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May 2014



Growing the Global Economy Through Offshoring and Tax Competition

Written by , Posted in Taxes
Coauthor(s): Dan Mitchell
Originally published in China Offshore
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High-growth nations have learned the importance of good tax policy when it comes to enhancing prosperity and living standards. Low marginal tax rates reward productive behavior by encouraging people to work more, save more, and invest more. Bad tax policy, on the other hand, can significantly stunt economic development. More specifically, excessive taxes on capital – such as capital gains, dividends, interest and inheritances taxes –are particularly destructive because they inhibit the formation of capital, which all economic theories agree is necessary for economic growth.

With economic growth comes advancement in human prosperity. Even slight differences in growth rates provide a major impact over time thanks to compounding. A seven percent growth rate can double economic output every 10 years, for instance, but a one percent growth rate can only do so every 70 years. Even smaller differences can be profound. A modest three percent rate of growth means doubling economic output in less than 24 years, or about once every generation or so.

Unfortunately, politicians rarely care about promoting growth, and often are themselves obstacles to its achievement. They care more about raising tax revenues that can then be spent in the quest for the accumulation of personal power and prestige.

The Power of Competition

Thankfully there is a mechanism by which the interests of the people in growing the economy can be imposed, at least to some degree, onto the political class. Tax competition between jurisdictions makes it difficult for politicians to impose bad policy and it gives them an incentive to adopt less punitive tax policies instead.

This is because when individuals and businesses relocate either physically or financially to jurisdictions with more favorable tax rates, they apply pressure on home governments to reduce excessive taxation. Nations that ignore competition suffer fiscally and economically, whereas those which embrace it are shown to prosper.

When the U.S. and the U.K underwent tax reform under Ronald Reagan and Margaret Thatcher, it kicked off a round of global tax cutting. The number of flat tax nations increased ten-fold, and the top income tax rates on both corporations and individuals plummeted.

Competition’s Discontents

Where there are political winners there are also losers. Short-sighted politicians see only declining tax rates and not the benefits that come with economic growth, including higher revenues in the long run. Acting through the Organization for Economic Cooperation and Development (OECD), politicians in high tax nations reacted by seeking to erode tax competition. Their efforts to create a global tax cartel – essentially an “OPEC for politicians” – have resulted in a constant imposition of new obstacles to fiscal competition.

The effort began with a 1998 OECD entitled, “Harmful Tax Competition: An Emerging Global Issue.” When a backlash erupted, the organization backed off from officially labeling tax competition as harmful and instead sought ways to slowly chip away at its effectiveness.

The bureaucrats and politicians who supported this effort claimed that they merely wanted to crack down on illegal tax evasion, but their actions indicate that the real goal is to make it easier for politicians to grab more money from the economy’s productive sector.

For example, in 2009 at the Mexico City meeting of the OECD’s Global Forum on Transparency and Exchange of Information for Tax Purposes, organizers secretly inserted a bombshell into their draft “summary of outcomes” document. Legal tax planning and avoidance were suddenly identified as a “harmful tax practice” on par with evasion.

This was a shot aimed squarely at the heart of tax competition, with a clear goal of hindering the legal movement of capital toward low tax jurisdictions. It again induced a backlash from attendees, with China taking a lead role in scuttling the effort.

Despite the Mexico City setback, the OECD continued to make progress in their quest. Nations that use their tax code to attract investment are constantly pressured and cajoled into abandoning recognition of financial privacy rights, and have been forced into signing lopsided information sharing treaties designed to eliminate the benefits of relocating for tax purposes.

If the politicians from high-tax nations can’t prevent jurisdictions from offering more competitive tax policies, then they are content to stop their citizens from taking advantage of them.

Opposition Reaches Fever Pitch

Even with their successful introduction of Tax Information Exchange Agreements and other measures designed to blunt the impact of competition, the OECD continues to assert new powers over the flow of global capital. The latest item on the agenda is the bulk and automatic exchange of taxpayer information between jurisdictions. In reality, this means information will flow one way – from low-tax jurisdictions to high-tax jurisdictions – since nations with good tax policy have no interest in seeking revenues from extraterritorial earnings.

The OECD is piggybacking on international financial upheaval created by U.S. passage of the Foreign Account Tax Compliance Act (FATCA), which imposes unilateral requirements on foreign institutions to report information collected on Americans to the U.S. government. Through FATCA, the United States is asserting its universal “right by might” to enforce domestic tax laws on the entire world. FATCA purports to combat tax evasion, using a dragnet-style spying regime that threatens to cost the world far more than it will rise in new revenue for the U.S. government.

Rather than be appalled by the United States’ assault on fiscal sovereignty, or its onerous and costly burdens on the global financial sector, the OECD appears jealous of FATCA’s bold demands and the bureaucrats have used to it justify their own renewed assault on competition.

The G20 and the OECD have recently asserted a new global standard. The July 2013 Communiqué at the conclusion of the Meeting of Finance Ministers and Central Bank Governors in Moscow declared the body is “committed to automatic exchange of information as the new, global standard.” They even acknowledge that FATCA “acted as a catalyst for the move towards automatic exchange of information in a multilateral context.”

The OECD’s pursuit of automatic exchange of taxpayer information threatens the foundations of tax competition by making it possible for all nations to tax income no matter where it is earned. Currently only the United States engages in this destructive practice, but politicians in other nations are no less greedy than their American counterparts; they have simply lacked the means to apply such a policy in the past. With new rules to pressure other tax agencies to help spy on their citizens throughout the world, the OECD’s new standard would make it much easier for additional governments to adopt the practice of worldwide taxation. Making it more difficult for citizens to take advantage of low-tax jurisdictions will erode the power of competition in restraining political excess. The inevitable result is higher global taxes and reduced economic output.

OECD tax policy head Pascal Saint-Amans calls these developments a “watershed moment for international tax policy,” and OECD Secretary-General Angel Gurría has trumpeted its new standard as “a real game changer.” The game he refers to is international tax competition, which has for so long worked in the interests of taxpayers, and the change he desires is a tilting of the field away from economic producers and toward wealth confiscators.

In the past the OECD has relied heavily upon coercion to establish its tax regimes. This tactic has worked because the targets of their attacks are typically small and too afraid to stand up for their sovereign rights. But as Western nations continue to languish under the destructive weight of excessive taxing and spending, the emergence of new global competitors with increased political power could change the dynamic. If Chinese citizens want to continue to avail themselves of favorable tax policies – and maintain the pressure created by tax competition at home – they should oppose efforts by the OECD to rewrite in their own interests the rules of global commerce.