Archive for the ‘Jurisdictional Competition’ Category

I’ve previously written about the bizarre attack that the European Commission has launched against Ireland’s tax policy. The bureaucrats in Brussels have concocted a strange theory that Ireland’s pro-growth tax system provides “state aid” to companies like Apple (in other words, if you tax at a low rate, that’s somehow akin to giving handouts to a company, at least if you start with the assumption that all income belongs to government).

This has produced two types of reactions. On the left, the knee-jerk instinct is that governments should grab more money from corporations, though they sometimes quibble over how to divvy up the spoils.

Senator Elizabeth Warren, for instance, predictably tells readers of the New York Times that Congress should squeeze more money out of the business community.

Now that they are feeling the sting from foreign tax crackdowns, giant corporations and their Washington lobbyists are pressing Congress to cut them a new sweetheart deal here at home. But instead of bailing out the tax dodgers under the guise of tax reform, Congress should seize this moment to…repair our broken corporate tax code. …Congress should increase the share of government revenue generated from taxes on big corporations — permanently. In the 1950s, corporations contributed about $3 out of every $10 in federal revenue. Today they contribute $1 out of every $10.

As part of her goal to triple the tax burden of companies, she also wants to adopt full and immediate worldwide taxation. What she apparently doesn’t understand (and there’s a lot she doesn’t understand) is that Washington may be capable of imposing bad laws on U.S.-domiciled companies, but it has rather limited power to impose bad rules on foreign-domiciled firms.

So the main long-run impact of a more onerous corporate tax system in America will be a big competitive advantage for companies from other nations.

The reaction from Jacob Lew, America’s Treasury Secretary, is similarly disappointing. He criticizes the European Commission, but for the wrong reasons. Here’s some of what he wrote for the Wall Street Journal, starting with some obvious complaints.

…the commission’s novel approach to its investigations seeks to impose unfair retroactive penalties, is contrary to well established legal principles, calls into question the tax rules of individual countries, and threatens to undermine the overall business climate in Europe.

But his solutions would make the system even worse. He starts by embracing the OECD’s BEPS initiative, which is largely designed to seize more money from US multinational firms.

…we have made considerable progress toward combating corporate tax avoidance by working with our international partners through what is known as the Base Erosion and Profit Shifting (BEPS) project, agreed to by the Group of 20 and the 35 member Organization for Economic Cooperation and Development.

He then regurgitates the President’s plan to replace deferral with worldwide taxation.

…the president’s plan directly addresses the problem of U.S. multinational corporations parking income overseas to avoid U.S. taxes. The plan would make this practice impossible by imposing a minimum tax on foreign income.

In other words, his “solution” to the European Commission’s money grab against Apple is to have the IRS grab the money instead. Needless to say, if you’re a gazelle, you probably don’t care whether you’re in danger because of hyenas or jackals, and that’s how multinational companies presumably perceive this squabble between US tax collectors and European tax collectors.

On the other side of the issue, critics of the European Commission’s tax raid don’t seem overflowing with sympathy for Apple. Instead, they are primarily worried about the long-run implications.

Veronique de Rugy of the Mercatus Center offers some wise insight on this topic, both with regards to the actions of the European Commission and also with regards to Treasury Secretary Lew’s backward thinking. Here’s what she wrote about the never-ending war against tax competition in Brussels.

At the core of the retroactive penalty is the bizarre belief on the part of the European Commission that low taxes are subsidies. It stems from a leftist notion that the government has a claim on most of our income. It is also the next step in the EU’s fight against tax competition since, as we know, tax competition punishes countries with bad tax systems for the benefit of countries with good ones. The EU hates tax competition and instead wants to rig the system to give good grades to the high-tax nations of Europe and punish low-tax jurisdictions.

And she also points out that Treasury Secretary Lew (a oleaginous cronyist) is no friend of American business because of his embrace of worldwide taxation and BEPS.

…as Lew’s op-ed demonstrates, …they would rather be the ones grabbing that money through the U.S.’s punishing high-rate worldwide-corporate-income-tax system. …In other words, the more the EU grabs, the less is left for Uncle Sam to feed on. …And, as expected, Lew’s alternative solution for avoidance isn’t a large reduction of the corporate rate and a shift to a territorial tax system. His solution is a worldwide tax cartel… The OECD’s BEPS project is designed to increase corporate tax burdens and will clearly disadvantage U.S. companies. The underlying assumption behind BEPS is that governments aren’t seizing enough revenue from multinational companies. The OECD makes the case, as it did with individuals, that it is “illegitimate,” as opposed to illegal, for businesses to legally shift economic activity to jurisdictions that have favorable tax laws.

