Center for Freedom and Prosperity Strategic Memorandum

Date:  December 4, 2001
To:      Supporters of Tax Competition
From: Dan Mitchell, Heritage Foundation Senior Fellow
Re:      Undermining the EU Savings Tax Directive
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 As we have mentioned in earlier communications, the Organization for Economic Cooperation and Development's so-called "harmful tax competition" initiative is most properly characterized as a "foot in the door" for the European Union's "savings tax directive." This EU scheme, which is based on automatic and unlimited "information exchange," would create a tax cartel and is a significant threat to market-based policy and fiscal competition.

Bad Tax Policy

 Like the OECD proposal, the EU initiative seeks to protect uncompetitive nations from the discipline of market forces. In particular, it is an effort to preserve bad tax policy. The two worst features of the plan are:

1. It would enable nations to more easily tax income earned outside their borders. This violates the principle of territorial, or source-based, taxation and inevitably creates conflict with jurisdictions that do not want to become vassal tax collectors for high-tax nations.
2. It would enable nations to more easily impose a second layer of tax on income that is saved and invested. This violates the principle of neutrality and hinders economic growth and job creation by depressing capital formation.

Thwarting the EU's Savings Tax Cartel

 Fortunately, there is every reason to believe that the EU's cartel can be defeated. In large part, this is because there is a great deal of dissension within Europe on the issue. Nations like Luxembourg and Austria (along with a few others) would be very happy to see the initiative collapse. Perhaps even more importantly, the savings tax cartel is contingent on the participation of the United States and five non-EU jurisdictions in Europe – including Switzerland and Liechtenstein. If any of them say no, the cartel falls apart.

 Because of the inherent tensions inside Europe on this issue, the proposal almost surely will fall apart if it runs into any major obstacle. Supporters of tax competition, financial privacy, and fiscal sovereignty can help hasten its demise in the following two ways:

1. U.S. lawmakers must be made aware that the EU savings tax cartel would undermine America's competitive advantage in the world economy. As the recent Center for Freedom and Prosperity Foundation paper (http://www.freedomandprosperity.org/press/p11-27-01/p11-27-01.shtml) exhaustively documents, the United States is the world's biggest beneficiary of tax competition. The EU savings tax cartel would cripple America's ability to attract flight capital from around the world, and a large coalition of free market groups intends to educate U.S. policy makers about this threat.
    
2. Low-tax jurisdictions should not give the EU any momentum by capitulating to the OECD. This is important for the reasons we have previously discussed, but it also is critical because there is no way the EU scheme can succeed unless all financial centers – including many of the jurisdictions being persecuted by the OECD – join the cartel. (The cartel will be unsustainable, after all, if flight capital can simply go to places like the Bahamas, Panama, and Antigua). It is especially important for British territories to hold firm. The U.K. government wants to see the savings tax cartel succeed because of the fear that a withholding tax might be the other alternative. As such, they are quite willing to sacrifice their own colonies to protect the City of London. (Our friends in the UK government are trying to explain to their less astute colleagues that the status quo is a perfectly acceptable and desirable alternative.)

In conclusion, we hope that people understand that this battle can be won. One year ago, skeptics told us that it would be impossible to derail the OECD scheme. Yet we have made tremendous strides (only a tiny handful of minor jurisdictions have surrendered since the OECD published its reprehensible blacklist) and have completely hamstrung the Paris-based bureaucracy. The EU proposal is a bigger threat, but it also will be easier to defeat. All that we ask is that jurisdictions protect their own interests by saying no to both Paris and Brussels.

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