Date: September 26, 2012

To: Supporters of tax competition, fiscal sovereignty, and financial privacy

From: Andrew Quinlan and Brian Garst

Re: The Radical Agenda of Anti-Tax Competition Forces

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Opponents of tax competition have long argued that the need to combat tax evasion justified aggressive and counter-productive policies designed to eviscerate tax competition, financial privacy, and fiscal sovereignty. Coming off of recent legislative successes, such as passage of the Foreign Account Tax Compliance Act (FATCA), and taking advantage of big spending politicians on the hunt for more revenue, these groups are growing in strength and have been emboldened to push an even more radical agenda.

As part of an effort to dramatically expand the size and scope of governments at both national and international levels, organizations such as the Tax Justice Network (TJN), Citizens for Tax Justice, FACT Coalition, New Rules for Global Finance, Business for Shared Prosperity, Wealth for the Common Good, American Sustainable Business Council, The Main Street Alliance, and Business and Investors Against Tax Haven Abuse, among others, are waging an aggressive campaign to erode financial privacy rights, hinder tax competition, and fill government coffers with ever more resources extracted from the private sector in order to fund a statist agenda.

The Plan to Increase Taxes

Statists have always advocated for high taxes as a matter of “fairness,” but what we’re seeing today is a constant moving of the goalposts, redefining the idea of fairness to encompass ever higher taxes and ever more government spending. This is a convenient rhetorical tool, as once a public is sold the emotional argument of growing government for ostensible reasons of fairness, they don’t need to be re-convinced after each successive expansion of the state. There’s always more “unfairness” in the world to solve, and thus always more need for government.

A typical example of this approach can be seen in a recently released report by TJN, titled “The Price of Offshore Revisited,” which portrays all cross-border financial activity as illegitimate and untaxed.¹ If you bank offshore, it must be to avoid taxes or to hide income, according to the reports authors. Using this self-serving assumption of the illegitimacy and untaxed nature of every dollar invested overseas in so-called tax havens – referred to as “pirate banking” – the report breathlessly estimates at least $21 trillion in “missing” dollars that needs to be “put to use.”

You read that correctly. They believe that money belongs first to government and that money in the productive sector of the economy is not being “put to use.” Rather, some government bureaucrat could better allocate resources than private individuals, entrepreneurs, investors and businesses.

As shocking as this argument is, they make little effort to hide it. At a recent event titled, “United States: A Tax Haven,” and sponsored by New Rules for Global Finance, the Heinrich Böll Foundation and the FACT Coalition, an entire panel of anti-tax competition forces openly discussed the supposedly dire need to get more money into the hands of politicians and bureaucrats, and made it clear that they see eliminating tax competition and financial privacy as a key way to do it.²

To illustrate the single-minded tenacity with which they pursue more taxes, and how little the tax hikers care about the economic destruction left in their wake, Jack Blum, Chairman of Tax Justice Network, admitted that FATCA – which threatens foreign financial institutions with stiff penalties if they don’t comply with burdensome new reporting rules and otherwise act as deputy US tax collectors – is a “draconian law,” but said that he supports it anyway as a “very positive development.” This is a law that is estimated to raise not even one billion per year in additional revenue for the US, but which will impose costs many times that amount, both on the affected international institutions, and also on the American economy. A “very positive development,” indeed.

Attacking Tax Competition

The event began with journalist Leslie Wayne discussing Delaware’s competitive practices, a topic she covered in a recent article for the New York Times titled, “How Delaware Thrives as a Corporate Tax Haven.”³ Among Delaware’s list of apparently questionable practices is being “so eager to attract businesses that the office of its secretary of state stays open until midnight Monday through Thursday,” a factoid which she repeated at last month’s event, along with the shocking realization that “Delaware officials go around the globe promoting Delaware as a place to do business.” Why, it’s almost like they want people to prosper!

Delaware’s real crime, as Ms. Wayne makes clear in her article, is that it attracts business, using a so-called “loophole,” from other states that “are desperate for tax dollars.” But tax competition is no loophole, and the fact that it upsets profligate politicians is a feature, and not a bug.

The attacks on tax competition came in many different forms. For instance, Rebecca Wilkins of Citizens for Tax Justice favorably cited the definition of “tax haven” used by Nick Shaxson, a radical anti-tax competition activist, as being “a jurisdiction that tries to attract business by creating a stable financial and economic system – an environment where it makes it easy to avoid the rules and regulations that would apply to them in their home jurisdiction.”⁴ You read that correctly, they really think it’s bad to offer a stable financial and economic system to attract business! In this view, if one nation has bad regulatory policies, no other nation can offer a better alternative as that would be providing a means for “avoiding” the bad regulations. It thus comes as little surprise that Wilkins also referred to Delaware as a “parasite” taking revenue “out of the system,” as if the fruits of private labor properly belong in the hands of tax collectors.

But it got even worse. Wilkins later attacked tax competition between governments as “a terrible thing,” and repeated the nonsensical accusation that it promotes a “race to the bottom.” In reality, tax competition promotes efficiency and restraint, pressuring governments to focus on only those core services necessary for the functioning of a free and prosperous society, instead of draining resources out of the productive sector to fund every vote-buying scheme that power-hungry politicians are able to imagine.

How They’ll Spend Your Money

Jo Marie Griesgraber, Executive Director of New Rules for Global Finance Coalition and moderator of the Tax Haven event, said the mission of New Rules is to “promote global justice through the regulation of international financial institutions.” Simply put, they want to extract as much money from the private sector as possible so that politicians and bureaucrats can then spend it on a wish list of statist programs. In fact, underlying the entire discussion was an abhorrent belief that resources are best put to use by governments, as opposed to the private sector, and that most if not all of the world’s problem could be solved if only taxes were higher and governments had more money to spend.

Panelist Liane Schalatek of the Heinrich Böll Foundation, an organization affiliated with the German Green Party, said that there is “a lot of money needed for the realization of the Millennial Development Goals,” a United Nations list of vague policy objectives typically used to justify a catalog of radical left-wing policies, and a need to fund “global public goods,” such as “combating climate change.” Jack Blum, also a former John Kerry staffer who famously fabricated the claim that tax havens result in $100 billion of lost revenue to the Treasury each year⁵ – a claim still repeated today – then bemoaned that there was “no revenue for anything.” Just how many more trillions will it take to satisfy their greed?

The wish list of spending programs offered by the anti-tax competition organizations offers just a hint at an answer to that question. The American Sustainable Business Council wants to “ensure that taxpayer dollars are spent on American-made renewable energy systems, including solar, wind, geothermal, and biofuels.” Wealth for the Common Good wants to “build a more just economy,” including a “minimum safety net that is adequate enough to allow all members of our society to live in dignity.” Jubilee USA, a member of the FACT Coalition, wants to cancel sovereign debt of developing nations. Calls to dump an endless stream of funds into the Special Climate Change Fund and the Least Developed Countries Fund, global redistribution funds created under the auspices of fighting climate change, are also frequently heard. And after all these things are done, it’s certain a new set of demands will quickly arise.

Conclusion

The Tax Justice Network report declares that governments are “starved of resources,” but optimistically asserts it has successfully “located a huge pile … of untapped financial wealth.” But being relatively unmolested by government is not the same thing as being untapped. The so-called tax havens often operate way-stations temporarily collecting savings from around the world until they are invested in productive projects – real economic projects that would be expected to take a back seat to the political priorities of elite global bureaucrats and the special interests pushing anti-tax competition organizations.

In order to increase the amount of other people’s money that politicians are able to spend on redistributive policies, these organizations want to dismantle all rights to financial privacy, eliminate tax competition between governments, and deny the ability to of taxpayers and institutions to escape bad policies. It’s hard to describe these arguments as anything other than madness. Unfortunately, the class-warfare based, tax-and-spend philosophy upon which they base their agenda is shared by the nation’s highest elected officials and appointed bureaucrats, and is cheered on in both the news media and popular culture.

Despite the increasing openness of their true agenda, the public is still often sold a different view. Calls for higher taxes and reduced financial freedoms are typically made with references to “fairness.” But as their own rhetoric demonstrates, they view “fairness” as an ever adjustable threshold to be used to fund an endless stream of government spending projects. The true purpose of anti-tax competition policies, in other words, is to finance a radical agenda too unpopular to be implemented without the force of government and political subterfuge.

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Endnotes

¹“The Price of Offshore Revisited: New Estimates for Missing Global Private Wealth, Income, Inequality and Lost Taxes,” available at  http://www.taxjustice.net/cms/upload/pdf/Price_of_Offshore_Revisited_120722.pdf

²Full video of the event is available at http://www.new-rules.org/events/3-nr-event/407-us-a-tax-haven

³“How Delaware Thrives as a Corporate Tax Haven,” available at http://www.nytimes.com/2012/07/01/business/how-delaware-thrives-as-a-corporate-tax-haven.html

⁴Wilkins cited Nick Shaxson’s book, “Treasure Islands: Uncovering the Damage of Offshore Banking and Tax Havens”

⁵See Congressional Research Service Memorandum, http://www.freedomandprosperity.org/files/blum-crs-ltr.pdf

The Case Against Taxing Powers and Direct Funding for International Organizations

International Organizations have historically relied upon payments from member governments to finance their operations. This creates a semblance of accountability since nations can withhold funding or withdraw membership if an organization engages in improper or imprudent behavior.

Since the bureaucrats running international organizations are not elected, such indirect control is the only way for national governments – on behalf of their taxpayers – to oversee the responsible use of funds.

This is why it would be imprudent to give international bureaucracies an independent source of revenue. Not only would this augment the already considerable risk of imprudent budgetary practices, it would exacerbate the pro-statism bias in these organizations.

Moreover, the first incidence of direct taxation to fund an international organization would unleash a tidal wave of similar direct-funding proposals. The camel’s nose would soon become an entire animal, then followed by a herd.

Global Tax Proposals

The issue of taxing powers and direct funding has become an important issue because international organizations are challenging the contribution model and pushing for independent sources of revenue.

The United Nations has been particularly aggressive in pushing for global taxes, seeking to expand its budget with levies on everything from carbon to financial transactions. Indeed, financial transactions have long been the go-to tax option for would be tax collectors. The United Nations Development Programme (UNDP) has been pushing for this levy for decades. Most recently, the 2011 Human Development Report, commissioned by the UNDP, called for a global redistribution regime – financed by taxes on either international currency or financial transactions – in order to promote “social justice within and amongst nations,” and “to fund the fight against climate change and extreme poverty.”

Another subsidiary of the United Nations, the World Health Organization (WHO), is also looking to self-fund through global taxes. The WHO in 2010 publicly considered asking for global consumer taxes on internet activity, online bill paying, or the always popular financial transaction tax. Currently the WHO is pushing for increased excise taxes on cigarettes, but with an important condition that they get a slice of the added revenue. The so-called Solidarity Tobacco Contribution would provide billions of dollars to the WHO, but with no ability for taxpayers or national governments to monitor how the money is spent.

The Dangers

What all of these proposals have in common – in addition to their obvious intended use in promoting statist policies – is that they would erode the influence of national governments, reduce international accountability, promote waste, and undermine individual sovereignty and liberty.

The imposition of global taxation to fund international organizations would require the cooperation of national governments to act as collection agents. While this means governments will not be entirely powerless, it is also important to realize that there will be immediate and ongoing pressure to reduce the role and influence of national governments.

Before long, international organizations will begin proposing – no doubt in the name of efficiency or reducing the burden on nation states – that affected taxpayers withhold and transfer taxes directly to the international body. This would effectively mean the end of the Westphalian system of sovereign nation-states, and would result in a slew of new statist policies, and increased waste and corruption, as bureaucrats make use of their greater freedom to act without political constraint.

As elected governments at the national level lose sovereignty to international bureaucrats, individuals will inevitably suffer. Citizens are able to provide a check on government policy through a multitude of mechanisms, such as voting, lobbying, or even emigration, but those options will be unavailable to them when it comes to taxes levied by international organizations. Given that politicians and bureaucrats will naturally seek to expand their influence and power as far as these various political constraints will allow them, the absence of external restraints on international organizations will mean more statist policies and greater infringements on individual liberty. The one-size-fits-all nature of the proposals also prohibits consideration of local factors, such as a countries’ stage of economic and social development, rendering many of them ineffective at their intended goals.

National governments have something that the unelected international bureaucrats desperately want: taxing power. The bureaucrats need national governments to believe that they will not lose sovereign power as the international organizations attempt to get direct-funding authority.

National governments should not be fooled. Any sort of taxing power or direct funding for international bureaucracies would undermine national sovereignty. More importantly, it will further weaken the ability of people to influence and control the policies to which they are subjected. Moreover, once the first global tax is imposed, the floodgates will be opened for similar proposals.

To the unelected bureaucrats at international organizations, the absence of democratic accountability is a feature, not a bug. That’s why direct funding and taxing powers inevitably will lead to an expansion of big government policies implemented under a one-size-fits-all international system.

Proposed IRS Interest Reporting Regulation
Threatens U.S. Economy

In January of 2011, the IRS proposed a regulation (REG-146097-09) to force American banks to report the interest paid to all nonresident aliens. Banks do not currently report this private financial information to the IRS because it is long standing policy not to tax such foreign investment in the interests of keeping the U.S. an attractive destination for foreign capital. The regulation would overturn this policy and by sharing financial information of foreign investors, would most likely allow the home countries of these depositors to tax the interest, resulting in their flight to other jurisdictions that do not tax or share information. The rule will drive capital investment from the U.S., goes against 90-years of Congressional intent, costs more than it benefits, and threatens the lives and human rights of many investors.

Regulation History

Three days before President Clinton left office, the IRS proposed REG-126100-00. Like today’s proposal, REG-126100-00 sought to require US banks to report interest deposit payments to non-resident aliens. This initial proposal drew heated opposition from both industry and the public policy community. More than 99 percent of the submissions during the public comment period were hostile, and 100 percent of the testimony at the public hearing was negative.

In the face of overwhelming opposition, the IRS was forced to withdraw the regulation in August 2002, but played a game of bait-and-switch and immediately submitted a similar measure (REG-133254-02).which affected a smaller number of countries. The cosmetic changes did not succeeded in fooling critics, and the “new” regulation encountered the same degree of opposition. Between the two versions, more than 150 Senators and Congressmen weighed in against the proposed regulations. The interest-reporting regulation then remained in limbo until 2011, when the second version was also withdrawn and the modern incarnation was proposed. The new version again looks to apply the requirements to nonresident aliens from all countries.

Why It’s Bad Policy

The repeated efforts by the IRS to require nonresident alien interest reporting have met consistent and bipartisan opposition from a wide variety of sources precisely because it offers little to no direct benefit to the U.S., despite coming at a high cost to the economy. Specifically, the proposed regulation represents bad policy for the following reasons:

• The proposal would drive capital from U.S. banks, causing irreparable harm to the economy. Adoption of the regulation will place U.S. banks at a competitive disadvantage to jurisdictions which maintain a respect for financial privacy and sound tax policy. Because the IRS intends to share the information with foreign tax collectors, it has the same effect as if the U.S. were taxing it directly – an incentive for depositors to relocate their funds. This in turn will reduce the amount of credit available to local communities. When the IRS proposed a version of the rule applicable to only 15 countries, one study found it would result in a loss of $88 billion in foreign investment. With the broader scope of the current proposal and growth in foreign investment in the U.S., that estimate would necessarily be higher today. Nonresident aliens are estimated to have deposited over $3 trillion in U.S. financial institutions, and losing even a fraction of those deposits represents a significant threat to the U.S. economy.
• The regulation violates the intent of Congress. Congress most recently addressed the tax treatment of nonresident alien bank deposit interest in the Tax Reform Act of 1976 and the Tax Reform Act of 1986. Both laws clearly demonstrated that lawmakers wanted to retain the longstanding policy of attracting capital to the American economy by not taxing interest paid to non-resident aliens. The Joint Committee on Taxation summarized in 1976 that “Congress has concluded that the elimination of the exemption would result in a significant decline in the substantial deposits by nonresident aliens and foreign corporations in banks in the United States.” This proposal, while not a direct tax on deposits by the U.S., will have the same impact as JCT feared because it makes no difference to depositors which country is doing the taxing. Lawmakers have explicitly chosen not to tax the deposit interest paid to nonresident aliens for the purpose of attracting capital to the U.S. economy, and regulatory agencies such as the IRS are tasked with enforcing – not overturning – law.
• The IRS has not followed legal requirements. According to Executive Order 12866, regulatory agencies are required to conduct a cost-benefit analysis for any regulation that would have an annual effect of more than $100 million on the economy. Despite considerable evidence and testimony showing a much greater impact from this rule than $100, the IRS waved the requirement away by declaring without substantiation that their proposal is “not a significant regulatory action.”
• The regulation threatens human rights. Financial privacy is a key component of defending against human rights abuses in many countries. Not all governments respect the privacy of their citizens, nor prove capable of defending them against crime. Depositors from certain nations, for instance, are particularly sensitive to threats of kidnapping and extortion. Even worse, many governments themselves threaten the well-being of their citizens when they are overly corrupt, prone to bribery, or just plain tyrannical, yet this regulation would potentially expose financial data to rogue regimes like that of Venezuala’s Hugo Chavez.

