Empirical studies: Tax havens, institutional change, and income

To all appearances, stopping such a process will have a great effect on economic growth. In the last decade, it has become clear that institutional quality may be the most important driving force of economic prosperity and growth. Acemoglu, Johnson and Robinson (2001) is the best-known study of the effect of institutions on domestic income. They estimate that if a country whose institutional quality at the outset lies on the 25^th percentile could improve its institutional quality to place it on the 75^th

percentile, domestic income would increase 7-fold. Few factors have as strong an

188

effect on growth as improved institutions. Precisely for this reason, the damaging effects of tax havens are so disastrous for developing countries – tax havens

contribute not only to conserving poor institutions – but also to making them worse.

If tax havens not only affect institutional quality, but also have an effect on the choices political agents make between conflict and democracy, the growth effects become still more dramatic. Nothing is as damaging for development and growth as war.

4. Conclusion

The negative effects of tax havens are greater for developing countries than for other countries. There are many reasons for this. Reduced government income will have a greater social cost for developing countries than for industrialised countries. In addition, other mechanisms make themselves felt in countries with weak institutions and political systems. In such countries, “income opportunities” represented by tax havens for the private sector in reality contribute to the reduction of private income.

Tax havens are central to the explanation of the paradox of plenty – and give

resources that normally contribute to economic growth and development the opposite effect. The damage is particularly great in countries with weak public institutions, in countries with presidential rule, and in countries with unstable democracies. At the same time, institutions cannot be regarded as natural givens. Tax havens give the agents in the economy incentives to change institutions – but for the worse rather than for the better. Political agents are given incentives to weaken public institutions, to establish a type of presidential rule where much power is concentrated in the

president’s hands, and to undermine democracy. For developing countries, the growth effects of putting a stop to the use of tax havens are great.

189 Appendix: Data used in the analyses

COUNTRY IQ SXP GROWTH GDP65 OPEN INV SNR AFR PRES PARL ZAMBIA 0.414 0.5431 -1.88 7.66 0.00 15.98 0.38 1 0 0 GUYANA 0.284 0.5072 -1.47 8.06 0.12 20.23 0.19 0 1 0 MALAYSIA 0.690 0.3681 4.49 8.10 1.00 26.16 0.09 0 0 1 GAMBIA 0.563 0.3612 0.35 7.17 0.19 6.05 0.00 1 1 0 GABON 0.538 0.3263 1.73 8.35 0.00 28.18 0.55 1 0 0 IVORY COAST 0.670 0.2932 -0.56 7.89 0.00 10.06 0.02 1 0 0 UGANDA 0.297 0.2655 -0.41 7.10 0.12 2.52 0.01 1 0 0 VENEZUELA 0.556 0.2370 -0.84 9.60 0.08 22.16 0.35 0 1 0 HONDURAS 0.339 0.2320 0.84 7.71 0.00 13.40 0.02 0 1 0 GHANA 0.370 0.2109 0.07 7.45 0.23 5.05 0.12 1 0 0 MALAWI 0.447 0.2073 0.92 6.68 0.00 11.29 0.00 1 0 0 NICARAGUA 0.300 0.1939 -2.24 8.45 0.00 12.19 0.01 0 1 0 COSTA RICA 0.547 0.1935 1.41 8.52 0.15 17.26 0.00 0 1 0 ALGERIA 0.436 0.1924 2.28 8.05 0.00 27.14 0.22 1 0 0 TOGO 0.435 0.1907 1.07 6.82 0.00 18.35 0.21 1 0 0 BOLIVIA 0.227 0.1845 0.85 7.82 0.77 15.34 0.17 0 1 0 CAMEROON 0.566 0.1815 2.40 7.10 0.00 10.59 0.00 1 0 0 KENYA 0.556 0.1808 1.61 7.14 0.12 14.52 0.00 1 0 0 NEW ZEALAND 0.965 0.1775 0.97 9.63 0.19 23.79 0.01 0 0 1 SOUTH AFRICA 0.692 0.1720 0.85 8.48 0.00 18.53 0.19 1 0 0 TANZANIA 0.464 0.1716 1.93 6.58 0.00 11.60 0.06 1 0 0 ZIMBABWE 0.444 0.1661 0.86 7.58 0.00 14.87 0.05 1 0 0 EL SALVADOR 0.258 0.1567 0.19 8.15 0.04 8.19 0.00 0 1 0 IRELAND 0.832 0.1543 3.37 8.84 0.96 25.94 0.01 0 0 1 PERU 0.323 0.1528 -0.56 8.48 0.12 17.49 0.07 0 1 0 NETHERLANDS 0.981 0.1513 2.27 9.38 1.00 23.32 0.01 0 0 1 CHILE 0.633 0.1488 1.13 8.69 0.58 18.18 0.10 0 0 0

