June 19, 2001

Bermuda Vacation: Its Tax-Free Policy Has
Self-Interested U.S. Pols Disturbed

By Daniel J. Mitchell

Some politicians from high-tax countries consider it "unfair" when jobs and capital flee to jurisdictions with lower levels of taxation. Welfare states such as France insist this represents "harmful tax competition," and want it stopped. That's why the French and others are using the Paris-based Organization for Economic Cooperation and Development, or OECD, to attack low-tax nations, threatening to cut them off from world financial markets unless they agree to help enforce Europe's oppressive tax laws. This amounts to a particularly onerous form of protectionism.

Fortunately, the Bush administration has rejected this misguided OECD proposal. Treasury Secretary Paul O'Neill quite correctly has pointed out that tax competition promotes fiscal responsibility, and that countries have sovereign rights to determine their own tax policies. This not only makes economic sense, it also promotes America's national interests, since our tax burden is lower than most of our trading partners and our attractive tax and privacy laws make us a tax haven for overseas investors. In short, America is the world's biggest beneficiary of tax competition.

But tax competition is a two-way street. America's tax system is far from perfect, and plenty of jurisdictions have more attractive tax regimes. Unfair Advantage For instance, Bermuda levies no personal or corporate income tax. That has enabled it to develop a competitive insurance industry and become, according to the World Bank, the third-richest economy in the world.

Some U.S.-based insurance companies - and their hometown lawmakers - argue that insurers in Bermuda have an unfair advantage. They sound an awful lot like the OECD-promoting French. Indeed, several members of Congress adopt the same rhetoric as the OECD, saying Bermuda's lack of a corporate income tax gives companies based there an "unwarranted tax benefit."

They are especially upset that Bermuda insurers have captured so much of the "reinsurance" market. This refers to the practice of insurance companies purchasing policies to spread risk and to make sure they have enough resources to pay claims, even for catastrophes such as hurricanes.

Congress can react to this competition from Bermuda in one of three ways. It can do nothing, which probably would serve only to help Bermuda capture even more of the market.

Territorial Taxation

It could make our tax system more competitive by reducing the corporate income tax - or, even better, by junking our "worldwide" system for taxing U.S. corporations and instead taxing companies only on the income they earn in America. This common-sense approach is known as territorial taxation, and no single step would do more to help our companies compete effectively against businesses in low-tax jurisdictions.

Finally, Congress could attempt to rewrite the rules of international taxation so that America could impose bad U.S. tax law on foreign companies, even on income those companies earn abroad. U.S. Reps. Nancy Johnson, R-Conn., and Richard Neal, D-Mass., adopt this approach in legislation they are pushing to impose additional taxes on insurance companies operating in the U.S. if they purchase reinsurance from Bermuda-based firms. The legislation targets American affiliates of Bermuda-based insurance companies. Not surprisingly, this legislation is supported by a handful of U.S.-based insurance companies headquartered in its sponsors' states.

Horrible Precedent

Parochial legislation is usually a bad idea, but it is downright dangerous in this case because of how it could affect other international tax issues. For instance, would the White House and Treasury Department have had the moral authority to reject the OECD's so-called "harmful tax competition" initiative if Congress could undermine tax competition any time a hometown company faced a challenge from overseas?

On a more specific level, consider the horrible precedent that would be created if Johnson and Neal succeeded in extending U.S. law to tax income earned by foreign companies outside of America. Once that approach became acceptable, it would not take long for France and other socialist governments in Europe to assert the right to impose additional taxes on the foreign subsidiaries of successful U.S.-based companies, such as Microsoft and General Electric. After all, they would argue, America's (relatively) low tax burden creates an "unfair" advantage.

Tax competition should be celebrated rather than persecuted, even in those rare cases when America is on the losing side. If members of Congress hold genuine concerns that U.S. tax law makes American companies uncompetitive, they should change the law - instead of trying to broaden its reach.

Daniel J. Mitchell is McKenna senior fellow in political economy at The Heritage Foundation.

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