Heritage Foundation Leadership for America

A spectre haunts the world's governments. They fear that the combination of economic liberalization with modern information technology poses a threat to their capacity to raise taxes.¹

--The Financial Times, July 19, 2000

Globalization is making it harder for governments to overtax, because it is increasingly easy for taxpayers to shift their productive activities to lower tax environments. This is what is known as tax competition. Unfortunately, not everyone favors this development. The Organisation for Economic Co-operation and Development (OECD), a Paris-based international organization with 29 member nations from the industrialized world, has urged its member states to stop "harmful tax competition."²

In "Towards Global Tax Co-operation: Progress in Identifying and Eliminating Harmful Tax Practices," the OECD is calling on its members to eliminate low-tax policies that attract foreign investment.³ It is also trying to dictate tax policy in non-member nations by pressuring 41 low-tax nations and territories (called "tax havens" in the report) that have "harmful tax regimes"⁴ to sign an agreement to remove their low-tax policies and repeal their attractive financial privacy laws. If they do not, the report recommends that OECD members exercise financial protectionism against them.

Such an effort contradicts international norms and threatens the ability of sovereign countries to determine their own fiscal affairs.⁵ The OECD proposal, which is backed by officials in the primarily high-tax nations that form the core of its membership, would create a cartel by eliminating or substantially reducing the competition these high-tax nations face from low-tax regimes. The United States, a member of the OECD and its biggest source of funds, should put a stop to this ill-advised effort by unequivocally stating that it will not impose financial sanctions against the 41 blacklisted countries. (See Table 2.)

Critics have characterized this OECD effort as "an attempt by governments of high-tax countries to protect their tax revenues."⁶ Indeed, some opponents of tax competition have estimated that successful implementation of the proposed initiative could mean a tax increase that is "likely to be in the hundreds of billions, if not trillions, of dollars worldwide."⁷ Needless to say, a return to the profligate fiscal policies like those of the 1960s and 1970s would threaten the economic advances that have occurred over the past 20 years.⁸

Some policymakers from high-tax OECD nations appear so desperate to hold tax revenues hostage that they ignore the interests of less-developed countries. As one Canadian tax expert points out, the OECD proposal targeting the so-called tax havens would pit "wealthy--and white" industrialized nations against "predominantly black, poor" countries.⁹ Indeed, some politicians are so greedy for tax revenue that the G-7 nations, the seven most powerful countries in the world, urged that taxes be enforced "with the same laws used against the laundering of drug proceeds."¹⁰

But such efforts miss the point. The fact that low-tax nations are magnets for jobs, capital, and entrepreneurial talent is a development that should be celebrated, not persecuted.¹¹ Governments should not be sheltered from competition. Globalization is helping to create more prosperity by forcing businesses to be more productive. The same competitive forces should be allowed to impose fiscal discipline on government.

A cartel would have adverse consequences for U.S. taxpayers and threaten national sovereignty, financial privacy, technological development, and the rule of law. America should not participate in a regime that undermines one of its most significant competitive advantages--a low-tax environment compared with other industrialized nations. Instead, U.S. policymakers should make the economy even more competitive by reducing tax rates. Ultimately, lawmakers should enact a flat tax, a reform that would lure more economic activity to America's shores as well as substantially reduce incentives to either avoid or evade the tax system.

Whe Some Governments Want to Eliminate Tax Competition

The OECD's "Towards Global Tax Co-operation" report on efforts to eliminate low-tax competition and financial privacy is, at its core, a response to globalization. As one European bureaucrat explains, "differences in national tax systems are becoming increasingly evident and are therefore having an increasing influence on economic decisions concerning, for example, investment, savings, employment and consumption."¹² And just as banks, pet stores, and car companies treat customers better when they know there is a competitor down the block, governments treat taxpayers better when they know economic activity can cross national borders.¹³

As the world economy becomes more integrated and technology improves, it is becoming much easier to avoid excessive taxation. As a senior International Monetary Fund (IMF) economist noted:

Today, individuals may be able to choose among many countries in deciding where to work, to shop, to invest their financial capital, to allocate the production activities of the enterprises they control and so on. In these decisions, they take into account the impact of taxes, especially as long as the tax systems of different countries diverge as much as they do today.¹⁴

This taxpayer mobility--the ability to "vote with one's feet"--means that countries with high tax rates are likely to lose revenue, making it harder for their policymakers to fund expensive government programs. Supporters of the OECD initiative tend to see the effort as an attempt by governments "to regain the capacity to finance redistribution through tax revenue."¹⁵ As Michel Vanden Abeele, the Director General of the European Commission's Taxation and Customs Union puts it, "protection of adequate tax revenues is of particular concern in order to guarantee the survival of the fair and caring society."¹⁶ Needless to say, lawmakers who support these programs prefer that tax competition did not exist.

