December 31, 2003

December 31, 2003 | Commentary on Taxes

Siren Song

Every year, as we wade through hundreds of tax forms and thousands of pages of regulations, it's hard to believe the United States is actually a low-tax nation. But for all our faults, we're light years ahead of many European nations.

And they're doing everything they can to change that-by trying to drag us down to their level.

One way they want to do that is with the innocent-sounding concept of "tax harmonization." The idea is to make national borders unimportant: A Frenchman would be charged his country's confiscatory tax rates on any money he earned, whether he earned it in France, the United States, or elsewhere.

This seems like a good plan for high-tax countries like France and Germany. But it would be a disaster for the United States, and for individual investors worldwide.

There's about $5 trillion in foreign-owned capital invested in the U.S. today, including more than $1 trillion deposited in U.S. banks. Smart investors put their money here because they know it will be safe (a violent coup seems unlikely), and because our Congress has made the sensible decision to not tax the money that foreigners deposit in our banks (the investors get to keep what they earn).

This money helps create jobs in America-but perhaps not for long, thanks to a draft IRS regulation that would help foreign governments tax the interest income their citizens earn on American investments.

The regulation was slipped in just three days before President Clinton left office. The Bush administration hasn't implemented it, but investors remain nervous. They know they could see their tax bills soar if it takes effect.

There are several problems with this regulation. For one thing, it's unfair. Income should be taxed based on where it is earned, not where a taxpayer happens to live.

That simple concept encourages governments to slash taxes to encourage investment. As my Heritage Foundation colleague Daniel Mitchell has written, "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." The trend toward lower taxes is something we should encourage, not stifle.

Also, the regulation is illegal. Federal agencies such as the IRS are supposed to enforce only those laws passed by our Congress, not the laws of other nations. And in this case, not only would the IRS be acting as a tax-collector for foreign governments, it would actually be ignoring the wishes of our lawmakers, who have specifically sought to attract money to our economy by not taxing interest paid to foreign-held accounts.

Finally, the regulation would endanger our economy. Again, one reason foreign capital comes here is because smart investors realize they'll be able to pocket their gains. If we start imposing-or even facilitating-French and German taxation levels, investors will take their money elsewhere.

That would harm the banking industry. Investment banks currently hold hundreds of billions of dollars in foreign capital. Imagine all the money flowing out of our economy overnight to, say, Hong Kong, where the government maintains a fair, flat tax.

It also would damage our federal treasury. Foreigners hold at least a third of our debt. If they're forced to pay tax on the interest they earn here, they won't invest here, and we'd have to find somebody else to purchase our Treasury bills.

There are plenty of ways that we could improve our tax system. But "tax harmonization" isn't one of them. If high-tax European countries want to succeed economically, they should start singing from the low-tax hymnal-and begin enjoying the growth that goes along with it.

About the Author

Edwin J. Feulner, Ph.D. Founder, Chairman of the Asian Studies Center, and Chung Ju-yung Fellow
Founder's Office