For more information, visit: http://freedomandprosperity.org/issues/irs-information-sharing-regulation/

OECD Subsidies Are Against U.S. Interests

The Organization for Economic Cooperation and Development (OECD) is a Paris-based bureaucracy which increasingly promotes a big government agenda. In recent years the organization has supported for the U.S. a value-added tax, Obamacare style healthcare, cap-and-trade or carbon taxes, and stimulus spending. Since 1998, the OECD has also pushed an anti-tax competition project aimed at persecuting low-tax jurisdiction. The organization has increasingly come under the control of politicians and tax bureaucrats from high-tax nations who, unwilling to reform their tax codes for fear of undermining their ballooning and highly inefficient welfare states, push the OECD to enforce unjust protectionist measures against jurisdictions that have adopted free-market tax policies.

U.S. taxpayers shoulder a disproportionate share – nearly one-fourth – of the OECD’s budget, yet receive little to no benefit in return. In fact, the OECD frequently pushes for policies both within the U.S. and internationally that are not in the interest of the United States, and would increase the tax burdens on U.S. citizens, inhibit the free flow of capital, and reduce economic prosperity. With a direct contribution from American taxpayers of almost $100 million, and other expenses on the U.S. delegation in Paris and U.S. agencies that participate in OECD activities, this negative return is unacceptable. Funding of the OECD should be cutoff until such time as the organization ends its campaign against low-tax jurisdictions and the principles of limited government.

Over the years, OECD actions undermining the interests of U.S. taxpayers have included:

• Repeated urging of the United States to adopt a value-added tax and a plethora of other tax increases.
• Support for big government style healthcare and other spending programs.
• A decade-plus anti-tax competition project that poses a threat to national sovereignty. Bureaucrats in Paris should have no right to dictate tax policy to sovereign jurisdictions.
• Deliberate conflation of legal tax avoidance and illegal tax evasion. The OECD has adopted a radical theory, known as Capital Export Neutrality, which holds that taxpayers should never be allowed to benefit from better tax policy in other jurisdictions.
• Expression of support for global taxation by endorsing the United Nations’ proposal for “innovative sources of financing,” which means taxes levied by the U.N. – such as on carbon, currency and financial transactions, and airline tickets.
• Efforts to interfere with the right of U.S. states to control their own corporation laws. The OECD is attacking incorporation laws in American states because high-tax nations are unhappy that investment activity is shifting to America.
• Siding with unions in a campaign to hinder competition in the international shipping market. The OECD proposal, the result of an unholy alliance between unions and high-tax governments, sought to cripple “open registries” that have lowered shipping costs.
• Seeking to make it easier for nations to: a) impose high tax rates; b) double-tax income that is saved and invested; and c) tax income earned in other jurisdictions. If the OECD is successful, reforms like the flat tax would be an impermissible “harmful tax practice.” Global growth will suffer as bad policy is perpetuated.

For More Information:

October 2011, University of Alabama Public Law Research Paper No. 1950627, “Cartelizing Taxes: Understanding the OECD’s Campaign Against ‘Harmful Tax Competition’,” by Andrew P. Morriss and Lotta Moberg
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1950627

May 2011, CF&P Foundation Prosperitas, “Monitoring the OECD’s Campaign Against Tax
Competition, Fiscal Sovereignty, and Financial Privacy: Strategies for Low-Tax Jurisdictions,” by Dan Mitchell and Brian Garst
http://freedomandprosperity.org/2011/publications/strategies-for-low-tax-jurisdictions/

August 2010, CF&P Foundation Economic Lessons Video, “The Paris-Based OECD: Pushing Obama’s Big-Government Agenda With Your Tax Dollars,” narrated by Dan Mitchell
http://youtu.be/oVr8R41nZJU

CF&P Market Center Blog posts on the OECD
http://freedomandprosperity.org/tag/oecd/?cat=11

Date: November 17, 2011

To: Supporters of tax competition, fiscal sovereignty, and financial privacy

From: Andrew Quinlan and Brian Garst

Re: Congressional Hearing on IRS Nonresident Alien Interest Reporting Proposal
______________________________________________________________________

The proposed IRS non-resident alien interest deposit reporting requirement received an unfriendly reception at an October 27 hearing held by a subcommittee of the House Financial Services Committee. We were on hand to represent CF&P, and noted that the hearing was both a testament to our success in disseminating the many arguments against the proposed regulation, as well as affirmation of the need to continue fighting vigorously against the IRS proposal.

Testifying at the hearing were three panelists opposed to the rule and one in support. Testifying against the rule was J. Thomas Cardwell, former Commissioner of the Florida Office of Financial Regulation; Alex Sanchez, President of the Florida Bankers Association; and Gerry Schwebel, Executive Vice President of International Bancshares Corporation. In support was Rebecca Wilkins of Citizens for Tax Justice, and part of the liberal network which works closely with Senator Levin’s office promoting a high-tax agenda.

Several members of the Committee offered opening statements. CF&P is pleased to note that the criticisms we have levied for over 10 years were heavily represented. Cited in the opening statements was the threat of capital flight, including the estimation done by the Mercatus Center which CF&P has first brought to light years ago and continues to highlight today; the lack of a cost-benefit analysis by the IRS, which has consistently been included as a major criticism by CF&P; the threat the rule poses to human rights, an issue which dovetails with our commitment to financial privacy; and the IRS’s complete disregard for 90 years of Congressional intent, as first evidenced in a study published by CF&P.

Congressman Posey and Financial Services Chairman Bachus, though not members of this particular subcommittee, were both also present. Chairman Bachus really drove home our point on financial privacy when he asked, “Do we really want this blood on our hands?” Bachus and Posey also quoted from portions of the letter signed by the entire Florida House delegation against the rule, and then entered it into the record. CF&P worked with Cong. Posey and others as they drafted these delegation letters, in an effort to ensure that our objections were included, and helped recruit signers.

None of the members present at the hearing, even on the Democratic side of the aisle where some ideological support could be expected, were gung-ho in support of the rule, although Senator Levin’s office did submit a letter for the record which is no doubt effusive in its love of the proposed regulation. At most, some members on the Democratic side hedged their bets and offered noncommittal commentary citing both sides of the debate. Others, such as Rep. Hinojosa of Texas, were clearly opposed.

The same cannot be said for Ms. Wilkins, whose testimony provides a blueprint of the baseless charges that supporters of financial privacy need to be prepared to debunk. Both her prepared remarks and her answers to member questions included some particularly outrageous claims. Not only was the old and discredited $100 billion in tax evasion figure bandied about, but Ms. Wilkins boldly declared that “those who oppose the proposed rules have a vested interest in facilitating tax cheating.” There was push-back from some members in response to this diversionary claim, and Mr. Cardwell also testified that in his work as Financial Regulator he had found “no credible evidence” that these funds came from tax cheating.

During a break in the hearing, we talked with Alex Sanchez and Gerry Schwebel, who both thanked us for CF&P’s years of work in fighting all versions of the IRS proposal. Gerry also praised our video on the subject as “powerful,” and noted that he has personally shown it to clients in order to educate them on the issue.

CF&P has been aggressive on Capitol Hill in recent months, working to educate members of Congress on the IRS proposal. In total we’ve met with over 100 House and Senate offices, and are pleased to report growing support for the two pieces of legislation currently in Congress to block the rule. Rep. Posey’s bill (H.R. 2568) currently has 9 cosponsors, and Sen. Rubio’s (S. 1506) has 18. Both have bipartisan support.

[PDF Version]

May 2011, Vol. XI, Issue I

Monitoring the OECD’s Campaign Against Tax
Competition, Fiscal Sovereignty, and Financial Privacy:

Strategies for Low-Tax Jurisdictions

The Paris-based Organization for Economic Cooperation and Development has an ongoing anti-tax competition project. This effort is designed to prop up inefficient welfare states in the industrialized world, thus enabling those governments to impose heavier tax burdens without having to fear that labor and capital will migrate to jurisdictions with better tax law. This project received a boost a few years ago when the Obama Administration joined forces with countries such as France and Germany, which resulted in all low-tax jurisdictions agreeing to erode their human rights policies regarding financial privacy. The tide is now turning against high-tax nations – particularly as more people understand that ever-increasing fiscal burdens inevitably lead to Greek-style fiscal collapse. Political changes in the United States further complicate the OECD’s ability to impose bad policy. Because of these developments, low-tax jurisdictions should be especially resistant to new anti-tax competition initiatives at the Bermuda Global Forum.

By Daniel J. Mitchell and Brian Garst

The next chapter in the Organization for Economic Cooperation and Development’s (OECD) campaign against tax competition will take place at the Global Tax Forum in Bermuda, May 31-June 1, 2011. The OECD, dominated and controlled by European welfare states, has been working for more than a decade to impose punitive international tax rules in order to prop up the inefficient policies of member nations such as France and Greece. This illiberal effort is now being pursued with even greater urgency because politicians from those nations hope to find new revenue sources to postpone the inevitable collapse of their bankrupt and corrupt fiscal systems.

Current status

Unfortunately, high-tax nations have made progress on their anti-tax competition efforts in the past few years. Low-tax jurisdictions, faced with direct and indirect threats of sanctions from powerful nations, have been forced to weaken their human-rights policies by agreeing that privacy laws no longer protect foreign investors. Indeed, jurisdictions are being coerced to sign tax information exchange agreements (TIEAs) to provide confidential data upon request to high-tax OECD countries.

Expanding the network of these so-called information-exchange-agreements (a bit of a misnomer since the information flow is in one direction) is a major goal of this year’s forum. Simply stated, high-tax nations want the ability to impose higher tax rates on income that is saved and invested, and this means they are demanding other jurisdictions help them in their efforts to track – and tax – flight capital.

This effort undermines good tax policy, which is based on common-sense principles such as low tax rates, no tax bias against saving and investment, and territorial taxation. Ironically, the OECD’s economists agree on these principles of good tax policy, which strips away even the pretense of any intellectual justification for the anti-tax competition scheme being pushed by the OECD’s Fiscal Affairs Committee. For instance:

• The OECD has acknowledged that, “The overall tax burden is found to have a negative impact on output per capita. Furthermore, controlling for the overall tax burden, there is an additional negative effect coming from an extensive reliance of direct taxes.”¹
• Another OECD study confessed that it is very misguided to double-tax saving and investment, noting, “Any taxation of capital income, however, represents a significant departure from the neutrality of taxation over time, favouring present over future consumption.”²
• And other study from the OECD stated, “Taxation of capital income, rather than the taxation of the consumption from that income, introduces a bias into the tax system. It ensures that the eventual consumption that flows from saving, over time, is less than that obtained by consuming immediately.”³
• Ironically, even an anti-tax competition manifesto published by the OECD admitted that, “The more open and competitive environment of the last decades has had many positive effects on tax systems, including the reduction of tax rates and broadening of tax bases which have characterized tax reforms over the last 15 years. In part these developments can be seen as a result of competitive forces that have encouraged countries to make their tax systems more attractive to investors. In addition to lowering overall tax rates, a competitive environment can promote greater efficiency in government expenditure programs.”⁴

The high-tax nations that dominate the OECD don’t care about good policy, however. The politicians from those countries simply want more tax revenue in hopes of postponing the day of reckoning. This point is evidenced by the recent agreement between Swiss authorities and the UK to “regularize” British funds in Swiss banks by taxing them at a 50% rate. The UK authorities were more than willing to drop their original goal of eliminating financial privacy in return for an injection of revenue. But like the drug addict, it won’t be long before they need their next fix.⁵

The key issue, for advocates of good tax policy, is how to prevent the high-tax nations from making more progress in their efforts to create a global tax cartel. That means guarding against schemes to expand the OECD’s power. The 2010 Global Forum in Singapore was uneventful, but the OECD did spring the “Mexico City Surprise” at the 2009 Forum in an attempt (fortunately unsuccessful) to give the OECD broad authority to attack tax avoidance and other legal forms of tax planning.

Why the campaign against tax competition will never cease: theory and reality

The OECD’s disingenuous stunt in 2009 should not have been a surprise. The politicians from high-tax nations who control the OECD are guided by bad theory and motivated by an unending appetite for more tax revenue.

The bad theory is CEN, which is an abbreviation for “capital export neutrality.” CEN refers to an ideological notion, taught by left-wing law professors, that taxpayers should never be allowed to benefit from better tax policy in other jurisdictions. OECD bureaucrats (as well as officials from finance ministries and finance departments in high-tax nations) are heavily influenced by the CEN mindset and this leads them to support policies designed to hinder all forms of tax competition.

From the perspective of CEN, any form of tax planning is illegitimate. Tax avoidance is just as bad as tax evasion. This is why the “Mexico City Surprise” should not have been a surprise. Adherents of CEN want to eliminate all forms of tax planning and create – for all intents and purposes – a tax cartel. From an economic perspective, this inevitably leads to an “OPEC for politicians.” Except instead of a price-fixing agreement, it would be a tax-fixing cartel.

Politicians, of course, have no understanding of the theoretical issues. A common joke in the tax community is that most elected officials couldn’t even spell CEN. They simply want more tax revenue to buy more votes, and these base impulses are particularly acute as they all face some level of Greek-style fiscal chaos in the near future. Fiscal forecasts and analyses by the OECD, EU, IMF, and private entities paint the same grim picture. Most European nations have taxed and spent themselves into fiscal cul-de-sacs, and the anti-tax competition effort is an endeavor to buy more time before the house of cards collapses.

The next steps

The OECD has its own version of the Brezhnev Doctrine (“what’s mine is mine; what’s yours in negotiable”). Now that low-tax jurisdictions have been coerced into signing TIEAs, the Paris-based bureaucracy almost certainly will expand its demands. Low-tax jurisdictions should be fully aware of the OECD’s bad-faith approach. Some policy makers from these jurisdictions are being duped into thinking they are “partners” with the OECD and that signing TIEAs will end the harassment from high-tax nations.

This is a triumph of hope over reality. There’s an old saying that feeding your leg to a crocodile does not turn him into a vegetarian. The same is true about appeasing the OECD. Just as a crocodile will come back for another meal, the opponents of tax competition will put forth new demands.

The following policies are the most immediate areas of concern.

1. Automatic information sharing.

The current system of TIEAs allows high-tax nations to request information about specific taxpayers if there is some reason to suspect they are investors in low-tax jurisdictions. It is quite likely that this system will not generate the desired windfall of new tax revenue. This is largely because estimates of foregone tax revenue are wildly exaggerated, but the OECD and its allies will argue that the “upon-request” model is inadequate and begin to push for automatic information sharing. This, of course, raises all sorts of concerns regarding data integrity, identity theft, misuse of information, and human rights abuses. And it would mean very high costs imposed on low-tax jurisdictions.

2. Attack on tax planning and tax avoidance

The “Mexico City Surprise” failed in 2009, but that does not mean the OECD and high-tax nations will let the issue drop. The Capital Export Neutrality theory makes no distinction between tax evasion and tax avoidance. Revenue-hungry politicians also don’t care whether they are missing out on potential tax revenue because of legal or illegal actions. There is an assumption that substantially more tax can be collected from both rich people (high net worth individuals, or HNWIs) and corporations (particularly multinationals), and that this will require coordinated action. This would lead to much higher compliance burdens on targeted taxpayers, but also costly new rules and reporting regimes for low-tax jurisdictions.

