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CFP Strategic Memo, July 17, 2001

Center for Freedom and Prosperity Strategic Memorandum

To: Interested Parties

From: Dan Mitchell, Heritage Foundation Senior Fellow

Date: July 17, 2001

Re: Senate Hearings Likely to Attack Civil Liberties and Tax Competition
_______________________________________________________________

 The Permanent Subcommittee on Investigations (part of the Governmental Affairs Committee) will hold hearings on Wednesday, July 18, entitled "What is the U.S. Position on Offshore Tax Havens." The Secretary of the Treasury is among those scheduled to testify, and these hearings almost surely will be used by the Democratic majority to pressure the Administration on the issues of tax competition and financial privacy.

 With regards to tax competition, the majority seems very sympathetic to the attack on low-tax nations launched by the Organization for Economic Cooperation and Development (there are related initiatives from the European Union and United Nations). As such, it is quite likely that the majority on the Subcommittee will try to lure the Treasury Secretary into making statements that would move U.S. policy closer to the anti-tax competition view of Europe's welfare states.

 On the issue of financial privacy, the majority probably will attack the Treasury Secretary for launching a review of U.S. money laundering laws and regulations. It is therefore to be expected that the Subcommittee will press Treasury to scale back or abandon any effort to use cost-benefit analysis and/or respect civil liberties and due process legal protections.

 Incidentally, I have asked to testify, but my request was denied. The purpose of this memo is to identify issues that likely will arise in the hearing and to show how to deflect demagoguery that the majority will use to advance its position.

Likely Attack: Only supporters of tax evasion are unwilling to endorse the OECD's so-called "harmful tax competition" initiative.

Response: There are two ways to deal with tax evasion. The approach used by the OECD the collection and swapping of private financial information by governments so income can be taxed on a worldwide basis is a back-door form of tax harmonization that would undermine financial privacy and cause conflict between nations. Moreover, this "information exchange" approach surely would increase the underground economy, which already accounts for one-fourth to one-third of GDP in many of Europe's high-tax welfare states.

The other approach is to reform the tax code by shifting to a territorial tax system (the common-sense notion that nations only tax the income earned inside their borders) and eliminating the double-taxation of income that is saved and invested. This approach happens to be good tax policy, but it also would wipe out a huge percentage of tax evasion since "offshore" accounts no longer would have a financial advantage over "onshore" accounts.

Likely Attack: The United States will benefit from "information exchange" since we have at least for now a tax code that taxes on a worldwide rather than territorial basis.

Response: Information exchange would have no value to the United States if we adopted the long-overdue tax reforms listed above. But even if those reforms are not enacted, the United States would be a net loser under a global information exchange regime. Yes, it is true that the wholesale destruction of financial privacy around the world might generate a few billion dollars of additional tax revenue (catching Americans with accounts in "tax havens").

But this "benefit" must be weighed against the likely costs. The United States is the world's largest tax haven. Nonresident foreigners can invest in U.S. stocks and bonds and pay little or no tax. And since the U.S. generally does not require the reporting of that income, this makes it very difficult for foreign governments to tax this income either. This combination of low taxes and effective privacy protection has helped attract trillions of dollars to the American economy. Yet if the U.S. decides to participate in an international information exchange system, much of that capital will flee to other jurisdictions.

Likely Attack: So-called tax havens are major sources of money laundering.

Response: This is pure demagoguery. The vast majority of the world's criminal proceeds are obtained and laundered in OECD nations. Indeed, roughly half of the world's money laundering occurs in the United States, and the plethora of laws and regulations manages to catch less than one percent of that dirty money. Moreover, only seven of the seventeen nations on the Financial Action Task Force (FATF) blacklist are considered tax havens by the OECD.

 This should not come as a surprise. Criminals have little use of offshore accounts since the entire purpose of money laundering is to create the appearance that assets have a legitimate origin so that the funds can be spent in the domestic economy. This goal is more difficult if the criminal has to figure out both how to shift money offshore and then back onshore. Little wonder, then, that the United Nations reported that "Money laundering can proceed very easily without bank secrecy; in fact, it may well be that launderers avoid it precisely because it acts as a red flag."

Likely Attack: Financial privacy laws in low-tax jurisdictions make it difficult to investigate and prosecute criminal activity.

Response: If there were rogue regimes that acted as havens for terrorists, drug dealers and hit-men, that would justify a coordinated international response. Fortunately, this description does not apply to low-tax nations. So-called tax havens usually have mutual legal assistance treaties (MLATs) and other crime-fighting arrangements with the U.S. and other OECD nations. These agreements allow widespread cooperation in the investigation and prosecution of drug dealers and other criminals. Indeed, most low-tax jurisdictions bend over backwards to cooperate in these matters (and if the Subcommittee uncovers evidence of a regime that does not fulfill its legal commitments, that would be a valuable exercise).

 Just like the United States, however, low-tax jurisdictions generally do not assist in the enforcement of other nation's laws if the alleged offense is not a crime in the low-tax jurisdiction as well. The United States, for instance, would never consider (hopefully) helping China persecute escaped pro-democracy protestors or women fleeing that government's forced-abortion policy. Why? Because those activities are not criminal offenses in the U.S. This "dual criminality" principle also explains why many countries do not help high-tax nations that are seeking to impose their tax laws on income earned in other jurisdictions particularly when they themselves do not tax the affected income.

Likely Attack: The White House is soft on money laundering.

Response: The Administration has announced a review of money laundering laws and regulations, but this is because the current approach imposes a huge regulatory burden on private financial institutions and runs roughshod over due process legal protections and Constitutional protections against unreasonable search and seizure. Combined with the fact that the current approach only detects a tiny fraction of money laundering, the Administration is responsibly researching whether there is a more effective way to use law enforcement resources.

 While this process has just begun, it hopefully will result in changes that protect civil liberties and due process. The Constitution's Fourth Amendment, for instance, protects individuals from search and seizure in the absence of probable cause, yet money laundering laws and regulations allow governments and often require financial institutions to spy on the financial transactions of law-abiding citizens. (Fewer than 1/1000th of one percent of currency transaction reports are used in a criminal conviction according to the most recent Justice Department figures.). Due process protections require that citizens receive notice of legal proceedings and that they have a right to contest the government, but money laundering laws and regulations usually involve secret actions that deprive citizens of the right to be heard.

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