The only way to stop taxpayers from fleeing to lower tax environments, however, is to have all governments agree to maintain high tax rates--in effect, by establishing a tax cartel. The OECD proposal is just the latest development in an ongoing battle between taxpayers and their governments. Under the guise of "tax harmonization," for example, high-tax nations in the European Union have been working for years to impose a cartel on taxpayers.¹⁷

The creation of a tax cartel may be just the beginning of a process that results in higher taxes and a more costly government--policies that will adversely affect U.S. taxpayers. In order to understand why eliminating tax competition is bad public policy, it is important to understand what tax competition is and is not, and how it benefits people around the world.

What is Tax Competition, and Why is it Good?

Competition exists when rivals offer similar or better products at lower prices. In the business world, competition leads to innovation, lower prices, and good service. In effect, competitive markets mean the "customer is king." Competition serves the same role when the taxpayer is the consumer and governments must learn not to overtax lest they drive economic activity away.¹⁸

Government officials who fear tax competition are like the owner of a town's only gas station who suddenly has to deal with a bunch of competitors after years of being able to charge high prices while offering poor service. The residents of the town are like the world's taxpayers. The competition lowers the price of gas and auto repairs and makes their lives better.

This is the central reason why tax competition is a good thing. As a response by Switzerland in a 1998 OECD report noted, "competition in tax matters has positive effects. In particular, it discourages governments from adopting confiscatory regimes, which hamper entrepreneurial spirit and hurt the economy, and it avoids alignment of tax burdens at the highest level."¹⁹ Moreover, as one academic expert notes, "Competition will often have a `negative effect' on less competitive suppliers in a market, but the losses incurred by them, while real, are not `harm' in the proper sense."²⁰ A British newspaper notes that tax competition is only damaging

in the absurdist sense that any government that finds itself in competition with a lower-tax regime can condemn its competitor as "harmful." Accept this and you introduce an irresistible upward bias in international taxation. Bad news for the tax havens, for sure, but scarcely better for the citizens of some of the tax hells that we hear rather less about.²¹

Perhaps most important, tax competition is not about governments. It is about people and whether they enjoy more freedom and have more opportunity.²² Tax competition tilts the balance of power away from government and towards taxpayers.²³ Or, as The Wall Street Journal opined,

Tax competition between states is a good thing. The power of individuals and companies to vote with their feet is one of the most potent weapons against overweening government. Any attempt to deprive them of places to run must surely be considered an attack on freedom and a threat to prosperity.²⁴

The Attraction of Lower Taxes
Ample evidence exists that economic activity is drawn to low-tax regimes.²⁵ People work, save, invest, and take risks in order to improve their after-tax income. This insight is particularly relevant to international investment flows since, as an expert from the University of California in Riverside observes,

[A]rbitrage in capital markets causes rates of return to converge; but it is the net rates of return after taxes that tend to converge, not gross rates of return, so that businesses in jurisdictions with high taxes must offer and generate correspondingly higher gross rates of return on capital, to continue to attract investment.²⁶

Consider the example of an investor looking at two potential business opportunities. In Country A, a project might generate a 10 percent return, while in Country B, a similar investment is expected to yield a 7 percent return. On paper, this would suggest the investor would take advantage of the opportunity in Country A. But what if Country A has a 50 percent tax and Country B has no tax? In that case, the investor will choose to invest in the project in Country B. This choice is made because the actual after-tax return in Country A falls to 5 percent, less than the 7 percent after-tax profit that could be earned in Country B.

This does not mean, of course, that all investment will flow to low-tax nations. It does mean that investors will steer away from projects in Country A unless the expected pre-tax return is sufficiently large to compensate for the tax burden. In non-economic terms, this means that where there are two equally attractive projects, investors will choose the project that is subject to lower tax rates.²⁷

Taxation is not the only government policy that influences economic decisions. It may not even be the most important one. Excessive regulation, corruption, inflation, and protectionism also make an economy unattractive to entrepreneurs and investors.²⁸ Other factors include property rights, flexible labor markets, and government spending.²⁹ If the OECD project is any indication, however, government officials clearly think tax policy plays a dominant role in economic decisions.