John O’Sullivan, writing for National Review, echoes Veronique’s point about tax competition and notes that elimination of competition between governments is the real goal of the European Commission.

…there is one form of European competition to which Ms. Vestager, like the entire Commission, is firmly opposed — and that is tax competition. Classifying lower taxes as a form of state aid is the first step in whittling down the rule that excludes taxation policy from the control of Brussels. It won’t be the last. Brussels wants to reduce (and eventually to eliminate) what it calls “harmful tax competition” (i.e., tax competition), which is currently the preserve of national governments. …Ms. Vestager’s move against Apple is thus a first step to extend control of tax policy by Brussels across Europe. Not only is this a threat to European taxpayers much poorer than Apple, but it also promises to decide the future of Europe in a perverse way. Is Europe to be a cartel of governments? Or a market of governments? A cartel is a group of economic actors who get together to agree on a common price for their services — almost always a higher price than the market would set. The price of government is the mix of tax and regulation; both extract resources from taxpayers to finance the purposes of government. Brussels has already established control of regulations Europe-wide via regulatory “harmonization.” It would now like to do the same for taxes. That would make the EU a fully-fledged cartel of governments. Its price would rise without limit.

Holman Jenkins of the Wall Street Journal offers some sound analysis, starting with his look at the real motives of various leftists.

…attacking Apple is a politically handy way of disguising a challenge to the tax policies of an EU member state, namely Ireland. …Sen. Chuck Schumer calls the EU tax ruling a “cheap money grab,” and he’s an expert in such matters. The sight of Treasury Secretary Jack Lew leaping to the defense of an American company when in the grips of a bureaucratic shakedown, you will have no trouble guessing, is explained by the fact that it’s another government doing the shaking down.

And he adds his warning about this fight really being about tax competition versus tax harmonization.

Tax harmonization is a final refuge of those committed to defending Europe’s stagnant social model. Even Ms. Vestager’s antitrust agency is jumping in, though the goal here oddly is to eliminate competition among jurisdictions in tax policy, so governments everywhere can impose inefficient, costly tax regimes without the check and balance that comes from businesses being able to pick up and move to another jurisdiction. In a harmonized world, of course, a check would remain in the form of jobs not created, incomes not generated, investment not made. But Europe has been wiling to live with the harmony of permanent recession.

Even the Economist, which usually reflects establishment thinking, argues that the European Commission has gone overboard.

…in tilting at Apple the commission is creating uncertainty among businesses, undermining the sovereignty of Europe’s member states and breaking ranks with America, home to the tech giant… Curbing tax gymnastics is a laudable aim. But the commission is setting about it in the most counterproductive way possible. It says Apple’s arrangements with Ireland, which resulted in low-single-digit tax rates, amounted to preferential treatment, thereby violating the EU’s state-aid rules. Making this case involved some creative thinking. The commission relied on an expansive interpretation of the “transfer-pricing” principle that governs the price at which a multinational’s units trade with each other. Having shifted the goalposts in this way, the commission then applied its new thinking to deals first struck 25 years ago.

Seeking a silver lining to this dark cloud, the Economist speculates whether the EC tax raid might force American politicians to fix the huge warts in the corporate tax system.

Some see a bright side. …the realisation that European politicians might gain at their expense could, optimists say, at last spur American policymakers to reform their barmy tax code. American companies are driven to tax trickery by the combination of a high statutory tax rate (35%), a worldwide system of taxation, and provisions that allow firms to defer paying tax until profits are repatriated (resulting in more than $2 trillion of corporate cash being stashed abroad). Cutting the rate, taxing only profits made in America and ending deferral would encourage firms to bring money home—and greatly reduce the shenanigans that irk so many in Europe. Alas, it seems unlikely.

America desperately needs a sensible system for taxing corporate income, so I fully agree with this passage, other than the strange call for “ending deferral.” I’m not sure whether this is an editing mistake or a lack of understanding by the reporter, but deferral is no longer an issue if the tax code is reformed to that the IRS is “taxing only profits made in America.”

But the main takeaway, as noted by de Rugy, O’Sullivan, and Jenkins, is that politicians want to upend the rules of global commerce to undermine and restrict tax competition. They realize that the long-run fiscal outlook of their countries is grim, but rather than fix the bad policies they’ve imposed, they want a system that will enable higher ever-higher tax burdens.