190

COUNTRY IQ SXP GROWTH GDP65 OPEN INV SNR AFR PRES PARL SRI LANKA 0.433 0.1480 2.30 7.67 0.23 10.93 0.00 0 0 1 ZAIRE 0.298 0.1473 -1.15 6.93 0.00 5.20 0.32 1 0 0 NIGERIA 0.308 0.1382 1.89 7.09 0.00 15.06 0.13 1 1 0 JAMAICA 0.470 0.1368 0.78 8.32 0.38 18.85 0.11 0 0 1 SENEGAL 0.475 0.1352 -0.01 7.69 0.00 5.11 0.06 0 0 1 DOMINICAN REP. 0.452 0.1346 2.12 7.85 0.00 17.75 0.01 0 1 0 PHILIPPINES 0.297 0.1260 1.39 7.78 0.12 16.50 0.03 0 1 0 MADAGASCAR 0.467 0.1187 -1.99 7.63 0.00 1.39 0.00 1 0 0 GUATEMALA 0.284 0.1140 0.71 8.16 0.12 9.19 0.00 0 1 0 INDONESIA 0.367 0.1124 4.74 6.99 0.81 21.57 0.12 0 0 0 MOROCCO 0.430 0.1100 2.22 7.80 0.23 11.22 0.10 1 1 0 BELGIUM 0.971 0.1077 2.70 9.27 1.00 22.26 0.01 0 0 1 ECUADOR 0.542 0.1056 2.21 8.05 0.69 22.91 0.00 0 1 0 NORWAY 0.960 0.1032 3.05 9.30 1.00 32.50 0.01 0 0 1 TUNISIA 0.459 0.1030 3.44 7.81 0.08 14.54 0.14 1 0 0 AUSTRALIA 0.943 0.0998 1.97 9.57 1.00 27.44 0.07 0 0 1 DENMARK 0.968 0.0986 2.01 9.47 1.00 24.42 0.00 0 0 1 PARAGUAY 0.440 0.0971 2.06 7.88 0.08 15.53 0.00 0 0 0 CANADA 0.967 0.0959 2.74 9.60 1.00 24.26 0.06 0 0 1 COLOMBIA 0.530 0.0942 2.39 8.19 0.19 15.66 0.04 0 1 0 URUGUAY 0.512 0.0910 0.88 8.67 0.04 14.34 0.00 0 1 0 SIERRA LEONE 0.542 0.0906 -0.83 7.60 0.00 1.37 0.51 1 0 0 JORDAN 0.408 0.0898 2.43 8.04 1.00 16.80 0.01 0 0 0 SOMALIA 0.373 0.0884 -0.98 7.51 0.00 9.85 0.00 1 0 0 THAILAND 0.626 0.0856 4.59 7.71 1.00 17.56 0.01 0 0 1 MALI 0.300 0.0838 0.82 6.71 0.12 5.89 0.00 1 0 0 TRINIDAD&TOBAGO 0.609 0.0831 0.76 9.39 0.00 13.10 0.21 0 0 1 SYRIA 0.308 0.0808 2.65 8.37 0.04 15.31 0.05 1 0 0