3. Global financial taxes

There is a drumbeat for some sort of worldwide financial tax. In some cases, advocates envision a global tax, perhaps imposed and collected by an international bureaucracy. The Tobin Tax would be one example of this approach. In other cases, proponents urge bank taxes imposed on a country-by-country basis, but with some sort of agreement that all jurisdictions participate since a tax cartel is needed to prevent investors/depositors from shifting funds across national borders. This latter approach often is characterized as a response to bailouts, either to recoup funds already spent or to accumulate funds for potential future bailouts. Regardless of the design, and regardless of the stated reason for the tax, politicians from high-tax nations are salivating at the thought of additional revenue. Imposing new costs on the “offshore” world would be a fringe benefit, sort of akin to icing on a cake.

4. Savings tax directive, part II

The European Union already has implemented a version of automatic information sharing, but the politicians are very unhappy with the system because it does not apply to all forms of capital income and asset accumulation and because some of the participating nations (all EU countries, plus a handful of non-EU jurisdictions) can choose a withholding tax instead. This system has not generated the desired (and hopelessly unrealistic) level of new tax revenue, so there are discussions about how to expand the scope of the directive – including a scheme to ensnare more jurisdictions into the cartel. This is a non-OECD issue, but rest assured it will be in the minds of all European representatives at the Bermuda meeting.

5. Formula apportionment of business income

Proponents of tax harmonization would like all nations to impose identical tax regimes. Such an approach would, by definition, eliminate tax competition and give politicians from all nations a common ability to increase tax rates. And it is the logical end point for proponents of the Capital Export Neutrality theory. A direct attack on fiscal sovereignty is not plausible in the current environment, however, so advocates hope to gain a partial victory by harmonizing the tax base (i.e., the definition of taxable income) and then dividing up a company’s profits based on some sort of formula based on sales, employment, and/or assets. The European Commission is pushing for such an approach (the common consolidated corporate tax base), and many on the left are urging that this system be imposed on a global basis. The motive for this approach is that companies earn a “disproportionately” large share of their profits in low-tax jurisdictions. But if there was some sort of harmonized tax base, perhaps imposed in a might-makes-right fashion by big nations, then a formula could be used that would unilaterally turn profits earned in so-called tax havens (as well as places such as Hong Kong, Switzerland, Ireland, Slovakia, and China) into taxable income for Germany, France, Japan, and the United States. This would dramatically undermine incentives to invest in jurisdictions with better tax policy and lead to a significant increase in the corporate tax burden.

6. Worldwide taxation

Worldwide taxation refers to the practice of nations taxing things that occur outside their borders, and the United States has the worst worldwide tax system of any nation. Most jurisdictions at least attempt to impose double taxation on individual capital income (dividends, interest, and capital gains) on a worldwide basis, and the United States certainly is in this category. But the United States is an outlier in that it also imposes worldwide taxation on corporate income. And it is virtually alone in taxing the labor income of citizens who live and work abroad. Indeed, the United States actually restricts the right of emigration, imposing punitive exit taxes (disgracefully reminiscent of the policies of Nazi Germany and Soviet Russia) on people who want tax residency in other jurisdictions. Other nations rely much more on territorial taxation, but not because of an affinity for good tax policy or respect for human rights. Instead, their tax authorities don’t have the long reach and unchecked power of the IRS. But as privacy gets eroded and it becomes easier for other nations to track economic activity across the globe, the temptation will grow to copy America’s bad approach. Politicians from high-tax nations would love to retain taxing power over companies and individuals that move to places such as Hong Kong, Switzerland, Cayman, Panama, Monaco, Singapore, etc. If they succeed, this would dramatically reduce incentives to move to jurisdictions with better tax law and (because of the crippling impact on tax competition) facilitate big increases in tax rates.

7. National Blacklists

To augment the OECD attack on low-tax jurisdictions, some governments have created national blacklists. This usually means a high-tax nation will impose a law that specifically identifies “tax havens” and imposes restrictions on economic relations. Discriminatory withholding taxes are sometimes imposed, and there also can be restrictions on doing business with companies domiciled in the targeted low-tax jurisdictions.

These national efforts, to be sure, are not an official part of the OECD’s anti-tax competition campaign. But it is rather revealing that low-tax jurisdictions are targeted – even if they are “participating partners” in the OECD’s global forum. If the bureaucrats in Paris and the high-tax nations that dominate the OECD actually believed in a fair process, these national blacklists would be forbidden.

It is impossible to say which, if any, of these proposals will be discussed at the Bermuda Global Forum. With any luck, none of these issues will get on the agenda. But that is just a matter of timing. Sooner or later, politicians from high-tax nations will pursue some or all of these policies. And since the OECD is a tool of those high-tax nations, it is quite likely that a Global Forum will be the vehicle for continued assaults on tax competition, fiscal sovereignty, and financial privacy.

What should low-tax jurisdictions do?

Prior to the 2008 election, the American government had a policy of benign neglect regarding the OECD’s anti-tax competition project. This was very helpful. After all, just as OPEC would be feeble without the participation of Saudi Arabia, a global tax needs U.S. support. Ever since the 2008 elections, however, the United States government has been aligned with Europe’s welfare states. This unfortunate development largely explains why the OECD was able to go back on offense and coerce low-tax jurisdictions into agreeing to upon-request TIEAs.

That’s the bad news. The good news is that the Obama Administration recently suffered a sweeping repudiation in the mid-term elections. There is now a divided government, as Republicans control the House of Representatives.

This has important implications for the tax competition battle. The Coalition for Tax Competition, led by the Center for Freedom and Prosperity and comprised of various taxpayer organizations, think tanks, and free market groups, is coordinating a much more concerted effort to reduce the huge subsidy that American taxpayers provide to the OECD. Because of the backlash among voters against excessive government spending, and because Republicans feel they have to prove that they “got the message” after losing the last two elections due to profligate spending during the Bush years, there is a much more receptive climate for the Coalition’s anti-OECD message.

So what does this mean? The OECD is like every other government bureaucracy. The first imperative is more money and more staff. And OECD bureaucrats know they have a very comfortable scam. Not only do they receive above-market compensation, but they also are exempt from paying any tax on their overly-generous incomes (yes, it goes without saying that it is ironic that tax-free bureaucrats get to jet-set around the world seeking to raise taxes on everybody else).

With Republicans now in control of the House of Representatives, it is an open question whether the OECD will be able to maintain an aggressive anti-tax competition campaign. Direct and indirect pressure is growing for the Paris-based bureaucracy to ease up on the big-government agenda.

In response to the anti-OECD message, one budget proposal submitted by several dozen members of the House even included a complete cut of OECD funding. Other divisions of the Paris-based bureaucracy will hopefully learn from this that their gravy train may get derailed because of the actions of the Committee on Fiscal Affairs, so there will be significant internal pressure to be more rational.

From the perspective of low-tax jurisdictions, it remains critical that the OECD and high-tax nations not be allowed to ram through any new initiatives before this pressure can fully materialize. The clock is not on their side, so it is imperative to block the OECD from any schemes designed to accelerate the process. In addition, low-tax jurisdictions can help solidify a reversal of the decades-long trend toward big-government by beginning to speak up and raise their objections to the process.

Speak Up And Fight Back

The OECD and high-tax jurisdictions count on quiet acquiescence from their low-tax counterparts. So long as low-tax jurisdictions are intimidated and shamed into rolling over and playing dead, the process of eroding fiscal sovereignty will continue to advance.

If the constant moving of the goal posts has proven anything, it is that appeasement is not a viable strategy. By speaking up and aggressively defending the superiority of their tax policies on both fiscal and moral grounds, low-tax jurisdictions can force those driving the agenda to have to choose between openly displaying their contempt for the interests of the jurisdictions that they are seeking to saddle with bad tax policy, or allowing the process to hoist them with their own petard.

While standing up for themselves is the preferred strategy for low-tax jurisdictions, even the simple act of talking more can serve an important function by forcing OECD bureaucrats and delegates from high-tax nations to address key issues. If nothing else, this can be useful because where there is substantial disagreement between large and small states, the OECD chair needs time to ‘wind down’ the objections of the speakers before moving on. If there is no winding down, issues either get tabled or the position of the small countries is conceded.

Speaking up also helps solve the false consensus problem. Often times, issues are agreed to simply because no one objects, making it seem as if there is greater consensus than there really is. One way to get the ball rolling in preventing false consensus from building against low tax jurisdictions is to ask questions. It’s quite likely that the large jurisdictions will respond with objectionable answers, thus giving other jurisdictions reason to speak up, and help thwart the false consensus the OECD seeks to create. However for this to happen, countries must speak up. The Forum is depending on countries to stay in line. Combating the consensus building can be a powerful tool, as it relies on an absence of dissenting voices. Any dissenting voice must be responded to.

The problem, of course, is that low-tax jurisdictions are concerned that they will be singled out for discriminatory and unfriendly attention if they make comments. There is a widely shared perception, for instance, that the OECD is using the “peer review” evaluations for precisely this purpose.

A number of low tax jurisdictions have already received ‘deficient’ phase I evaluations. These evaluations give these countries reason to speak up. After all, there’s no point in being compliant if you’ve already been mistreated.

But other jurisdictions should add their voices. If a sufficient number point out the flaws in the process, it becomes very difficult for OECD nations to engage in retribution.

Indeed, the key recommendation of this paper is that officials from low-tax jurisdictions have nothing to lose by being more assertive. Officials from Barbados, for instance, have been rather vocal at times in their reaction to bad-faith behavior by the OECD.⁶ Has this put them in any worse position than other persecuted jurisdictions? Panama officials also have been somewhat vocal and this has not resulted in any additional harassment.

The OECD and high-tax nations want to put smaller jurisdictions out of business, and meek responses encourage rather than discourage this destructive mentality. Some representatives from low-tax jurisdictions privately complain that it is too risky to make noise. But this don’t-raise-your-head-above-the-foxhole approach is a recipe for gradual extinction.

Fighting for Prosperity and Opportunity

Part of the OECD’s strategy has been to imply that low-tax jurisdictions are rogue regimes that somehow threaten the global economy. This is why they have striven to make “tax haven” a negative term. And remember when politicians from high-tax nations asserted the financial crisis somehow was caused by “hot money” from tax havens? Even gullible journalists quickly realized that was an absurd assertion.

It’s time to regain the offensive. The high-tax nations are the rogue regimes. They are the nations with unsustainable fiscal policy. Places such as Greece, Spain, Italy, and France are examples of high-tax nations that will destabilize the world economy by causing sovereign debt crises. OECD nations are the ones with punitive tax systems that undermine growth.

Tax havens and other low-tax jurisdictions are outposts of fiscal sanity – at least relatively speaking. Yes, they periodically fall into bad habits and let government get too big and spend too much, but at least they’re subject to the discipline of global markets and can’t bury their heads in the sand and cross their fingers that big new sources of revenue will be magically forthcoming.

The world would be a much better place if OECD nations copied the fiscal policy of tax havens, not vice versa.

Tax competition means better policy

Low-tax jurisdictions generally are the ones with good tax policy. There is wide agreement among public finance economists that an ideal tax system should be based on low tax rates, no double taxation, no loopholes, and territoriality. Yet the OECD’s anti-tax competition effort is designed to help high-tax nations impose double taxation on an extraterritorial (or worldwide) basis.

This is why economists tend to be strong supporters of competition between jurisdictions. Tax competition encourages nations to adopt good tax policy, even if politicians from those countries would prefer to adopt class-warfare policies because of perceived short-run electoral considerations.

Conclusion

No matter what the high-tax lobby claims, the anti-financial privacy agenda is not being pushed to benefit low-tax jurisdictions. They will make that claim, but it is nothing more than the bait intended to lure the next prey on which they will feast. As we have shown, the stark reality is that all of these efforts are being undertaken to identify additional sources of revenue to prop-up, even if only temporarily, the high-tax welfare states.

In order to help facilitate the process of defending low-tax jurisdictions, CF&P is willing to confer privately with interested jurisdictions and offer our expertise. We will also be available at the Bermuda Global Forum to meet with delegates.

Finally, rather than reiterate the main points in a conclusion, the best way to end this paper is with a series of quotes from Nobel laureates. These economists understand that a cartel of high-tax nations would be a mistake. An “OPEC for politicians” would hurt the global economy and condemn people around the world to a more dismal future.

“…competition among nations tends to produce a race to the top rather than to the bottom by limiting the ability of powerful and voracious groups and politicians in each nation to impose their will at the expense of the interests of the vast majority of their populations.”

Gary Becker

“…tax competition among separate units…is an objective to be sought in its own right.”

James Buchanan

“Competition among national governments in the public services they provide and in the taxes they impose is every bit as productive as competition among individuals or enterprises in the goods and services they offer for sale and the prices at which they offer them.”

Milton Friedman

“…international competition provided a powerful incentive for other countries to adapt their institutional structures to provide equal incentives for economic growth and the spread of the ‘industrial revolution.’”

Douglas North

“Competition among communities offers not obstacles but opportunities to various communities to choose the type and scale of government functions they wish.”

George Stigler

“[Tax competition] is a very good thing. …Competition in all forms of government policy is important. That is really the great strength of globalization …tending to force change on the part of the countries that have higher tax and also regulatory and other policies than some of the more innovative countries. …The way to get revenue is doing all you can to encourage growth and wealth creation and then that gives you more income to tax at the lower rate down the road.”

Vernon Smith

“With apologies to Adam Smith, it’s fair to say that politicians of like mind seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise taxes. This is why international bureaucracies should not be allowed to create tax cartels, which benefit governments at the expense of the people.”

Ed Prescott

“[I]t’s kind of a shame that there seems to be developing a kind of tendency for Western Europe to envelope Eastern Europe and require of Eastern Europe that they adopt the same economic institutions and regulations and everything. …We want to have some role models… If all these countries to the East are brought in and homogenized with the Western European members then that opportunity will be lost.

Edmund Phelps

Endnotes

[PDF Version]

September 2010, Vol. X, Issue I

An Update on the OECD’s Campaign Against Tax
Competition, Fiscal Sovereignty, and Financial Privacy

By Daniel J. Mitchell

The Paris-based Organization for Economic Cooperation and Development has an ongoing project to prop up Europe’s inefficient welfare states by attacking tax competition in hopes of enabling governments to impose heavier tax burdens. This project received a boost when the Obama Administration joined forces with countries such as France and Germany, but the tide is now turning against high-tax nations – particularly as more people understand that such an approach inevitably leads to Greek-style fiscal collapse. Looming political changes in the United States will further complicate the OECD’s ability to impose bad policy. Because of these developments, low-tax jurisdictions should be especially wary of schemes to rush through new anti-tax competition initiatives at the Singapore Global Forum.

The next chapter in the Organization for Economic Cooperation and Development’s (OECD) campaign against tax competition will take place at the Global Tax Forum in Singapore, Sept 29-30, 2010.  The OECD, dominated and controlled by European welfare states, has been working for more than a decade to impose punitive international tax rules in order to prop up the inefficient policies of member nations such as France and Greece. This illiberal effort is now being pursued with even greater urgency because politicians from those nations hope to find new revenue sources to postpone the inevitable collapse of their bankrupt and corrupt fiscal systems.

Current status

Unfortunately, high-tax nations have made progress on their anti-tax competition efforts in the past few years. Low-tax jurisdictions, faced with direct and indirect threats of sanctions from powerful nations, have been forced to weaken their human-rights policies by agreeing that privacy laws no longer protect foreign investors. Indeed, jurisdictions are being coerced to sign tax information exchange agreements (TIEAs) to provide confidential data upon request to high-tax OECD countries.

Nailing down a network of these so-called information-exchange-agreements (a bit of a misnomer since the information flow is in one direction) is the main official agenda of this year’s conference.

This effort undermines good tax policy, which is based on the common-sense principle of territorial taxation, but the greater worry is whether the high-tax nations plan to make new demands. At last year’s OECD Global Forum, for instance, high-tax nations sprang the “Mexico City Surprise,” which was an attempt to give the OECD broad authority to attack tax avoidance and other legal forms of tax planning.

Why the campaign against tax competition will never cease: theory and reality

The OECD’s disingenuous stunt last year should not have been a surprise. The politicians from high-tax nations who control the OECD are guided by bad theory and motivated by…well, greed.

The bad theory is “capital export neutrality,” which is an odd name, but it refers to an ideological notion, taught by left-wing law professors, that taxpayers should never be allowed to benefit from better tax policy in other jurisdictions. OECD bureaucrats (as well as officials from finance ministries and finance departments in high-tax nations) are heavily influenced by the CEN mindset and this leads them to support policies designed to hinder all forms of tax competition.

