Tax Haven Haters

The OECD's hypocritical campaign against low-tax countries.

"I'm a uniter, not a divider," boasts Heritage Foundation economist Daniel Mitchell. "I brought Maxine Waters and Jesse Helms together on an issue. I want a Nobel Peace Prize."

Mitchell is actually looking for something more modest than a Nobel. And to achieve it, he'll need at least the tacit approval of President George W. Bush, the man who first put the phrase "uniter, not divider" into play. Mitchell, Waters, Helms, and more than 30 other members of Congress want the United States to drop out of an international effort to crack down on countries that provide foreigners tax-free, and private, financial services.

Although individuals still physically reside in particular countries, capital is increasingly mobile. Many small countries specialize as capital caretakers, offering private, tax-free financial services. Thirty mostly high-tax countries, conveniently organized under the auspices of the Organization for Economic Co-operation and Development, label these countries "tax havens."

The OECD has spent the last three years decrying "harmful tax competition" and fretting about other countries' tax policies that "distort the location of capital and services." Last year, the OECD identified 35 "tax havens," all conveniently small, non-OECD member countries. Each of these countries, the OECD claims, is guilty of some combination of offering tax-free accounts to foreigners, failing to report earnings to the tax authorities of other countries, not having transparent rules and regulations, and treating foreigners differently than locals. If they don't pledge by July to reform their ways, the OECD encourages its member nations to take "defensive measures"–such as burying citizens who invest in those countries in paperwork, not honoring tax exemptions for reported income from these countries, and withholding income from citizens of targeted countries.

The issue is complex, as if often the case with questions of taxation and justice. What's fair and morally right is hotly disputed and ambiguous at best. There are, however, many good, non-tax related reasons for people to seek private tax-free offshore accounts. For example, Americans who want to invest in companies that haven't met Security and Exchange Commission guidelines need to do so from outside U.S. borders. Investing in a tax-free country saves reams of paper work for investors who'd be eligible to have offshore taxes refunded anyway. And let's not forget the need to escape government despotism. Secret accounts were useful to anyone being persecuted by Nazis, citizens of communist regimes, and anyone else who doesn't trust a government not to confiscate their wealth.

But the tax issue is legitimate as well. Tax competition, like any competition, disciplines governments. The U.S. tax cuts of the 1980s kept taxes lower in Europe than they otherwise would have been, just as Virginia's lower taxes puts pressure on neighboring Maryland and the District of Columbia. The United States is a giant free-trade zone in which states compete as tax jurisdictions; we've all benefited from it.

Perhaps the most offensive aspect of the OECD initiative is its blatant hypocrisy. Critics note that all of the tax sinners are small, non-member countries, but these countries certainly don't account for the preponderance of tax-driven investment behavior. Self-audits by OECD countries turned up no less than 61 preferential tax practices–and that count grossly underestimates the phenomenon. Consider the United States, which cops only to one violation, Foreign Sales Corporations, which allow domestic companies to avoid U.S. taxes.

"It does not surprise anyone when I tell them that the most important tax haven in the world is an island," international tax expert Marshall Langer pointed out in a speech last November. "They are surprised, however, when I tell them that the name of the island is Manhattan."

By OECD standards, we are the largest tax haven in the world. The United States, for example, taxes neither interest nor capital gains earned by non-resident aliens. This offer isn't available to citizens or residents. And it doesn't require financial institutions to notify the Internal Revenue Service of any earnings, which means we're not tattling to foreign governments. (The only exception is Canada.)

It's not as if Congress wouldn't like to tax the income of foreigners. It's that members understand that if they did so, considerable sums of money would flee the country, which would hurt our economy. "We have $7 to $10 trillion of foreign investment in our country," says Heritage's Mitchell, who contends that picking off the small countries is simply the first step in a prolonged campaign by high tax France to get at such obvious tax havens as Switzerland, the United Kingdom, Hong Kong, Singapore, and the United States. "We are the biggest threat to basket-case economies like France because the United States is a place where you can have your money managed and invested in one place with zero taxes and privacy."

And that explains why both Jesse Helms and Maxine Waters are on the same side of this issue. Helms doesn't like an international effort that will result in higher taxes; he also understands the U.S. is a huge beneficiary of tax competition. Waters and 25 other Congressional Black Caucus members don't like the targeting of poor Caribbean countries that are using financial services to develop their economies. Who can blame her? The OECD proposes to send in the World Bank and other dispensers of international welfare to make up for the loss of the thriving financial industries. "Of course we are attentive to the potential impact on their economies," says OECD head of Fiscal Affairs Jeffrey Owens, "which is why we have initiated a dialogue with our Development Assistance Committee."

The OECD, however, has a major problem: It's not a government. Although it can arrange a cartel among sovereign states, it can't enforce its will. The Clinton Administration happily went along with the OECD initiative, but President Bush might have different ideas. It's an issue for the Treasury Department, and so far Secretary Paul H. O'Neill hasn't committed. The administration resisted pressure to issue a statement supporting the OECD initiative at a G7 meeting in late April. The OECD hosts a ministerial meeting in Paris in mid-May, at which time observers expect the U.S. to have settled its position. "If we get the Bush administration to tell the OECD to jump in a lake because this is contrary to U.S. economic interests, we win," says Mitchell. "If the career bureaucrats in Treasury and the IRS convince it to go along, we lose, although we can still fight it in Congress."

They certainly can. And they'll certainly win: The Maxine Waters-Jesse Helms coalition will be able to block just about anything.