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Wall Street Journal (Europe)

July 25, 2002

The End of Europe's Savings-Tax Cartel

By Daniel Mitchell and Andrew Quinlan

The Bush administration has decided not to participate in the European Union's "Savings Tax Directive." This is the final nail in the coffin for the proposal, which would have required financial institutions in low-tax jurisdictions to collect information on nonresident investors and share that confidential data with tax authorities in other nations.

This good news has been confirmed to us by several senior White House officials. Because of comparatively attractive tax laws, the U.S. has attracted financial capital from around the world. The Savings Tax Directive would have undermined this process, harming stock markets and reducing economic growth. Indeed, it is likely that the U.S. rejection of the EU directive was at least partially driven by a well-justified concern that it would put additional downward pressure on financial markets.

The U.S. decision will be greeted with sighs of relief in many other nations. Britain, Luxembourg, Belgium, and Austria correctly view the directive as a threat to their financial-service sectors. Indeed, those governments originally refused to let the directive go forward unless six non-EU jurisdictions, including Switzerland and the United States, agreed to join the cartel. They assumed, quite correctly, that either Switzerland or the U.S. would veto the directive.

Many free-market groups, think tanks, and taxpayer organizations in the United States led the fight to reject the Savings Tax Directive. But their efforts were not motivated by a desire to protect America's national interests. Instead, the Savings Tax Directive was viewed as fundamentally inconsistent with good tax policy. Had it been implemented, it would have crippled tax reform and undermined the liberalizing process of tax competition.

The Savings Tax Directive, for instance, was designed to facilitate the extraterritorial double-taxation of individual savings. Yet all the major tax reform plans in America, such as the flat tax, eliminate double-taxation of income that is saved and invested. And tax-reform plans also rely on the common-sense notion of territorial taxation -- taxing only activity inside national borders.

Fundamental tax reform will be a difficult undertaking. Many interest groups have preferences built into the tax code and they will oppose efforts to implement a neutral, consumption-based tax code. Tax reformers in the U.S. correctly believed that the battle for a simple and fair tax system would become even more difficult if bad tax policy was embedded in international agreements. This is why there was such strong opposition to the Savings Tax Directive. A desire to protect America's competitive advantage was a secondary issue.

Opponents of the Savings Tax Directive also want to preserve tax competition. Governments, like private businesses, have a tendency to charge high prices and offer substandard services in the absence of competition. The knowledge that jobs and capital can cross national borders compels lawmakers to be more fiscally responsible. Indeed, the global reduction in tax rates following the Thatcher and Reagan tax cuts is powerful evidence that tax competition is a force for good economic policy.

The directive also raised important privacy issues. It would have required unlimited and automatic sharing of personal financial information between governments. This is a significant development. Governments today collect and share information, of course, but generally in response to specific requests. Current procedures also provide taxpayers with some due process legal protections since governments usually have to demonstrate a reason for the information. This guards against fishing expeditions and ensures that information will not be abused.

There is also an important sovereignty issue at stake. The very definition of sovereignty is the ability to determine laws inside national borders. This includes the right to determine how and when to tax economic activity. Some governments use this power well and others do not, but they should have the sovereign right to decide whether to assist other governments that want to tax income earned inside their borders.

This raises the issue of tax evasion. High-tax EU governments argue that the directive is needed to reduce tax evasion. Yet this assumes that there is only one way to reduce evasion. If high-tax nations like France and Germany lowered tax rates and reduced the double-taxation of income that is saved and invested, the problem would largely disappear. Lower tax rates and tax reform also would revive moribund economies and boost job creation.

So what happens now that the U.S. has decided to ax the directive? The EU Savings Tax Directive was probably dead anyhow because of Swiss opposition. The U.S. decision merely confirms that it is time to schedule a funeral. High-tax governments probably will try to reverse the decision, but that is unlikely. Efforts to revive a EU-wide withholding tax on savings also are likely to fail because of UK resistance. So the only realistic option left is lower tax rates, meaning that the big winners are taxpayers living in high-tax nations.

Mr. Mitchell is a senior fellow at the Heritage Foundation in Washington, D.C. Mr. Quinlan is president of the Center for Freedom and Prosperity in Washington.


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