June 29, 2000

International Commentary:
An OPEC For Tax-Hungry Politicians

     By Daniel J. Mitchell, a senior fellow at the Washington-based Heritage Foundation.

     Globalization is under assault. Fearful that international competition will make costly welfare states unsustainable, politicians from industrial countries are diligently working to set up a cartel of high-tax nations. The latest gambit from the high taxers is a breathtakingly brash effort to compel low-tax nations to act as collectors for their more greedy brethren. If this plot succeeds, international investment will suffer and worldwide growth will  slow.

     The European Union and the Organization for Economic Cooperation and Development are the champions of this scheme. The EU has identified 66 "anti-competitive" corporate tax provisions and continues its campaign for  member nations to "harmonize" tax policies. Having failed to impose an EU-wide tax on savings, the bureaucrats in Brussels are now bent on outlawing financial privacy.

     Not to be outdone, the OECD issued a report entitled "Harmful Tax Competition: An Emerging Global Issue."  This document not only focuses on "preferential tax regimes" in OECD nations (calling, of course, for their elimination), but also has set the stage for an effort to identify and persecute non-member nations. Indeed, the  OECD on Monday released yet another report, "Progress in Identifying and Eliminating Harmful tax Practices," which lists so-called tax havens. It warns them that they will face sanctions if they do not acquiesce to various  demands from high-tax nations.

     The OECD's work is particularly dangerous to global commerce. Cartels, by their very nature, only succeed if consumers have no alternatives. For instance, if conducted unilaterally, the EU's crusade to protect high-tax member nations is doomed to failure; jobs, talent, and capital will migrate out of the EU to jurisdictions with a less  hostile attitude toward private sector wealth creation.

     The OECD is attempting to overcome this "leakage" problem in two ways. First, theorganization encompasses almost twice as many members as the EU (29 vs. 15). Anyagreement to maintain high-tax rates therefore would  include not only most of the European nations, but also the U.S., Canada, and the advanced economies of Asia. The  bigger the cartel, the easier it will be to maintain high-tax rates.

     Much to the chagrin of politicians, however, even an OECD-wide cartel would not do the trick. There are plenty of nations, particularly in the Caribbean and South Pacific, that would welcome the new business that would come their way if the OECD nations created a tax oligopoly. If tax-hungry lawmakers want their cartel to work, they will  have to stop leakage to these non-OECD jurisdictions.

     This is why the OECD has decided to resuscitate imperialism. In a startling move that tramples sovereignty and makes a mockery of international law, the OECD is trying to force low-tax regimes to collect taxes for confiscatory regimes. In effect, low-tax nations will be threatened with sanctions - ranging from ostracism to financial protectionism -- if they object to vassal status.

     Unfortunately, it appears that the pressure tactics may be successful. Bermuda, Cyprus, Malta, Mauritius, San Marino, and the Cayman Islands just announced that they would cooperate with the OECD. At the very least, this  means an end to financial privacy in those regimes.

     Before allowing the EU and the OECD to throw a monkey wrench in the gears of the global economy, policy  makers should ask -- and answer - two questions. First, what is the likelihood that a tax cartel would be successful?  Second, assuming it was successful, what effect would a cartel have on worldwide growth?

     Economic theory tells us that cartels are very difficult to sustain. In order to work, the cartel must convince  everyone to participate and obey the rules, even though all have an incentive to "cheat." Many of the so-called tax  havens are unlikely to knuckle under to the OECD's pressure. Moreover, even if most of them do capitulate, that will increase business and profitability for those who refuse -- making them even less likely to join the cartel.  Indeed, the rewards to low-tax regimes will be so large that other countries may decide to adopt similar policies to  jump-start their economies. In short, trying to enforce a high-tax world will be like herding cats: Difficult in theory, impossible in practice.

     Yet what if the OECD is successful? Would it really matter if a few well-to-do investors had to pay more in taxes  and lost their financial privacy? The answer is yes. Low-tax regimes play two very important roles in the world economy.

     First and foremost, competition is good. It promotes higher efficiency and better service. And there is every reason to believe that the same force that gives us better car companies, pet stores, and banks will also give us  better government policy. Even the OECD's Business and Industry Advisory Committee recognizes this, writing  that, "Tax competition tends to keep tax burdens lower, which create pressure for less wasteful, and, therefore, more efficient use of public funds."

     To cite just one example, look at what happened after U.S. President Ronald Reagan slashed marginal income  tax rates in the 1980s. Almost every nation in the world was forced to lower tax rates. Not because the politicians in these other nations wanted to cut tax rates, but because the pressure to attract and retain capital, jobs, and  entrepreneurship forced them to adopt better policies.

     Tax competition also has a beneficial impact by keeping a greater share of resources in the productive sector of the economy. Politicians often act as if there is a fixed amount of savings and investment, and that the key issue is whether it is "hiding" overseas or whether it is back home where they can tax it. Yet this assumes people are indifferent to taxes and that they wouldn't be willing to forgo consumption regardless of the after-tax return to  capital. This is a preposterous assumption. High global tax rates on savings and investment reduce global capital  formation, and the biggest losers will be workers who suffer a concomitant drop in productivity.

     The EU and OECD want to turn back the hands of time. By pushing for a world tax cartel, they hope that they  can undermine the liberalizing impact of globalization on public finance. To the bureaucratic mind, tax competition is a "race to the bottom." For the sake of taxpayers around the world, one can only hope that the contest is allowed  to continue.

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