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CF&P Strategic Memo, August 26, 2002

Center for Freedom and Prosperity Strategic Memorandum

Date:    August 26, 2002

To:      Supporters of Tax Competition

From:  Dan Mitchell, Heritage Foundation Senior Fellow

Re:      Death of the EU Savings Tax Directive
______________________________________________________

 Last month, the White House held a crucial meeting to determine whether the Bush Administration would support the EU Savings Tax Directive. High-level representatives from several cabinet departments and White House offices were present at the meeting.

The Good News

According to several sources, the White House decided to reject the EU Savings Tax Directive. As one senior White House official stated, "We are not signing the European Union's Savings Tax Directive. There is zero support in the Administration for signing." Another high-level presidential appointee echoed these sentiments, noting "the directive is contrary to America's national interests."

Needless to say, this is a huge victory. The Savings Tax Directive was on life-support even before this decision. The Brussels-based bureaucracy was having a very hard time producing unanimous support from all 15 EU nations, and they faced even greater obstacles getting approval for their scheme from the six non-EU nations (the United States, Switzerland, Liechtenstein, Monaco, San Marino, and Andorra) that were needed to make the cartel work. Now that the U.S. has decided not to participate, the EU Directive is unambiguously dead.

This victory is the culmination of nearly two years of hard work by many organizations. The Center for Freedom and Prosperity deserves special credit for leading the charge and organizing the Coalition for Tax Competition, but organizations such as the Heritage Foundation, the Cato Institute, Americans for Tax Reform, and the National Taxpayers Union also played important roles. Likewise, victory would have been impossible without assistance from many people on Capitol Hill. Dozens of congressional offices used their influence to steer policy in a market-oriented direction. And, of course, we all owe a debt of gratitude to the people in the Bush Administration who fought to preserve jurisdictional tax competition.

This victory is good news for low-tax jurisdictions, particularly those such as the United States, Luxembourg, and Switzerland that were expected to participate in the EU's tax cartel. But other low-tax jurisdictions also will benefit, especially those in the developing world. Many of these jurisdictions had been strong-armed into promising the OECD that they would sacrifice their fiscal sovereignty so Europe's welfare states could collect tax revenue on an extra-territorial basis. But almost all of the "commitment letters" sent to the Paris-based bureaucracy included "level playing field" clauses, stating that the jurisdiction would not implement bad tax policy unless all OECD member nations agreed to abide by the same misguided rules.

This means that the defeat of the EU Savings Tax Directive puts a final nail in the coffin of the OECD's "harmful tax competition" scheme. And with this threat gone, tax competition can continue to serve as a liberalizing force in the world economy. Governments will feel pressure to lower marginal tax rates and reduce (or even eliminate) discriminatory taxes against income that is saved and invested. Economic growth will rise, opportunity will increase, freedom will be enhanced, and living standards will improve.

This is why the battle for tax competition is worth fighting. This is not an effort to preserve America's competitive advantage in the world economy. This is an effort to promote good tax policy and expand the blessings of liberty for everyone. (For more information on the EU Savings Tax Directive: http://www.freedomandprosperity.org/eu/eu.shtml.)

The Bad News

 Unfortunately, the Bush Administration did not make the right decision on another important issue. The Internal Revenue Service received approval to issue a weakened version of a Clinton-era information-sharing regulation. If the proposed regulation is implemented, American banks will be forced to report the deposit interest they pay to nonresident aliens from selected nations. This decision is bad for America's national interests and it undermines good tax policy.

 It is bad for the United States since many investors will withdraw funds from the American economy. Simply stated, the U.S. banking system will be less attractive if the IRS succeeds in forcing financial institutions to violate their fiduciary obligations. Individuals seeking privacy will shift money to Hong Kong, Switzerland, and the Caribbean. This means less capital available in the United States to finance car loans, home mortgages, and business expansion.