The United States is a good example. Compared with Europeans, Americans enjoy low taxes, which seems to have a notable impact on economic performance. The United States has experienced faster economic growth, which has resulted in the creation of 30 million net new jobs since the mid-1970s compared with 3.5 million in all of Europe (almost all of which were government jobs).³⁰

There is compelling anecdotal evidence that people do care about taxes when deciding where to live, work, save, and invest. For instance:

• British sports millionaires like cricketer Ian Botham, Formula 1 driver Nigel Mansell, and golfer Ian Woosnam live in the Channel Islands or the Isle of Man, two of the so-called tax havens.³¹ Boris Becker and Luciano Pavarotti have taken up residence in Monaco.³²

• Fruit of the Loom moved its headquarters to the Cayman Islands, saving almost $100 million in taxes each year.³³

• U.S. insurance companies are moving some of their operations to Bermuda to avoid America's 35 percent corporate income tax.³⁴

• Many Scandinavians and Germans have bank accounts in Luxembourg.³⁵

• Many Latin American countries no longer tax dividends and interest to reduce the amount of capital going overseas.³⁶

Tax Competition Promotes Fiscal Responsibility

Economists like tax competition because the resulting lower tax rates reduce the penalties on productive behavior.⁴⁶ Taxpayers have a more narrow perspective--they simply enjoy the prospect of keeping more of the money they earn. The Reagan tax rate reductions--and the tax cuts that followed around the world--demonstrate that tax competition has generated big savings already for taxpayers.⁴⁷ Another compelling piece of evidence is the new round of tax cuts currently taking place in Europe.⁴⁸ It is likely that these tax cuts will induce other nations to propose competing tax rate reductions.⁴⁹ This certainly has happened in the past. For instance:

In response to the U.S. tax rate reductions in the 1980s, all but two OECD countries lowered their top marginal rate on personal income tax between 1986 and 1991.⁵⁰

Rates of income tax all over the world dropped by up to 50 percent after the Reagan and Thatcher tax rate reductions.⁵¹

Following the Reagan tax cuts, all but one European Union nation reduced corporate tax rates between 1985 and 1998.⁵²

Yet many government officials, particularly in Europe, do not like this competitive process.⁵³ In effect they are losing their power to set tax rates.⁵⁴ And as an IMF official observed in a recent publication, with the passage of time it will likely become even "more difficult and more costly for a country to maintain high taxes."⁵⁵ So long as tax competition continues, taxpayers will win.

Tax competition limits the growth of government. A vast majority of budget expenditures are financed by tax revenue. It stands to reason, therefore, that a policy that puts downward pressure on taxes will help to control spending. This is a welcome development, particularly since lower levels of government spending are associated with better economic performance.⁵⁶

It is not just that tax competition can make governments smaller.⁵⁷ It also can encourage lawmakers to be more frugal with the money they collect.⁵⁸ According to the OECD's business advisory group, tax competition "creates pressure for less wasteful, and, therefore, more efficient uses of public funds."⁵⁹ In more academic terms, tax competition is

not a "race to the bottom" (towards zero tax rates), but a race to the most efficient use of tax receipts. The institutional competition that will be triggered by mobile labor and capital will consequently indicate or reveal what is efficient and inefficient government use of tax income.⁶⁰

Finally, tax competition frees people to pursue better lives; taxpayers have more opportunity to "vote with their feet."⁶¹ Savings and investment are particularly mobile, making excessive taxation of capital difficult to maintain.⁶² But people, particularly highly productive individuals, also can cross national borders and migrate to tax systems that reward entrepreneurship and hard work; this migration is a form of tax competition.⁶³ This process maximizes economic growth and advances individual liberty, benefits that will evaporate if the OECD succeeds in creating an international tax cartel.

How the OECD Wants to Limit Competition

The OECD proposal began in earnest with the 1998 publication of "Harmful Tax Competition: An Emerging Global Issue," which largely outlined the theory that low taxes are unfair and harmful because they lure economic activity away from high-tax nations.⁶⁴ Subsequently, the OECD investigated low-tax policies around the world that would qualify as "harmful," and published the results this year in "Towards Global Tax Co-operation." The new report lists 47 supposedly "harmful tax practices" in OECD member nations and names 41 "harmful tax regimes"--non-OECD nations and territories that have very attractive tax systems. Specifically:

The OECD recommends that member nations eliminate tax practices that are deemed to be harmful. The "Towards Global Tax Co-operation" report lists 47 such policies that are considered unfair because tax rates are too low. This effort resembles the EU's "tax harmonization" campaign, although the OECD does not have enforcement powers. Other than making a list of offending tax laws and suggesting a date by which it would like to see these provisions repealed, the OECD does not propose a plan to make this happen. Moreover, it does not suggest any penalties for member nations that do not acquiesce to its wishes.