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COUNTRY IQ SXP GROWTH GDP65 OPEN INV SNR AFR PRES PARL HAITI 0.258 0.0774 -0.25 7.40 0.00 6.64 0.03 0 0 0 CONGO 0.369 0.0763 2.85 7.60 0.00 9.24 0.08 1 0 0 EGYPT 0.435 0.0732 2.51 7.58 0.00 5.13 0.05 1 0 1 FINLAND 0.968 0.0702 3.08 9.21 1.00 33.81 0.01 0 0 1 BRAZIL 0.636 0.0549 3.10 8.16 0.00 19.72 0.02 0 1 0 ARGENTINA 0.428 0.0526 -0.25 8.97 0.00 16.87 0.02 0 1 0 SWEDEN 0.965 0.0504 1.80 9.56 1.00 22.38 0.01 0 0 1 BOTSWANA 0.700 0.0503 5.71 7.10 0.42 24.61 0.05 1 0 1 PORTUGAL 0.774 0.0478 4.54 8.25 1.00 22.99 0.00 0 0 1 NIGER 0.583 0.0464 -0.69 7.12 0.00 9.37 0.01 1 0 0 BURKINA FASO 0.475 0.0435 1.26 6.52 0.00 9.49 0.00 1 0 0 GREECE 0.550 0.0409 3.17 8.45 1.00 24.57 0.01 0 0 1 ISRAEL 0.609 0.0399 2.81 8.95 0.23 24.50 0.03 0 0 1 AUSTRIA 0.945 0.0389 2.91 9.18 1.00 25.89 0.01 0 0 1 TURKEY 0.526 0.0380 2.92 8.12 0.08 22.52 0.02 0 0 1 FRANCE 0.926 0.0300 2.58 9.37 1.00 26.72 0.01 0 0 1 SPAIN 0.764 0.0299 2.95 8.87 1.00 25.05 0.01 0 0 1 PAKISTAN 0.411 0.0294 1.76 7.49 0.00 9.57 0.01 0 1 0 HONG KONG 0.802 0.0277 5.78 8.73 1.00 20.79 0.00 0 0 0 U.K. 0.934 0.0263 2.18 9.38 1.00 18.12 0.02 0 0 1 SINGAPORE 0.856 0.0262 7.39 8.15 1.00 36.01 0.00 0 0 1 SWITZERLAND 0.998 0.0247 1.57 9.74 1.00 28.88 0.00 0 1 0 MEXICO 0.541 0.0241 2.22 8.82 0.19 17.09 0.02 0 1 0 KOREA. REP. 0.636 0.0224 7.41 7.58 0.88 26.97 0.02 0 1 0 TAIWAN 0.824 0.0223 6.35 8.05 1.00 24.44 0.01 0 0 0 GERMANY. WEST 0.959 0.0218 2.37 9.41 1.00 25.71 0.02 0 0 1 ITALY 0.820 0.0208 3.15 9.07 1.00 25.90 0.00 0 0 1 CHINA 0.569 0.0195 3.35 6.94 0.00 20.48 0.04 0 0 0

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COUNTRY IQ SXP GROWTH GDP65 OPEN INV SNR AFR PRES PARL INDIA 0.576 0.0165 2.03 7.21 0.00 14.19 0.03 0 0 1 U.S.A. 0.980 0.0126 1.76 9.87 1.00 22.83 0.03 0 1 0 BANGLADESH 0.274 0.0098 0.76 7.68 0.00 3.13 0.00 0 0 1 JAPAN 0.937 0.0064 4.66 8.79 1.00 34.36 0.00 0 0 1

Explanation of variables:

IQ – Institutional Quality. This is an index based on data from Political Risk Services.

The index consists of an unweighted average of five part-indices: (i) the degree to which the population of a country accept its law-enforcement institutions, (ii)

bureaucratic quality, (iii) corruption in government, (iv) risk of expropriation and (v) probability that government will honour contractual obligations. The index goes from zero to one, with zero as den worst institutional quality and one as the best.

SXP – Resource wealth: Primary exports as share of domestic income in 1970.

GROWTH: A country’s average annual growth rate in GDP per capita in the period 1965 – 1990.

GDP65 – Initial level of income: Logarithm of GDP per capita in 1965.

OPEN – Openness for trade: An index that measures the proportion of years in the period when a country is characterised by openness for international trade.

INV – Investments: Average percentage share of real investments of GDP.

AFR – Africa: Coded as 1 if a country lies in Africa and zero otherwise.

PRES – Democratic countries with presidential rule: Coded as 1 if the country is classified as et democracy in the period and if its political system is presidential, 0 otherwise.

PARL – Democratic countries with parliamentary regime: Coded as 1 if the country is classified as a democracy in the period and if it has a parliamentary political system, 0 otherwise.

Sources for data: Sachs and Warner (1995, 1997), Mehlum, Moene and Torvik (2006a), Andersen and Aslaksen (2008). For some of the countries, these works do not include data for all the countries. In such cases, the data sources referred to in these works are used to complete the data sets. For Hong Kong, there are no data for the political variable. Hong Kong is therefore classified neither as a democratic presidential regime nor as a democratic parliamentary regime.

