November 2000 Fraser Forum: An OECD Tax Cartel?
A troubling movement has been gaining ground in the Organisation for Economic Co-operation and Development (OECD) over the last 3 years. The OECD has been slowly promulgating the need for what amounts to a tax cartel among its 29 member countries. Indeed, in a series of studies published over the last 3 years, the OECD has in fact argued that both member and non-member countries should avoid what they refer to as "harmful tax competition."
The studies have focused on the claims that competition between countries based on taxes is harmful and economically inefficient, and therefore, that greater tax harmonization would achieve economic efficiencies.1 Make no mistake about it, this is a sleeping tax leviathan. Not only would the result of the movement by the OECD require a convergence of tax rates at the high end, but as a result of higher taxes, it would also significantly reduce economic growth.
Laying the foundation for a tax leviathan
In 1998, the OECD published a report on tax competition between both its member and non-member countries entitled Harmful Tax Competition: An Emerging Global Issue. It concluded that tax competition altered the desired mix of taxes and public spending, while inducing economic distortions in the patterns of trade and investment, thus reducing global economic welfare. In addition, the study argued that tax competition could also impede both progressivity in the tax system and redistribution efforts by government.
An OECD study published earlier this year, Towards Global Tax Co-operation, listed a number of these so-called economic distortions or inefficiencies. For instance, the study argued that low-tax regimes "unfairly erode the tax bases of other countries and distort the location of capital and services." It also quite forcefully argued that taxes should not be the dominant factor in capital allocation. The theme of both OECD reports is that tax competition between countries is harmful.
A call to action
The 1998 report urged its member states to eliminate harmful tax competition and listed some 47 tax practices deemed harmful. It essentially, although not specifically, recommended a convergence of tax rates and tax burdens among its member countries. Neither report explicitly states convergence at the high end; however, the focus on eliminating the so-called harmful tax practices of low-tax jurisdictions implies a preference for forcing those countries to increase their tax levels (as opposed to having high-tax countries lower their rates). This should be particularly striking to Canadians, since the OECD strongly recommended in its 1999 Economic Survey of Canada that this country reduce tax rates and reform its tax system. In fact, it specifically stated that high taxes were a major hindrance to increased economic growth and expansion of personal income.
Contrary to international convention, the reports also dealt with non-member countries. The 1998 report demands that so-called "tax havens" make an open-ended commitment to alter their jurisdictional laws in order to make it easier for foreign governments to collect taxes on a world-wide basis. This would require that privacy laws be rolled back in most low-tax countries.
The 1998 report also states that the OECD will encourage its member countries to impose stiff financial penalties against countries that do not comply. In fact, the 2000 report specifically identifies 41 non-member countries as "tax havens." A number of these so-called havens, including Bermuda, Malta, San Marino, and the Cayman Islands, have already signed a preliminary letter of commitment based on the strength of such threats.
Some perspective on the OECD’s mission
According to its own convention, the OECD will promote policies that:
- achieve the highest sustainable economic growth and employment and a rising standard of living while maintaining financial stability
- contribute to sound economic expansion
- [promote the] expansion of world trade
It is unclear how the policies advocated in the movement to harmonize tax rates and tax burdens primarily through tax increases achieve any of the goals listed above. In fact, financial protectionism seems to directly contravene the goal of expanding trade. Also, it seems quite straightforward, given recent experience, that the goals of economic growth, reduced unemployment, and increasing living standards are best achieved through competitive tax levels, prioritized government spending, and appropriate regulation.
What competition achieves
What is inherently contained in the logic of the recent OECD reports is that competition is destructive. This is antithetical to the OECD’s own philosophy.
Competition ensures that resources are used efficiently, whether by business or government. This efficiency translates into lower prices, greater choice, and better quality for consumers and taxpayers. Similarly, producers that survive the rigours of competition are stronger and more viable entities.
Competition between countries forces governments to focus first on those areas where they have a legitimate and primary role—such as protection of property and persons, infrastructure, and national defense. In other words, competition forces government to focus its efforts in areas where society actually benefits from active government participation and where society receives the biggest gain from government spending.
Governments that focus on those key areas and charge taxes related to those services will be rewarded in the form of increased human and financial capital. Governments that maintain higher than necessary tax burdens and delve into areas of lower priority—such as subsidizing business, redistributing income, and job creation schemes—will be punished. Put another way, competition between countries for financial and human capital will force governments to focus on those things we need them to do and do well, while discarding politically-favoured projects and other generally unproductive schemes.
Why cartels don’t work
Thankfully, private cartels don’t work in the long or even medium term. In a cartel, competitors agree to act as a monopoly to gain monopoly profits. However, the monopoly price—set above the competitive market price— motivates each participant to cheat by selling more than agreed upon, eventually eroding the power of the cartel.
Unfortunately, government cartels can and do work because governments can enforce, through coercion, cartel agreements. Canada’s Wheat Board is an example of a long-lasting cartel.
The question to ask about the OECD tax cartel is whether it will have the ability to impose sanctions or penalties on countries not abiding by any possible tax agreement. If the OECD lacks punitive abilities, the same economic logic of non-government cartels will apply to the OECD. If OECD nations agree to some harmonized level of tax rates, then there will be an enormous incentive for member nations to cheat.
Governments around the world are currently grappling with how to encourage economic growth and increase living standards through reduced taxation, prioritized government spending, and appropriate regulation while still providing demanded government services. Through competition, governments are moving, albeit slowly, towards their optimal size and function. The OECD’s proposal to effectively create a tax cartel would not only stall, but would reverse this process, by allowing governments to become bigger than is competitive.
Conclusion
Although an attempt to harmonize tax rates and tax burdens would not in the long run be successful unless accompanied by new powers for the OECD, the intermediate costs associated with such an endeavour would be very high. The accompanying reduced rates of economic growth and subsequent loss of income would be devastating for OECD member and non-member countries alike. Let us hope that an organization founded to promote economic growth and prosperity will recognize that we need more economic competition between countries, not a monopoly over tax policy that permits high taxes for everyone.
Note
1For an excellent summary of the OECD proposals and the reasons for rejecting them, see Daniel Mitchell’s An OECD Proposal.
References
Gwartney, J., Lawson, R, with Samida S. (2000). Economic Freedom of the World: 2000 Annual Report. Vancouver, BC: Fraser Institute.
Mitchell, Daniel J. (2000). An OECD Proposal to Eliminate Tax Competition Would Mean Higher Taxes and Less Privacy. Washington, DC: Heritage Foundation. Available on the Internet at www.heritage.org.
Organisation for Economic Co-operation and Development. (1998). Harmful Tax Competition: An Emerging Global Issue. Paris, France: OECD. Available on the Internet at www.oecd.org.
_____ (1999). OECD Economic Surveys: Canada: A Special Feature—Structural Reform. Paris, France: OECD.
_____ (2000). Towards Global Tax Co-operation: Progress in Identifying and Eliminating Harmful Tax Practices. A Report to the 2000 Ministerial Council Meeting. Paris, France: OECD.
Jason Clemens (jasonc@fraserinstitute.ca) is the Director of Fiscal Studies at The Fraser Institute. He has a Masters Degree in Business Administration from the University of Windsor.
info@fraserinstitute.ca
4th Floor, 1770 Burrard Street, Vancouver, BC, Canada, V6J 3G7
Tel: (604) 688-0221 Fax: (604) 688-8539 Book Orders: 1-800-665-3558 ext. 580
You can contact us at the above email address for any comments or information requests. Please report any dead links or technical problems.