In the long run, that leads to disaster, but politicians rarely think past the next election.

P.S. To close on an upbeat point, Senator Rand Paul defends Apple from predatory politicians in the United States.

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Like all good libertarians, I hate waiting in government-mandated lines. Heck, you don’t even have to be a curmudgeonly libertarian to have unpleasant thoughts about the Post Office or Department of Motor Vehicles (not to mention the virtual lines that exist for people stuck on hold after calling the IRS or some other inefficient bureaucracy).

And it must be doubly irritating to wait in line to get bureaucratic approval for things that shouldn’t require any sort of government permission in the first place.

Since I have to do a bit of travel, I’m especially resentful of the lines I face for customs and immigration when I cross borders. In some cases, these restrictions can even turn “Heaven into Hell.”

My aversion to government-mandated lines is so strong that I’m a big fan of the European Union’s “Schengen Zone” that has made crossing many European borders as simple as crossing from one American state to another (and regular readers know that I’m normally very reluctant to say anything nice about the policies concocted by the crowd in Brussels).

Given all this, I was very interested to see that the leading bureaucrat of the European Commission, Jean-Claude Juncker, has said that borders are “the worst invention ever.”

Was he making a libertarian argument about the value of making it easier for people to travel and/or move? Let’s investigate. Here’s some of what was reported about Juncker’s comments in the U.K.-based Daily Mail.

EU chief Jean-Claude Juncker risked widening divisions with European leaders today by saying borders were the ‘worst invention ever’. He called for all borders across Europe to be opened, despite the chaos caused over the last year from the flood in refugees fleeing Syria and the wave of terror attacks hitting various continent’s cities. …Mr Juncker also said a stronger EU was the best way of beating the rising trend of nationalism cross Europe. In another extraordinary remark, he appeared to warn of war on the continent if the EU disintegrates as he echoed the warning from the former French president Francois Mitterrand, who said nationalism added to nationalism would end in war.

Writing for the American Enterprise Institute, Michael Barone offered a different perspective.

He starts with the observation that Juncker’s home country of Luxembourg is rich because of borders.

Juncker comes from Luxembourg, a 998-square mile country… If you look up Luxembourg in lists of world economic statistics, you’ll find it rated No. 2 in gross domestic product per capita. That’s thanks to what Juncker called politicians’ worst invention ever, borders. Luxembourg is a financial haven and headquarters of the world’s largest steel company, Arcelor Mittal. Without their borders and national laws, the 576,000 Luxembourgers wouldn’t be as affluent as they are.

Barone is correct. Luxembourg is only a very successful tax haven because it has the right to have tax laws inside its borders that are attractive relative to the tax laws that exist in adjoining nations such as France and Germany.

For those who care about foreign policy, Barone also pushes back at the notion the European Union somehow has prevented World War III.

Juncker said, “We have to fight against nationalism, we have the duty not to follow populists but to block the avenue of populists.” Such is the faith of the Eurocrats: The EU exists to prevent another war between France and Germany. Never mind that the chance of such a war has been zero since 1945, 71 years ago. …Juncker was denouncing Austria and other nations for erecting border controls to keep out Muslim refugees. Evidently he believes that World War III will somehow break out if they are kept out.

This is surely right. The people in Western Europe no longer have any interest in fighting each other. And to the extent any international organization deserves credit for that, it would be NATO (even if it no longer serves a purpose).

Let’s now shift back to the role of borders and the size and power of government.

If you want a really good libertarian-oriented explanation of why borders are valuable, let’s go back in time to 2004. Professor Andy Morriss wrote an article for The Freeman that explains borders are good for liberty because they limit the powers of governments.

Borders come from property rights and are essential to a free society…are wonderful things. Lorain and Cuyahoga counties in Ohio must compete for my family’s residence. Choosing to live where we do is related to the taxes charged by the communities where we might have lived.

The value of borders, Andy explains, is that they represent a territorial restriction on the power of government and people can cross those borders if they think governments are being too greedy and oppressive.

Investors make similar choices. …Choosing bad policies produces an exodus; choosing good policies leads to immigration of both capital and people. …the competition offered on local taxation policy and other regulatory issues is important in restraining governments from infringing liberty. …National borders are also important sources of liberty. …without borders we would not have the competition among jurisdictions that restricts attempts to abridge liberty. …Jurisdictions…compete to attract people and capital. This competition motivates governments to act to preserve liberty.