193 References

Acemoglu, D., Johnson, S. and Robinson, J.A. (2001) “The colonial origins of comparative development: An empirical investigation”, American Economic Review 91, 1369-1401.

Acemoglu, D., Robinson, J.A. and Verdier, T. (2004) “Kleptocracy and divide-and-rule: a theory of personal rule”, Journal of the European Economic Association 2, 162-192.

Aslaksen, S. and Torvik, R. (2006) “A theory of conflict and democracy in rentier states”, Scandinavian Journal of Economics, 571-585.

Andersen, J.J. and Aslaksen, S. (2008) “Constitutions and the resource curse”, Journal of Development Economics 87, 227-246.

Besley, T. and Persson, T. (2009) “The incidence of civil war: Theory and evidence”, note, London School of Economics.

Boschini, A.D., Pettersson, J. and Roine, J. (2007) “Resource curse or not: A question of appropriability”, Scandinavian Journal of Economics 109, 593-617.

Collier, P. and Hoeffler, A. (2004) “Greed and grievance in civil wars”, Oxford Economic Papers 56, 663-695.

Collier, P. and Hoeffler, A. (2009) “Testing the neocon agenda: Democracy in resource-rich societies”, forthcoming in European Economic Review.

Miguel. E., S. Satyanath, S. and Sergenti, E. (2004) “Economic shocks and civil conflict: An instrumental variables approach”, Journal of Political Economy 725-753.

Mehlum, H., Moene, K. and Torvik, R. (2006a) “Institutions and the resource curse”, Economic Journal 116, 1-20.

Mehlum, H., Moene, K. and Torvik, R. (2006b) “Cursed by resources or institutions?”, World Economy, 1117-1131.

Robinson J.A and Torvik, R. (2009) “Endogenous presidentialism”, note, Harvard University.

Ross, M.L. (2001a) “Timber booms and institutional breakdown in Southeast Asia”, Cambridge University Press, New York.

Ross, M.L. (2001b) “Does oil hinder democracy?”, World Politics 53, 325-361.

194

Sachs, J.D., Warner, A.M. (1995) “Natural resource abundance and economic growth”, NBER Working Paper No. 5398.

Sachs, J.D., Warner, A.M. (1995) “Natural resource abundance and economic growth”, NBER Working Paper No. 5398.

Sachs, J.D., Warner, A.M. (1997) “Sources of slow growth in African economies”, Journal of African Economies 6, 335-376.

Torvik, R. (2002) “Natural resources, rent seeking and welfare”, Journal of Development Economics 67, 455-470.

Torvik, R. (2007) “The paradox of plenty – relevant for Norway?”, notat, Institutt for samfunnsøkonomi, NTNU.

Torvik, R. (2009) “Why do some resource abundant countries succeed while others do not?”, forthcoming in Oxford Review of Economic Policy.

195 Appendix 2

The importance of taxes for development by Odd-Helge Fjeldstad

June 2009

Summary: Improving the tax system is one of the main challenges in many

developing countries. This appendix focuses on three interconnected topics: (1) weak state finances and low tax revenue; (2) characteristics of the tax base in poor

countries; and (3) the connection between taxation and good governance. A series of factors contribute to explaining the low tax base in poor countries, among them a large informal sector, widespread corruption, and tax evasion. Capital flight also undermines the tax base, and thus the domestic resources available for financing the development of public institutions, social services, and investment in infrastructure.

This appendix demonstrates that the political impact of taxation goes far beyond obtaining funds for financing the public sector, investment, and the basic needs of the population. Bad governance is often correlated with the state not depending on revenue from taxation of its citizens and businesses. Experience shows that taxation has contributed to more representative and accountable government by stimulating dialog between state and civil society about taxation. Developing an effective tax administration has stimulated the development of institutions also in other parts of the public sector. Systems for recruitment, competence building, and management in the tax administration have been models for developing other parts of the public

administration. In this perspective, the challenge for poor countries is not necessarily to tax more, but to tax a greater part of their population and businesses. Income from aid and natural resources may substitute non-existent tax revenue, and ensure that important development goals are reached. Financing state expenditure through these sources, however, contributes little to developing the institutional capacity of the state.