BrianGarst.com

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.

Earlier this year, the Organization for Economic Cooperation and Development (OECD) released its finalized Standard for Automatic Exchange of Financial Account Information. The standard boasts requirements for sharing of a variety of information, including full account balances, that constitute both an intrusion on personal privacy and a costly imposition on the institutions expected to implement the standard.To make matters worse, nations are expected to adapt their laws and policies to accommodate the organization’s demands.

The OECD’s new standards are part of a lengthy effort by the Paris-based bureaucracy to police international taxation and force low-tax jurisdictions to conform to the will of large, high-tax welfare states. The fundamental issue has always been about the ability of individuals, businesses and capital to flow away from jurisdictions with bad or unfavorable tax and regulatory policies and toward jurisdictions with more attractive systems.The nations that consistently lose out to this kind of tax competition are the very ones who dominate the international discussion and hold the most influence within organizations such as the OECD.

The losers in this battle are nations like Panama, which seek to attract capital and investment through competitive policies but lack the power and leverage of the larger nations to advance their interests within international bodies. Past OECD efforts, such as the blacklisting of Panama and other low-tax jurisdictions as so-called tax havens, combined with efforts to compel adoption of policies against Panama’s economic interests, have proven costly and disruptive. But the new initiative is an existential economic threat unlike others Panama has faced.

Full automatic exchange of all tax information is de facto tax harmonization. It allows high-tax nations to pursue even income earned in other territories, which given their track record is likely to happen. This will negate the appeal of pro-growth tax systems and reduce the ability of Panama to attract international investment. Yet the OECD expects Panama and nations like it to jump at the initiative and pass legislation for the benefit of other nations. In a world where nations respected the sovereignty and rights of their neighbors, this would never happen. But we don’t live in such a world, and if Panama does not comply there will be punishments of some kind.

Given the heightened stakes and increased costs for compliance compared to prior demands, more significant punishments will certainly accompany the OECD’s current initiative. And while it’s worked in the past, eventually something will have to give. Low-tax jurisdictions cannot continue enabling the insatiable greed of international tax collectors, but on their own they also cannot be expected to simply absorb the high costs of non-subservience.

Perhaps it’s time to take a page from the OECD play book. Europe and the United States, which drive the OECD agenda, themselves rely heavily on international investment. Their fragile economies would not easily withstand a significant lose of foreign money. If low-tax jurisdictions band together and form a counter-OECD body to advance their own interests, they could similarly threaten to redirect investment toward more respectful nations unless their fiscal sovereignty is respected. That may seem like drastic action, but this could represent the last chance for Panama to defend its right of fiscal self-governance.

The Organization for Economic Cooperation and Development (OECD) claims that new rules in its recently published Common Reporting Standard for Automatic Exchange of Financial Account Information are necessary to eliminate tax evasion. They’ve used the same argument in the past to justify numerous other demands, and each time when low-tax jurisdictions undertook the costly process of meeting OECD mandates, the goal posts were subsequently moved.

Jurisdictions surprised by ever evolving standards make the mistake of taking OECD claims at face value. Far from being motivated primarily by reducing tax evasion, their true objective is to eliminate tax competition so that the world’s largest welfare states can maximize the extraction of wealth from the global economy.

Tax evasion is not a very complicated problem to solve. Nations with the highest compliance rates tend also to be those with the least burdensome tax code. If members of the OECD took the sensible route of lowering tax rates and ending double taxation on capital, they could achieve the twin objectives of increasing both prosperity and fairness.

Unfortunately, politicians in high tax nations have other goals. Chief among them is collecting every potential tax dollar they can get their hands on. This includes dollars that might otherwise be attracted, even legally, to jurisdictions offering more favorable tax rates or more efficient regulations. The OECD is not aiming to even the playing field, in other words, but to kneecap the competition.

Evidence of this agenda is simple to find. Numerous OECD documents refer favorably to the theory of capital export neutrality (CEN), which asserts that economic efficiency is best promoted by harmonizing tax rates between domestic and international investments. The argument is that so-called neutrality promotes the making of investment decisions on business rather than tax considerations, which in turn enhances economic efficiency. But CEN fails to account for the negative economic impact of high tax rates, and thus the legitimate reasons for considering the impact of taxes not just as a fundamental part of choosing an investment, but simply of running a successful business. CEN also ignores the positive impact of tax competition as a pressure for the adoption of pro-growth fiscal policy.

