January 20, 2003

BUSINESS EUROPE

Europe's Tiny Tax Havens Have Survival Skills

By BRIAN M. CARNEY

It was a scene that would have made Peter Sellers proud. The date was Dec. 24, 2002 and Marc Forne, the prime minister of Andorra, population 67,000, had a message for Brussels. At issue was whether Andorra would accede to the demands of the European Union, pop. 378 million, and open its banking sector up to greater information sharing with the EU. The minister's answer was, in effect, "Ask us again in 15 years."

The Principality of Andorra sits atop the Pyrenees, which divide Spain from France. Nestled between those two European powers, in the middle of a border that otherwise they share only with each other, is a country with a long history of independent-mindedness and a current niche as a tax haven for overburdened Spaniards and Frenchmen.

They must be doing something right, too. Andorra is accessible only by a long, twisting drive through the mountains or a tortuous train trip. The country has no airport, and the main border crossing with France is 3,000 meters up in the clouds. Yet it has more visitors every year than does Euro Disney right outside of Paris.

Andorra is a beautiful country, with lush green valleys in the summer and snow-draped mountains in the winter, but most of the 12 million passers-through do not come for the scenery. They come for commerce. As such, they are a powerful testament to the incentive power of taxation -- or the lack of taxation, in Andorra's case.

Andorra taxes gasoline and diesel fuel, but at a lower rate than just about everywhere else in Europe, so no one passes through Andorra without topping up the tank, as the rows of filling stations at either end of the country's main road (there's really only one) attest. Cigarettes are an even better deal. Spain has some of the EU's lowest taxes on cigarettes, but in Andorra prices are lower still -- just over a dollar a pack when I was there last summer. Not surprisingly, Andorra imports almost everything and -- officially, at least -- exports next to nothing. This doesn't make the French or Spanish very happy, so although they have torn down the checkpoints along almost the entire border between them, each country continues to diligently check the people entering from tiny Andorra.

There are limits to how many cartons of Marlboros anybody can cart out of the principality in his car. Money, however, is a different matter. In this age of electronic finance, neither the size or population of a country is a serious impediment to the accumulation of unreported funds if the incentive is strong enough and country's system of laws is deemed reliable.

For the citizens of the EU, where taxes routinely confiscate half a person's income, the incentive to hide income and wealth is powerful. The EU would like to stop people socking away their money out of reach of the taxman, and so some years ago it hatched its "Savings Tax Directive." The idea was to get all the EU members to agree to share information on account holders with fellow EU members, so that EU burghers could no longer hide money in places like Luxembourg, which nestles on the borders of France, Belgium and Germany the way Andorra sits on the French-Spanish border.

But Luxembourg, which is a member of the EU, knows a good thing when it sees it, and banking has been very good to the Luxembourgeois. They also understand that their banking secrecy, light regulation and relatively low taxes have sent money pouring into the Grand Duchy's banks. Destroying its competitive advantage through information-sharing would send the money streaming out. So they put a condition on the deal: Luxembourg would only play ball if six non-EU countries signed up too. Switzerland and the U.S. are the two that have received the most attention, but the other four are among Europe's last remaining city-states -- Liechtenstein, Monaco, San Marino and Andorra.

Compared to Switzerland and the U.S., the other four are minnows in international banking. But the EU came to realize how quickly that would change if those holes in the information-sharing pledge went unplugged, so the directive's rules cannot go into effect unless all six sign up.

That is how tiny Andorra and its fellow city-states have come to hold a dagger over the head of the EU's information-sharing agreement. It is leverage that they will not lightly surrender. Until the middle of the last century, Andorra was a relatively poor, backward country that maintained its independence largely because neither the French nor the Spanish could be bothered to stamp it out. But after World War II, tourism and its small-government, low-tax policies started to lift it out of poverty. It now sports per capita income on a par with the rest of the EU. And the tighter the EU countries squeeze their citizens, the better things get for Andorra.

So far, the EU hasn't expended much energy on compelling cooperation from Andorra and its fellow havens, in part because Brussels assumes that if the U.S. and Switzerland sign up, the small fry can be compelled to go along. But there's been little evidence so far that the Swiss will ever agree to what the EU is demanding. The EU's finance ministers will meet again today to decide whether to forge ahead anyway -- something Luxembourg will never agree to do -- or settle on some face-saving way to climb down from their threats and demands.

But even if the six could be compelled to cooperate, that would not be the end of the road, as the Andorrans appreciate. "The whole thing does not end with Andorra, Monaco or Liechtenstein," Prime Minister Forne told Reuters in his Christmas Eve interview. "I would like to know what other countries like the United States, Singapore and Taiwan think about the fiscal directive on saving, because money is volatile and if in the end Europe applies the directive it will see capital flee to these other countries."

In Peter Sellers' classic movie, "The Mouse That Roared," a tiny mountain country in Europe invades the United States with an army of 20 with the goal of losing the war and then receiving U.S. reparations. But they can find no way to lose. Andorra is not yet mounting an expeditionary force, but the signs are that the principality knows that in its struggle with the EU, it has attributes that outweigh the EU's enormous advantage in size. Not least of these, as Mr. Forne observed, is that the EU's struggle to bottle up capital is a truly quixotic venture. In the struggle of Europe's smallest countries against the Brussels behemoth, I'd bank on the minnows, who have the power of money on their side.

The EU could certainly smother Andorra or its counterparts if it chose to -- militarily, economically or diplomatically. Andorra, in particular, relies on France and Spain for most of its electrical power, and Andorra would become a castle under siege if, to take an extreme example, France and Spain shut the border and turned out the lights. But the city-states don't defend themselves by brute force. Their position of strength comes rather from belonging to a club of free-enterprise-oriented states that dot the globe. Those states will never all be co-opted or stamped out, because the demand for the services they offer -- cheap goods, low taxes, financial privacy -- will never go away.

The advantage of Europe's city-states is not that they are irreplaceable, but the opposite; someone will always step in to play their role. In its battle against financial privacy, the EU faces not four minnows, but a legion of them. When the mouse that is Andorra roars, the elephants in Brussels have reason to be afraid.
 

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