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GLOBAL TAX ANALYSIS
The Outlook for "Tax Competition"
A Flat Tax for the U.S.A.?
By Andrew F. Quinlan
(Editor's Note: For over a decade, tax collectors from the European Union (EU) and the Organization for Economic Cooperation and Development (OECD) have carried out a campaign of threats and
intimidation against low-tax jurisdictions to force them to abolish bank secrecy and enforce the fiscal laws of high-tax nations.
That campaign now lies in tatters. Andrew Quinlan, head of the Center for
Freedom and Prosperity (CF&P), explains why high-tax governments haven't been able to stamp out tax competition, and what's ahead in the way of lower taxes and simpler, less coercive tax collection.)
Tax competition is a good thing. Despite longstanding efforts of high-tax welfare states to harmonize taxes at a uniformly high level, nations that have lowered taxes have
flourished.
Take Ireland, for instance. Not that long ago, Ireland was a high-tax nation. And it suffered from 15% unemployment and some of the EU's lowest living standards. Since slashing tax rates in the
1990s, Ireland has enjoyed a remarkable turnaround. The former "Sick Man of Europe" is now the "Celtic Tiger." Income is soaring, unemployment has plummeted to 5% and Ireland is now one of the richest economies in
Europe.
Ireland isn't alone in proving that tax competition works. The newest success stories come from the former communist states of Eastern Europe. Since 1994, eight European nations have adopted a flat
tax—Estonia (1994), Latvia (1995), Russia (2000), Serbia (2003), Ukraine and Slovakia (2004), and Georgia and Romania this year. Serious discussions are underway to implement a flat tax in Bulgaria, the Czech
Republic, Finland, Poland and Spain. And outside this "New Europe," even communist China is getting the flat tax fever. In 2003, they invited flat tax guru Alvin Rabushka to Beijing to discuss the possibility.
A low, predictable flat tax rate in these countries has not only led to economic growth, but has also boosted tax revenues. This shouldn't be a surprise. Corporate tax revenues skyrocketed when Ireland lowered
its corporate tax rate from 50% to 12.5%. The same thing happened in tiny Estonia, which has a flat rate of tax of 24% for individuals, which is slated to fall to 20% over the next two years. According to the Bank
of Estonia, government revenue for 2003 was 48 billion kroons (US$4.06 billion). That compares with 42 billion kroons in 2002, and 36 billion kroons in 2001. Obviously, lower taxes mean more—not less—government
revenues.
Motivated by tax competition, several other nations are reforming their tax systems. Austria recently lowered corporate taxes to 25% and Indonesia will cut its corporate tax rate to this level over
the next five years. Montenegro is lowering its corporate tax rate to 9% and permitting foreign investors to repatriate their profits tax-free. Turkey has reduced both corporate and individual tax rates. Finland is
eliminating its class-warfare wealth tax.
These developments, along with the results of the recent U.S. elections, make it increasingly unlikely that the EU and OECD initiatives to compel low-tax nations to
enforce the tax laws of high-tax countries like France and Germany will succeed. Indeed, on a wide range of issues, the elections represent a significant victory for tax competition and a clear defeat for the
advocates of tax harmonization.
The current U.S. political lineup—a Republican White House, augmented by additional Republican seats in the House and Senate—provides a golden opportunity for President Bush,
and a tax reform commission he has appointed, to steer the United States toward a simpler and more logical tax system. While the president's attempt to reform the Social Security entitlement program will garner most
of the attention this year, advocates of tax reform hope that he will look toward the recent developments in Eastern Europe for guidance. In particular, they hope for a strong flat tax initiative from the president,
who endorsed the concept during his re-election campaign.
However, there are several other issues that are important to supporters of tax competition, which include members of The Sovereign Society. These
items are discussed in the following paragraphs and more information can be found on the Center for Freedom and Prosperity's Web page (link below).
The OECD "harmful tax competition" scheme. The OECD wants
to empower high-tax governments to tax income outside their borders, thereby reducing or eliminating the advantage of investing or doing business in low-tax jurisdictions. The only way this would work is to
eliminate financial privacy so that foreign tax collectors can search for individual and business taxpayers with a connection with another country. The good news is that due to the efforts of U.S. lawmakers and
organizations like the CF&P, this onerous project is on life support.
One worthwhile initiative the United States could take to derail this campaign completely would be to reduce U.S. funding for the
OECD. Currently, U.S. taxpayers pay US$60 million each year to the OECD, representing 25% of its budget. Sen. Judd Gregg (R-N.H.) is spearheading this effort, which is likely to focus on cutting funding to the main
villain at the OECD—the Fiscal Affairs Committee, architects of the harmful tax competition scheme and comprised of tax collectors from OECD countries.
EU tax harmonization proposals. The EU "Savings Tax
Directive" requires all EU member states to pass details of interest payments to EU nationals to their respective tax authorities, or alternatively, withhold tax on interest payments to EU nationals. This scheme,
scheduled to become effective later this year, originally was predicated on the participation of six non-EU jurisdictions, including the United States and Switzerland. Fortunately, the Bush Administration in 2002
unequivocally rejected this proposal, severely crippling its application outside the EU.
United Nations International Tax Organization. Meanwhile, bureaucrats at the United Nations have proposed an
international tax organization with the power to levy and collect taxes across national borders. Thankfully, the Bush administration summarily rejected this privacy-destroying initiative.
IRS
interest-reporting initiative. This proposed Clinton-era regulation would compel U.S. financial institutions to report interest payments to foreign investors to the depositors' respective national tax authorities.
If the regulation becomes effective, experts predict it could drive US$100 billion or more from the U.S. financial system and place tremendous downward pressure on the volatile U.S. dollar. It could also breathe new
life into the OECD and EU tax harmonization schemes.
Corporate inversion and international corporate taxation. The 2004 tax reform law contains punitive provisions that prevent U.S. based companies from
re-chartering in low-tax jurisdictions such as Bermuda and the Cayman Islands. This law significantly undermines the competitiveness of American companies.
Americans living and working overseas. The United
States is the only major country that taxes its non-resident citizens. However, there's a silver lining in section 911 of the Internal Revenue Code, which excludes the first US$80,000 earned by expatriate Americans
from income tax. Pressure is building in Congress to eliminate this exclusion, thereby forcing millions of U.S. expats to pay two sets of income taxes—one to the country in which they reside and a second to the IRS.
There are many reasons for supporters of tax competition to be optimistic. However, there is much work to be done. Let's hope that the United States can learn from the success of our tax reform allies in
Eastern Europe and implement a tax regime that isn't based on outdated class warfare rhetoric, but is designed to create long-term economic prosperity.
Andrew F. Quinlan is president of the Center for Freedom and Prosperity and the CF&P Foundation. Both organizations are leading the international fight to preserve and protect tax
competition, financial privacy, and fiscal sovereignty. Visit CF&P's web site for up-to-date information on tax competition and a daily dose of their free market web log, The Market Center Blog. Link:
www.freedomandprosperity.org.
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