Politicians, of course, have no understanding of the theoretical issues. A common joke in the tax community is that most elected officials couldn’t even spell CEN. They simply want more tax revenue to buy more votes, and these base impulses are particularly acute as they all face some level of Greek-style fiscal chaos in the near future. Fiscal forecasts and analyses by the OECD, EU, IMF, and private entities paint the same grim picture. Most European nations have taxed and spent themselves into fiscal cul-de-sacs, and the anti-tax competition effort is an endeavor to buy more time before the house of cards collapses.

The next steps

The OECD has its own version of the Brezhnev Doctrine (“what’s mine is mine; what’s yours in negotiable”). Now that low-tax jurisdictions have been coerced into signing TIEAs, the Paris-based bureaucracy almost certainly will expand its demands. Last year’s Mexico City Surprise is an example of this pattern.

Low-tax jurisdictions should be fully aware of the OECD’s bad-faith approach. Some policy makers from these jurisdictions are being duped into thinking they are “partners” with the OECD and that signing TIEAs will end the harassment from high-tax nations.

This is a triumph of hope over reality. There’s an old saying that feeding your leg to a crocodile does not turn him into a vegetarian. The same is true about appeasing the OECD. Just as a crocodile will come back for another meal, the opponents of tax competition will put forth new demands.

The following policies are the most immediate areas of concern.

1. Automatic information sharingThe current system of TIEAs allows high-tax nations to request information about specific taxpayers if there is some reason to suspect they are investors in low-tax jurisdictions. It is quite likely that this system will not generate the desired windfall of new tax revenue. This is largely because estimates of foregone tax revenue are wildly exaggerated, but the OECD and its allies will argue that the “upon-request” model in inadequate and begin to push for automatic information sharing. This, of course, raises all sorts of concerns regarding data integrity, identity theft, misuse of information, and human rights abuses. And it would mean very high costs imposed on low-tax jurisdictions.

2. Attack on tax planning and tax avoidance

The “Mexico City Surprise” failed last year, but that does not mean the OECD and high-tax nations will let the issue drop. The CEN theory makes no distinction between tax evasion and tax avoidance. Revenue-hungry politicians also don’t care whether they are missing out on potential tax revenue because of legal or illegal actions. There is an assumption that substantially more tax can be collected from both rich people (high net worth individuals, or HNWIs) and corporations (particularly multinationals), and that this will require coordinated action. This would lead to much higher compliance burdens on targeted taxpayers, but also costly new rules and reporting regimes for low-tax jurisdictions.

3. Global and/or universal financial taxes

There is a drumbeat for some sort of worldwide financial tax. In some cases, advocates envision a global tax, perhaps imposed and collected by an international bureaucracy. The Tobin Tax would be one example of this approach. In other cases, proponents urge bank taxes imposed on a country-by-country basis, but with some sort of agreement that all jurisdictions participate since a tax cartel is needed to prevent investors/depositors from shifting funds across national borders. This latter approach often is characterized as a response to bailouts, either to recoup funds already spent or to accumulate funds for potential future bailouts. Regardless of the design, and regardless of the stated reason for the tax, politicians from high-tax nations are salivating at the thought of additional revenue. Imposing new costs on the “offshore” world would be a fringe benefit, sort of akin to icing on a cake.

4. Savings tax directive, part II

The European Union already has implemented a version of automatic information sharing, but the politicians are very unhappy with the system because it does not apply to all forms of capital income and asset accumulation and because some of the participating nations (all EU countries, plus a handful of non-EU jurisdictions) can choose a withholding tax instead. This system has not generated the desired (and hopelessly unrealistic) level of new tax revenue, so there are discussion about how to expand the scope of the directive – including a scheme to ensnare more jurisdictions into the cartel. This is a non-OECD issue, but rest assured it will be in the minds of all European representatives at the Singapore meeting.

5. Formula apportionment of business income

Proponents of tax harmonization would like all nations to impose identical tax regimes. Such an approach would, by definition, eliminate tax competition and give politicians from all nations a common ability to increase tax rates. And it is the logical end point for proponents of the CEN theory. A direct attack on fiscal sovereignty is not plausible in the current environment, however, so advocates hope to gain a partial victory by harmonizing the tax base (i.e., the definition of taxable income) and then dividing up a company’s profits based on some sort of formula based on sales, employment, and/or assets. The European Commission is pushing for such an approach (the common consolidated corporate tax base), and many of the left are urging that this system be imposed on a global basis. The motive for this approach is that companies earn a “disproportionately” large share of their profits in low-tax jurisdictions. But if there was some sort of harmonized tax base, perhaps imposed in a might-makes-right fashion by big nations, then a formula could be used that would unilaterally turn profits earned in so-called tax havens (as well as places such as Hong Kong, Switzerland, Ireland, Slovakia, and China) into taxable income for Germany, France, Japan, and the United States. This would dramatically undermine incentives to invest in jurisdictions with better tax policy and lead to a significant increase in the corporate tax burden.

6. Worldwide taxation

Worldwide taxation refers to the practice of nations taxing things that occur outside their borders, and the United States has the worst worldwide tax system of any nation. Most jurisdictions at least attempt to impose double taxation on individual capital income (dividends, interest, and capital gains) on a worldwide basis, and the United States certainly is in this category. But the United States is an outlier in that it imposes worldwide taxation on corporate income. And it is virtually alone in taxing the labor income of citizens who live and work abroad. Indeed, the United States actually restricts the right of emigration, imposing punitive exit taxes (disgracefully reminiscent of the policies of Nazi Germany and Soviet Russia) on people who want tax residency in other jurisdictions. Other nations rely much more on territorial taxation, but not because of an affinity for good tax policy or respect for human rights. Instead, their tax authorities don’t have the long reach and unchecked power of the IRS. But as privacy gets eroded and it becomes easier for other nations to track economic activity across the globe, the temptation will grow to copy America’s bad approach. Politicians from high-tax nations would love to retain taxing power over companies and individuals that move to places such as Hong Kong, Switzerland, Cayman, Panama, Monaco, Singapore, etc. If they succeed, this would dramatically reduce incentives to move to jurisdictions with better tax law and (because of the crippling impact on tax competition) facilitate big increases in tax rates.

It is impossible to say which, if any, of these proposals will be discussed at the Singapore Global Forum. With any luck, none of these issues will get on the agenda. But that is just a matter of timing. Sooner or later, politicians from high-tax nations will pursue some or all of these policies. And since the OECD is a tool of those high-tax nations, it is quite likely that a Global Forum will be the vehicle for continued assaults on tax competition, fiscal sovereignty, and financial privacy.

What should low-tax jurisdictions do?

Prior to the 2008 election, the American government had a policy of benign neglect regarding the OECD’s anti-tax competition project. This was very helpful. After all, just as OPEC would be feeble without the participation of Saudi Arabia, a global tax needs U.S. support. Ever since the 2008 elections, however, the United States government has been aligned with Europe’s welfare states. This unfortunate development largely explains why the OECD was able to go back on offense and coerce low-tax jurisdictions into agreeing to upon-request TIEAs.

That’s the bad news. The good news is that the Obama Administration is on the verge of a sweeping repudiation in the mid-term elections. Republicans almost certainly will win control of the House of Representatives. And the White House’s statist policies are so unpopular that it’s even possible that the Senate may switch to the GOP (something that almost certainly will happen in 2012 anyway because of which seats will be in play that year).

This has important implications for the tax competition battle. The Coalition for Tax Competition, led by the Center for Freedom and Prosperity and comprised of various taxpayer organizations, think tanks, and free market groups, intends to make a much more concerted effort to reduce the huge subsidy that American taxpayers provide to the OECD. And because of the backlash among voters against excessive government spending, and because Republicans feel they have to prove that they “got the message” after losing the last two elections because they had become big spenders during the Bush years, there will be a very receptive climate for the Coalition’s anti-OECD message.

So what will this mean? The OECD is like every other government bureaucracy. The first imperative is more money and more staff. And OECD bureaucrats know they have a very comfortable scam. Not only do they receive above-market compensation, but they also are exempt from paying any tax on their overly-generous incomes (yes, it goes without saying that it is ironic that tax-free bureaucrats get to jet-set around the world seeking to raise taxes on everybody else).

If Republicans take control of the House of Representatives (and even more so if they also win the Senate), it then becomes an open question whether the OECD is able to maintain an aggressive anti-tax competition campaign. There will be direct and indirect pressure to ease up on the big-government agenda. Other divisions of the Paris-based bureaucracy, for instance, will understand that their gravy train may get derailed because of the actions of the Committee on Fiscal Affairs, so there will be significant internal pressure to be more rational.

From the perspective of low-tax jurisdictions, it means that the OECD and high-tax nations should not be allowed to ram through any new initiatives. The clock is not on their side, so it is imperative to block the OECD from any schemes designed to accelerate the process. There will then be an opportunity to reassess after the American elections.

Fighting for Prosperity and Opportunity

Part of the OECD’s strategy has been to imply that low-tax jurisdictions are rogue regimes that somehow threaten the global economy. This is why they have striven to make “tax haven” a negative term. And remember when politicians from high-tax nations asserted the financial crisis somehow was caused by “hot money” from tax havens? Even gullible journalists quickly realized that was an absurd assertion.

It’s time to regain the offensive. The high-tax nations are the rogue regimes. They are the nations with unsustainable fiscal policy. Places such as Greece, Spain, Italy, and France are examples of high-tax nations that will destabilize the world economy by causing sovereign debt crises. OECD nations are the ones with punitive tax systems that undermine growth.

Tax havens and other low-tax jurisdictions are outposts of fiscal sanity – at least relatively speaking. Yes, they periodically fall into bad habits and let government get too big and spend too much, but at least they’re subject to the discipline of global markets and can’t bury their heads in the sand and cross their fingers that big new sources of revenue will be magically forthcoming.

The world would be a much better place if OECD nations copied the fiscal policy of tax havens, not vice versa.

Tax competition means better policy

Low-tax jurisdictions generally are the ones with good tax policy. There is wide agreement among public finance economists that an ideal tax system should be based on low tax rates, no double taxation, no loopholes, and territoriality. Yet the OECD’s anti-tax competition effort is designed to help high-tax nations impose double taxation on an extraterritorial (or worldwide) basis.

This is why economists tend to be strong supporters of competition between jurisdictions. Tax competition encourages nations to adopt good tax policy, even if politicians from those countries would prefer to adopt class-warfare policies because of perceived short-run electoral considerations.

Rather than reiterate the main points in a conclusion, the best way to end this paper is with a series of quotes from Nobel laureates. These economists understand that a cartel of high-tax nations would be a mistake. An “OPEC for politicians” would hurt the global economy and condemn people around the world to a more dismal future.

“…competition among nations tends to produce a race to the top rather than to the bottom by limiting the ability of powerful and voracious groups and politicians in each nation to impose their will at the expense of the interests of the vast majority of their populations.”

Gary Becker

“…tax competition among separate units…is an objective to be sought in its own right.”

James Buchanan

“Competition among national governments in the public services they provide and in the taxes they impose is every bit as productive as competition among individuals or enterprises in the goods and services they offer for sale and the prices at which they offer them.”

Milton Friedman

“…international competition provided a powerful incentive for other countries to adapt their institutional structures to provide equal incentives for economic growth and the spread of the ‘industrial revolution.’”

Douglas North

“Competition among communities offers not obstacles but opportunities to various communities to choose the type and scale of government functions they wish.”

George Stigler

“[Tax competition] is a very good thing. …Competition in all forms of government policy is important. That is really the great strength of globalization …tending to force change on the part of the countries that have higher tax and also regulatory and other policies than some of the more innovative countries. …The way to get revenue is doing all you can to encourage growth and wealth creation and then that gives you more income to tax at the lower rate down the road.”

Vernon Smith

“With apologies to Adam Smith, it’s fair to say that politicians of like mind seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise taxes. This is why international bureaucracies should not be allowed to create tax cartels, which benefit governments at the expense of the people.”

Ed Prescott

“[I]t’s kind of a shame that there seems to be developing a kind of tendency for Western Europe to envelope Eastern Europe and require of Eastern Europe that they adopt the same economic institutions and regulations and everything.  …We want to have some role models… If all these countries to the East are brought in and homogenized with the Western European members then that opportunity will be lost.

Edmund Phelps

__________________________________

Daniel Mitchell is a Senior Fellow at the Cato Institute (www.cato.org), a free-market think tank located in Washington, DC. He also co-founded the Center for Freedom and Prosperity Foundation and serves as the Chairman of its Board of Directors.

The Center for Freedom and Prosperity Foundation is a public policy, research, and educational organization operating under Section 501(C)(3). It is privately supported, and receives no funds from any government at any level, nor does it perform any government or other contract work. Nothing written here is to be construed as necessarily reflecting the views of the Center for Freedom and Prosperity Foundation or as an attempt to aid or hinder the passage of any bill before Congress.

The Center for Freedom and Prosperity Foundation, the research and educational affiliate of the Center for Freedom and Prosperity (CF&P), can be reached by calling 202-285-0244 or visiting our web site at www.freedomandprosperity.org.

_______________________________________________

Center for Freedom and Prosperity Foundation
P.O. Box 10882
Alexandria, Virginia 22310-9998
Phone: 202-285-0244
info@freedomandprosperity.org
www.freedomandprosperity.org

[PDF Version]

November 2009, Vol. IX, Issue II

Government-Run Health Care Means
Higher Deficits and Debt:

Realistic Assumptions Show 10-Year Deficits
Easily Could Exceed $600 Billion

The healthcare proposals in the House and Senate are bad news for taxpayers and would permanently damage the American economy with more spending, taxes, and debt. While the details differ, both plans add about $1 trillion to the burden of federal spending over the next 10 years according to congressional estimates. Some of this spending is financed with higher taxes, and both plans also promise to finance a portion of the new spending by curtailing the growth of other programs, particularly Medicare.

Supporters of a government take over of health care argue this approach is fiscally responsible because the higher taxes and promises of future spending restraint supposedly exceed the amount of proposed new spending. Making government bigger, however, is not fiscally prudent – especially when the estimates put together by the congressional forecasters are deeply flawed.

In reality, the proposals on Capitol Hill will make government more expensive and increase deficits. Government programs almost always cost more than the preliminary estimates, and projections for healthcare spending have been notoriously inaccurate. Moreover, tax increases will not collect as much revenue as politicians want because of “Laffer Curve” effects. Last but not least, the promised spending restraint is a farce. If congressional forecasts are modified to be more realistic, deficits and debt will climb by at least $600 billion – and perhaps more than $850 billion – over the next 10 years.

By Daniel J. Mitchell, Ph.D.

Key Observations

• The Senate plan would increase the burden of federal spending by nearly $900 billion, while the House legislation would increase government by nearly $1.3 trillion according to the Congressional Budget Office.
• These estimates are far too low because they do not properly measure how people and businesses change their behavior in response to government handouts.

• Even tiny errors in forecasts from the Congressional Budget Office (CBO) and Joint Committee on Taxation (JCT) have enormous fiscal implications. If revenues and offsets are 25 percent below the forecast and spending is 50 percent higher than estimated (and that almost surely is still too optimistic), the 10-year deficits will be $602 billion to $860 billion higher.

• There are significant incentives for companies to dump their healthcare plans since workers will then get more take-home pay and be able to obtain health insurance using subsides and handouts from the government. This will dramatically increase budgetary costs.
• The spending estimates also are far too low because they do not recognize that politicians in the future will be tempted to expand subsidies as part of routine vote-buying behavior, similar to what happened with Medicare and Medicaid.
• The estimated savings are especially implausible since many details about the legislation are still unknown.
• ·The cost of the proposals is disguised since the new spending is backloaded. More than 90 percent of spending in the Senate plan and 84 percent of spending in the House plan takes place in the second five years of the 10-year scoring estimate.
• ·Even the savings that might be real in the Senate plan, such as reductions in Medicare payment rates for physicians’ services, are pushed off into the future, where they can be canceled by politicians seeking to curry favor with key constituencies.
• The federal government’s ability to predict healthcare spending leaves much to be desired. When Medicare was created in 1965, the long-run forecasts estimated that the program would cost about $12 billion by 1990. In reality, it cost more than $100 billion that year (and now costs $500 billion).