He cites the example of how Delaware became the leading jurisdiction for company formation (and also a very good tax haven for foreigners).

…states compete for corporations, with Delaware the current market leader. Delaware corporate law offers companies the combination of a mostly voluntary set of default rules and an expert decision-making body (the Court of Chancery). As a result, many corporations, large and small, choose to incorporate in Delaware, making it their legal residence. (Their actual headquarters need not be physically located there.) Corporations get a body of liberty-enhancing rules; Delaware gets tax revenue and employment in the corporate services and legal fields. That state’s position is no accident. At the beginning of the twentieth century, New Jersey was the market leader in corporate law. When New Jersey’s legislature made ill-advised changes to its corporations statute that reduced shareholder value, Delaware seized the opportunity and offered essentially the older version of New Jersey’s law.

Borders also are good, Andy explains, because they create natural experiments that allow us the compare the success of market-oriented jurisdictions with the failure of statist jurisdictions.

Statists are correct that competition among jurisdictions will make clear the costs of the policies they promote. …The former divide between East and West Berlin is a fine example of the impact of cross-border comparisons. East Germans could see the difference in outcomes between the two societies, and East Germany had to resort to increasingly costly and desperate measures to prevent its citizens from voting against communism with their feet. …Competition between the two Germanys exposed the cost of East German policies.

In an observation that could have been taken from today’s headlines, he also notes that uncompetitive governments try to prop up their inefficient welfare states by clamping down on pro-market policies in other nations.

To prevent cross-border competition from exposing the costs of their favorite policies, …special interests attempt to forestall it. …High-tax, heavy-regulatory jurisdictions in the European Union are waging just such a fight now, arguing, for example, that Ireland’s low taxes are “unfair” competition.

He’s exactly right. Which is precisely why it’s so important to block efforts to replace tax competition with tax harmonization.

Andy’s conclusion hits the nail on the head. We may not like having to wait in lines and fill out forms to cross borders, but the alternative would be worse.

Even though borders can be an excuse for reducing liberty, a world with lots of borders is nonetheless a far friendlier world for liberty than one with fewer borders. They promote competition for people and money, which tends to restrain the state from grabbing either. Borders offer chances to arbitrage regulatory restrictions, making them less effective. Without borders these constraints on the growth of the state would vanish.

Before closing, let’s look at an example of how governments are forced to dismantle bad policy because of the the jurisdictional competition that only exists because of borders. It’s from an academic study written by Jayme Lemke, a scholar from the Mercatus Center. Here are some excerpts from the abstract.

Married women in the early nineteenth century United States were not permitted to own property, enter into contracts without their husband’s permission, or stand in court as independent persons. This severely limited married women’s ability to engage in formal business ventures, collect rents, administer estates, and manage bequests through wills. By the dawn of the twentieth century, legal reform in nearly every state had removed these restrictions by extending formal legal and economic rights to married women.

Why did states grant economic liberty and property rights to women?

Was it because male legislators suddenly stopped being sexist?

Maybe that played a role, but it turns out that people moved to states that eliminated these statist restrictions and that pressured other states to also reform.

…what forces impelled legislators to undertake the costs of action? …interjurisdictional competition between states and territories in the nineteenth century was instrumental in motivating these reforms. Two conditions are necessary for interjurisdictional competition to function: (1) law-makers must hold a vested interest in attracting population to their jurisdictions, and (2) residents must be able to actively choose between the products of different jurisdictions. Using evidence from the passage of the Married Women’s Property Acts, I find that legal reforms were adopted first and in the greatest strength in those regions in which there was active interjurisdictional competition.

The moral of the story is that competition between states improved the lives of women by forcing governments to expand economic liberty.

And since even the New York Times has published columns showing that feminist-type government interventions actually hurt women, perhaps the real lesson (especially for our friends on the left) is that you help people by expanding freedom, not by expanding the burden of government.

P.S. There is a wealth of scholarly evidence that the western world became rich because of borders and jurisdictional competition.

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Economists certainly don’t speak with one voice, but there’s a general consensus on two principles of public finance that will lead to a more competitive and prosperous economy.

To be sure, some left-leaning economists will say that high tax rates and more double taxation are nonetheless okay because they believe there is an “equity vs. efficiency” tradeoff and they are willing to sacrifice some prosperity in hopes of achieving more equality.

