U.S. Benefits from International Tax Competition

Published January 1, 2007

The beneficial effects of international tax competition continue, 25 years after President Ronald Reagan and Prime Minister Margaret Thatcher of Great Britain reduced personal income tax rates. Many other nations followed suit, much to the benefit of the global economy.

In 2006 alone, plans for tax reductions and major reforms were announced by a string of nations, including the Isle of Man, Switzerland, the Netherlands, Germany, and New Zealand.

Government officials in all those nations have cited the need to make their economies more competitive in attracting foreign investment. All are finding ways to govern more efficiently, reduce tax rates, and thus keep jobs and capital within their borders.

The ultimate effect is a more robust global economy that benefits workers, consumers, and investors worldwide.

‘Celtic Tiger’ Roars Ahead

This is more than theory; it is real-world experience. A few years ago Ireland cut tax rates on corporations, capital gains, and personal income. Since then, the “sick man of Europe” has become the “Celtic Tiger.” Other European nations have been cutting corporate tax rates to keep pace.

In 2001, Russia abolished its so-called progressive tax and enacted a flat tax, in part because the Baltic nations of Estonia, Latvia, and Lithuania had adopted successful flat tax systems.

To remain competitive, other Eastern European nations soon went down the same path.

Ukraine implemented a 13 percent flat tax, and Slovakia scrapped a tax code with a 38 percent top rate in favor of a 19 percent flat tax. Romania adopted a 16 percent flat tax, and Georgia now has a 12 percent flat tax.

Competition, Freedom Indispensable

To friends of free markets, there’s nothing surprising in this. We know that competition, and the freedom it requires, are indispensable foundations of prosperity.

Unfortunately, many lawmakers and policymakers today need to be educated on the importance of tax competition.

Lower tax rates and tax reform came about in these cases because each nation started to compete for capital and labor. Like gas stations at a busy interstate exit, each has to fight for customers.

As Nobel laureate Milton Friedman has said, “Competition among national governments in the public services they provide and in the taxes they impose is every bit as productive as competition among individuals or enterprises in the goods and services they offer for sale and the prices at which they offer them.”

Unfortunately, there has been a growing threat to tax competition. Even though government officials in many countries have responded to competitive pressure by reforming their uncompetitive tax regimes and lowering tax rates–the correct approach–others are bucking the trend.

‘Old Europe’ Attacks Competition

High-tax welfare states such as Germany and France have no desire to compete with low-tax nations. Their aim is to eliminate the competition, because tax competition threatens the revenues that support their top-heavy welfare states.

Big government is the status quo in much of Europe. In 1965, the 15 European Union nations were taking 28 percent of their combined gross domestic product in taxes. By 2000, they were taking almost 42 percent.

But tax competition has forced them to begin trimming taxes, which have fallen about two percentage points since 2000.

That is not a big drop, but it’s enough to show welfare statists the writing on the wall: If tax competition continues to flourish, they will be forced to reduce taxes and gradually abandon the stale principles of their centralized, command-and-control economies and permit greater economic and political freedom.

Rather than do that, they have mounted an all-out offensive to preserve the status quo.

NGOs Provide Clout

High-tax European countries are using multinational organizations to press their agenda.

Operating through international bureaucracies such as the Organization for Economic Cooperation and Development (OECD), European Union (EU), and United Nations (UN), the welfare states of Old Europe are using their clout to dictate policies that are detrimental to lower-tax countries.

Those bureaucracies favor “tax harmonization” to combat tax competition.

Tax harmonization can be inflicted on low-tax countries in two ways. In some cases, the international bureaucrats argue for explicit harmonization, which would occur by forcing all nations to enact high tax rates. In other cases, they urge implicit forms of harmonization such as global information-sharing, so high-tax governments can track and tax capital that flees to lower-tax countries.

Many high-tax welfare states want low-tax nations to “share” private financial information on non-resident investors. If the OECD has its way, financial privacy will be emasculated, a goal it made explicit in June 2004 with its amended Tax Model Convention.

U.S. Is Target

The United States should care about this because even though U.S. tax rates are far too high and the aggregate tax burden is onerous, American taxpayers are lucky compared with their counterparts in the nations of Old Europe. As such, this anti-tax competition campaign by Old Europe, the OECD, the EU, and the UN is particularly worrisome.

As momentum builds for fundamental tax reform in the United States, international pressure would make it all the more difficult to achieve any real results. According to many of the international bureaucracies, proposals such as a flat tax would be “unfair.”

The anti-tax-competition schemes of the international bureaucracies would thus hinder the flow of jobs and capital to America.

According to the Commerce Department, foreigners have invested more than $10 trillion in the U.S. economy. This money creates a huge number of jobs and dramatically boosts American prosperity, but our competitive position will be undermined if European governments are able to reach across the ocean and tax that money.

Coalition Defends Competition

To combat such proposals, the Center for Freedom and Prosperity started the Coalition for Tax Competition, which includes more than 35 influential organizations. Participants include The Heritage Foundation, Cato Institute, American Enterprise Institute, American Conservative Union, Americans for Tax Reform, FreedomWorks, National Taxpayers Union, and the Small Business & Entrepreneurship Council.

The coalition is fighting to restrict funding to the OECD and UN and other international organizations if they continue to promote taxing U.S. citizens and corporations or otherwise interfering with American tax policy. The coalition has been successful in stalling the advancement of these schemes so far, but continued vigilance is needed.

Andrew F. Quinlan ([email protected]) is president and CEO of the Center for Freedom and Prosperity and its affiliated think tank, the CF&P Foundation.

For more information …

For more information on tax competition, tax harmonization, and the OECD and UN tax grab schemes, visit the Center for Freedom and Prosperity’s Web site at http://www.freedomandprosperity.org.