Is There A Place For Small Developing States In The Global Services Economy?

Small developing states such as Barbados have every reason to be concerned about the initiatives being undertaken by The Organisation For Economic Cooperation And Development (OECD) in pursuit of recommendations contained in its report entitled "Harmful Tax Competition - An Emerging Global Issue". While one is tempted to discourse on the deficiencies of the report, one also recognises that the OECD has itself identified the defects of the report without going on further to acknowledge that these deficiencies undermine the value of the report. In fact it is rather surprising that based on this less than creditable report, the OECD is prepared to continue, through what seems be international duress to undermine the viability of small developing states.

Members of the international business community will recall that the Ministers of OECD member states in May 1996 called upon the OECD to "develop measures to counter the distorting effects of harmful tax competition on investment and financing decisions and the consequences for national tax bases, and report back in 1998". The report emerging from this study focuses on geographically mobile activities, such as financial and other service activities. The report identifies what it refers to as harmful tax practices and goes on to make 19 recommendations to counteract these practices. The report was approved on April 9, 1998 in OECD Council. Luxembourg and Switzerland abstained on the approval of the report and the adoption of the recommendations. The report has been endorsed by the G7 countries.

Many commentators have wondered at the particular focus of the OECD on services and not on other sectors of the world economy. Within this context, one should note that it has been acknowledged that trade in services is growing rapidly and that it is likely to continue to grow at an even faster pace in the future. A 1991 report to the United States of America congress estimated that such trade already accounted for 25% of all world trade (see endnote 1). It has also been recognised that this sector is poised to be one of the most competitive in the world economy. It is expected to create significant opportunities for employment and revenue generation within both developed and developing economies. Also with advances in information technology it is recognised that small developing countries like Barbados have the best opportunity to advance provided that they adopt the appropriate strategies. The growth in services and the mandate of the OECD to prevent the transfer of service trade from developed countries to developing countries does not seem to be a chance occurrence.

This particular initiative by the OECD cannot be viewed in isolation as there are grave implications for how principles regarding international tax are developed as well as broader implications for international economic relations. One of the acknowledged principles of international taxation is that the exercise or non-exercise of jurisdiction over tax matters is the sovereign right of each individual state. Further it is accepted that the resolution of issues which arise from conflicts over the jurisdiction to tax is best achieved through agreement, whether bi-lateral or multi-lateral. Furthermore the facility by which the world might seek to in some way censor individual countries should be through truly international organisations and not through the initiatives of a small group of nations. The OECD process sets a bad precedent for resolution of matters concerning the exercise of tax jurisdiction and indeed other disagreements arising from the sovereign actions of states. The OECD is an interest group and has acknowledged its inability to develop disciplines suitable to all countries, especially developing countries.

As early as 1965 the OECD acknowledged that its Model Tax Convention on Income and Capital might not have been appropriate for developing countries. The OECD at that time acknowledged that income flows are largely from developing countries to developed countries and with a residence based treaty the country of source would be required to give up tax revenue. If the term had been current then the model might even have been considered harmful to developing countries. Arguably utilising the OECD model results in the erosion of the tax bases of developing countries. The OECD at that time acknowledged that the principles on which the OECD Model were based were more suited to developed countries. While countries choose to use the OECD Model, the OECD in this initiative seems intent on determining the fiscal policy of select countries.

Barbados is a developing country and certainly is not of the view that its incentives regime is harmful neither in fact nor in theory. Barbados' economic and fiscal policy has developed with the knowledge and support of OECD countries. Evidence of the attitude of developed countries toward developing countries like Barbados is reflected in the United Nations Manual for the Negotiation of Bi-lateral Tax Treaties Between Developed and Developing Countries. One should note that this manual and the accompanying United Nations Model Convention arose out of the OECD’s acknowledgement that its model was inappropriate for developing countries. The manual, in examining the ability of developing countries to attract investment, expressed the view that foreign investment properly integrated into the political, economic and social priorities of developing countries, could make a positive contribution to their social development.

That United Nations publication acknowledged that many developing countries alleviate the effective tax burden on investors by unilaterally offering major tax incentives which might include income tax exemptions or a low tax rate on all or certain corporate profits, extra deductions for business expenses aimed at securing export sales, reduction of withholding taxes on dividends and interest, reduction of individual taxes for expatriate personnel. At that time also, some developed countries were providing unilateral tax relief to investors in developing countries. The thesis of this exposition in the United Nations manual was that for developing countries to utilise such tax incentives was not enough and that they should go on to negotiate tax treaties in support of their incentive programmes.

