TCS Daily

Europes Tax Harmonization Agenda a Threat to the High-Tech Economy

By Daniel J. Mitchell - August 30, 2001 12:00 AM

Globalization is bad news for the world's over-taxed welfare states, particularly those in Europe. Thanks to the increased mobility of capital, individuals can more easily shift their economic activity to low-tax jurisdictions. Such tax competition liberalizes the world economy by putting downward pressure on taxes and government spending.

Not surprisingly, politicians from high-tax governments resent this constraint. Using international bureaucracies like the Organization for Economic Cooperation and Development (OECD), the European Union (EU), and the United Nations as front groups, these lawmakers are pushing to "harmonize" taxes across countries. Their argument is simple: It is unfair when nations with low taxes lure savings, investment, and entrepreneurial talent away from nations with high taxes.

As might be expected, the European experience demonstrates that harmonization always means that taxes go up, not down. The direct form of tax harmonization - a requirement that all countries have similar tax rates - is not politically feasible outside of Europe. So high-tax nations are pursuing an indirect form of harmonization known as "information exchange." Under this policy, governments agree to collect detailed financial information about taxpayers from other nations - including investors and entrepreneurs - and then swap that data with tax collectors from other countries.

Information exchange allows a high-tax nation like France to subject income earned by its citizens in other countries to French tax rates. Then French taxpayers are, for all intents and purposes, held hostage by this system of "worldwide" taxation. No matter where they move their money, they are unable to benefit from lower taxes. But good news for French politicians is not good news for the world economy, and higher taxes are just the tip of the iceberg.

But this is not just a fiscal policy issue. The multilateral assaults on tax competition also represent bad policy across a variety of fronts. Indeed, Europe's tax harmonization agenda is a threat to technological development, especially in the financial services sector.

The tax harmonization agenda has adverse tech implications. The willingness of consumers to adopt new technologies and to expand their use of existing technologies could be undermined if they feel government is monitoring their private financial transactions. Another problem is that governments may stifle new technologies because they are not able to monitor private financial transactions. Here is what international bureaucracies have in mind:

1. The OECD is worried that "smart cards" and other forms of digital cash will make it difficult to track financial flows.

2. The Financial Action Task Force (FATF), an arm of the OECD, is concerned that the Internet makes it possible for people to do business in other nations without the knowledge of government.

3. The OECD and the EU both are seeking to create monitoring systems for e-commerce so consumers no longer have the freedom to shop where taxes are lower.

4. The United Nations blames financial deregulation for creating too many new products and services because it is now more difficult for governments to track money.

5. An OECD official has stated that online banking is a dangerous problem.

6. Those who fear transactions taking place without government supervision also have targeted the cyber-payments system. The OECD even has suggested limiting the range of online services or the amount of transactions.

7. The UN has criticized stock exchanges and other financial institutions that allow anonymous trading.

8. The FATF actually has suggested that it may be desirable to place restrictions on international ATM withdrawals.

The good news is that this tax collectors' wish list has not been put into action. The bad news is that information exchange - if implemented - will be the proverbial camel's-nose-under-the-tent. Once that occurs, there is no principled argument to prevent the government from co-opting new technologies and interfering with the development of more efficient financial markets.

Then there's the non-tech consequences of information exchange:

  • A loss of financial privacy. In order for governments to tax worldwide income, all nations must suspend financial privacy laws so that private data can be collected and shared with other governments.
  • A loss of fiscal sovereignty. The tax cartel envisioned by the OECD and EU only succeeds if every nation participates in the information exchange scheme. This is why low-tax jurisdictions are being coerced through blacklists and threats of protectionism
  • Bad trade policy. The OECD is so desperate to thwart tax competition that it is threatening low-tax nations with financial protectionism if they refuse to join the cartel. The trade barriers being considered would hinder global capital flows and violate WTO obligations.
  • Bad legal policy. The OECD and EU want to eliminate 4th Amendment protections that require probable cause before obtaining private information, and they also hope to do away with due process legal protections such as notification and the right to contest government actions.

  • Simply stated, tax harmonization is a threat to America's national interests. As the world's largest tax haven, America should defend tax competition. Unfortunately, the Bush Administration has sent mixed signals. The Treasury Secretary clearly has stated his opposition to explicit tax harmonization, yet he also testified in July that he would seek to negotiate information-exchange treaties with targeted low-tax countries.

    The United States is the biggest beneficiary of global tax competition and any effort to undermine this process - even if America is not the immediate target - will hamper our long-term competitiveness. Compared to other OECD member countries, we are a low-tax nation. Our marginal tax rates are moderate and the aggregate burden of taxation in America - about 30 percent of GDP - is significantly lower than it is in Europe. Indeed, compared to nations like France, where taxes consume about half the economy's output, we are a tax Mecca. Perhaps more important, the U.S. has very attractive tax and privacy laws for nonresident foreign investors. For them, America is the Cayman Islands.

    If countries accept the concept that governments should know everyone's private financial affairs, then any technology that allows individuals to do business in a confidential fashion will be seen as obstacles to what House Majority Leader Dick Armey has referred to as, "a global network of tax police."

    Daniel J. Mitchell is the McKenna senior fellow in political economy at The Heritage Foundation, a Washington-based public policy research institute.

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