March 1999
Tax authorities are having a hard time collecting from hedge funds and other global players, and national policy-making and social benefits are paying the price, according to a report presented in February to the UN Commission for Social Development. The exponential growth of offshore hedge funds is one of a number of international phenomena analyzed for their effect on narrowing tax bases in a paper prepared in an individual capacity by Vito Tanzi, director of fiscal affairs for the International Monetary Fund.
"'Rocket scientists' have been developing progressively harder-to-understand market and investment strategies, and the lack of clear national identity for the money invested or even for the institutions that make the investment" makes it very difficult to tax the earnings, the report says. "This is especially the case when these institutions operate, as they often do, from offshore and from tax havens." The report cites an estimate that offshore deposit holdings now total 7-8 trillion dollars--close to the total gross domestic product of the United States.
The paper on "International Dimensions of Taxation Policy" identifies a number of developments, in addition to the emergence of offshore funds, that are "lowering the politically or technically sustainable tax burden" and cutting into the ability of many countries to pursue national policy goals or to maintain social benefits without widening their fiscal deficits:
Multinational corporations are shifting the reporting of profits from components operating under national jurisdictions where taxes are high to countries with low rates.
Many more people are travelling or working abroad, where it is harder to tax activities than if they took place domestically. Especially tough for existing tax regimes to handle are cross-border credit card purchases over the Internet.
To compete internationally for investments and for shoppers, countries are bringing down their marginal tax rates.
"We see a growing gap between the tax systems that were largely created at a time when national economies were closed, capital did not move, and individuals did not travel much, and the systems that would fare well in the current environment", the report concludes.
A number of possible approaches to the problem are considered, including exchange of information among tax authorities; international codes of taxation conduct; and a "formula allocation", which would tax multinational components based on their proportional share of company assets. Uniform tax rates among nations are not politically feasible, the author notes, but even an internationally accepted definition of taxable income would ease international tax competition.
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