The OECD demands that "tax haven" nations and territories make an open-ended commitment to change their laws so that foreign governments can more easily collect taxes on the "worldwide" income and assets of their citizens. This will include requirements to raise tax rates and/or eliminate financial privacy. The OECD does not have any enforcement power over non-members. It is trying to enforce its demands, however, by asking its member nations to impose financial protectionism against "Uncooperative Regimes" that do not capitulate and sign the agreement.⁶⁵ The list of sanctions (see Appendix) is so severe that six of these jurisdictions, including Bermuda and the Cayman Islands, have already signed the OECD letter.

Double Standards

As described above, the OECD is not being even-handed. The proposals require that low-tax regimes make unlimited concessions or face penalties for being "non-cooperative." The same harsh standard is not recommended for OECD member nations. They are being asked to make changes in their tax laws, but there are no specific penalties for non-compliance.⁶⁶

Similarly, the OECD is using a double standard in its campaign against privacy. Many industrial nations respect citizens' financial privacy and are reluctant to eliminate their bank secrecy laws. Switzerland, for instance, has refused several times to abolish financial privacy.⁶⁷ Austria's constitution guarantees privacy and the government has fought to preserve bank secrecy.⁶⁸ Luxembourg, Belgium, and Greece, to their credit, also have indicated a reluctance to phase out financial privacy.⁶⁹ Yet none of these nations are being threatened with financial protectionism from other countries.

Targeting Low-Tax Non-Members

A cartel to keep taxes high is doomed to failure unless every country in the world signs on. Consider what would happen if all OECD member nations agreed to implement and maintain high tax rates. At first glance, "harmful tax competition" would decrease. Canadians, for example, no longer would have an incentive to move to America, and Europeans no longer would have an incentive to protect their assets in Switzerland. Yet this kind of cartel would not deliver the desired results--more revenue in high-tax nations--as long as investors and entrepreneurs are free to shift their activities to low-tax jurisdictions.

The OECD report acknowledges that an agreement to maintain high taxes in the industrialized world would "cause a shift of the targeted activities to economies outside the OECD area, giving them an unwarranted competitive advantage and limiting the effectiveness of the whole exercise."⁷⁰ This, of course, would mean that high-tax nations would fail to collect more revenue, defeating the purpose of the project. U.S. Treasury Secretary Larry Summers has been forthright about this goal, stating that, "The OECD's work and our unilateral initiatives are first steps in ensuring that our policy objectives can be realized without fear of eroding our tax base."⁷¹

This is why the OECD has taken the unprecedented step of trying to force non-member nations to alter their tax policies. The organization realizes a cartel will not work unless low-tax regimes are forced to participate. In addition to shutting down low-tax nations, OECD members want to make sure new tax havens do not spring up to take their place. Therefore, the report states that it intends to maintain a permanent project to prevent any nation from adopting competitive tax policies in the future.⁷²

What Are Tax Havens?

Tax havens, more properly known as offshore financial centers (OFCs), are usually perceived as places with low tax rates and financial privacy.⁷³ According to the U.N. definition, an offshore institution is "any bank anywhere in the world that accepts deposits and/or manages assets denominated in foreign currency on behalf of persons legally domiciled elsewhere."⁷⁴ The Financial Stability Forum defines OFCs as "jurisdictions that attract a high level of non-resident activity."⁷⁵

OFCs exist all over the world. According to the United Nations Offshore Forum, between 60 and 90 nations and territories participate in the offshore market.⁷⁶ The U.S. Department of State lists 52 regimes, including the United States.⁷⁷ The largest OFC, by some measures, is London.⁷⁸ In addition to being an OFC, the United States serves as a tax haven for overseas funds;⁷⁹ and the state of Montana is seeking to become a depository for offshore money.⁸⁰

Notwithstanding the false stereotype that all OFCs are sun-drenched islands in the Caribbean and South Pacific, some of the popular perceptions about tax havens are accurate. As a general rule, OFCs either do not tax bank accounts by foreign nationals or they impose very modest levies. Also, these regimes are likely to be among the 90-plus jurisdictions around the globe that "offer themselves as providers of bank secrecy."⁸¹

According to the United Nations, about $8 trillion is invested in offshore companies and accounts.⁸² According to a British-based interest group, the so-called tax havens are estimated to have attracted $6 trillion to $7 trillion in assets, with $3 trillion to $4 trillion of that amount representing the savings of the wealthy.⁸³ (To put these figures in perspective, the total holdings of the world's well-to-do are believed to be in excess of $25 trillion.⁸⁴)

