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Wall Street Journal (Europe), 11-08-01

November 8, 2001

State of the Union:
The Icelandic Miracle Cure

By Roger Bate,
a director of the International Policy Network.

REYKJAVIK -- In 1991, David Oddsson, a one-time actor and lawyer, became prime minister of Iceland. He inherited a poorly performing economy, overburdened by heavy taxation, which was hemorrhaging businesses to more benign environments. A decade later he is Europe's longest-serving leader and presides over a globally integrated economy with moderate inflation, full employment, and growth of more than 25% over the last five years.

But Iceland has not just caught up with the rest of the developed world. In many respects, it has surpassed it. Most intriguingly, it combines Scandinavian welfarism with American tax policy, thus potently undercutting Continental arguments that urge high taxation for the sake of a strong social safety net. What Mr. Oddsson has accomplished in Iceland, therefore, poses not just a practical model for Europe, but an ideological challenge to the still regnant social-market ideology. When I spoke to the prime minister last week, he was pleased with the progress Iceland has made. Previous tax cuts by his Conservative-led coalition have reduced the tax burden on business to 30% from 50%; now Mr. Oddsson is proposing a further cut to 18%. And he's determined to move beyond even that. "I wanted to cut business tax to 15%, and hopefully soon we will, but we have to maintain the trust of the people that it will not harm social services. The previous tax cuts didn't and neither will these." The opposition expected that tax cuts would reduce social spending, "but there has been no hocus-pocus, we have not borrowed to pay for services, the economy has grown and tax revenues have been stable." Not surprisingly, popular opposition to tax cuts is minimal.

Partly because of this success, partly because of the poor performance of such high-tax countries as Germany and France, Mr. Oddsson rejects calls from the European Commission and the Organization for Economic Cooperation and Development for tax harmonization. This, he says, "can be dangerous," because harmonized taxes are nearly always higher taxes. Instead, his government has removed certain classes of tax entirely, such as stamp duty on various financial transactions, and is lowering property taxes with a view toward abolishing them by 2004. Income tax, it's true, is still too high at about 40% for top earners, but Mr. Oddsson plans to cut this tax further once government debt is wiped out, probably in 2003.

A related concern of Mr. Oddsson is the ongoing attack on financial privacy by the high-tax countries, and especially how the terrorist events of September 11 are undermining critical U.S. support for individual privacy. Mr. Oddsson is adamant that his government is very eager to combat terrorism, but is critical of those using antiterrorism rhetoric to pursue lost tax revenue through invasions of financial privacy. "If you are going to make banks report on innocent people and overtly target those promoting avoidance of tax then one should be honest about it, rather than saying its only about stopping the Osama bin Ladens of the world." After the terrorists have been caught, he warns, "I'm afraid that it will take a lot of time to turn back the tide of excess control on movement of people and investment activities." Yet the risk that something like this might occur is significant. At a conference here on tax competition hosted by the University of Reykjavik's Institute of Economic Studies, Solveig Singleton of the Competitive Enterprise Institute explained the recent changes in the U.S. antiterrorism bill would throw "a broad net of new reporting requirements over foreign investors and domestic brokers and securities dealers. This is a significant departure from the basic principle that the police should not initiate an investigation of an individual without some reason to suspect him or her or wrongdoing." Mr. Oddsson agrees: "You have to trust the financial institutions until they demonstrate they cannot be trusted. Where evidence of criminal activity is provided action must be taken but the presumption of innocence -- a fundamental human right -- is paramount."

But if Iceland eventually reduces its business taxes to a flat 15% rate, along with a raft of other tax cuts, and, as expected, attracts businesses from the EU, will it be able to survive the bureaucratic onslaught on privacy that has brought financial centers such as the Cayman Islands to their knees? Fortunately, the answer is probably yes. First, Iceland is not a member of the EU, and although it subsidizes its agriculture, it is not subject to whims of changing EU agriculture policy (Ireland, which lowered taxes in the 1990s to great effect, also received massive farming aid from the EU; it was therefore reluctant to criticize the anti-tax-competition stance of the EU). Second, its main income is from a renewable and profitable resource -- fisheries. Iceland has the most sophisticated private market in fishing rights in the Northern hemisphere and its system is flourishing -- unlike the EU common fisheries policy, which is a financial and conservation disaster. Third, it is a whaling nation and is therefore used to taking on the world community to defend its cultural heritage -- not to mention sound science.

It is this last point that is the most significant. Mr. Oddsson receives no overt support from officials from other countries about Iceland's whaling activities. Yet he insists that most officials admit that whaling is an environmentally sustainable activity. These officials only refuse to defend it publicly for fear of pressure from radical environmentalists.

So Iceland is used to being isolated on an issue, working with its allies (in the case of whaling, Japan and Norway) and promoting sound science in the face of environmentalist hysteria. It is this approach that will win the battle for tax competition and ensure that Iceland continues to prosper by lowering taxes. As Mr. Oddsson observes, taxation is like whaling: "We must continue to do what is right and not what is politically expedient when emotion is driving policy." It is a lesson that those officials in other countries caving into EU and OECD pressure should learn. One can be a tiny country and still be a trailblazer.

-- From The Wall Street Journal Europe

 

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