You can't build an economy on tax breaks. Ireland proves it. Look at this for an example of paranoia about how vulnerable they are to tax, written by Declan O'Neill, Partner, Corporate Tax Services partner in Ernst & Young Dublin, commenting on their 2007 Budget:
While some of the changes announced in the Finance Bill will be welcomed by business, we need to be doing a lot more in order to remain an attractive location for inward investment. In the face of serious competition from alternative locations such as the Netherlands and Luxembourg, we need to consider our entire suite of incentives and ensure that we at least match the range of benefits which are available elsewhere.
In particular, we should consider an expansion of our participation exemption regime and an abolition of our withholding tax rules on interest and royalties, as well as broadening the tax benefits of our R&D regime. Some of the changes introduced in the Bill are little more than a tinkering around the edges of what is required, and we could be faced with further high profile relocations out of Ireland if we don't remain competitive on the taxation front.
The synopsis is simple: once you prostitute yourself on the tax band wagon it's very hard to get off. Ireland has done that. It can only go so far before the policy stops paying (and when your tax rate is 12.5% you've already gone quite far). Then the relocations begin.
Tax competition does not pay.
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Interesting comments. They remind me of the sort of criticisms often levelled at international capital controls by e.g. Fund economists; namely, that investors will always find the next loophole so that you’ll have to be continually updating the controls – and this has an inevitable and non-trivial administrative cost. I seem to recall the MoF of Chile (relatively successful system of controls) saying that each of their controls had about 2-3 effective years before change was necessary to block the loopholes that were being exploited.
He certainly didn’t agree that this made it impossible or undesirable to try to reduce the volatility of their capital flows; but more right-wing economists certainly argued this. In this case, of course, there is not simply a level of cost to absorb but also a long-term downward trend in the effectiveness of the policy and any revenue and investment benefits.
Although the impact for the countries that Ireland and the rest are free-riding upon is more important, this is one more reason why the tax haven route is unsustainable. Sheila Killian’s paper on this, presented in Nairobi, set out very neatly the problems faced by Ireland on this road:
http://visar.csustan.edu/aaba/KillianNairobi.pdf