To be fair, the United States' representatives have not completely capitulated to their European counterparts. Paraphrasing an old Clint Eastwood movie title, the new OECD proposal is part good, part bad, and part ugly.
Starting with the good news, the OECD did make a handful of concessions in an effort to obtain U.S. support. Most noticeably, the rhetoric has shifted. The OECD now refers to "harmful tax practices" instead of "harmful tax competition," and there is almost no discussion today of tax harmonization or the evils of low tax rates. On a more substantive note, the OECD is no longer demanding that low-tax jurisdictions automatically provide private financial information to foreign tax collectors. The organization also has agreed that it is okay for nations to offer favorable tax rates to foreign investors (so-called "ring-fencing").
The bad news is that low-tax countries would be required to turn over private financial information on a case-by-case basis. And even though "information exchange" in response to individual requests is not as objectionable as automatic exchange of all data, the principles of financial privacy and fiscal sovereignty are still emasculated. Why should low-tax nations, after all, be forced to amend their laws just because they have market-based policies that lure capital from high-tax nations? Moreover, limited information exchange surely would be the proverbial camel's nose under the tent. It would only be a matter of time before the OECD and other Europe-dominated bureaucracies used this agreement as the first step in the complete evisceration of privacy laws in low-tax jurisdictions.
The ugly news is that Washington is being snookered. The OECD proposal is a threat to America's economic interests. The U.S. tax system may be deeply flawed, but America is the Cayman Islands compared to some of Europe's welfare states. This is why the U.S. economy grows faster and creates more jobs than all of Europe combined. Yet this comparative advantage will be dissipated if information exchange gives foreign countries the right to impose their draconian tax rates on income that is earned in America.
Ironically, the European Union is having trouble getting its own member states to agree to the sorts of measures the U.S. seems close to accepting. In a compromise struck last year, the EU agreed to make an internal information-exchange agreement contingent on the participation of outsiders such as the U.S. and Switzerland. Without the U.S., the EU cannot get its tax cartel off the ground. And yet the U.S. is in danger of playing into Europe's hands.
What makes this development so bizarre is that the United States is the world's biggest beneficiary of tax competition. As such, America has the most to lose if it buys into the notion that a country must alter its tax and privacy laws if such policies have the effect of making it difficult for other nations to enforce oppressive tax systems.
The OECD is trying to pull a clever bait-and-switch scam on the U.S. Treasury. In exchange for giving up on tax harmonization, the Paris-based bureaucracy has convinced Washington to back limited information exchange. The problem with this deal is that tax harmonization was not -- and is not -- the immediate danger. Instead, the OECD's real agenda from the outset has been information exchange. The OECD is so keen on this concept that it even is threatening low-tax nations with financial protectionism unless they force their financial institutions to divulge client data so that high-tax nations can double-tax capital income on a world-wide basis.
But information exchange is a backdoor form of tax harmonization in that both policies make it very difficult for taxpayers to shift their money to lower-tax environments. Tax harmonization achieves this goal by making sure that all jurisdictions have similar tax rates. Information exchange achieves this goal by allowing a taxpayer's home country to tax economic activity in another nation -- particularly the returns on income that are saved and invested. In other words, an overburdened French taxpayer has little incentive to shift money to a lower-tax jurisdiction when France is able to tax any resulting income at French tax rates.
Information exchange would be bad news for both the United States economy and European taxpayers. America has a much lower tax burden than most other OECD nations, and it also has extremely appealing tax and privacy laws for nonresident foreign investors. For all intents and purposes, Europeans can invest in America without having to pay tax on their interest income or capital gains. But most importantly, they can make those investments knowing that the U.S. government does not require that income to be reported to home-country tax collectors. In other words, America is a tax haven.
And because these policies have helped attract trillions of dollars to the U.S. economy, it is downright foolish for American negotiators to support information exchange. It does not take a rocket scientist to figure out that high-tax nations will use the OECD agreement as a weapon in their campaign to force changes to American tax and privacy laws.
European tax havens such as Luxembourg and the U.K. would suffer too, and they know this; that is why they have insisted on U.S. complicity before signing up for the EU's information-exchange cartel.
Fortunately, the battle is far from over. In an attack led by the Heritage Foundation and the Center for Freedom and Prosperity, the OECD agenda has attracted intense opposition from a wide range of think tanks, taxpayer groups, and free-market organizations in America. To be sure, the OECD has some friends in Washington. Career bureaucrats at Treasury are ideologically sympathetic to information exchange, and they have been somewhat successful in manipulating the president's political appointees. At some point, the White House will have to step in and make a final decision. And since the choice is between Europe's tax collectors and America's private sector, the OECD probably will have very little time to enjoy its victory.
Daniel J. Mitchell is McKenna Senior Fellow in Political Economy at The Heritage Foundation.
Originally published in Wall Street Journal Europe (07/11/01)