• Medicaid was also created in 1965 and was supposed to be a very small program with annual expenditures of about $1 billion. It has now become a huge $250 billion entitlement – and that’s just the cost to federal taxpayers.
• Medicaid’s disproportionate share hospital (DSH) program is a sobering example. Created in 1987 to subsidize hospitals with large numbers of Medicaid and uninsured patients, the programs was supposed to cost less than $1 billion in 1992, but the actual cost that year was a staggering $17 billion.

• The Medicare Catastrophic Coverage legislation was adopted in 1988 and then repealed less than two years later, in part because some provisions were already projected to cost six times more than originally forecast.
• The tax provisions in the healthcare proposals will impose considerable damage without raising much revenue. The House legislation supposedly raises more than $460 billion with higher income tax rates, but actual collections would be far smaller because of reduced incentives to earn income and increased incentives to avoid and evade taxes.
• The Senate plan has big tax increases on high-cost insurance policies, medical devices, and health insurance providers, but a substantial share of the projected revenue will evaporate as businesses and consumers alter their behavior to protect themselves from the tax.
• Both plans hide the actual tax burden by counting “penalty fees” on individuals and companies as negative spending, which is a nontrivial issue, particularly for the House plan, with has nearly $170 billion of these hidden taxes.
• Thanks to the phase-out of insurance subsidies, taxpayers with modest incomes will face marginal tax rates of nearly 70 percent, a staggering penalty on upward mobility that will hinder overall economic performance.
• Deficits and debt will skyrocket under both plans. Big increases in government spending and higher taxes are a poisonous combination that will slow growth and expand government even further.
• To add insult to injury, the internal revenue service would get new enforcement powers to determine if people have acceptable (in the eyes of politicians and bureaucrats) health insurance.

Introduction

The political tangling over “Obamacare” is a bit of a misnomer since there is no official plan from the White House. The Administration has deliberately – some say cleverly, others say evasively – avoided specifics and instead focused on vague themes such as a desire for universal coverage and support for government run insurance to “compete” with private health insurers (much as Fannie Mae and Freddie Mac “competed” with private financial institutions).

But even those items are negotiable. The White House has signaled that the President will sign just about any bill Congress enacts. Based on the proposals in the House and Senate, this is troubling news for taxpayers. The federal government has a record of waste and abuse with new entitlement programs. Medicare and Medicaid, both of which are models for proposed government run insurance, were both far more expensive than first predicted. Moreover, a larger public sector will divert resources from the productive sector of the economy, further undermining prosperity. The combination of a growing government and a sputtering private sector is a recipe for more deficits and more debt.

The House and Senate Plans Mean Much Bigger Government According to Official Estimates

The proposals being considered by the House¹ and Senate² are both designed to expand health insurance through a costly carrot-and-stick approach. Subsidies are used to artificially reduce the cost of obtaining insurance, and various mandates, taxes, penalties, and fees are used to prod consumers (or their employers) into providing insurance.³

From a fiscal perspective, the subsidies are the biggest parts of both proposals. As shown Figure 4, the Senate proposal includes nearly $900 billion of subsidies and spending over the next 10 years (2010-2019) according to the official estimates of the Congressional Budget Office,⁴ while the House bill is even more extravagant, with CBO estimating close to $1.3trillion of subsidies.⁵

Both proposals have “offsets” that supposedly finance some or all of this new spending. The offsets can be divided into two categories – tax increases and promises of spending restraint. The tax increases in the two proposals are significantly different, both in content and magnitude. The lion’s share of the revenue in the House bill, at least according to estimates from the Joint Committee on Taxation, will be generated by higher tax rates on investors, entrepreneurs, and other upper-income taxpayers.⁶ JCT predicts the biggest source of new revenue in the Senate proposal, meanwhile, is a big tax increase on health insurance policies above a certain cost.⁷ As seen in Figure 5, the House bill has a larger overall tax increase. And although this does not change the amount of money going to Washington, taxpayers presumably will not be happy that the internal revenue service is going to be the chief enforcement agency for determining if people have the appropriate (as defined by the crowd in Washington) health insurance policy.⁸

The other offsets in the two proposals are various initiatives to curtail the rapid rise in spending for Medicare⁹ (there also are savings from Medicaid,¹⁰ but a significant share of the new spending is funneled through that program, so the overall Medicare budget becomes even bigger). These provisions in the House and Senate proposals often are characterized as “cuts,” but that is disingenuous. Under current law, Medicare is expected to climb from about $500 billion to nearly $950 billion over the next 10 years. Federal spending on Medicaid, meanwhile, is projected to jump from less than $300 billion to more than $425 billion during the same period.¹¹ The so-called cuts in the two proposals merely trim how fast the budgets grow for these two programs. But this may be a meaningless discussion since no actual savings are guaranteed. With that caveat in mind, Figure 6 compares the ostensible savings in the two proposals.

Even though the size and cost of government are the key variables, the debate in Washington about major pieces of legislation often revolves around the impact on government borrowing. This supposedly is good news for advocates of government-run health care. If one believes the official estimates, the proposal produced by the Senate Finance Committee will reduce cumulative budget deficits by $81 billion over the next 10 years. The House legislation, meanwhile, will reduce 10-year budget deficits by $104 billion according to the scorekeepers employed by Congress.

Reality: A Fiscal Time Bomb Waiting to Explode

These estimates, though, are deeply flawed. The methodology – and track records – of both CBO and JCT leave much to be desired. Government estimators routinely fail to capture the degree to which people change their behavior to access money and services from the government, and they also fail to measure the degree to which people change their behavior to protect themselves (or their businesses) from changes in tax policy. Economic analysis and historical experience both suggest that spending will be higher than CBO estimates and tax collections will be lower than JCT estimates. Expanding government’s role in healthcare therefore is a path to much higher budget deficits.

Why the Congressional Budget Office is Under-Estimating Spending

Despite the track record of waste in Washington, the CBO assumes that these bills will not result in abuse and overspending. Yet people generally try to maximize their living standards, so when government offers a new set of subsidies and handouts, most people will endeavor to get “their share” of the loot that they are “entitled” to receive under the new program. Moreover, other people will alter their circumstances – legally or illegally – so that they also can benefit from the largesse. The CBO theoretically tries to measure these “microeconomic” responses, but history indicates that the bureaucracy does not do a good job.

In addition, the forecasters do not seem to have a proper understanding of how expanded insurance will increase demand for healthcare, particularly in a system where insurance is not reserved for unexpected and catastrophic expenses and instead is also used for routine medical costs. Health experts frequently grouse about significant expenditures for unnecessary care, but consumers have little reason to self-ration and shop carefully when that the marginal out-of-pocket costs of visits to the doctor or hospital are artificially low because of insurance (the infamous “third-party payer” problem). It is akin to going to an all-you-can-eat restaurant, but with the perception that someone else is paying the bill – meaning people over-consume and do not care much about cost. Similarly, the forecasters at CBO do not fully measure how insurance providers will respond. If the government implements big subsidies for the purchase of health insurance, this will increase the demand for policies, and even a first-year economic student can explain that this will lead to higher prices. This is illustrated in Figure 7, which shows an increase in demand (D1 to D2), which results in higher prices (P1 to P2).

Consider a hypothetical example of what would happen if government started subsidizing the purchase of other products, such as golf clubs or dog food. Instinctively, we understand that producers would raise prices to take advantage of the additional demand. Or consider a real-world example. Fannie Mae and Freddie Mac were government-created entities designed to make mortgage financing more affordable. Along with other subsidies, this understandably increased the demand for housing, and housing prices rose (too far, but that’s a separate issue). The same thing will happen with health insurance.

The House and Senate plans also will drive up the cost of insurance because of provisions that require similar premiums, regardless of whether people are healthy or sick. Known as “guaranteed issue” and “community rating,” these provisions will increases insurance coverage for people with high medical costs, but there is no escaping the fact that this will push up overall premiums.¹² For these and other reasons, a major accounting firm estimated that health insurance costs for the average American family will rise dramatically. Specifically:

This analysis shows that the cost of the average family coverage is approximately $12,300 today and could be expected to increase to approximately: $15,500 in 2013 under current law and to $17,200 if these provisions are implemented. $18,400 in 2016 under current law and to $21,300 if these provisions are implemented. $21,900 in 2019 under current law and to $25,900 if these provisions are implemented.¹³

The CBO numbers also are deeply flawed because there is little (if any) recognition of the incentive that has been created for employers to dump their employee health plans. Most firms view these plans as a hassle, but they offer plans because workers benefit from getting as much compensation as possible in the form of untaxed fringe benefits. But the benefit of those tax breaks for many workers will be less than the value of the handouts and subsidies the government will be offering. In such an environment, the workers will be happy to lose their employer-provided coverage. This is because the money they receive (more take-home pay and big subsidies from the government will be greater than the costs (any tax on the take-home pay plus out-of-pocket costs for health insurance). This is particularly true for the growing share of the population – 47 percent according to recent estimates – that is exempt from the income tax already.¹⁴

Another problem is that the CBO numbers don’t measure the extent to which costs are hidden in future years. This occurs when lawmakers delay the implementation of certain provisions to create an artificially low estimate. This “backloading” gimmick is happening with the House and Senate plans. More than 90 percent of the spending in the Senate plan taking place in the second five years of the 10-year scoring estimate, and more than 84 percent of the spending in the House plan also in the last five years. Michael Tanner of the Cato Institute elaborates:

The CBO provides 10- year projections of a bill’s cost. But most provisions of the health bill don’t take effect until 2014. So the “10-year” cost projection only includes six years of the bill. Plus, the costs ramp up slowly. In its first year, the House bill would only cost about $6 billion; in its first three, less than $100 billion. The big costs are in the final years of the 10-year budget window — and beyond. In fact, over the first 10 years that the House bill would be in existence (2014 to 2024), its costs would be closer to $2.4 trillion. Similarly, the real cost of the Senate bill over 10 years of operation is estimated at $1.5 trillion.¹⁵

Tanner also explains that the long-term unfunded liability, at least for the House legislation, is more than $9 trillion.¹⁶ That is a lot of money, even in Washington.

Last but not least, the official budget estimates from CBO fail (albeit more understandably) to anticipate changes in political behavior. Simply stated, it is inconceivable that politicians in the future will resist the temptation to increase benefits and expand eligibility. This is particularly true since it would be just a matter of time before the media started reporting about the share of the population that still lacked insurance, or gave coverage to hardship examples of people that could not afford insurance even with all the subsidies and handouts.

Why the Joint Committee on Taxation is Over-Estimating Revenues

Taxes discourage people from engaging in the actions that result in tax. Politicians frequently raise taxes on tobacco, for instance, because they want to discourage smoking. Setting aside whether government should try to control people’s private lives, the politicians care correct – at least in the narrow sense that higher tobacco taxes will discourage smoking. But that also means that there will be fewer cigarettes to tax, and therefore less money for government (or at least not as much additional money as would be the case if tobacco consumption did not change). Almost all taxes generate behavioral responses. Upper-income people, for instance, earned and reported far more income after the Reagan tax cuts. The response was so large that the IRS actually collected five times more money from the “rich” in 1988 (when the top tax rate was 28 percent) than it did in 1980 (when the top tax rate was 70 percent).¹⁷

The tax provisions in the healthcare proposals on Capitol Hill will generate similar behavioral responses. The higher income tax rates in the House bill will discourage investors, entrepreneurs, and other upper-income taxpayers from working, saving, and investing. This means they will earn less taxable income. Moreover, the higher tax rates will encourage tax avoidance and tax evasion, which means they will report less taxable income. The combination of these factors will result in far less than the $460.5 billion that JCT is projecting for that provision.¹⁸ The same is true for the other JCT estimates (as well as CBO’s estimates for the amount of revenue that will be generated by hidden taxes such as “play-or-pay” fees for employers and mandates for individuals).¹⁹

The revenue estimates for the Senate plan are equally unrealistic. The biggest share of revenue, $201.4 billion, supposedly will come for a 40 percent excise tax on the value of expensive insurance plans.²⁰ To be fair, JCT tries to measure the extent to which businesses and workers will shift to lower-cost health plans, but it is very doubtful this provision will collect anywhere close to $200 billion. And since CBO assumes that revenues from this provision will grow by more than 10 percent annually even past the 10-year budget window, there clearly is insufficient attention to how people will respond to avoid the huge tax. The same is true of the steep taxes on medical devices and insurance providers. Clearly there will be behavioral responses, yet there are not properly reflected in the revenue estimates.

Why the Congressional Budget Office is Over-Estimating Spending Offsets

The House and Senate proposals both promise to finance (or offset) some of the subsidies and handouts by curtailing the growth of other government health programs – particularly Medicare. Since Medicare is projected to nearly double over the next ten years, from $500 billion to $950 billion, reducing the program’s growth rate is a worthy endeavor. Unfortunately, the supposed offsets are either gimmicks or dubious promises to be more frugal in the future.

The Senate plan, for instance, pretends to save money, but that is in part because it uses gimmicks without any actual guarantees of savings. The two main ploys are a “Medicare Commission” and a “Failsafe Budget Mechanism.” Both are based on the fatuous notion that politicians will meekly stand aside and let bureaucrats and/or formulas make changes to programs to keep spending from climbing too rapidly. Yet the last 45 years have shown that politicians do precisely the opposite. They routinely seek to expand benefits and increase eligibility in order to buy votes from various interest groups.

There are some non-gimmicky provisions in the House and Senate plans, but they are extremely improbable. Are politicians really going to start reducing subsidies to hospitals beginning in 2014? Are they really going to cut physician reimbursements – but only in the future, and notwithstanding that Congress has rejected such savings every year since 2003?²¹ The only realistic offset is the evisceration of the Medicare Advantage plan, which is being targeted by some in Washington for ideological reasons because it gives senior citizens some degree of control and allows them to choose among competing health plans.

Finally, the official “scoring” of the proposals do not count the enormous costs imposed on consumers. Forcing individuals to purchase health insurance is essentially the same as taxing them – and such mandates were considered a tax by the congressional estimators in the early 1990s when the Clinton Administration sought to impose a government-run system. Now the politicians have used clever legislative language to dodge this issue, but that doesn’t mean the costs are no longer there.

The Cumulative Negative Impact of Bigger Government and Higher Taxes

Neither the JCT nor the CBO even try to measure the impact of fiscal policy on the overall economy. Yet academic research shows that a rising burden of government will reduce economic growth. And since even small changes in economic growth can have a big impact on taxable income over time (and also impact eligibility for government programs), this should be a critical component of any accurate revenue estimate. As shown in Figure 8, the Obama Administration estimates that the 10-year deficit would jump by a staggering 3.14 trillion if economic growth is one percentage point less each year.

There also are other effects that make the estimates very unreliable. As explained earlier in the paper, much of the new spending in the proposals is to subsidize insurance coverage. But the subsidies are not universal. In order to limit handouts to those with more modest incomes, the subsidy is gradually withdrawn as household income increases. That sounds reasonable, and it does help control spending, but it has the unintended effect of increasing the effective marginal tax rate on a wide range of people. As Greg Mankiw of Harvard University explains:

…a family of four making $54,000 would pay $4,800 for health insurance. The rest of the premium would come from government subsidies. If the family’s income rises to $66,000, the subsidy falls, and the cost of health insurance rises to $7,600. In other words, earning an additional $12,000 requires the family to pay an additional $2,800. The implicit marginal tax rate is $2,800/$12,000, or 23 percent. Similarly, a single person earning $26,500 would pay $2,300 for health insurance, but if his income rises to $32,400, his premium rises to $3,700. This yields an implicit marginal rate of 24 percent. You get somewhat different numbers at other income levels. Typically, however, the implicit marginal tax rates are around 20 percent. Those figures for marginal tax rates are, of course, added on top of those already imposed by existing income and payroll taxes.²²

The higher implicit marginal tax rates are very substantial in both House and Senate proposals, and they will discourage productive activity. Indeed, some middle-income taxpayers will face effective marginal tax rates of nearly 70 percent – which was the highest statutory tax rate that existed for the wealthy when Ronald Reagan took office. The failure to measure the impact of these higher tax rates is a major failure of the estimating process. More important, it is yet another reason why spending will be higher, tax receipts will be lower, future generations will be saddled with greater debt and deficits will be bigger if government-run healthcare is enacted.

