The End of Financial Privacy

Why Switzerland, Luxembourg, and Austria caved on protecting its foreign investors.

Despite a long, storied history of protecting financial privacy, Switzerland, Luxembourg, and Austria recently announced that they will soften rules on banking secrecy to root out tax dodgers for foreign countries. Fearful that they might be missing a chance to collect more taxes, European bureaucrats have pressured the three countries to change their policies for years. After the Organization for Economic Cooperation and Development (OECD) threatened to put them on a blacklist of tax havens just before the start of April's Group of 20 (G-20) meetings, Switzerland, Luxembourg, and Austria have finally caved.

Bank secrecy laws have long been seen as an obstacle to tax enforcement. Supposedly by setting up "safe havens" for French euros, bank secrecy laws get in the way of the French government forcing its high income tax rates down its taxpayers' throats. The only way to fix this problem, the French argue, is for all nations to implement an automatic and unlimited exchange of information about nonresident investment. So-called tax havens, goes this line of thinking, should collect private financial data on foreigners and turn that information over to the appropriate governments.

Forcing relatively low-tax jurisdictions to serve as vassal tax collectors for European welfare states is a brilliant idea if one wants to preserve higher-tax policies and impose multiple layers of taxation on saved and invested income. It is a death blow to healthy tax competition, since it would permanently undermine the right of nations to determine how income earned inside their borders—such as interest paid to foreigners on the income they invest in another country—is taxed. Like other forms of economic competition, tax competition is good at generating new and innovative ways of doing business and creating value. But European politicians have always claimed that tax competition and the financial privacy that goes along with it simply abets tax evasion. The politicians want instead a policy of "tax harmonization," which they think would make countries less competitive and reduce capital flight from one place to another.

However, basic economic theory tells us that if a country wants to reduce tax avoidance and evasion, all it has to do is lower its own tax rates and simplify its tax code. These are far more effective tools for thwarting tax evasion and reducing capital flight than tax harmonization across a number of countries. European governments should give tax reform a try instead of trying to force other nations to adopt a single, uniform system.

But most of them won't, and as they keep losing capital to lower-tax nations, they will continue to try to undermine countries with strong privacy laws. Until now the European Union (E.U.) failed to force countries such as Switzerland and Luxembourg to give up their privacy laws, mainly because the United States refused to agree to participate in the shared information schemes pushed by the E.U. As one of the biggest recipients of foreign capital, the U.S. knew that it had much to lose.

So why would Switzerland, Austria, and Luxembourg cave now? The Paris-based OECD announced that it was preparing an updated list of uncooperative tax havens for presentation at the April 2 summit of the leaders of the G-20 countries. These meetings traditionally feature politicians from around the world jockeying to promote bad ideas. This one looks to be no exception, with members planning to discuss sanctions on banking centers that fail to provide legal assistance with international tax probes.

Switzerland, Austria, and Luxembourg were on the new OECD blacklist. After meeting together to discuss the matter, the countries decided to give up their years of resistance to avoid the financial consequences of being treated as rogue financial states. It didn't help that the U.S. and China—two countries who might have been on their side in the past—are going to the meeting with some bad ideas of their own, such as convincing unwilling Europeans to spend more money on stimulus-spending plans. In order to have a better shot at getting what they want regarding pump-priming, Switzerland, Austria, and Luxembourg seem more than ready to sacrifice previous stands on financial privacy. After all, neither the Obama administration nor China appears to value financial privacy much anyway.

While that sort of political compromise is understandable, it is sad news for those who do value financial privacy—or any other kind of privacy. Switzerland claims that it will share information only after a country issues a detailed request on an individual case. Don't count on it. German Finance Minister Peer Steinbrueck has told Der Spiegel that he wants countries like Switzerland to unveil the names of their account holders "even when there's no concrete suspicion of tax evasion." Like virginity, financial privacy is awfully difficult to regain once surrendered.

Veronique de Rugy is a Reason columnist (read her archive here) and an economist at the Mercatus Center at George Mason University.