Tax Competition: Enemy of the Welfare State

by | Sep 9, 2002

In addition to offering sanctuary to the world’s tax-burdened, tax havens provide an indirect benefit to the tax-payers who remain pinned under welfare state tax burdens: they cause tax rates and tax burdens in those welfare states to be lower than they might be otherwise. The Business and Industry Advisory Committee to the OECD (BIAC), […]

In addition to offering sanctuary to the world’s tax-burdened, tax havens provide an indirect benefit to the tax-payers who remain pinned under welfare state tax burdens: they cause tax rates and tax burdens in those welfare states to be lower than they might be otherwise. The Business and Industry Advisory Committee to the OECD (BIAC), in a report commenting on the OECD’s 1998 study, put it this way:

It is unwarranted taxation by governments, rather than competition among them in the tax area, that is stifling economic and business development. . . . Tax competition tends to keep tax burdens lower, which creates pressure for less wasteful and therefore more efficient use of public funds. . . . In a world which generally espouses free cross-border trade and investment, multinationals are, in major part, free to structure and operate their businesses as they see fit, generally in a manner that makes most sense from a business point of view. . . . The theme of the report, which involves taking proposed actions in a concerted way, runs counter to the notion of free and unrestricted cross border business activities.17 (emphasis added)

This is a decent statement. But not wishing to question the gargantuan welfare states that make oppressive taxation possible, BIAC also adds that it “understands the valid concern of governments to protect their revenues from unwarranted erosion.”

In fact, there’s nothing “valid” about today’s world-wide web of punitive regulation and confiscatory taxation, which makes virtual invalids of producers. And there’s nothing “valid” about the welfare state, which is nothing but a huge scheme to shackle, punish and tax the successful in order to subsidize the unproductive (recipients of individual and corporate welfare) and the anti-productive (primarily government officials — including OECD bureaucrats). Oppressive taxation wouldn’t be possible without the oppressive welfare state; it’s useless opposing the former while “understanding” the latter.

According to supply-side tax economist Steve Entin, “If high-tax foreign nations succeed in curbing capital flight to tax haven nations, the result may be less investment in the U.S.”18 The BIAC explains why that might be: “The end result of a wholesale adoption of the Report’s recommendations will be to raise the effective tax rates of the OECD-based multinationals.” Thus even those parties that do not currently access tax havens have a stake in this issue, since they benefit indirectly by tax havens that unwittingly check and curb punitive tax regimes elsewhere. Switzerland made this point, in its dissent to the OECD’s report:

A certain degree of competition in tax matters has positive effects. In particular, it discourages governments from adopting confiscatory regimes — which hamper entrepreneurial spirit and hurt the economy — and it avoids alignment of tax burdens at the highest level. The Report recognizes that each State has sovereignty over its tax system and that levels of taxation can differ from one State to another. However, that same report presents the fact that tax rates are lower in one country than in another as a criterion in identifying harmful preferential tax regimes. This results in unacceptable protection of countries with high levels of taxation, which is contrary to the economic philosophy of the OECD. (emphasis added)

Wall Street Journal editorialists, who otherwise support the welfare state, recognize this same benefit:

Tax competition between states is a good thing. The power of individuals and companies to vote with their feet is one of the most potent weapons against overweening government. Any attempt to deprive them of places to run must surely be considered an attack on freedom and a threat to prosperity.19

But in the words of the OECD, tax competition and the lowering of global tax rates represents a “race to the bottom.” It’s an interesting (and dishonest) use of words. Most people believe greater prosperity, made possible by lower tax rates and lower tax burdens, inspires a “race to the top” — that is, to the highest possible living standards. But leaders of OECD nations have a different standard in mind: their sole concern is that no one “poach” their “rightful” claims to wealth and that nothing sap — or drag down — their precious welfare states.

OECD officials don’t really care about wealth creation, even though the benefits of “tax competition” — between high-tax nations — were obvious in the 1980s. Starting with tax-rate cuts in Britain pushed by Prime Minister Thatcher — followed by President Reagan’s tax-rate cuts from 1981 to 1986 — most governments in the industrialized world were forced to cut their tax rates as well (for fear of losing capital).

That pattern is shown in Table Eleven. On average in 1979 these seventeen major countries imposed a top marginal tax rate of 61%. But five years later the average top rate was 53% — and then fell further, to 41% in 1989 and 39% in 1996. Britain’s top rate was reduced from a punitive 83% to 40%. South Korea adopted the largest cut, from 89% in 1979 to 40% in 1996. The top U.S. rate fell from 70% in 1979 to as low as 28% after 1986, before rising again in 1991 (to 31%) and 1993 (to 40%) amid the Clinton-Bush administrations.