I disagree, mostly because there’s compelling evidence that the left’s approach ultimately leads to less income for the poor, but this is a fair and honest debate. Both sides agree that lower rates and less double taxation will produce more growth (though they’ll disagree on how much growth) and both sides agree that a low-tax/faster-growth economy will produce more inequality (though they’ll disagree on whether the goal is to reduce inequality or reduce poverty).

Since I’m on the low-tax/faster-growth side of the debate, this is one of the reasons why I’m a big fan of tax competition and tax havens.

Simply stated, when politicians have to worry that jobs and investment can cross borders, they are less likely to impose higher tax rates and punitive levels of double taxation. Interestingly, even the statist bureaucrats at the Organization for Economic Cooperation and Development (who, ironically, get tax-free salaries) agree with me, writing that tax havens “may hamper the application of progressive tax rates.” They think that’s a bad thing, of course, but we both agree that tax competition means lower rates.

And look at what has happened to tax rates in the past few years. Now that politicians have undermined tax competition and weakened tax havens, tax rates are climbing.

So I was very surprised to see some economists signed a letter saying that so-called tax havens “serve no useful economic purpose.” Here are some excerpts.

The existence of tax havens does not add to overall global wealth or well-being; they serve no useful economic purpose. …these jurisdictions…increase inequality…and undermine…countries’ ability to collect their fair share of taxes. …There is no economic justification for allowing the continuation of tax havens.

You probably won’t be surprised by some of the economists who signed the letter. Thomas Piketty was on the list, which is hardly a surprise. Along with Jeffrey Sachs, who also has a track record of favoring more statism. Another predictable signatory is Olivier Blanchard, the former top economist at the pro-tax International Monetary Fund.

The only surprise was that Angus Deaton, the most recent recipient of the Nobel Prize for economics, signed the letter.

But if that’s an effective “appeal to authority,” there’s a far bigger list of Nobel Prize winners who recognize the economic consensus outlined above and who understand a one-size-fits-all approach would undermine progress.

In other words, there is a very strong “economic purpose” and “economic justification” for tax havens and tax competition.

Simply stated, they curtail the greed of the political class.

Philip Booth of the Institute of Economic Affairs in London opined on this issue. Here’s some of what he wrote for City A.M.

…the statement that tax havens “have no useful purpose” is demonstrably wrong and most of the other claims in the letter are incredible. Offshore centres allow companies and investment funds to operate internationally without having to abide by several different sets of rules and, often, pay more tax than ought to be due. …Investors who use tax havens can avoid being taxed twice on their investments and can avoid being taxed at a higher rate than that which prevails in the country in which they live, but they do not avoid all tax. …tax havens also allow the honest to shelter their money from corrupt and oppressive politicians. …one of the advantages of tax havens is that they help hold governments to account. They make it possible for businesses to avoid the worst excesses of government largesse and crazy tax systems – including the 39 per cent US corporation tax rate. They have other functions too: it is simply wrong to say that they have no useful purpose. It is also wrong to argue that, if only corrupt governments had more tax revenue, their people would be better served.

Amen. I especially like his final point in that excerpt, which is similar to Marian Tupy’s explanation that tax planning and tax havens are good for Africa’s growth.

Last but not least, Philip makes a key point about whether tax havens are bad because they are sometimes utilized by bad people.

…burglars operate where there is property. However, we would not abolish property because of burglars. We should not abolish tax havens either.

When talking to reporters, politicians, and others, I make a similar point, arguing that we shouldn’t ban cars simply because they are sometimes used as getaway vehicles from bank robberies.

The bottom line, as Professor Booth notes, is that we need tax havens and tax competition if we want reasonable fiscal systems.

But this isn’t simply an issue of wanting better tax policy in order to achieve more prosperity. In part because of demographic changes, tax havens and tax competition are necessary if we want to discourage politicians from creating “goldfish government” by taxing and spending nations into economic ruin.

P.S. Here’s my video on the economic case for tax havens.


P.P.S. Let’s not forget that the Paris-based Organization for Economic Cooperation and Development is the international bureaucracy most active in the fight to destroy tax competition. The is especially outrageous because American tax dollars subsidize the OECD.

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Imagine if you had the chance to play basketball against a superstar from the NBA like Stephen Curry.

No matter how hard you practiced beforehand, you surely would lose.

For most people, that would be fine. We would console ourselves with the knowledge that we tried our best and relish he fact that we even got the chance to be on the same court as a professional player.