Historical Evidence Shows Government Programs Cost More than Predicted

There are ample reasons to be very skeptical about the fiscal estimates produced by the CBO and JCT. Congressional forecasters are good at building elaborate models, but those efforts do not yield useful information since the models fail to reflect how individuals in the real world respond to changing incentives. Simply stated, CBO and JCT have always failed to correctly measure behavioral responses. A look at past episodes shows how the forecasts are routinely way off the mark.

Congressional Estimators Routinely Underestimate Cost of Health Care Programs

The bureaucrats who estimate the budgetary effects of tax and spending proposals have a track record of misleading the public. For more than forty years, government officials have consistently underestimated how much programs cost and routinely overestimated how much revenue will be collected by higher taxes. Here are a few of the more dramatic examples:

1. When Medicare was created in the mid-l960s, actuaries projected the program’s hospital insurance budget would reach $9 billion by 1990.²³ The actual 1990 cost was $67 billion.²⁴
2. The long-run forecasts estimated that the entire Medicare program would cost about $12 billion by 1990.²⁵ In reality, it cost more than $100 billion that year (and now costs $500 billion).²⁶
3. Medicaid was also created in 1965 and was supposed to be a very small program with annual expenditures of about $1 billion.²⁷ It has now become a huge $250 billion entitlement.
4. Medicaid’s disproportionate share hospital (DSH) program is a sobering example. Created in 1987 to subsidize hospitals with large numbers of Medicaid and uninsured patients, the programs was supposed to cost less than $1 billion in 1992, but the actual cost that year was a staggering $17 billion.²⁸
5. The Medicare Catastrophic Coverage legislation was adopted in 1988 and then repealed less than two years later, in part because some provision were already projected to cost six times more than forecast.²⁹

The accompanying table, prepared by the Joint Economic Committee, using state, national, and international examples, shows that there is a pervasive pattern of government health programs being more expensive than indicated by forecasts. Needless to say, there is rarely if ever pressure to correct the mistakes. Instead, taxpayers get saddled with higher deficits and more debt.

The Medicare Prescription Drug Program: The Exception that Proves the Rule

While CBO almost always is guilty of underestimating costs, there is one notable exception. When the bureaucrats estimated the cost of the prescription drug program in 2003, they overestimated how much the program would cost.³⁰ Since the program is still only a few years old (the benefits generally did not begin until 2006), it would be unwise to draw too many sweeping conclusions, but the Trustees of the program report that forecasters erred in their predictions about drug prices.

So while it is good news that a program actually wound up costing less than initially projected, it was because of a specific (and rather substantial) error about a unique parameter – the price of pharmaceuticals. If anything this is further proof of dangerously sloppy budget projections in Washington. There is little reason to think that CBO has suddenly become more accurate about the broader challenges of assessing how people respond to incentives and measuring the impact of taxes and spending on economic performance.

It’s Not Just a Healthcare Problem

The failure to properly estimate costs is not limited to healthcare programs. Government programs of all kinds usually cost more than the initial cost estimates. This is true for military contract, road projects, agriculture subsidies, and other forms of income redistribution.³¹

Government estimators also have a hard time figuring out how changes in tax policy will affect revenues. This is often because the Joint Committee on Taxation assumes that tax policy changes–regardless of their magnitude–have no impact on the economy’s performance. Revenue estimators assume that the growth rate, job creation, and income will remain unchanged regardless of how much taxes are reduced or increased. As a result, official estimates from JCT commonly overstate both the amount of tax revenue that will be generated by tax increases and the amount of revenue the government will “lose” due to tax rate reductions.

The absurdity of this approach became clear in 1988 when Senator Robert Packwood (R-OR), then ranking Republican on the Finance Committee, asked the JCT to estimate the revenue impact if the government confiscated all income over $200,000 annually. The revenue estimators at JCT responded that such a tax would raise $104 billion the first year, $204 billion the second year, $232 billion the third year, and $263 billion and $299 billion in the fourth and fifth years, respectively.³² Needless to say, this was a nonsensical estimate. As Senator Packwood noted, the JCT’s calculation “assumes people will work if they have to pay all their money to the Government. They will work forever and pay all of the money to the Government when clearly anyone in their right mind will not.”

To cite a real-world example, the lower tax rates implemented during the 1980s resulted in a huge jump in taxable income reported by upper-income taxpayers. As noted in an earlier section of the paper – and as detailed in Table 2, the net result was that the government collected five times as much revenue from the so-called rich.

The Bottom Line

Even tiny errors in forecasts from the Congressional Budget Office and Joint Committee on Taxation have enormous fiscal implications. Devising more realistic estimates would be a daunting exercise, well beyond the scope of this analysis. But consider what happens if the official forecasts are altered to be more realistic. Assume, for instance, that both CBO and JCT have been slightly too optimistic and that spending is 10 percent higher than forecast and that revenues and offsets are 10 percent less than estimated. Even with that trivial change, the predicted 10-year deficit reduction disappears. The Senate plan increases deficits by $183 billion and the House proposal boosts deficits by $258 billion.

But history suggests that the errors will be far larger. If revenues and offsets are 25 percent below the forecast and spending is 50 percent higher than estimated (and that almost surely is still too optimistic), the 10-year deficits will be $602 billion to $860 billion higher. And if the cost is two or three times higher than the forecast, then the deficit (and, more importantly, the size of government) reaches staggering levels.

Conclusion

In every possible way, the government’s forecasters do a dismal job predicting the cost of government programs. The estimators also have a poor track record of predicting the revenue impact of changes in tax policy. This is not necessarily because CBO and JCT are biased, though some suspicion is warranted since spending estimates almost always are too low and tax estimates generally are too high.

Congress controls the pay and employment of the forecasters at CBO and JCT, so the ultimate responsibility belongs on the shoulders of elected officials. Yet it is these officials that want favorable budget scoring to help make legislation more palatable for a skeptical public.

Regardless of whether the problems are due to honest mistakes or “cooked books,” the final result is the same. The budget forecasts for a government take over of health care are grossly optimistic. Spending will be higher than forecasted if a bill is enacted to subsidize health insurance. Tax increases will not generate the amount of forecasted receipts. And budget deficits and debt will grow even more rapidly.

__________________________________

Daniel Mitchell is a Senior Fellow at the Cato Institute (www.cato.org), a free-market think tank located in Washington, DC. He also co-founded the Center for Freedom and Prosperity Foundation and serves as the Chairman of its Board of Directors.

The Center for Freedom and Prosperity Foundation is a public policy, research, and educational organization operating under Section 501(C)(3). It is privately supported, and receives no funds from any government at any level, nor does it perform any government or other contract work. Nothing written here is to be construed as necessarily reflecting the views of the Center for Freedom and Prosperity Foundation or as an attempt to aid or hinder the passage of any bill before Congress.

The Center for Freedom and Prosperity Foundation, the research and educational affiliate of the Center for Freedom and Prosperity (CF&P), can be reached by calling 202-285-0244 or visiting our web site at www.freedomandprosperity.org.

Endnotes

¹ A “leadership bill” has been proposed, H.R. 3962, which is a modified version of H.R. 3200, the bill produced earlier this year by the three major committees of jurisdiction.

² The Senate plan is the proposal put forward by Senator Max Baucus, Democratic Chairman of the Senate Finance Committee.

³ For a detailed look at the provisions of the two proposals, see “A Side by Side Comparison of Major Healthcare Reform Proposals.” The Kaufman Family Foundation. October, 15 2009. http://www.kff.org/healthreform/sidebyside.cfm.

⁴ CBO scoring of the Senate plan is available in the Letter to Senator Max Baucus, Chairman of the Senate Finance Committee from the Congressional Budget Office to Senator Max Baucus. October 7, 2009. http://www.cbo.gov/ftpdocs/106xx/doc10642/10-7-Baucus_letter.pdf.

⁵ CBO scoring of the House bill is available in the Letter to Congressman Charles Rangel, Chairman of the House Ways and Means Committee from the Congressional Budget Office. October 29, 2009. http://www.cbo.gov/ftpdocs/106xx/doc10688/hr3962Rangel.pdf.

⁶ Most of the revenue estimates for the House bill are available in Joint Committee on Taxation, JCX-43-09, “Estimated Revenue Effects Of Possible Modifications To The Revenue Provisions Of H.R. 3962, The “Affordable Health Care For America Act”.” http://www.jct.gov/publications.html?func=startdown&id=3619. Other revenue provisions (ones that are not being called taxes, for inexplicable reasons) can be found in the CBO estimate.

⁷ Most of the revenue estimates for the Senate plan are available in “Estimated Revenue Effects of the Provisions Contained in Title VI of The America’s Affordable Health Choices Act Of 2009.” Joint Committee on Taxation. http://www.jct.gov/publications.html?func=startdown&id=3590. Other revenue provisions (ones that are not being called taxes, presumably for political reasons) can be found in the CBO estimate.

⁸ Byron York. “Healthcare Reform Means More Power for the IRS.” The Washington Examiner, September 2, 2009. http://www.washingtonexaminer.com/politics/Health-care-reform-means-more-power-for-the -IRS-56781377.html.

⁹ Medicare is the federal government’s health program for the elderly.

¹⁰ Medicaid the federal government’s health program for the poor, though nursing home care for the elderly is a significant part of the program’s budget.

¹¹ Data available at “Projected Deficits and Surpluses in CBO’s Baseline.” The Congressional Budget Office. http://www.cbo.gov/ftpdocs/105xx/doc10521/budgetprojections.xls.

¹² Steven Spruiell. “Obamacare Dissected.” National Review, October, 13 2009. http://article.nationalreview.com/?q=MGVmMjNjNmExMzUyMGZiY2ZiNDgzM2RjMGMxNDgzNmI

¹³ Keith Hennessey disagrees with the methodology, but agrees that costs for health insurance will rise. See Keith Hennessey. “Higher Premiums and Lower Wages.” October 12, 2009. http://keithhennessey.com/2009/10/12/pwc-study/.

¹⁴ Alan Reynolds. “A 10 Million-Person Exaggeration?” Forbes, October 11, 2009. http://www.forbes.com/2009/10/11/cbo-baucus-health-insurance-income-tax-opinions-contri butors-alan-reynolds.html.

¹⁵ Michael D. Tanner. “How Congress is Cooking the Books.” September 30, 2009. The New York Post, http://www.cato.org/pub_display.php?pub_id=10591

¹⁶ Ibid.

¹⁷ Daniel J. Mitchell, “The Laffer Curve: Understanding the Relationship Between Tax Rates, Taxable Income, and Tax Revenue,” Center for Freedom and Prosperity Foundation Prosperitas, August 2009. http://www.freedomandprosperity.org/Papers/laffer1/laffer1.shtml

¹⁸ Joint Committee on Taxation, JCX-43-09, “Estimated Revenue Effects Of Possible Modifications To The Revenue Provisions Of H.R. 3962, The “Affordable Health Care For America Act”.” The Joint Committee on Taxation. http://www.jct.gov/publications.html?func=startdown&id=3619.

¹⁹ Ibid.

²⁰ Joint Committee on Taxation, JCX-41-09, Estimated Revenue Effects Of The Revenue Provisions Contained In Title VI Of The “America’s Healthy Future Act Of 2009,” As Amended Through October 2, 2009, And Under Consideration By The Committee On Finance, (October 08, 2009). Available at http://www.jct.gov/publications.html?func=startdown&id=3590.

²¹ Michael F. Cannon. “Max’s budget-gimmick magic.” The New York Post. October 13, 2009. http://www.nypost.com/p/news/opinion/opedcolumnists/max_budget_gimmick_magic_P0Yk0 5WHnje84Sqvnf9FKI

²² Greg Mankiw. Marginal Tax Rates from Health Reform. October 10, 2009. http://gregmankiw.blogspot.com/2009/10/marginal-tax-rates-from-health-reform.html

²³ Robert J. Myers, “Actuarial Cost Estimates and Summary of Provisions of the Old-Age, Survivors, and Disability Insurance System as Modified by the Social Security Amendments of 1965, and Actuarial Cost Estimates and Summary of Provisions of the Hospital Insurance and Supplementary Medical Insurance Systems Established by such Act,” Committee Print, Committee on Ways and Means, House of Representatives, 89th Congress, 1st Session; July 30, 1965, Table 11, p. 33.

²⁴ 1993 Annual Report of the Board of Trustees of the Federal Hospital Insurance Trust Fund, Table I.C.2, p. 10.

²⁵ Robert J. Myers, “Actuarial Cost Estimates for the Old-Age, Survivors, Disability, and Health Insurance System as Modified by the Social Security Amendments of 1967,” Committee Print, Committee on Ways and Means, House of Representatives, 90th Congress, 1st Session; December 11, 1967.

²⁶ Budget of the U.S. Government, Fiscal Year 2010: Historical Tables, table 16.1, p. 334.

²⁷ Clay Chandler, “Health Care Costs a Long-Term Headache; Economists Fear New Entitlements Would Become a Budget Buster,” The Washington Post, October 17, 1993.

²⁸ Robert E. Mechanic, “Medicaid’s Disproportionate Share Hospital Program: Complex Structure, Critical Payments,” National Health Policy Forum Background Paper, September 14, 2004, p. 4. In 1991, Congress began a process-still on-going-of reforming Medicaid to close loopholes.

²⁹ Marilyn Moon, “The Rise and Fall of the Medicare Catastrophic Coverage Act,” National Tax Journal, Vol 43, no 3, September 1990.

³⁰ 2006 Annual Report of the Board of Trustees of the Federal Hospital Insurance and Federal Supplementary Medical Insurance Trust Funds. http://www.cms.hhs.gov/reportstrustfunds/downloads/tr2006.pdf

³¹ Chris Edwards. “Government Cost Overruns.” March 2009. http://www.downsizinggovernment.org/government-cost-overruns

³² Letter to Senator Robert Packwood from Joint Committee on Taxation, November 15, 1988. For more information, see http://www.heritage.org/Research/Taxes/BG1544.cfm.

_______________________________________________

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[PDF Version]

October 2009, Vol. IX, Issue I

The Health Care Choice Act: Lowering Costs by
Allowing Competition in the Individual Insurance Market¹

Government restrictions are artificially boosting costs and making it more difficult for families to get health insurance. More specifically, regulatory intervention by state governments is a significant problem, particularly protectionist barriers preventing consumers from buying insurance policies issued in other states. Combined with expensive mandates that states impose on health plans – for everything from chiropractors to breast reduction, the results are less competition and higher premiums. Congressman John Shadegg (R-AZ) has introduced the Health Care Choice Act (H.R. 3217) to restore unfettered interstate commerce and let consumers shop for health insurance plans in a national market. According to one estimate, freedom to purchase insurance policies issued in other states could save some families as much as 30 percent on their health policies. Unleashing the Constitution’s promise of unfettered interstate commerce is the most effective way of breaking up the inefficient oligopolies created by state politicians.

By Sven R Larson, Ph.D.

Introduction

In many ways, America’s health care system is the best in the world. It has state-of-the-art technology and highly-skilled medical professionals. America is also home to most of the cutting-edge medical research in the world. However, there are also important problems, such as the “third-party payer” model where consumers rarely pay the full cost of their own health care. This creates an incentive for both excessive and expensive use of health care, a problem that would be exacerbated by current proposals for greater government control of the health care system.²

But the third-party payer problem is not the only reason that health care costs are high. State governments impose health insurance coverage mandates, often for “gold-plated” coverage, that drive up the cost of insurance. These regulations, which are unique to each state, are imposed at the behest of interest groups seeking to increase demand for their services. Combined with protectionist barriers that prevent consumers from buying policies from providers in other states, these mandates have severe unintended consequences:

• They limit competition in the health insurance market by preventing insurance buyers from shopping across state lines, creating monopolistic and oligopolistic situations in many states;
• They impose coverage mandates that force health insurance buyers to purchase coverage that they either do not want or cannot afford;
• They force insurers to use community rating instead of experience rating, which means healthy people are forced to subsidize unhealthy people – to the effect that insurance premiums rise for many buyers and healthy people are driven out of the market.

The symptoms of a dysfunctional health insurance market – foremost the significant number of uninsured, but also rising costs – are recognized by many legislators. But the problem cannot be solved, as some suggest, by means of increased government regulation.³ Indeed, government regulation is the cause of most problems in the health insurance market, not the solution.