 Perhaps more importantly, the IRS regulation is bad tax policy. It will enable other nations to tax income earned in the United States. And it will facilitate an additional layer of tax on income that is saved and invested. Both of these features undermine good tax policy and fundamental tax reform. Proposals such as the flat tax which has been endorsed by President Bush are based on common-sense principals such as taxing income only one time and taxing only income earned inside national borders.

 The IRS regulation also will give aid and comfort to the bureaucrats in Brussels. More specifically, the EU will argue that the Savings Tax Directive is still viable because the proposed IRS regulation is an "equivalent measure." This certainly is an inaccurate reading of both the regulation and the EU Directive, but supporters of tax harmonization almost surely will adopt this strategy since it is their only option short of admitting defeat.

 For obvious reasons, market-oriented organization will be opposing the proposed IRS regulation. The IRS is accepting public comments until November and taking testimony in early December. The Center for Freedom and Prosperity already has announced it will be opposing the initiative (see http://www.freedomandprosperity.org/update/irsreg/irsreg.shtml), and other organizations also will be registering their opposition as well.

Winning the End Game

 This good news/bad news scenario raises an obvious question: How can the Bush White House reject the EU Savings Tax Directive yet also give the green light to a Clinton-era IRS regulation? These decisions, after all, contradict each other. The simple answer is that the Administration is divided on the issue of jurisdictional tax competition. Without divulging any confidences, one can generally state that the various offices in the White House support tax competition. The Treasury Department, by contrast, is more sympathetic to tax harmonization (particularly since the career bureaucracy sees Secretary O'Neill as a lame duck and feels free to pursue its own agenda).

 Because of this split, the Administration decided to cut the proverbial baby in half. At last month's meeting, supporters of tax competition in the White House prevailed on the all-important issue of whether to join the EU tax cartel. But Treasury did not come away empty-handed. Their "consolation prize" was a watered-down version of the IRS regulation.

 So what happens now? In all likelihood, there will be very little news. The Bush Administration has no desire to antagonize the European Union, particularly since it is seeking support for the ongoing war against terrorism. As such, there is no reason to expect an "in-your-face" public announcement. Yet the White House also knows that the Treasury Department will try to undermine the Administration's position, so there will be close scrutiny of all Treasury Department actions. That is why the Deputy Treasury Secretary Kenneth Dam, in a letter to the EU announcing the decision on the IRS regulation, had to state that the regulation did not indicate US support for the Savings Tax Directive. (Link to letter: http://www.freedomandprosperity.org/treasury-eu.pdf.)

 Supporters of tax competition in the United States will continue to monitor the situation. The Coalition for Tax Competition will work with allies inside the Administration and on Capitol Hill to make sure that the Treasury Department is unable to resuscitate the Savings Tax Directive.

Supporters of tax competition outside the United States can help our efforts by pressuring their own governments to reject the EU scheme. This may seem superfluous, but there is no such thing as a permanent victory when dealing with governments. The bureaucrats in Brussels almost surely will extend deadlines and/or make cosmetic changes to their scheme in hopes of regaining the offensive. Indeed, it is quite likely that they will delay any decision in hopes that the 2004 elections in the United States will result in a new Administration. This tactic will be much less plausible, though, if other low-tax nations take a strong stand against the proposed cartel.

At the very least, we can savor an important victory for the next two years. The European Union's proposal for automatic and unlimited information-sharing has been thwarted. And since we can safely assume that the United Kingdom will stop the Brussels bureaucracy from resurrecting the withholding tax alternative, tax competition will continue to have a liberalizing impact on tax policy in Europe. But let us not forget that the collapse of the Savings Tax Directive significantly cripples the OECD tax harmonization effort. As such, the defeat of the EU will have a beneficial impact on tax policy all around the world.

Supporters of tax competition in Washington, however, will not take time to celebrate. In addition to opposing the IRS regulation, we will be fighting to reform America's anti-competition international tax laws so that U.S.-based corporations no longer have to expatriate in order to compete on a level playing field. We will be seeking to halt IRS abuses such as the wholesale assault on the privacy of people with foreign credit card accounts. And we will be working to stop the OECD from imposing costly new regulations on business incorporation.

 

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