But some people would want to cheat to make things “equal” and “fair.” So they would say that the NBA player should have to play blindfolded, or while wearing high-heeled shoes.

And perhaps they could impose enough restrictions on the NBA player that they could prevail in a contest.

But most of us wouldn’t feel good about “winning” that kind of battle. We would be ashamed that our “victory” only occurred because we curtailed the talents of our opponent.

Now let’s think about this unseemly tactic in the context of corporate taxation and international competitiveness.

The United States has the highest corporate tax rate in the industrialized world, combined with having the most onerous “worldwide” tax system among all developed nations.

This greatly undermines the ability of U.S.-domiciled companies to compete in world markets and it’s the main reason why so many companies feel the need to engage in inversions.

So how does the Obama Administration want to address these problems? What’s their plan to reform the system to that American-based firms can better compete with companies from other countries?

Unfortunately, there’s no desire to make the tax code more competitive. Instead, the Obama Administration wants to change the laws to make it less attractive to do business in other nations. Sort of the tax version of hobbling the NBA basketball player in the above example.

Here are some of the details from the Treasury Department’s legislative wish list.

The Administration proposes to supplement the existing subpart F regime with a per-country minimum tax on the foreign earnings of entities taxed as domestic C corporations (U.S. corporations) and their CFCs. …Under the proposal, the foreign earnings of a CFC or branch or from the performance of services would be subject to current U.S. taxation at a rate (not below zero) of 19 percent less 85 percent of the per-country foreign effective tax rate (the residual minimum tax rate). …The minimum tax would be imposed on current foreign earnings regardless of whether they are repatriated to the United States.

There’s a lot of jargon in those passages, and even more if you click on the underlying link.

So let’s augment by excerpting some of the remarks, at a recent Brookings Institution event, by the Treasury Department’s Deputy Assistant Secretary for International Tax Affairs. Robert Stack was pushing the President’s agenda, which would undermine American companies by making it difficult for them to benefit from good tax policy in other jurisdictions.

He actually argued, for instance, that business tax reform should be “more than a cry to join the race to the bottom.”

In other words, he doesn’t (or, to be more accurate, his boss doesn’t) want to fix what’s wrong with the American tax code.

So he doesn’t seem to care that other nations are achieving good results with lower corporate tax rates.

I do not buy into the notion that the U.S. must willy-nilly do what everyone else is doing.

And he also criticizes the policy of “deferral,” which is a provision of the tax code that enables American-based companies to delay the second layer of tax that the IRS imposes on income that is earned (and already subject to tax) in other jurisdictions.

I don’t think it’s open to debate that the ability of US multinationals to defer income has been a dramatic contributor to global tax instability.

He doesn’t really explain why it is destabilizing for companies to protect themselves against a second layer of tax that shouldn’t exist.

But he does acknowledge that there are big supply-side responses to high tax rates.

…large disparity in income tax rates…will inevitably drive behavior.

Too bad he doesn’t draw the obvious lesson about the benefits of low tax rates.

Anyhow, here’s what he says about the President’s tax scheme.

The President’s global minimum tax proposal…permits tax-free repatriation of amounts earned in countries taxed at rates above the global minimum rate. …the global minimum tax plan also takes the benefit out of shifting income into low and no-tax jurisdictions by requiring that the multinational pay to the US the difference between the tax haven rate and the U.S. rate.

The bottom line is that American companies would be taxed by the IRS for doing business in low-tax jurisdictions such as Ireland, Hong Kong, Switzerland, and Bermuda.

But if they do business in high-tax nations such as France, there’s no extra layer of tax.

The bottom line is that the U.S. tax code would be used to encourage bad policy in other countries.

Though Mr. Stack sees that as a feature rather than a bug, based on the preposterous assertion that other counties will grow faster if the burden of government spending is increased.

…the global minimum tax concept has an added benefit as well…protecting developing and low-income countries…so they can mobilize the necessary resources to grow their economies.

And he seems to think that support from the IMF is a good thing rather than (given that bureaucracy’s statist orientation) a sign of bad policy.

At a recent IMF symposium, the minimum tax was identified as something that could be of great help.

The bottom line is that the White House and the Treasury Department are fixated at hobbling competitors by encouraging higher tax rates around the world and making sure that American-based companies are penalized with an extra layer of tax if they do business in low-tax jurisdictions

For what it’s worth, the right approach, both ethically and economically, is for American policy makers to focus on fixing what’s wrong with the American tax system.