Table Eleven
Top Marginal Tax Rates on Personal Income,
Globally Ranked by Largest Reductions, 1979-1996

Country 1979 1984 1989 1996 Change from
1979 to 1996
South Korea 89% 55% 48% 40% -49%
United Kingdom 83 60 40 40 -43
New Zealand 66 66 33 33 -33
Brazil 55 60 25 25 -30
Malaysia 60 45 45 30 -30
United States 70 50 28 40 -30
Singapore 55 40 33 28 -27
Japan 75 70 50 50 -25
Thailand 60 65 55 37 -23
Italy 72 65 50 51 -21
Indonesia 50 35 35 30 -20
Argentina 45 62 30 30 -15
Chile 60 57 50 45 -15
France 60 53 53 52 -8
Canada 58 50 47 53 -5
Hong Kong 15 17 20 15 0
Germany 56 56 53 58 2

It’s no coincidence that the 1980s and 1990s saw a re-birth of economic growth and entrepreneurial activity. Put simply, the Atlases of the world weren’t being punished to the extent they had been in the 1970s. The incentive effects of tax rate cuts on the world’s top income-earners is illustrated in Table Twelve (page 9). On average in 1979 they retained only 39% of each new dollar earned; the rest went to the welfare states. In 1984 they were able to retain 46% of their newly-earned income, still less than half, but an 18% rise in after-tax income. By 1996 they were able to keep 61% of each new dollar earned, a 56% rise compared to 1979.

Tables Eleven and Twelve also show that the high-tax European nations — those with the world’s biggest welfare states — most resisted cuts in top marginal tax rates in the 1980s and 1990s. In fact, Germany’s top rate was a bit higher in 1996 (58%) than it was in 1979 (56%). And France cut its top rate by just 8% points, from 60% to 52%. Nevertheless, without the leadership of Thatcher and Reagan — without “tax competition” — it’s doubtful that broad-based tax rate cuts around the world would have occurred at all.

Because the U.S. reversed course on tax policy — and raised its top tax rate in 1991 and 1993 — the impetus for further tax cuts around the world virtually disappeared. The recent enactment of tax rate cuts in the U.S. — though measly (reducing the top rate from near to 40% to just 35%, still above the 1991 rate) and stretched out over five years — could still induce yet another return to global rate cuts. But the OECD’s assault on tax havens — and on its own rate-cutting members — diminishes that possibility.

References:

17 The Business and Industry Advisory Committee to the OECD, “A Business View on Tax Competition,” June 1999 (available at www.biac.org).

18 Stephen J. Entin, “Treasury’s Qualified Intermediary Regulations and the OECD Tax Haven Initiative: Threats to International Capital Mobility and Investment,” IRET Congressional Advisory #116, Institute for Research on the Economics of Taxation, June 28, 2001, p. 5 (available at www.iret.org).

19 “Tax and Trade,” The Wall Street Journal, September 22, 1999.

20 The OECD devoted an entire report (an astounding 116 pages long) to the issue of bank secrecy. See OECD, “Improving Access to Bank Information for Tax Purposes,” March 24, 2000 (available at www.tax-news.com/asp/res/bankinfo.pdf). The OECD notes that “The effective administration and enforcement of many laws and regulations, including those on taxation, require access to, and analysis of, records of financial transactions” and, blurring the distinction between tax avoidance (legal) and tax evasion (illegal), writes that “conditions where financial records and transactions can be concealed from, or access denied to, law enforcement officials may present numerous and obvious opportunities to evade and avoid taxation.” (p. 7, emphasis added)

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Dr. Salsman is president of InterMarket Forecasting, Inc., an assistant professor of political economy at Duke University and a senior fellow at the American Institute for Economic Research. Previously he was an economist at Wainwright Economics, Inc. and a banker at the Bank of New York and Citibank. Dr. Salsman has authored three books: Breaking the Banks: Central Banking Problems and Free Banking Solutions (AIER, 1990), Gold and Liberty (AIER, 1995), and The Political Economy of Public Debt: Three Centuries of Theory and Evidence (Edward Elgar Publishing, 2017). In 2021 his fourth book – Where Have all the Capitalist Gone? – will be published by the American Institute for Economic Research. He is also author of a dozen chapters and scores of articles. His work has appeared in the Georgetown Journal of Law and Public Policy, Reason Papers, the Wall Street Journal, the New York Times, Forbes, the Economist, the Financial Post, the Intellectual Activist, and The Objective Standard. Dr. Salsman earned his B.A. in economics from Bowdoin College (1981), his M.A. in economics from New York University (1988), and his Ph.D. in political economy from Duke University (2012). His personal website is richardsalsman.com.

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