OFCs are also major business centers. American banks, for instance, often make overnight deposits in the Cayman Islands to avoid burdensome U.S. regulations.⁸⁵ Indeed, a Wall Street Journal article reports that "more than 90 percent of deposits in Cayman banks are short-term, inter-bank funds booked by `on-shore' banks."⁸⁶ Bermuda, meanwhile, has used the absence of income taxes, combined with reasonable levels of regulation, to become one of the world's major insurance centers.⁸⁷

Since major U.S. banks view such "tax havens" as a safe investment, it should come as no surprise that other businesses utilize their services as well. Companies operating in countries with unstable financial systems use OFCs to protect liquid assets.⁸⁸ Low-tax jurisdictions also are widely used because of financial privacy, a practice that enables firms to "maintain their privacy and thereby their competitive edge in a business environment in which competitive intelligence has become almost mandatory."⁸⁹ Even the much-maligned international business companies (IBCs) have a variety of uses, "such as the holding of patents, the legitimate exploitation of tax treaties and the conduct of legitimate foreign trade transactions."⁹⁰

Low-Tax Policies That Attract Wealth.
Major OFCs such as the Cayman Islands, Bermuda, and the Bahamas do not have personal or corporate income taxes.⁹¹ Other so-called tax havens have income taxes that tend to be very low. Guernsey, for example, has a 20 percent flat tax and does not tax capital gains or inheritances.⁹² And because policies like this are the norm rather than the exception, people from G-7 countries boosted their investment in offshore jurisdictions by more than 500 percent between 1985-1994.⁹³

Evidence that low-tax regimes attract investment abounds:

The Cayman Islands has 580 banks with $500 billion in holdings.⁹⁴ It has 2,238 mutual funds, 499 insurance companies and 40,000 offshore companies.⁹⁵

St. Vincent and the Grenadines has 15 banks and 7,000 IBCs.⁹⁶

St. Kitts and Nevis has 9,000 offshore companies.⁹⁷

There are 3,000 IBCs in Niue, a nation of only 2,000 people.⁹⁸

Dominica has 5,800 IBCs.⁹⁹

Liechtenstein has 75,000 business entities.¹⁰⁰

The Cook Islands have 6,000 IBCs and 2,000 international trusts.¹⁰¹

The Bahamas has 580 mutual funds, 60 insurance companies, and 100,000 IBCs.¹⁰² It has $350 billion worth of assets under management.¹⁰³ There are 418 banks from 36 countries in the Bahamas.¹⁰⁴

The Channel Islands and Isle of Man have $525 billion in assets.¹⁰⁵

The Netherlands Antilles has 50 international banks.¹⁰⁶

The British Virgin Islands is the fourth largest source of foreign investment into Shanghai.¹⁰⁷

Austria has 24 million anonymous accounts with assets of $100 billion.¹⁰⁸

In Luxembourg, 90 percent of all accounts are foreign-owned.¹⁰⁹

Monaco has 70 financial establishments, which manage 350,000 accounts.¹¹⁰ With only 30,000 residents, it has $44 billion on deposit.¹¹¹

The ability of "tax havens" to attract investment demonstrates that the right fiscal policies can help poor nations develop and rich nations become more prosperous:

The so-called tax havens, which account for 1.2 percent of the world's population, have 26 percent of the world's assets and 31 percent of the net profit of U.S. multinationals.¹¹²

Liechtenstein's people have the highest living standard in Europe.¹¹³

The Cayman Islands is the fifth largest banking center in the world, after New York, London, Tokyo, and Hong Kong.¹¹⁴

The service sector accounts for three-fourths of Panama's national income.¹¹⁵

Banking in the Channel Islands is so popular that the minimum account has jumped to more than $100,000.¹¹⁶

Offshore banks are more likely to be profitable than onshore banks.¹¹⁷

In Asia, countries like Hong Kong, Malaysia, and Singapore have escaped Third World status thanks to low-tax policies.¹¹⁸

Financial services provide 80 percent of Jersey's income.¹¹⁹

Why the OECD Proposal is Misguided

Because the OECD proposal was developed in order to protect member nations from tax competition, it will have sweeping ramifications. Taxpayers will be harmed, of course; but the proposal also will have significant adverse implications for privacy, sovereignty, free trade, technological development, and the rule of law.

