TCS Daily

Paris, Taxes

By Daniel J. Mitchell - May 19, 2004 12:00 AM

An interesting policy debate is taking place in Paris. On one side is an international bureaucracy that opposes tax competition. This organization wants to hinder the flow of jobs and capital from high-tax nations to low-tax jurisdictions. It endorses tax harmonization and defends this policy as being necessary to facilitate income redistribution. This bureaucracy's anti-tax competition campaign is explicitly designed to facilitate high tax rates and the double-taxation of savings and investment. This statist institution even persecutes jurisdictions with free market tax policies.

Fortunately, there is an international bureaucracy in Paris with a differing viewpoint. This organization recognizes that tax competition is a liberalizing force in the world economy. It has written that, "[T]he ability to choose the location of economic activity offsets shortcomings in government budgeting processes, limiting a tendency to spend and tax excessively." It does not try to scapegoat so-called tax havens. Instead, this bureaucracy says the real problem is bad tax policy. It explains that, "[I]llegal 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."

This pro-free market institution supports supply-side tax policy. Its economists have estimated, "that economies grow one-half of 1 percent (0.5 percent) faster for every 10-percentage-point reduction in marginal tax rates." This organization understands that the correct tax base is just as important as low tax rates, noting that, "the best way to improve economic performance would be to replace current wage-income and capital-income taxes by a general tax on consumption." As a matter of fact, this bureaucracy just called for lower tax rates in Eastern Europe and cited Ireland as an example of how a nation can use market-based policies to dramatically boost national living standards.

Needless to say, this organization has views that are completely and diametrically opposed to the views of the other bureaucracy. But what really makes this debate interesting is that all of the aforementioned policies are advocated by just one institution -- the Organization for Economic Cooperation and Development (OECD). Funded by 30 of the world's developed nations, this international bureaucracy was originally created in the 1960s to promote economic liberalization and market-based reforms.

Unfortunately, not all parts of the OECD have stayed true to the original mission. This schizophrenia, at least in the field of tax policy, is partly the result of organization structure. The career economists who work directly for the OECD usually are market-oriented. They keep up with the academic research and they work closely with member nations, allowing them to observe the clear link between tax policy and economic performance.

But the OECD also has a division known as the Committee on Fiscal Affairs (CFA). Consisting of representatives from the tax authorities from member nations who meet sporadically, the CFA has a small permanent staff comprised mostly of lawyers. It has a "tax enforcement uber alles" mentality, and the CFA is responsible for the OECD's "harmful tax competition" project -- an endeavor that threatens low-tax jurisdictions with protectionism unless they agree to help high-tax nations track flight capital so it can be subjected to double-taxation.

The CFA's agenda is controlled by high-tax governments, primarily France and Germany, but even representatives from low-tax governments often have the same statist mindset since tax collectors tend to identify with each other rather than the interests of their individual countries. Participants from the US Treasury Department, for instance, have been sympathetic to the anti-tax competition scheme, even though the United States is the world's biggest beneficiary of international capital flows and is a "tax haven" according to the OECD definition. The enthusiasm has been more muted since George W. Bush became president, to be sure, but career bureaucrats at Treasury (and even some political appointees) have been quite willing to undermine the current administration's pro-tax competition philosophy.

If nothing else, the OECD's internal inconsistency teaches an important lesson about the consequences of giving excessive authority to a specialized group like the CFA. Simply stated, such entities are incapable of looking at the broader picture. A university, for instance, would never allow its Chemistry Department to make decisions on behalf of the entire school. An automobile company would never give the marketing department unlimited authority over all business decisions. And a hotel would never let the catering division dictate how other sectors operate.

Yet by giving the CFA carte blanche to remake the world according to the narrow wishes of tax collectors, the OECD opened a Pandora's Box. As a result, the Paris-based bureaucracy has been severely criticized because the anti-tax competition effort undermines economic reform, causes international conflict, emasculates the rule-of-law, diminishes national sovereignty, and attacks individual privacy. These problems presumably could have been avoided had the original scheme been subject to some form of peer review, even if only from the OECD's career economists.

That is the bad news. The good news is that the CFA's anti-tax competition scheme is stalled. Many low-tax jurisdictions nominally acquiesced to the OECD, but only on the condition that OECD member nations agree to abide by the same misguided rules. But since nations like the United States, Switzerland, and Luxembourg have been unwilling to eviscerate their attractive tax and/or privacy laws, this means that jurisdictions on the OECD blacklist have no obligation to undermine their competitive position in the global economy.

Equally important, the CFA's anti-tax competition effort has significantly damaged the reputation of the OECD and many congressional Republicans now are talking about reducing the amount of money appropriated to the organization. And since most OECD bureaucrats live a very comfortable life -- everything from tax-free salaries to a well-stocked wine cellar, there is now an incentive for the headquarters staff to apply some much-need oversight on the activities of the CFA.

Daniel J. Mitchell is a Senior Fellow in Political Economy at the Heritage Foundation and the author of The Flat Tax: Freedom, Fairness, Jobs, and Growth. He recently wrote for TCS on The Real Threat From the East.


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