Elements of CEN theory were featured prominently in the OECD’s 1998 and 2000 anti-tax competition reports. While the anti-tax competition initiative was shelved after a backlash from both the U.S. and low-tax jurisdictions, subsequent OECD efforts – in particular those of the Global Forum on Transparency and Exchange of Information for Tax Purposes – continue to move in the direction of reducing or eliminating the ability of capital to gravitate toward more favorable tax structures.

Subsequent OECD efforts to pressure low-tax jurisdictions to sign tax information exchange agreements have not proven to be a mutually beneficial endeavor. While large nations have sought to acquire the information they desire in order to impose onerous tax rates no matter the location of their citizens or their money, low-tax jurisdictions which have no desire to double tax capital receive only the benefit of avoiding punishment for noncompliance.

This dynamic is not indicative of a healthy relationship built upon mutual respect between nations, and should provide low-tax jurisdictions with no stronger sense of security than the store operator feels after he’s paid the latest round of protection money to the local mafia.

Despite the asymmetry of benefits, it was nevertheless easy for low-tax jurisdictions to justify compliance. After all, if a nation presents evidence of wrongdoing on the part of a specific individual, it is not unreasonable for another to assist in the enforcement effort. Sure, the OECD’s tactics – including threats of blacklisting and economic sanctions – were both deplorable and an affront to national sovereignty and international camaraderie, but despite being also costly, the demands hardly appeared an existential threat to tax competition.

The current initiative is not so well disguised. Despite getting everything it has thus far requested, the OECD remains unsatisfied. The new standard’s demand for automatic transmission of bulk taxpayer data is aimed squarely at the heart of tax competition – and also the continued vitality of jurisdictions that rely on investment attracted by pro-growth tax policies and streamlined regulatory systems.

The U.S. is currently the only OECD nation that taxes the income of its citizens no matter where it is earned, but that will likely change with the widespread adoption of automatic exchange. OECD hand-wringing over so-called “double non-taxation” makes clear the distaste with which bureaucrats and finance ministers from high tax nations view the choice of other jurisdictions not to impose exorbitant tax rates on every type of economic activity. Widespread adoption of the new standard will allow them to rectify this perceived oversight.

Despite being the world’s largest (de facto) tax haven, attitudes in the U.S. have changed considerably since it helped torpedo the OECD’s anti-tax competition initiative in the early 2000’s. With passage of the Foreign Account Tax Compliance Act (FATCA), the U.S. has led the way on fiscal imperialism and the effort to globalize tax administration, which provided the opening the OECD needed to press ahead on its quest to eliminate tax competition.

The OECD acknowledges that FATCA “acted as a catalyst for the move towards automatic exchange of information in a multilateral context.” By unilaterally subjecting institutions to costly reporting requirements and draconian penalties for noncompliance, the United States inadvertently managed a feat in making the OECD seem reasonable that international bureaucrats couldn’t have dreamed possible.

In hopes of sparing the world from a proliferation of FATCA-like laws, some jurisdictions seem to have calculated that the OECD is the lesser of two evils. But if history is anything to go by, the costs of acquiescing to the OECD’s new initiative will be significantly higher than they first appear.

The new OECD standard, which is based largely on the model FATCA agreements, is being sold as a means to prevent the spread of FATCA-like laws and thus the need to comply with a hodgepodge of different rules and requirements. Even ignoring the obviously superior solution of standing up against fiscal imperialism and demanding that the U.S. stop its assault on the global financial sector, the OECD provides a poor alternative.

The new standards are themselves just a minimum requirement, and some nations will no doubt have demands that go above and beyond.

In other words, the new standard will do little to reduce the costs of complying with a multitude of different standards. But it will ensure the flow of information to high tax nations, which in turn will be used to facilitate the flow of tax dollars. Where will this leave low-tax jurisdictions?

After its initial defeats, the OECD realized that the way to boil a frog is not to dump it in blistering hot water, as it will simply jump out.

Rather, if the water is initially cool and the temperature raised gradually over time, the frog won’t notice the danger and will eventually boil alive. For more than a decade, the OECD has been slowly raising the temperature on tax competition and low-tax jurisdictions. They’ve so far played along and, like the frog, have yet to jump out of the water. But the water is no longer cool, and the new requirements threaten to send bubbles rippling toward the surface.

The time for low-tax jurisdictions to save themselves is now, but they must both recognize the gravity of the danger and possess the necessary fortitude to jump from the water.