An Assault on Taxpayers

The OECD report clearly argues that tax competition is bad and that governments should work together to stop "harmful" tax practices. What this really would entail, however, is the creation of a cartel of high-tax nations that would impose its will on low-tax jurisdictions.¹²⁰ The issue was neatly summarized by an Australian economist, who wrote

If the concern is with whether a country's tax regime induces economic activity to shift, than all tax competition is necessarily harmful. The only way to prevent tax-induced changes of investment location would be for all countries to adopt the same tax system and the same tax rates.¹²¹

To the non-economist, a tax cartel would be a way to change the rules of the game so that the "losers" would not have to compete.¹²² The OECD study advocates that governments work together to stop "unfair competition." Consider, for instance, the following published OECD statements:

"That `race to the bottom', where location and financing decisions become primarily tax driven, will mean that capital and financial flows will be distorted and it will become more difficult to achieve fair competition"¹²³

"[I]nternational cooperation is necessary"¹²⁴

Global enforcement of tax laws is "difficult to address effectively on a unilateral basis"¹²⁵

"[T]axation is no longer simply the territory of individual governments ... global action is needed"¹²⁶

"Tax authorities must develop global cooperative networks."¹²⁷

Many of the world's policymakers apparently think that a tax cartel is a good idea. For high-tax nations like Germany and France, this is understandable.¹²⁸ Yet the OECD project is receiving support from such relatively low-tax nations as the United States and the United Kingdom that currently benefit from tax competition. U.S. Treasury Secretary Larry Summers, for instance, has stated that "Cooperation between national tax administrators is absolutely critical."¹²⁹ Moreover, he says, "A key element of this effort must be to minimize opportunities for tax arbitrage across borders. Cooperation between national tax administrators is absolutely critical."¹³⁰ Great Britain also seems unwilling to defend its national interests. The government supports "coordinated international action" to stop tax competition.¹³¹

Even more worrisome, a tax cartel may be just the beginning. Advocates of the OECD project repeatedly stress the need for "global" action.¹³² As the Irish Times reported, the OECD has acknowledged that the current campaign is just the first step.¹³³ Unfortunately, that next step may be a radical proposal to create a new international organization "with worldwide enforcement powers."¹³⁴ The U.K.-based Commonwealth Secretariat foresees the OECD's actions as "the initial kernel of a `world tax organization.'"¹³⁵ This may sound preposterous, but consider the following statements:

Oxfam, an interest group that supports the OECD's campaign, urges the use of "global standards to define the tax base."¹³⁶ Moreover, it says a "global tax authority could be set up with the prime objective of ensuring that national tax systems do not have negative global implications."¹³⁷

A senior U.K. tax collector observed that "countries affected by harmful tax competition must take measures to protect themselves.... [D]omestic action is simply not effective and has to be underpinned by concerted international cooperation."¹³⁸

A high-level IMF official suggested that, "At some point the United Nations or some international conference should prescribe the minimum regulatory framework a country should have."¹³⁹

Whether the OECD "only" creates a tax cartel or whether this effort ultimately results in the creation of a global tax authority, the outcome will be bad news for taxpayers. The business community clearly understands this and has written that the OECD effort "translates into higher taxes for business."¹⁴⁰ But individual taxpayers are also in the crosshairs. Using language that suggests redistributive policies, the OECD has written that, "The goal of these measures is to ensure that the burden of taxation is shared fairly."¹⁴¹ This sentiment has been echoed by interest groups with pronounced left-of-center leanings.¹⁴²

An Affront to Free Trade and Global Commerce

In order to force the so-called tax havens to comply with their non-binding requests, the OECD report proposes that member nations subject low-tax regimes to severe and discriminatory financial protectionism.¹⁴³ (See Appendix.) This heavy-handed approach would impose crippling restrictions on international capital flows. In effect, the conditions and restrictions envisioned by politicians who support this initiative would impose a financial blockade against the targeted nations.¹⁴⁴

Though the OECD has no legislative powers, the organization does suggest a panoply of fees, penalties, charges, restrictions, and other measures that could be implemented by member nations. In a remarkable twist, the OECD even referred to these steps as "defensive measures."¹⁴⁵

A key question, of course, is whether the OECD member nations actually would implement the drastic steps the organization proposes. Unfortunately, it appears that the answer may be yes. The G-7 nations issued a statement that they are willing "to condition or restrict financial transactions with those jurisdictions."¹⁴⁶ The U.S. Treasury Secretary, meanwhile, has endorsed added regulatory burdens on financial institutions in low-tax countries.¹⁴⁷ Another Clinton Administration official has endorsed discriminatory treatment against offshore institutions.¹⁴⁸ The French have gone further, arguing that "the International Monetary Fund should oversee capital flows into these centers."¹⁴⁹