Restoring a free market health care system would be a daunting task, one that would involve, 1) sweeping reforms to the 45 percent of health care directly financed by government programs, and 2) a complete rewrite of the tax code to remove the distortions that exist in employer-provided health insurance. This paper focuses on the so-called third leg of the stool – policies to remove government barriers and restore competition to the market for individual health insurance.

The Problem

While many of the uninsured have adequate income,⁴ premiums are artificially expensive, particularly for those who do not obtain group coverage through their employer (federal law allows employers to buy group policies on the national market, so state mandates and protectionism are not a problem). The major stumbling block is the absence of a free market for non-employer-based health insurance – and state governments deserve the blame. First, state politicians set up cartels by requiring purchase of health insurance only from in-state insurers. Second, after setting up a cartel, the state politicians then impose a complex web of coverage mandates. These mandates drive up the cost of insurance, but since the state has imposed, for all intents and purposes, trade barriers that prohibit the purchase of insurance policies issued elsewhere, these costs get passed on to captive consumers.

The solution is to eliminate trade barriers by unleashing the Constitution’s promise of unfettered interstate commerce. This idea has thus far not been at the forefront of the reform debate. Senate Finance Committee Chairman Max Baucus (D-MT), for instance, has proposed a bill, backed by President Obama, that, according to the Wall Street Journal, would impose “vast new national insurance regulation, huge new subsidies to pay for the higher insurance costs this regulation will require and all financed by new taxes and penalties on businesses, individuals and health-care providers.”⁵

Governor Deval Patrick of Massachusetts, meanwhile, suggests his state’s health reform is a national model.⁶ However, the Massachusetts reform does not allow out-of-state purchase of insurance plans. It has also failed to achieve one of its major goals, namely universal coverage. According to the Census Bureau, in 2008 – a year into the Massachusetts reform – 352,000 residents lacked health insurance, up from 340,000 in ’07.⁷ And health insurance policies in Massachusetts are considerably more expensive than the national average, among the most expensive in the nation.

The Solution

However, the momentum in the health care debate may be turning, at least slightly, in favor of free-market competition. Recently, Senator Feinstein (D-CA) expressed some support for reducing or eliminating restrictions on selling health insurance across state lines.⁸ More important, a reform to accomplish this was introduced in 2006 by Congressman John Shadegg (R-AZ). In July 2009, Congressman Shadegg and 15 co-sponsors introduced a new version, H.R. 3217, to eliminate state-based protectionism and allow a national market for non-employer-based health insurance.⁹

A national market would achieve two things that would help bring insurance premiums down:

• More consumer choice. Insurance buyers would be able to shop for health insurance anywhere in the country and find the plan that best meets their needs. This increases competition among sellers and improves the chances for today’s uninsured to find a plan that is both affordable and suitable to their needs and preferences. One of the leading health insurance exchanges, eHealthInsurance.com, claims to offer more than 10,000 plans from 180 carriers, though obviously only a fraction are available to individual buyers in any given state because of protectionist restrictions.¹⁰
• Lower costs. Today, each state has its own specific set of mandates. These mandates unavoidably increase the cost of coverage so long as consumers do not have the Constitutional freedom to shop across state lines. The result is a high fixed cost in creating and offering health plans. But if buyers can purchase an insurance policy from states without costly mandates, they can find health insurance that is more affordable. Moreover, state governments will be encouraged to reduce or eliminate expensive mandates once consumers start buying health insurance policies from sellers in states with lower levels of regulation.

Pseudo-Reform Will Not Work

The bill introduced by Senator Baucus in September 2009, the Framework for Comprehensive Health Reform Act¹¹, contains a provision that would allow health insurance buyers to purchase insurance across state lines. States would be allowed to form compacts, which would be state-by-state bilateral agreements to form free-trade areas for health insurance.

But there are huge problems that make the Baucus bill a hollow gesture. First, each compact would require an approval by Congress, making it highly unlikely that a genuine national market could develop – especially if interest groups start lobbying to protect the status quo. Even more troublesome, states would have very little incentive to create compacts since that would undermine the cozy arrangements that have been created under the current system of protectionism.

The Shadegg proposal, on the other hand, does not contain any poison-pill provisions. The right to buy health insurance across state lines, which theoretically is guaranteed by the Constitution’s interstate commerce clause, would be legislatively affirmed. Congress would only have to enact it once in order to create an unrestricted, nationwide market for insurance plans.

Jurisdictional Competition is the Key to Affordable Health Insurance

Competition between governments increasingly is understood to be an important tool for good economic policy. Simply stated, politicians are less likely to over-tax, over-spend, and over-regulate when they know that individuals can work, save, shop, or invest in another jurisdiction. Borrowing from the insights of the Public Choice economists, jurisdictional competition treats governments as being competitors with each other for jobs and investment. Consider the following analogy: When there is no competition, businesses will charge high prices and offer inferior products and services. But when there is competition, businesses vie to provide better products at lower prices to attract consumers. The same principle applies to governments. When people are captive, politicians treat them shabbily. But when people can – in effect – choose their government (or at least the government where economic activity will occur), then the politicians must be less oppressive in order to keep the geese that lay the golden eggs from flying away.

Jurisdictional competition has become very controversial on the international level. Uncompetitive high-tax nations like France and Germany, for instance, are opposed to tax competition since economic activity has been migrating to lower-tax nations. Politicians from these nations want tax harmonization policies that make it difficult for people to escape oppressive policy. Not surprisingly, economists are particularly critical of these efforts. Indeed, several Nobel Prize winners have commented specifically on competition among governments. James Buchanan points out that “…the intergovernmental competition that a genuinely federal structure offers may be constitutionally ‘efficient’…” and that “…tax competition among separate units…is an objective to be sought in its own right.”¹² The late Milton Friedman, meanwhile, wrote, “Competition among national governments in the public services they provide and in the taxes they impose is every bit as productive as competition among individuals or enterprises in the goods and services they offer for sale and the prices at which they offer them.”¹³ And Gary Becker observed that “…competition among nations tends to produce a race to the top rather than to the bottom by limiting the ability of powerful and voracious groups and politicians in each nation to impose their will at the expense of the interests of the vast majority of their populations.”¹⁴

Legal scholars also recognize the dangers of one-size-fits-all policy and government cartelization. John McGinnis of Northwestern University Law School recently wrote that, “Jurisdictional competition…is a primary mechanism for…reducing the ability of interest groups to take resources from the government. Under jurisdictional competition, sovereigns compete by providing efficient levels of public goods. Leaders are thereby restrained from rewarding themselves, their supporters, or influential special interest groups. A large, diverse democracy, where interest groups are held in check by jurisdictional competition, substantially reduces the incentives for individuals to seek rents through government action. Individuals will instead spend their time, on balance, in relatively more productive and peaceful activity.”¹⁵

These arguments all apply to the individual health insurance market in America. Under current policy, state governments do not allow consumers to shop for insurance policies issued in other states – even though the Constitution was designed in part to prevent states from imposing trade barriers. Having nonetheless imposed these trade barriers, politicians then impose mandates that force captive consumers to pay more for insurance – or go without insurance at all. But if consumers had the freedom to purchase policies from insurers in states with less onerous levels of regulation, it would be virtually impossible for states to maintain these costly mandates.

A National Insurance Market Means Big Savings for Consumers

A coverage mandate requires a health insurance provider to include coverage of a specified benefit for all policies issued in a state. The insurance buyer, of course, must then pre-pay for all of these benefits. As a consequence, the costs of insurance policies go up as more mandates are added – and rising premiums mean more families are excluded, either because the minimum cost of health insurance grows beyond their budget or because they do not think a gold-plated policy is worth the cost.

In 2006 there were a total of 1,843 coverage mandates in effect at the state level, including the District of Columbia.¹⁶ In 2008 that number had risen to 1,961. The number of mandates varies dramatically from state to state: In 2008 Idaho only has 14 mandates while Minnesota imposes 63 mandates. To further complicate the matter, no two states impose the same set of mandates.

Mandates are divided into three categories: benefits, providers and persons. Alcoholism, breast reconstruction, diabetic supplies, mammograms and maternity stays are the most common benefit mandates, each being required in at least 45 states. Two of the rarest mandates are kidney disease (only in Wisconsin) and Wilm’s tumor (New Jersey).

Provider mandates, which require insurance buyers to pre-pay for services by various medical specialists, are also commonplace. Chiropractors are most frequently mandated (46 states), followed by psychologists (44) and optometrists (43). Denturists, pain-management specialists and pastoral counselors are the rarest provider mandates, demanded by only two states in each case.

In terms of covering persons, all 50 states, plus the District of Columbia, mandate that newborns be covered. More than 40 states mandate coverage of adopted children and continuation of coverage for dependents and employees. At the other end of the scale, only 12 states mandate coverage of dependent students and two states – California and Colorado – mandate that health plans cover domestic partners.

There is a link between the states amassing coverage mandates and the rate of Americans lacking health insurance. Those who cannot pay for policies loaded with mandates are left without insurance. Merrill Matthews of the Center for Affordable Health Insurance likens the state-coverage mandates to the auto market, saying that mandatory coverage “…is like saying to someone in the market for a new car, if you can’t afford a Cadillac loaded with options, you have to walk.”¹⁷ To elaborate on the analogy, the differences between coverage mandates would be like some states requiring cars to be equipped with satellite radio, others to demand that they all have four-wheel drive, sunroof, etc. The result is undeniably higher costs. Insurance issuers must invest heavily in designing a policy that meets one state’s requirements but is not marketable in other states. That cost gets passed on to insurance buyers in the form of higher premiums.

A closer look at the load of coverage mandates in high mandate states reveals considerable differences in health insurance costs between low and high mandate states. Table 1 below shows how much the mandates in each coverage category add to the cost of a health insurance plan:¹⁸

To illustrate how mandates drive the cost of health insurance, suppose an insurance policy without any mandates costs $100. This policy would cover catastrophic health care only; presumably the insurance buyer pays cash for all non-catastrophic health care.

If the insurance buyer lives in the District of Columbia he will have to pay $17.50 extra, on top of the cost for the catastrophic-only policy. If he lived in Idaho he would pay $19.50 on top of the $100.¹⁹ By contrast, in Minnesota, with the highest number of mandates, the mandates add $66.50 to the $100 catastrophic-only policy. Hypothetically, therefore, a policy that meets the District of Columbia mandates is 29.6 percent cheaper than one that is tailored to the mandates of Minnesota.

This comparison of the costs of state mandates is, again, based exclusively on the cost mark-up from various mandates. Many other factors affect the cost of health insurance, one of which is the size of the state. However, it nevertheless demonstrates how the mandates make a real difference to the cost of health insurance premiums.

Based on this estimate alone, a family buying an insurance policy for $800 under the Minnesota mandates would cut their monthly cost by $236 per month if they could purchase a policy that met the District of Columbia criteria instead.²⁰

Restored Competition – Good for Everyone, Including the Uninsured

Congressman Shadegg’s proposed Health Care Choice Act is an example of how free competition can be restored in the health insurance market. It allows health insurance buyers to purchase a policy out of state, thereby gutting protectionist barriers. This puts a downward cost pressure on health insurance policies, especially in states with many mandates and high rates of uninsured residents.

The link between state mandates and the uninsured rate is a compelling argument in favor of free competition on the health insurance market. As Figure 1 shows, states with many coverage mandates tend to have somewhat higher rates of uninsured than states with fewer mandates:

An analysis using the latest available data, from 2008, confirms the relationship between mandates and the uninsured rate. Unfortunately, the trend is in the wrong direction. Several states have migrated from the two lowest-mandate groups to the high-mandate group. In only two years the number of states with 40 or more mandates has increased from 16 to 23. This reflects the addition of 118 new state mandates, as identified by the Council for Affordable Health Insurance in 2008.²¹

The average rate of uninsured residents in those 23 states is 15 percent. This is down from 15.4 percent three years ago, but that difference is entirely attributable to Massachusetts. By forcing its residents to buy health insurance Massachusetts has cut its uninsured rate from eleven percent to 5.5 percent in two years. If we “undo” the Massachusetts reform (which has been a costly mistake²²) and make the realistic assumption that the percent of uninsured would have remained at eleven percent, the average uninsured rate for the high-mandate states jumps to 15.3 percent, virtually identical to the 2006 average for the high-mandate states.

The middle group of states with 30-39 mandates has shrunk to 14 from 19 in 2006. Its average uninsured rate fell from 14.8 percent to 12.7 percent. This drop is the result of the migration of states between the three mandate groups. States with more mandates and, on average, higher uninsured rates have added more mandates and thus moved up to the higher group. A similar increase in mandates in states with fewer mandates has added states with (thus far) lower uninsured rates.

The 14 states with fewer than 30 mandates now average 13.4 percent uninsured, up from 13.1 percent. This minor change reinforces the conclusion from 2006, namely that relatively few health insurance mandates are associated with lower rates of uninsured residents. Overall, the 2008 numbers confirm that if health insurance buyers were allowed to buy insurance out of state, fewer Americans would go without any insurance.

The tendency of high-mandate states to have higher rates of uninsured also has implications for the current health reform debate in Congress. If the federal government were to introduce federal mandates, either to replace or to supplement state mandates, the outcome, all other factors held constant, will be a rise in the rate of uninsured Americans.

These differences demonstrate that if health insurance consumers were allowed to buy insurance across state lines, fewer Americans would go without any insurance. Figure 1 is also a stark warning to states considering additional coverage mandates: if imposed, they will likely throw more people into the uninsured category.

In addition to reducing the number of uninsured, free competition in the health insurance market would reflect a proper understanding of federalism. Free competition across state lines was so important to our Founding Fathers that they wrote it in to the Constitution. We know it as the Commerce Clause, or Article I, Section 8, Clause 3. Its main message is that states must not impose protectionist trade barriers. When states prevent their residents from buying insurance out of state, they do in fact impose such protectionist measures.

Congressman Shadegg’s Health Care Choice Act is one way to restore interstate commerce in the health insurance market. It is worth noting, however, that there is nothing that prevents states from beginning such a process immediately. State politicians could repeal mandates, but the challenge with this approach is that interest groups have been very effective at creating the current system, and they would fight to preserve the status quo. In any event, a state-by-state reform approach would likely take time and may only work in states that avoided going overboard with mandates. If so, little would be accomplished in restoring a free market for health insurance in high-mandate states – the places where it is needed most.

Conclusion: The Shift to Market-Based Health Care

It would be simple to achieve the free market goals for the individual health insurance market once deregulation is under way. The most critical element is to ensure consumer freedom so that people can buy an insurance policy tailored to their needs. Health Savings Accounts are important in this aspect as they allow consumers a great deal of latitude in choosing a combination of insurance for unexpected costs and out-of-pocket payments for routine expenses. Indeed, if consumers can shop around for a policy that meets their needs and preferences, they can buy catastrophic insurance with their basic premium, and finance everything else through their HSA. But they can also choose to include a large number of non-catastrophic services.

Free competition on the health insurance market is an important step toward strengthening our Constitutional right to interstate commerce. Supporters of government regulation – such as the mandates that distort the health insurance market – sometimes object that one cannot allow market forces to price people out of health insurance because health care is vital for our survival and a good life. But just because a product or a service is vital to our survival or a good life, it does not mean that the government should be the primary arbiter of how that service is designed or delivered. While we may all agree that good health is inherent to a good life, it is by no means the duty of the government to help us obtain it (or, in this case, make it harder to get). Food is even more important than health care, but we fortunately do not allow the government to step in and regulate what food we buy.

Our Constitution grants us rights, but these rights protect us from government rather than being a promise that government will take care of us by taxing other people.²³ To further underscore the consequences of government intervention into the health insurance market, consider the following: A health insurance mandate forces many people to buy a service – such as coverage for a chiropractor – that they will never use. But by purchasing it, they contribute toward paying for chiropractor treatments for others who do use the service. This cross-subsidization, required by government coercion, has negative consequences.

The market for credit is a good analogy. Just like poor health, poor credit is the result of either lifestyle choices or bad luck. Some people end up with bad credit because they make foolish or risky decisions – they get more credit cards than they can handle and spend beyond their capabilities. Others have bad luck and lose their jobs or suffer other significant income losses and cannot pay their bills. In both cases the result is bad credit, with financial consequences that can be quite significant. You can lose your car or your home, be forced to rent under very poor conditions or be left out in the street.