P.S. When I debunked Jeffrey Sachs on the “race to the bottom,” I showed that lower tax rates do not mean lower tax revenue.

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There’s a very powerful statement, variously attributed to Alexis de Toqueville, Benjamin Franklin, or Alexander Tytler, that basically warns that democracy is doomed when people figure out they can vote themselves money.

There’s no evidence that any of them actually spoke or wrote those words, though I guess it doesn’t matter that the quote didn’t originate with someone like Franklin. What does matter is that it accurately captures something very important, which is the tendency for governments to over-tax and over-spend once people decide that it’s okay to use government coercion to take other people’s money.

But it’s still nice to be able to cite something accurate. With this in mind, I came up with my Theorem of Societal Collapse. And I think it’s actually more accurate than the vote-themselves-money quote because democracy doesn’t necessarily lead to statism. What leads to bad outcomes is democracy combined with bad values.

And a pervasive belief in redistributionism is a bad value. Heck, it’s a self-destructive value. Consider Greece. When you add together the people getting welfare and disability to the people getting pension payments to the people on the government payroll, it turns out that a majority of people in the country are riding in the wagon of government dependency.

That’s bad. But what makes the Greek situation so hopeless is that those are the same people who vote. Which means there’s very little chance of getting a government that would implement good policy.

After all, why would the recipients of other people’s money vote for politicians who support limits on redistribution?

But I’m not just blaming voters. Politicians also deserve scorn and disdain because they are the ones who often seek votes by promising to take other people’s money.

Some observers would like to believe that these politicians will use their supposed superior expertise and knowledge about public policy to make appropriate tradeoffs and prevent the system from becoming over-burdened.

But that’s somewhat naive.

Indeed, there’s an entire school of thought in economics, known as “public choice,” which is based on making real-world assumptions about the self-interested behavior of politicians and interest groups. Here’s a partial description from the Library of Economics and Liberty.

As James Buchanan artfully defined it, public choice is “politics without romance.” The wishful thinking it displaced presumes that participants in the political sphere aspire to promote the common good. …public officials are portrayed as benevolent “public servants” who faithfully carry out the “will of the people.” …public choice, like the economic model of rational behavior on which it rests, assumes that people are guided chiefly by their own self-interests… As such, voters “vote their pocketbooks,” supporting candidates and ballot propositions they think will make them personally better off; bureaucrats strive to advance their own careers; and politicians seek election or reelection to office. Public choice, in other words, simply transfers the rational actor model of economic theory to the realm of politics. …collective decision-making processes allow the majority to impose its preferences on the minority.

In other words, both voters and politicians can have an incentive for ever-larger government, even if the end result is Greek-style fiscal chaos because taxes and spending reach ruinous levels.

I call this “Goldfish Government” because some think that a goldfish lacks the ability to control its appetite and therefore will eat itself to death when presented with unlimited food.

Indeed, public choice scholars explicitly recognize that unconstrained democracy can lead to bad results.

Public choice scholars have identified…deep…problems with democratic decision-making processes.

That’s the bad news.

The good news is that their research suggests ways to compensate for the natural tendency of ever-expanding government.

Like that founding father of the American constitutional republic, public choice recognizes that men are not angels and focuses on the importance of the institutional rules… If, for example, democratic governments institutionally are incapable of balancing the public budget, a constitutional rule that limits increases in spending and taxes to no more than the private sector’s rate of growth will be more effective.

Hmmm…., a rule that limits the government so it doesn’t grow faster than the private sector.

Sounds like an idea worth embracing.

But while I like anything that builds support for the Golden Rule, I’m not sure it’s a sufficient condition for good policy.

Simply stated, we have too many examples of nations that followed the Golden Rule for several years, only to then fall off the wagon with a new splurge of spending.

There are two ways to deal with this problem. First, make the spending restraint part of a jurisdiction’s constitution, as we see in Switzerland and Hong Kong.

Second, augment the internal constraint of a spending cap with the external constraint of tax competition. Bluntly stated, destructive tax policies will be less likely when politicians are afraid that taxpayers will move across borders.

I spoke about this topic at a recent conference in Slovakia.

I also discuss the critical role of demographic change toward the end of my speech.

P.S. America’s Founding Fathers had the right solution. They set up a democratic form of government, but they strictly limited the powers of the central government. This system worked remarkably well for a long period, but then the Supreme Court decided that the enumerated powers listed in the Constitution were just a suggestion.

