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Daniel J. Mitchell

April 25, 2001

Dear Tax Notes Editor:

 Lee Sheppard's recent opinion piece on the Organization for Economic Cooperation's "harmful tax competition" initiative ("It's the Bank Secrecy, Stupid," April 16) was rather entertaining, but there are a few points that require a response.

 First and foremost, Ms. Sheppard asserts and/or implies throughout her article that the OECD proposal has nothing to do with higher tax rates and heavier tax burdens. Instead, she asserts that the Paris-based bureaucracy is focused on the elimination of financial privacy. But while it certainly is true that the OECD wants to dictate bank secrecy laws in non-member countries, there should be little doubt that the destruction of privacy is simply a means to an end. The OECD wants to make it easier for high-tax governments to collect more revenue and there should be little doubt that more taxes would be the ultimate effect.

Lest there be any doubt that higher tax burdens are both the theoretical goal and the practical result, consider:

    1. The number one condition the OECD listed for being a "tax haven" is to have either zero tax or very low tax on capital income. And while I normally do not like to agree with the OECD, this seems like a very straightforward admission of the organization's ideological bias. Indeed, the OECD also has openly stated that tax rates and tax burdens should not influence decisions on where to save and invest. And since the organization did not come up with a list of nations that are imposing excessive tax, it should not take a rocket scientist to figure out what the OECD would like to see happen.

    2. The theoretical underpinning of the OECD agenda is "capital export neutrality," the fanciful notion that tax harmonization is good for the global economy. Proponents of this theory begin with the reasonable assumption that resources will be allocated efficiently in a no-tax environment (because the pre-tax rate-of-return is the same as the post-tax rate-of-return). They also assume, quite logically, that geographic differences in tax burdens will cause resources to flow to the lower-tax environment. But they then take a giant leap into fantasyland by asserting that all economic decisions should be based on pre-tax rate-of-return instead of post-tax rate-of-return. This leads them to conclude that tax rates should be harmonized. And if they cannot be harmonized, the second-best alternative is to impose capital export neutrality on individuals by enforcing worldwide (or residence-based) taxation.

    3. The elimination of financial privacy will make it possible for a high-tax nation like France to successfully impose its tax rates on the worldwide income of taxpayers with whom they can claim a nexus. As a result, it will become very difficult for a French taxpayer to shift economic activity to a lower tax environment. Why bother taking your money out of France, after all, if you still will be subjected to oppressive French tax rates? Once this happens and competitive pressure disappears, it would be stunningly nave to think that this will not result in a higher tax burden in France. There is overwhelming evidence that tax competition is a liberalizing force in the world economy. Would the global shift to lower tax rates have happened, for instance, in the absence of Ronald Reagan's tax rate reductions? Would the United States be seeking to eliminate the death tax without the competitive pressure of offshore trusts? Tax competition also works within countries. Without New Hampshire, for instance, the tax burden in Massachusetts and Vermont would climb even higher. Moreover, California would be even more of a tax Hell without pressure from Nevada.

The failure to understand the OECD's real agenda is Ms. Sheppard's biggest mistake, but her article also contained lots of little errors that should be corrected. These include:

  • Contrary to Ms. Sheppard's assertion, the members of the House and Senate opposing the OECD agenda are hardly a bunch of "no-name legislators." Unless, of course, one thinks that the Majority Leader of the House and the Assistant Majority Leader of the Senate are backbenchers. The ranking Democrat on the House Ways & Means Committee also might be surprised to hear of his demotion, as would the many other elected officials from key committees.
     
  • Ms. Sheppard defends the OECD by stating that the organization has not endorsed a global tax police, but she (deliberately?) misconstrues the words of House Majority Leader Armey. The Majority Leader likened the OECD's proposed international regime of information exchange to a "global network of tax police." But if that is not an accurate description of what the OECD wants, what is?
     
  • Ms. Sheppard asserts that average residents of Caribbean "tax havens" have not benefited from pro-market policies. This is a rather amusing claim since even a cursory review of the region would show a significant correlation between median income and the extent of the financial services industry.
     
  • Ms. Sheppard quotes the OECD's response to a letter sent by Congressman Sam Johnson of the Ways & Means Committee, but she never points out that Congressman Johnson asked six specific questions and that the OECD did not even attempt to answer one of the questions. But don't take my word for it. The Center for Freedom and Prosperity's website (www.freedomandprosperity.org) has both letters so people can judge for themselves.
     
  • Ms. Sheppard blindly repeats OECD assertions that low-tax countries have deliberately tailored their laws to "poach" the tax base of other countries, but this is historically nonsensical. One hundred years ago, very few countries (including the US) had an income tax. The only thing that low-tax countries are "guilty" of is maintaining a consistent low or zero tax policy. It is OECD nations that have changed their laws by imposing confiscatory income taxes. If the OECD truly is upset that capital responds to differences in tax rates, it should sanction its own membership for "tailoring" their laws to cause capital flight.

Last but not least, I must respond to Ms. Sheppard's deliberately misleading characterization of our telephone conversation regarding whether the U.S. is a "tax haven" according to the OECD's criteria. During our discussion, I explained that the OECD initiative is contrary to America's national interests because we are a low-tax nation compared to other industrial nations, but also because our tax and privacy laws make us a tax haven for foreign capital.

In asking me to justify my argument, she asked whether I had ever read the relevant sections of tax law. I responded in the negative, of course, since there is no need to peruse the legal language when there is no dispute on what the law actually says. Yet since she questioned whether my description of US law was accurate, I suggested that she read Marshall Langer's speech, "Who are the Real Tax Havens." I picked this speech because it was very good and because it was reprinted in Tax Notes International and therefore would be easy for her to find.

So how did Ms. Sheppard report that exchange? She wrote, "Mitchell admits that he has not read the law and that his ideas come from a speech by tax lawyer Marshall Langer." The intent of this sentence, of course, is to make the reader believe that I am flying by the seat of my pants, basing all my work on one speech.

While this may be a clever literary device, I will simply respond by quoting from the Joint Committee on Taxation's Overview of Present-Law Rules and Economic Issues In International Taxation, which was issued March 11, 1999:

    "For example, the United States generally does not tax capital gains of a foreign corporation that are not connected with a U.S. trade or business. Capital gains of a nonresident alien individual that are not connected with a U.S. business generally are subject to the 30-percent gross-basis tax only if the individual was present in the United States for 183 days or more during the year (sec. 871(a)(2)). In addition, certain types of interest (for example, interest from certain bank deposits and from certain portfolio obligations) are not subject to the withholding tax."

 Combined with the fact that the United States generally does not have effective information reporting for these types of income, it is quite clear that we are a "tax haven." Indeed, we satisfy all of four criteria that the OECD used when developing its tax haven list. But this is not something of which to be ashamed. It is sound economic policy that has helped attract $7 trillion-$10 trillion of foreign capital to our economy.

 In the final analysis, this debate is really a battle over how best to deal with tax evasion. The OECD believes that all jurisdictions should be compelled using the threat of financial protectionism to participate in an international system of automatic information exchange. This approach assumes that the extra-territorial enforcement of double-taxation is more important that long-standing principles such as competition, privacy, sovereignty, and due process legal protections.

 The alternative view is that tax evasion would almost vanish if nations only taxed income earned inside their borders and did not double-tax income that is saved and invested. This approach protects privacy, respects the sovereign decisions of other nations, and preserves tax competition as a useful check on government.

 Should be an easy choice.

Dan Mitchell

 

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