Tax havens became headline news in Canada this summer following the leak of 2.5 million files which implicated more than 550 Canadian taxpayers in funneling funds through companies located in South American and Caribbean tax haven countries . For the individual taxpayer these sorts of activities are generally illegal, while for multinational firms, which represent a much greater share of tax haven usage, the confines of the law are much more elastic. The reason for this is that firms have many more tools at their disposal for redirecting income towards tax havens, most of which take advantage of areas of legal weakness. Transfer pricing, for example, involves manipulating prices on assets which are swapped between different firm branches. Typically, firms open shell companies in tax haven countries, and send over assets whose prices are deliberately inflated which effectively “hides” the income they wish to redirect. And while the Canadian Income Tax Act mandates that transfer prices be set fairly, as if the transaction occurred at “an arm’s length”, in practice this principle is fuzzy at best.
What effect does all this tax evasion have on the Canadian economy? The simplest answer is that by redirecting income away from Canadian authorities, the use of tax havens reduces tax revenue and fosters tax competition. Crucially, declining revenues can mean the under-funding of important social programs, or economic projects. However, while this view is the most commonly accepted among governments and international institutions such as the OECD and G7 which have been attempting to curb the use of havens since the late 1990s, there is an emerging view among academics that tax havens may not be as parasitic as popularly believed. For example, several authors have demonstrated that non-haven developing countries in close proximity to havens experience spin-off benefits such as economic growth or more competitive domestic banking sectors . Some attribute this to the fact that since tax havens reduce firms’ capital costs, extra funds are freed up for investment elsewhere. But this imitates the logic of “trickle-down economics” a little too closely and equally fails to account for the fact that firms often choose to distribute extra profits as dividends or bonuses, rather than reinvesting them. A more likely explanation for this effect is an economic agglomeration effect whereby firms and markets in nearby countries benefit from tax havens because the income and assets sent over to subsidiaries in haven countries are often reinvested in nearby markets.
Regardless, tax havens will continue to pose a major problem for the Canadian economy. The Canadians for Tax Fairness estimate that the top 5 tax havens for Canada – Barbados, the Cayman Islands, Ireland, Luxembourg and Bermuda – hold nearly $130 billion of Canadian dollars, and that 24% of all Canadian direct investment overseas in 2011 went to havens . It is clear that in order to guarantee the future prosperity of the Canadian economy this massive leakage of tax dollars must be plugged.
 Dharmapala, Dhammika. What Problems and Opportunities are Created by Tax Havens? Oxford Review of Economic Policy. 2008; 24(4): 661-679.