Taxation and Economic Growth: Introductory Remarks* By Vito Tanzi ** * Session on Taxation and Growth. International Conference, Confederation of Swedish Enterprises, Stockholm, June 15 ** Former Director, Fiscal Affairs Department, International Monetary Fund

Tax policy can affect economic growth in various ways. The most important are likely to be the following: i.Reductions in investment caused by high tax rates on individual and personal income ii.Reduction in labor supply due to high taxes on labor.The reduction can be in participation rates, in hours of work, and in incentives to work hard or to acquire human capital iii.Reduction in R&D and in the availability of venture capital iv.Distortions in investment decisions from highly taxed sectors (or countries) towards low taxed sectors, such as housing,in the same or in other countries v.Individuals’ preferences for sectors with lower productivity and lower taxes

Globalization has increased the possibility of cross countries’ investments promoted by different tax treatment.It has also increased the impact of taxes on the international allocation of capital.

Tax policy affects also the way enterprises finance their investment. They may prefer debt over equity financing. Increasingly debt financing comes from foreign sources, including those located in offshore centers or in tax havens. This has opened tax avoidance possibilities.Tax evasion connected with globalization is an increasingly serious problem.

In today’s globalized financial market, the debt used to finance investments (by both enterprises and individuals) can more easily be provided by foreign sources. It can be channeled through off-shores and tax-haven centers. It may take the form of various financial instruments. It may end up in activities not known to the lenders, such as housing.

Because of the very low (or at times negative) saving rates that prevailed in the United States in recent years, the housing boom, at the origin of the sub-prime crisis, was largely financed by the savings of foreign countries. Tax policy played an important role. Housing is hardly a growth promoting activity.

The crisis was fed by: i.A great financial deepening. The relationship between total debt and gross domestic product increased sharply; ii.Leverage reached dangerous limits; iii.The financial sector saw its share of total profits increase sharply; iv.When the loans came from tax havens or from off-shore centers, the possibility of tax evasion increased creating difficulties for some countries, or the need to increase tax rates; v.Both the financial system and the tax systems became very complex increasing the chance of systemic failure.

Tax complexity has become a major factor in many countries.In some cases it may have become more important than tax rates especially for smaller enterprises. Globalization has increased both the complexity of tax systems and its cost for enterprises that need to operate internationally.

The role that offshore centers and tax havens have played in the current crisis have received less attention than it merits. The Tax Justice Network has paid some attention to it. The combination of complex tax and financial systems, operating globally and in a world with many off-shore centers and tax havens, have created many situations in which capital could be invested in activities which contributed little to real, as distinguished from virtual, economic growth.

Economic growth may be affected as much by complexity as by higher rates.