unfair) foreign competition.One way of helping tax authorities to combat international tax evasion is toimprove the cross-border exchange of taxpayer-specific information, which hasemerged in recent years as one of the key issues in international tax policy discussions(applying a withholding tax is another instrument – see below for a241