Imagine if the government sought to cross-subsidize in the credit market? Should everyone who obtains a mortgage loan carry their share of other people’s bad credit, for example, by paying a higher rate of interest than their credit score merits? The economic consequences – and moral hazard – of this type of government intervention are unacceptable, of course, as should be intervention in the health insurance market.

The real solution to America’s health care mess is not more regulation, more mandates, more cross-subsidization, or more taxes. The problem is too much government, not too little. The Health Care Choice Act is one example of how steps can be taken to improve health care competition by reducing government intervention.

____________________________

Dr Sven R Larson served as a research fellow with the Center for Freedom and Prosperity in 2006. He is currently a research fellow with the Wyoming Liberty Group. He is the author of “A Prescription for 2008: What the Next President Needs to Know about Health Reform.”

The Center for Freedom and Prosperity Foundation is a public policy, research, and educational organization operating under Section 501(C)(3). It is privately supported, and receives no funds from any government at any level, nor does it perform any government or other contract work. Nothing written here is to be construed as necessarily reflecting the views of the Center for Freedom and Prosperity Foundation or as an attempt to aid or hinder the passage of any bill before Congress.

The Center for Freedom and Prosperity Foundation, the research and educational affiliate of the Center for Freedom and Prosperity (CFP), can be reached by calling 202-285-0244 or visiting our web site at www.freedomandprosperity.org.

Endnotes:

¹ This is an update of an earlier paper: Larson, S., The Health Care Choice Act: Restoring Competition in the Individual Insurance Market, CF&P Foundation Prosperitas Volume VI, Issue IV, June 2006.

² A proposed “public option” health insurance would add to the third-party payer problem by introducing a government-managed insurance plan. This would exacerbate the cost-driving problem of the third party model and bring America closer to universal, single-payer health insurance.

³ A campaign endorsed by labor unions, Americans for Health Care, http://americansforhealthcare.org/, is working across the country to convince state legislators to regulate by law how much employers spend on health insurance for their employees. This type of regulatory intervention has also been dubbed the “Wal-Mart tax” since it is typically directed toward Wal-Mart. Recently the Texas state legislature took a step in this direction, as reported by the Center for Freedom and Prosperity: http://www.freedomandprosperity.org/blog/2006-06/2006-06.shtml#091.

⁴ In its report Income, Poverty and Health Insurance Coverage of August 2005, the Bureau of the Census published income data of households without health insurance for 2004. It is notable that 34.6 percent of all the uninsured earned $50,000 or more, which means that more than one third of the uninsured earn more than the median household income ($44,389). This group is in fact larger than the group that earns $25,000 or less, which is exactly one third of the uninsured, or the group making $25,000-$50,000 (32.3 percent). The report is available at: http://www.census.gov/prod/2005pubs/p60-229.pdf.

⁵ Public Option Lite – The Baucus plan would make insurance even more expensive; Wall Street Journal Online, September 17, 2009. Available at: http://online.wsj.com/article/SB10001424052970204518504574416930475823324.html# printMode.

⁶ Patrick, D: Massachusetts Is a Health Reform Model; Wall Street Journal Online, September 17, 2009. Available at: http://online.wsj.com/article/SB10001424052970203440104574405252468577402.html.

⁷ U.S. Census Bureau: Historical Health Insurance Tables, Table HIA-4. Available at: http://www.census.gov/hhes/www/hlthins/historic/index.html.

⁸ Lockhead, C: Feinstein Skeptical about Health Care Costs, SFGate.com, September 12, 2009. Available at: http://www.sfgate.com/cgi-bin/article.cgi?f=/c/a/2009/09/12/MNBR19LPMV.DTL&type=p rintable.

⁹ The Health Care Choice Act of 2009, available at: http://thomas.loc.gov/cgi-bin/bdquery/D?d111:1:./temp/~bdHeuD:@@@L&summ2=m&|/b ss/111search.html|

¹⁰ eHealthInsurance.com, http://www.ehealthinsurance.com/ehi/DidYouKnow.ds. A search for insurance plans using this online exchange shows that an average family may have as few as two insurance plans to choose from if they live in upstate New York, or four plans if they live in Wyoming. It is rare to find more than a half dozen plans to choose from in any one state.

¹¹ Available at: http://www.kaiserhealthnews.org/Stories/2009/September/08/~/media/Images/KHN%20Fe atures/2009/Sep/08/090509baucus.ashx

¹² Geoffrey Brennan and James Buchanan (1980), The Power to Tax: Analytical Foundations of a Fiscal Constitution (Cambridge University Press: Cambridge).

¹³ Letter to Center for Freedom and Prosperity, 2001. Available at http://www.freedomandprosperity.org/update/u05-15-01/u05-15-01.shtml#3

¹⁴ Gary Becker, “What’s Wrong with a Centralized Europe? Plenty,” Business Week, June 29, 1998.

¹⁵ John O. McGinnis, “The Political Economy of Global Multilateralism,” Chicago Journal of International Law, 2000.

¹⁶ Council for Affordable Health Insurance: Health Insurance Mandates in the States 2008.
http://www.cahi.org/cahi_contents/resources/pdf/HealthInsuranceMandates2008.pdf

¹⁷ Matthews, Merrill: Testimony Before the Subcommittee on Workforce, Empowerment and Government Programs, Committee on Small Businesses, House of Representatives, United States Congress; Thursday April 27, 2006.

¹⁸ These are cost mark-ups from the mandates alone; in order to get a full assessment of the cost of imposing mandates, one would have to factor in the monopolization that follows when fewer insurance providers decide to offer policies in a high mandate state. In addition to that, higher premiums lead to buyer exclusion which means that insurance providers must spread the costs of offering tailored insurance policies to fewer buyers.

¹⁹ Not all mandates are equally expensive, so while insurance in a state with more mandates generally will be more expensive than in a state with fewer mandates, there are exceptions.

²⁰ It is difficult to estimate how much they would be able to save if they could shop nationally for catastrophic-only coverage. The reason is that such policies are not allowed by the state coverage mandates. However, the laws of economics dictate that the price of catastrophic-only insurance are lower in large states and that, all thing equal, competition on a national basis would drive down the cost of such bare-bones plans further.

²¹ Available from CAHI at: http://www.cahi.org/cahi_contents/resources/pdf/HealthInsuranceMandates2008.pdf.

²² In addition to the aforementioned increase in the number of uninsured in Massachusetts, Massachusetts has the costliest health insurance premiums in the country. America’s Health Insurance Plans (AHIP) reports that the average annual cost is $16,897 in Massachusetts, close to three times as much as national plans. See: http://www.ahipresearch.org/pdfs/Individual_Market_Survey_December_2007.pdf.

²³ Proponents of government intervention into the health market promote health care as an entitlement, but often confuse the entitlement with a right. Michael Barton of the Cascade Policy Institute explains the difference: http://www.cascadepolicy.org/pdf/health_ss/2006_06.pdf. He points out that when the government gives a person an entitlement, it promises that person a certain good or service, something that somebody else will have to provide. But there is no provision in the Constitution of the United States that grants us entitlements – what it does give us is the right to life, liberty and the pursuit of happiness. That does not mean that private solutions cannot be set up to help those in dire need. All it does is stress that such solutions are the primary responsibility of private citizens, not the government.

References

Americans for Health Care: http://americansforhealthcare.org/

Barton, Michael: “Right” to health care violates individual rights, Cascade Commentary, Cascade Policy Institute, May 2006, http://www.cascadepolicy.org/pdf/health_ss/2006_06.pdf.

Becker, Gary, “What’s Wrong with a Centralized Europe? Plenty,” Business Week, June 29, 1998.

Bolton, John R: “Should We Take Global Governance Seriously?” Chicago Journal of International Law, 2000.

Brennan, Geoffrey and Buchanan, James (1980), “The Power to Tax: Analytical Foundations of a Fiscal Constitution” (Cambridge University Press: Cambridge).

Bureau of the Census:  Income, Poverty and Health Insurance Coverage, August 2005, http://www.census.gov/prod/2005pubs/p60-229.pdf.

Center for Freedom and Prosperity: http://www.freedomandprosperity.org/blog/2006-06/2006-06.shtml#091

Council for Affordable Health Insurance: Health Insurance Mandates in the States 2006, http://www.cahi.org/cahi_contents/resources/pdf/MandatePub2006.pdf.

Friedman, Milton: Letter to Center for Freedom and Prosperity, 2001, http://www.freedomandprosperity.org/update/u05-15-01/u05-15-01.shtml#3

Lockhead, C: Feinstein Skeptical about Health Care Costs, SFGate.com, September 12, 2009. Available at: http://www.sfgate.com/cgi-bin/article.cgi?f=/c/a/2009/09/12/MNBR19LPMV.DTL&type=printable

Matthews, Merrill: Testimony Before the Subcommittee on Workforce, Empowerment and Government Programs, Committee on Small Businesses, House of Representatives, United States Congress; Thursday April 27, 2006.

McGinnis, John O, “The Political Economy of Global Multilateralism,” Chicago Journal of International Law, 2000.

Patrick, D: Massachusetts Is a Health Reform Model; Wall Street Journal Online, September 17, 2009. Available at: http://online.wsj.com/article/SB10001424052
970203440104574405252468577402.html

Review and Outlook Editorial, Public Option Lite – The Baucus plan would make insurance even more expensive; Wall Street Journal Online, September 17, 2009. Available at: http://online.wsj.com/article/SB10001424052970204518504574416930475823324.html#printMode

Center for Freedom and Prosperity Foundation
Strategic Memorandum

Date: September 9, 2009

To: Supporters of tax competition, fiscal sovereignty, and financial privacy

From: Dan Mitchell

Re: What happens after Cabo Mexico City?
______________________________________________________________________

Last week’s Organization for Economic Cooperation and Development (OECD) Global Tax Forum featured an unusual beginning as a looming hurricane in the Pacific forced the event from Cabo to Mexico City. This created special challenges for the Center for Freedom and Prosperity delegation since the government did not put jets at our disposal for the last-minute trip, as they did for official delegates. But we persevered and made our way to the Mexican capital.

That may have been our most significant accomplishment. The Strategic Memorandum we released last week warned that the OECD had its own version of the Brezhnev Doctrine (“what’s mine is mine; what’s yours in negotiable”), and that the Paris-based bureaucracy would expand its demands. Unfortunately, we were right.

The Return of the “Tax Avoidance” Issue: Multinationals Are the Next Target

The most remarkable development is that the OECD tried to resuscitate its campaign against legal tax avoidance – and how it happened is rather revealing. During the first day of the two-day conference, no mention was made of any campaign against tax avoidance and other forms of legal tax planning. The OECD even circulated a draft “summary of outcomes” after the dinner that evening, and it began with the innocuous statement that, “The main objectives of the meeting are…”

But the next morning, the version that was used as the working document included a dramatic change. Delegates (at least the ones from low-tax jurisdictions) were shocked to see the following revised text:

In the context of the broader effort to fight tax evasion and avoidance and to remove harmful tax practices that facilitate such activities, the main objectives of the meeting are…

This new clause was no minor edit. It revealed that the OECD still clings to the radical theory of “capital export neutrality.” CEN, as it is known, presupposes that all differences in tax rates (as well as any differences in how taxable income is defined) should be eliminated.  The OECD used CEN arguments in its original reports when it first launched the “harmful tax competition” project,¹ but quickly learned to steer clear of such extreme sentiments in hopes of making its agenda seem more reasonable.

What happened next was also quite revealing. Many of the low-tax jurisdictions understandably objected. They understood that language about tax avoidance and so-called harmful tax practices created a giant opening for further mischief since the bureaucrats at the OECD would have carte blanche to pursue the radical CEN agenda. Interestingly, the OECD and the high-tax nations (with the exception of the demagogues from Brazil) did not argue in favor of the language. Instead, they used passive resistance and asserted that time was short and that it was necessary to discuss other topics. The OECD and its allies obviously hoped that the jurisdictions would either forget about the language or grow tired of fighting (more on this OECD tactic later).

Fortunately, this did not happen. The small tax havens (from the 2000 blacklist) kept complaining. Low-tax nations inside the OECD also raised objections to this radical proposal. And other participants, such as Singapore, added their voices to the opposition. And while the OECD almost surely would have been willing to run roughshod over the little havens, the bureaucrats could not treat bigger nations in the same dismissive fashion.

Interestingly, the U.S. delegation stayed silent during this debate. But silence is just part of the story. It is almost inconceivable that the OECD would have pulled this stunt without advance approval from the American representatives (and OECD bureaucrats and U.S. officials were huddled in the hotel bar the previous evening, so there certainly was ample opportunity for scheming). Indeed, the head of the U.S. delegation, Stephen Shay of the Treasury Department, was the chair of the session that morning when the OECD’s surprise language was unveiled.

This does not bode well for the tax competition battle. It means that this process will not be over until low-tax jurisdictions are completely neutralized. The CEN theory unambiguously is based on the notion that taxpayers should never be allowed to benefit from better tax policy in other jurisdictions. The OECD is using tax evasion as a wedge for a broader campaign against any forms of tax planning. From the perspective of uncompetitive welfare states, this makes sense. Politicians from nations such as France want to postpone fiscal collapse and imposing a modern-day version of capital controls is an effective way to delay the day of reckoning. But it also is an effective way to reduce economic growth (and hurt living standards) in low-tax jurisdictions.

If the OECD is successful, there will be two main losers. Low-tax nations and territories obviously will suffer since they will be denied an opportunity for faster growth (ironically, OECD nations became rich in the 1800s when the burden of government was very small and there were no income taxes). The other big losers will be multinational companies. A campaign against tax avoidance – and other “harmful tax practices,” to borrow the OECD’s terminology – is largely an attack against the ability of major companies to engage in legal tax planning.

The OECD has fired the first salvo in what promises to be a major war. Interestingly, the OECD’s Business and Industry Advisory Committee (BIAC) initially was highly critical of the anti-tax competition project.<² But then, in a classic case of short-sighted behavior, BIAC officials were seduced into supporting the project after being assured that the project was only targeting tax evasion.² So they cheered when the alligator ate somebody else, and now they doubtlessly will act surprised and offended that the alligator is hungry for another meal and they are the ones on the menu.

Will the So-Called Tax Havens Pay for the Privilege of Being Mistreated?

One pervasive feature of the Global Forum was the OECD’s cavalier treatment of the smaller jurisdictions. The OECD routinely treated these jurisdictions with contempt. When the nations and territories that comprised the original 2000 blacklist raised points about either process or substance, they were – for all intents and purposes – ignored.

When asked about promises and commitments for double-taxation agreements, the OECD said there was not time to discuss that issue. When pressed on the review process, the OECD said that will have to be decided by the Steering Committee. When any debate or discussion became uncomfortable, the OECD either bumped it to a committee (controlled, naturally, by high-tax nations) or simply set it aside with nebulous comments about revisiting the issue.

But the real insult to injury is that the OECD then proposed that all participants – including the persecuted low-tax jurisdictions – should have to pay to be part of the Global Forum. This is akin to being dragged into a court after being falsely being charged with a crime, getting thrown in jail unjustly, and then being sent a bill for the cost of the kangaroo court proceedings.

The low-tax jurisdictions are in a tough position, to be sure. All the world’s powerful nations are aligned against them. But there must come a point where they simply refuse to pay for a project that is designed to eviscerate their competitive position – especially since the OECD treats them with contempt. If they feel they must acquiesce to the demands of the big nations, that is unfortunate, but they should not engage in a process of self-flagellation by paying the OECD for the supposed privilege.

Conclusion

This has not been a good year for supporters of tax competition, fiscal sovereignty, and financial privacy. The election of a pro-tax ideologue in the United States substantially strengthened the forces pushing for a global tax cartel. All jurisdictions have now been bullied into agreeing that privacy laws no longer should protect foreign investors. This weakens tax competition, but the real issue now is whether this liberalizing process will be completely eradicated. The OECD’s campaign against “tax avoidance” should be a wake-up call.

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Endnotes

¹See page 4 of http://www.heritage.org/Research/Taxes/upload/10525_1.pdf for examples from the 1998 and 2000 reports.

²A Business View on Tax Competition, available at http://www.biac.org/statements/tax/htc.pdf.

³“Promoting Tax Competition,” available at http://www.oecd.org/dataoecd/63/11/1915964.pdf.