Therefore, Barbados and other developing countries were encouraged by their partners in the developed world to attract foreign investment through the use of incentives and tax treaties. However, in that climate the economic development of non-industrialised countries was considered a worthwhile endeavour. The Ad Hoc group of experts who developed the United Nations model tax convention included representatives from OECD member states. The experts acting in their personal capacities came from France, Germany, Japan, the Netherlands, Norway, Switzerland, the United Kingdom, Ireland and the United States of America. It seems that the international economic climate has suddenly changed and that tax incentives that were not considered harmful previously are now being regarded as such, and at a time when the support mechanisms for developing countries are being removed.

Small developing countries like Barbados, have in the past received higher developmental assistance than larger states and their exports benefitted from preferential access to markets. Barbados has now been graduated out of World Bank funded programmes. With the decline in aid flows developing countries must rely more than ever on foreign investment. Many developing countries became members of the World Trade Organisation with the understanding that the peculiarities of small developing countries would be taken into consideration. The WTO has embarked on a programme of progressive liberalisation based on the premise that all countries can be successful in areas in which they have a comparative advantage. Specific disciplines in the area of services, have been developed through the General Agreement of Trade in Services (GATS).

One of the mandates within the GATS is to promote the economic growth of all trading partners and the further development of developing countries. The GATS also has as a general principle, the securing of an overall balance of rights and obligations, while giving due respect to national policy objectives. More specifically, the participation of developing countries in trade in services is encouraged. Further if we look to the body of the agreement Article XV deals with a commitment for working out a time table on subsidies. According to the agreement in the further negotiations on subsidies the members of the WTO have agreed that:

Such negotiations shall recognise the role of subsidies in relation to the development programmes of developing countries and take into account the needs of Members, particularly developing country members for flexibility in this area.

OECD countries, one of the most influential groups in the WTO have agreed to a particular approach with respect to subsidies while at the same time it seeks to undermine that process in its own forum. It should be noted however that the OECD had managed to negotiate a general exception with respect to this process under the GATS.

As acknowledged in the United Nations manual referred to earlier, there is a range of fiscal incentives offered by countries. Barbados has always applied fiscal incentives to certain economic activity in support of its economic policy, including tax holidays and low tax rates. These apply to services and non-services activity including agriculture, tourism and manufacturing. The principal economic objectives of Barbados’ fiscal policy are to generate employment, to encourage exports by both foreign and domestic investors and to earn foreign exchange.

In conducting a preliminary review of the tax practices of selected OECD countries, it is clear that in some OECD countries fiscal incentives are also used to create employment and to encourage exports. Reference is not being made here specifically to Ireland, Luxembourg, Switzerland or the Netherlands. Their use of incentives is well known. Incentives exist in the United States, France, Italy and the United Kingdom. In many instances they are most prevalent in under-developed regions, regions that in some instances are more developed than the country of Barbados. Incentives found in OECD states range from tax holidays and tax credits to soft loans and cash grants. It is difficult to see how cash grants, free accommodation and soft loans, are any less harmful than foregoing tax.

One is forced to wonder in observing this most curious exercise whether the attack on incentives is not merely political power disguised as economic principle. It is not in the interest of any state to support the approach of the OECD in this particular matter. Historically, the exercise of dominance by one country over another or one group of countries over another has always lead to disastrous consequences. Unfortunately being in a dominant position often causes amnesia amongst states. So that while in the WTO forum, we acknowledge the participation of developing countries in the creation of disciplines in services, in another forum these disciplines are being undermined by the very countries that agreed to them. All of this arouses some concern.

Indeed the sustainable economic development of small states has been the subject of study. A draft report prepared by the Commonwealth Secretariat-World Bank Joint Task Force on Small States in looking at the future of small developing states concluded:

The picture is not entirely bleak. In the past 20 years falling communications and transportation costs have created new opportunities for small states to greatly expand their tourism and service industries. In the medium-term, the potential income from these activities will likely be much higher than the losses these states face as a result of changes in the global trade regime.

The expectation that services could be the solution for small states stands in direct opposition to this OECD initiative.

ENDNOTE

  1. note that these estimates often rely on questionable data because of the difficulty in assessing the volume of trade in services.

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