Some policymakers in OECD member nations want to go even farther, imposing a total embargo against low-tax nations and territories. Representative Jim Leach (R-IA) has introduced a bill (H.R. 3886) that would "bar U.S. institutions from providing correspondent banking services for a whole class of banks that are licensed in offshore jurisdictions."¹⁵⁰ Senator Charles Schumer (D-NY) has testified that financial institutions incorporating in areas with "bank secrecy laws should not be allowed to participate in the U.S. financial system or transact with U.S. financial institutions.¹⁵¹

Once again, the French have adopted the most extreme position. The French president talked about outlawing all financial transactions with low-tax regimes.¹⁵² The French Finance Minister echoed this sentiment, stating that he is ready to "cease all financial relations of whatever type" with offending countries."¹⁵³ The British Manchester Guardian expressed a similar view, editorializing that, "Ultimate sanction may even be a ban on banking transactions between institutions in countries belonging to the OECD and banks in tax haven nations."¹⁵⁴

These views are antithetical to the free flow of trade and commerce, as any type of discriminatory treatment or financial embargo would be "accompanied by onerous rules, which will restrict and impede legitimate worldwide commerce."¹⁵⁵ Moreover, financial protectionism contradicts the OECD's professed support for "the concept of free trade and investment across national frontiers."¹⁵⁶

Not surprisingly, several countries have pointed out this hypocrisy. Caribbean leaders have stated that "tax competition is just another form of free trade in a globalized world."¹⁵⁷ And as Switzerland observed, "This results in unacceptable protection of countries with high levels of taxation, which is, moreover, contrary to the economic philosophy of the OECD."¹⁵⁸

An Attack on Sovereignty

The OECD's proposal would substantively interfere with the right of sovereign nations to determine their own tax policies. High-tax nations are especially interested in forcing so-called tax havens to raise their tax rates and eliminate financial privacy. But as the former Vice President and Chief Economist of the U.S. Chamber of Commerce, Richard Rahn, noted, such a radical approach represents "financial imperialism."¹⁵⁹

In effect, the OECD seeks to overturn 200 years of established international practice so that high-tax nations can impose taxes on assets and activities outside their own territory.¹⁶⁰ Traditionally, governments have used a "territorial" or "source-based" rule for taxation, allowing them to tax all incomes and activities within their borders.¹⁶¹ And because this type of system was not concerned with economic activity in other nations, conflicts were non-existent.¹⁶²

The problem with a territorial system--at least from the perspective of the OECD--is that it facilitates tax competition between nations.¹⁶³ As such, even though it is a recognized rule that one country should not be compelled to collect taxes for the benefit of another country, the OECD appears willing to discard tradition so that its member nations can seize more revenue.¹⁶⁴

The OECD report would impose restrictions on the tax policies of member nations.¹⁶⁵ More important, it would make low-tax countries abandon the activities upon which their livelihoods have been based.¹⁶⁶

Pressuring Third World Countries
Most OECD nations made the jump from poor, agriculture-dependent economies to industrial powers during the 1800s--a period when most did not impose income taxes of any kind. Today, poorer nations are being told they cannot adopt similar policies in order to have an attractive investment climate--a demand that has been called an "infringement on their sovereignty by a group of rich white nations."¹⁶⁷ In a stunning display of arrogance, a senior OECD official reportedly stated that the tax competition project was designed to "close down the islands in the sun."¹⁶⁸

The "advance commitment" letters the OECD sent to the so-called tax havens are a stark example of the organization's disregard for sovereignty. These OECD-drafted letters (see sidebar) require low-tax nations to make "imprecise and open-ended commitments" with regard to changing their tax system."¹⁷²

The OECD insists that with these letters it is merely trying to uphold internationally accepted standards, but it would be more accurate to say that the organization is trying to change international norms and practices. According to The Financial Times , "The implication is that the OECD intends that certain rules and practices relating to tax matters, of the most powerful countries in the world, should be imposed internationally on other jurisdictions."¹⁷³ Stripped of diplomatic double-talk, this is simply an "attempt to bully tax havens into raising their tax rates."¹⁷⁴

Many of the elected leaders in the less-developed nations clearly understand what is at stake. A sampling of their reactions includes:

The OECD is engaged in "economic terrorism";¹⁷⁵

"[T]he proposed OECD actions have no basis in international law and are alien to the practice of inter-state relations";¹⁷⁶

The Dominica Prime Minister vowed, "We will not give up our sovereign rights";¹⁷⁷

"[I]nternational organizations must not be allowed to discriminate against countries that do not have a seat at the decision-making table";¹⁷⁸

