Tax competition promotes good policy

Beginning with the 1998 publication of Harmful Tax Competition: an Emerging Global Issue, the Paris-based Organisation for Economic Co-operation and Development has been trying to bully low-tax jurisdictions into acting as deputy tax collectors for Europe ‘s welfare states.

The OECD was created to be a market-oriented think tank for 30 of the world’s industrialised nations, but the international bureaucracy is now controlled by countries such as France and Germany and is pursuing tax-harmonisation policies designed to stem the flight of capital from high-tax countries to low-tax countries.

The latest chapter in this battle will take place in Melbourne next week.

The OECD is hosting a global forum so its bureaucrats can team up with representatives from tax authorities of member countries, including Australia , in an effort to convince so-called tax havens to act as deputy tax collectors for high-tax nations. (It is worth noting that this project is riddled with hypocrisy since many OECD member nations, such as the United States, the United Kingdom, Switzerland, Luxembourg, Austria, and Belgium, are “tax havens”, according to the OECD’s own definition, yet they are not being asked to emasculate their attractive tax and privacy laws.)

The OECD’s anti-tax competition project is fundamentally inconsistent with good tax policy. Public finance experts almost universally recognise that an ideal tax system is characterised by low tax rates and the absence of a bias against saving and investment.

Tax competition has helped encourage governments to shift policy in this direction. Simply stated, if politicians are afraid that jobs and capital will escape across the border, they are more likely to lower tax rates and implement tax reform.

There are three historical episodes that illustrate how tax competition has become a liberalising force in the global economy:

1. The Thatcher/Reagan personal income tax rate reductions

Sweeping tax rate reductions were a significant component of both the Thatcher and Reagan agendas. The United Kingdom and the United States both benefited from these reductions, but other nations also profited because they were compelled to lower tax rates. Indeed, the average top tax rate in industrialised nations today is 20 percentage points lower than it was in 1980.

2. The Irish corporate tax rate reduction

Less than 20 years ago, Ireland was an economic basket case with double-digit unemployment and an anaemic economy. But after slashing the corporate income tax rate to only 12.5 per cent, the “sick man of Europe ” has become the “Celtic Tiger”. Ireland now enjoys the second-highest standard of living in the European Union and it has to import workers. Thanks to tax competition, Ireland ‘s tax rate reductions have had a positive effect on the rest of Europe . Among industrialised nations, average corporate tax rates have dropped by nearly 20 percentage points.

3. Flat taxes in Eastern Europe

Beginning with the Baltic nations in the 1990s, nine former Soviet bloc nations have implemented the flat tax. Tax competition is a key factor. Russia adopted a flat tax in 2001 after observing how well it worked in Estonia , Latvia and Lithuania . And Russia ‘s economic boom helped motivate Ukraine , Serbia , Slovakia , Romania and Georgia to join the flat-tax club. Poland and the Czech Republic may be the next dominoes to fall, and there is even discussion of the flat tax in “Old Europe” nations as well.

It is hardly surprising that France and Germany want to thwart tax competition. Jobs and capital are leaving those countries and going to places such as Switzerland , Hong Kong , the United States , Ireland , the Cayman Islands and Singapore . High-tax nations want to stop that flow, or at least retain the ability to tax flight capital – and the OECD is their vehicle.

Interestingly, the OECD is internally divided on the issue. The anti-tax competition project is controlled by the fiscal affairs committee, which comprises representatives of the tax authorities of the member nations. Perhaps it should come as no surprise that they have a “tax enforcement uber alles” mentality. The OECD’s economists, by contrast, are very sympathetic to tax competition. They have written that “the ability to choose the location of economic activity offsets shortcomings in government budgeting processes, limiting a tendency to spend and tax excessively”. And rather than make scapegoats of low-tax jurisdictions, the economists have noted that the real problem is bad tax policy, writing that, “illegal tax evasion can be contained by better enforcement of tax codes. But the root of the problem appears in many cases to be high tax rates”.

The OECD’s anti-tax competition project should be abandoned. Nations should have the sovereign right to determine their own tax policy. High-tax governments should not be allowed to create an OPEC (Organisation of the Petroleum Exporting Countries) for politicians. Tax competition is promoting good tax policy around the world, and if this makes it more difficult for high-tax nations to enforce punitive tax regimes, that is something to be celebrated rather than persecuted.

During the Clinton administration, the United States government supported the OECD’s effort to create a tax cartel. Fortunately, the Bush administration has taken a different approach – notwithstanding the pro-OECD ideology of career bureaucrats at the US Treasury Department.

Leaders in Canberra should adopt a similarly sceptical attitude. Thanks to reforms implemented by both Labor and Liberal governments over the past 20 years, Australia has become one of the world’s strongest economies. And with the future tax reductions and tax reforms likely, Australia has every reason to support policies such as tax competition that benefit fiscally responsible nations.

Daniel Mitchell is senior fellow at The Heritage Foundation, USA . He is a keynote speaker at a Centre for Independent Studies tax forum, Tax Competition: the Adverse Impact of Harmonisation, to be held on November 14 in Melbourne . There is a similar event in Sydney on November 17.