July 2001
Defending Tax Havens
by Daniel J. Mitchell
Tax competition is the process by which individuals discipline profligate governments by shifting economic activity from high-tax jurisdictions to low-tax jurisdictions—much to the dismay of politicians from places like France. Indeed, those politicians are so upset that they have directed the Paris-based Organization for Economic Cooperation and Development (the OECD, which is composed of 30 industrialized nations), to eliminate tax competition between nations.
The OECD is attempting to achieve this misguided goal by demanding that all countries—particularly "tax havens"— eliminate laws protecting financial privacy so that high-taxing governments can collect detailed information about the worldwide income and assets of taxpayers. The purpose of collecting this data, of course, is to enable politicians to collect even more tax revenue. And because low-tax jurisdictions normally would be reluctant to participate in such a scheme, the OECD is threatening them with financial sanctions unless they agree to surrender their fiscal sovereignty.
In recent months, though, the OECD has been put on the defensive. Free market advocates in the United States, led by the Heritage Foundation and the Center for Freedom and Prosperity, have spearheaded an impressive coalition, which includes The Fraser Institute, in defense of competition, privacy, and sovereignty (see www.freedomandprosperity.org for more information). As a result of this effort—and also because of a greater affinity for low taxes and competitive markets, the Bush Administration has announced that it cannot support the OECD initiative.
Extremists from America's left wing have criticized this decision. Led by the editorial pages of the New York Times and the Washington Post, critics have argued that anyone who opposes the Paris-based bureaucracy's attempt to set up a cartel for the benefit of high-tax nations is, for all intents and purposes, in favour of tax evasion and money laundering.
These accusations are nonsensical. The money laundering issue is a red herring, used mostly to smear the reputations of low-tax jurisdictions. Law enforcement officials already acknowledge, for instance, that the vast majority of the world's criminal proceeds are both obtained and laundered in OECD nations. The biggest money-laundering jurisdiction happens to be the United States, accounting for about one-half of the world's dirty money even though it generates only about one-fourth of the globe's economic output.
More specifically, low-tax nations are accused of being hotbeds of money laundering because of their privacy laws, but a recent United Nations report came to the opposite conclusion, noting 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." And since most criminal money is laundered in OECD nations, there is plenty of evidence for this proposition.
Incidentally, even the OECD admits that low-tax regimes are not hiding places for dirty money. The Paris bureaucracy identified 41 "tax haven" jurisdictions, but the Financial Action Task Force, the OECD's sister agency that deals with money laundering, has blacklisted only 10 of those governments. And even that list is highly suspect since it includes places like the Cayman Islands, which has money laundering laws far stricter than those in OECD nations.
Finally, there is no recognition of the value of financial privacy as a tool against tyranny. The Swiss bank secrecy laws are a good example. They were significantly strengthened in the 1930s to help people protect their assets from the Nazis. Today, jurisdictions with financial privacy guard the wealth of oppressed minorities like the Chinese in Indonesia and the Indians in Africa, and also shield people from crime and state-sponsored expropriation throughout the developing world.
The tax evasion charge is more legitimate, but only for those wearing blinders. There doubtlessly are many people, particularly from Europe's welfare states, that are using strong privacy laws in certain jurisdictions to protect their income and assets from confiscatory taxation. But OECD supporters blithely assume that letting the world's most powerful nations bully small regimes into becoming vassal tax collectors is the only way to address this concern.
In reality, there are two ways to deal with tax evasion. The OECD believes that all jurisdictions should be compelled—using the threat of financial sanctions—to repeal privacy laws and automatically provide information to foreign tax collectors. This approach assumes that the extra-territorial enforcement of double-taxation is perfectly acceptable, and certainly 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. Consider what would happen, for instance, if governments eliminated double taxation. In other words, what if they only taxed income the year it was earned, and did not try to impose a second layer of tax if any of that after-tax income was saved and invested? Eliminating the bias against capital formation is sound tax policy, and it also has the desirable effect of wiping out incentives to evade. There is very little reason to set up an offshore account, after all, if there is no tax penalty for an onshore account.
Likewise, territorial taxation, that is, taxing only income earned in a particular jurisdiction, is sensible tax policy, but a fringe benefit of not taxing income earned in other nations is that there is no need for the OECD's fiscal imperialism. Indeed, tax policy is a matter of international dispute precisely because high-tax OECD nations assert the right to enforce their tax laws on an extra-territorial basis. If that practice stops, the issue disappears and the only losers are the world's tax bureaucrats who no longer would be able to attend ritzy conferences in Paris to discuss the supposed problem of "harmful tax competition."
Notwithstanding the fevered demagoguery of OECD supporters, tax competition is something that should be celebrated rather than persecuted. This is why tax reform is the only way of tackling tax evasion that is consistent with a free society. Tax reform protects privacy, respects the sovereign decisions of other nations, and preserves tax competition as a useful check on government.
The last point is the most crucial one. Competition between jurisdictions promotes market-friendly tax policy. Consider how much higher taxes would be in New York and California, for instance, without pressure from states like Florida and Texas that have no income tax. And imagine how much worse France would be if the government did not have to worry about citizens protecting their money in Switzerland and Luxembourg.
The OECD's assault against low-tax nations would radically alter the rules of international commerce and taxation to shield high-tax nations like France from facing the consequences of fiscal irresponsibility. The United States, by contrast, is a low-tax nation (relatively speaking) that benefits from tax competition. The Bush Administration should be applauded for rejecting the OECD's flawed proposal and defending the interests of all the world's taxpayers.
Daniel J. Mitchell is the McKenna Senior Fellow in Political Economy at the Heritage Foundation in Washington, D.C. He holds a Ph.D. in Economics from George Mason University and Master's and Bachelor's degrees in Economics from the University of Georgia.
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