The OECD "would make us tax collectors for foreign countries";¹⁷⁹

Chief Minister David Brandt of Montserrat said, "The territory will not be relegated to the position of informer";¹⁸⁰

"[O]ur success should not lead other[s] to want to penalize us";¹⁸¹ and

A Barbados minister accused the OECD of practicing "institutional blackmail."¹⁸²

If a tax cartel is implemented, taxpayers in the industrialized world will be adversely affected. For certain countries targeted by the OECD, however, the results could be catastrophic. Some countries could see their GDP drop by as much as 25 percent--similar to what happened to the United States during the Great Depression.¹⁸³ In all likelihood, this would make these regimes dependent on OECD nations for aid, thus replacing market-based self-reliance with government-to-government dependency.¹⁸⁴

Writing in the Canadian Tax Notes, David Louis grimly notes that, "the prospect of driving some of these countries back to banana republic status is not troublesome to the OECD, if that is what it takes to impose its tax policies."¹⁸⁵ An expert in the United Kingdom, meanwhile, observed that:

The unspoken message seems to be--remain poor and we will occasionally throw you a bone of foreign aid or buy your expensive bananas. But don't get uppity and try to compete, or we will hit you with everything we can, from income tax to stamp duty.¹⁸⁶

The OECD tries to defend its actions by asserting that it also is asking member nations to eliminate "preferential regimes."¹⁸⁷ Nevertheless, the organization is not acting in an unbiased fashion. While it would threaten to penalize low-tax regimes, it includes no concrete penalties for its own members. In any event, it is trying to sidestep the core argument over whether sovereign regimes should be able to determine their own fiscal affairs.¹⁸⁸

An Attack on Privacy

Because it is impossible to tax worldwide income without knowing the worldwide assets and activities of taxpayers, eliminating financial privacy is an integral element of the OECD's proposal. This is a drastic step, one that undermines the common law principle that bank secrecy is an implicit part of the contract between banker and client.¹⁸⁹ Financial privacy historically has been viewed as "an essential safeguard of the citizen against the power of dictatorship."¹⁹⁰ Indeed, the famous Swiss laws regarding banking secrecy were significantly strengthened in 1934 after Adolf Hitler took control in Germany.¹⁹¹

Supporters of the OECD argue that people no longer need to worry about individual freedom and government oppression. Yet the United Nations recently stated that, "For much of the twentieth century, governments around the world spied on their citizens to maintain political control. Political freedom can depend on the ability to hide purely personal information from a government."¹⁹² And even if there is no immediate threat of dictatorship, privacy is still an important value, and government is prone to misuse personal information.¹⁹³

But bank secrecy laws do more than just protect privacy. They also provide systematic benefits to a country's financial institutions. The OECD admits that, "Customers would be unlikely to entrust their money and financial affairs to banks if the confidentiality of their dealings with banks could not be ensured."¹⁹⁴ As a result, bank secrecy laws can help stimulate a vibrant financial services industry.¹⁹⁵

Finally, privacy also makes it harder for criminals to select victims.¹⁹⁶ Many citizens, particularly those from the developing world, want confidentiality to reduce the likelihood of kidnapping and other violent crimes.¹⁹⁷ The ability to have private offshore accounts also enables people to protect themselves from financial instability and expropriation.¹⁹⁸

Those benefits could soon disappear. The OECD initiative would give government carte blanche access to personal financial information.¹⁹⁹ And the ability to snoop would not be limited by national borders. If successful, this effort would give tax collectors "a license to inspect any bank account anywhere."²⁰⁰ To make this happen, the OECD is pressuring low-tax nations to sign agreements that would give foreign tax collectors the right to rummage through accounts in search of tax revenue.²⁰¹

The G-7 nations supported this effort in a communiqué:

We also reaffirm our support for the OECD's report on improving access to bank information for tax purposes and call on all countries to work rapidly toward a position where they can permit access to, and exchange, bank information for all tax purposes."²⁰²

But the assault on financial privacy extends well beyond low-tax nations. The OECD and its allies want to force financial institutions and other businesses in all countries to divulge information about their customers to the government. In effect, opponents of tax competition want to extend the controversial "know-your-customer" regulations that compel banks to spy on their customers to other professional service providers.²⁰³ Ultimately, proponents of the OECD approach would like to repeal all types of client confidentiality.²⁰⁴ Consider, for instance, these proposed measures:

Under a plan being advocated by the Clinton Administration, "broker/dealers, casinos and money-service businesses would be forced to file the same suspiciou