P.P.S. While it’s bad news to combine democracy with bad value, I want to emphasize that the problem is bad values. Most non-democratic societies have policies that are so evil and destructive (think Cuba and North Korea) that they make France seem like a beacon of economic liberty.

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I sometimes wonder if I was put on this planet to defend tax competition and tax havens.

I argue for fiscal sovereignty, good tax policy, and financial privacy to the denizens of Capitol Hill, both in writing and in person.

I make the same arguments for readers of the New York Times, as well as readers of big-box store magazines.

My affection for low-tax jurisdictions is so strong that I ran the risk of getting thrown in a Mexican jail and also was accused of disloyalty to America by a bureaucrat for the Treasury Department.

Though I much prefer the hardship duty of arguing for tax competition and tax havens in places such as Bermuda, Antigua, Monaco, the British Virgin Islands, Anguilla, and the Cayman Islands. Yes, I’m willing to go the extra mile in the fight for economic liberty.

And, if nothing else, my intensity on these issues makes me quotable, at least to writers for the Economist.

Not one to mince words, Daniel Mitchell of the right-wing Cato Institute denounces the OECD’s push to co-ordinate global tax enforcement as “the devil’s spawn” and possibly even a step towards the fiscal equivalent of…the World Trade Organisation. Tax havens “should not have to enforce the burdensome tax laws of other countries”, he thunders. “Having grown rich with the tax policies of their choosing, the OECD countries are pulling up the ladder and saying, ‘you can’t do the same to attract investment’. It’s fiscal imperialism.”

But I’m not the only one with sensible views on these issues.

A different article in the Economist highlights some benefits made possible by “tax havens.”

Offshore centres oil the financial interface between larger economies, insists Alasdair Robertson of Maples. Grant Stein of Walkers, another Cayman firm, thinks of it as “the plumbing that connects the global financial system”. …They enjoy support from some fierce ideological warriors, including libertarians at the Cato Institute in Washington, DC. …many offshore transactions are about tax neutrality, not cheating. …“It’s not about evasion but about avoiding an extra, gratuitous layer of tax,” says John Collis of Conyers Dill & Pearman, a Bermuda law firm. Such structures offer legal neutrality too. In a joint venture in, say, the BVI, no shareholder has a home advantage; all get a sophisticated, predictable common-law system with a small but well-regarded local commercial court and Britain’s Privy Council as the ultimate arbiter. …Some offshore champions consider tax competition a good thing because it discourages countries from trying to tax their way out of trouble.

Writing for Hong Kong’s South China Morning Post, David Dodwell explains the valuable role of low-tax jurisdictions.

…offshore centres like Panama, the British Virgin Islands, Singapore, Hong Kong, Jersey, Lichtenstein or Switzerland serve a multitude of valuable roles. …Offshore financial centres have always acted as safe havens against such chaos or personal insecurity, and should be allowed to continue to do so. Is Hong Kong to be stigmatised as a tax haven because it offers a company low and simple tax arrangements compared with France, or Italy or India or wherever?

He uses his own experiences as an example.

When I settled permanently in Hong Kong, I did so not just because the work was interesting… I did so because I escaped onerous British taxes, and horrendous, stressful weeks completing nonsensically complex tax returns for Britain’s Inland Revenue. When I uplifted my Financial Times pension from Britain and placed it in a Hong Kong trust, I did so perfectly legally and transparently because if I had the pension sent to me monthly from Britain, it would be taxed. This was a pension built on a lifetime of hard-earned labour that had already been taxed once. I saw no justification for Britain’s inland revenue to tax me a second time. Was I acting unethically by eliminating a tax obligation to the British Government? …Building savings, and providing long-term security to my family…is not something I think I should feel embarrassed about. Nor should governments that create complex and burdensome personal and corporate tax regimes be surprised if people relocate to other jurisdictions where operating overheads are less onerous, and tax rules more simple and comprehensible.

He concludes with some wise words on the value of low-tax jurisdictions for the rest of the world.

As trade has exploded over the past four decades, so companies have become progressively more international, with operations sprawling across many economy and tax jurisdictions. Choosing a single low-tax base from which to coordinate such potentially messy production networks makes eminent good sense. So too is a zero-tax offshore location valuable as a way of avoiding double taxation for companies operating in more than one economy. …Use of such centres makes incorporation simpler, gives access to tried and tested legal systems including for arbitration, and tax-neutral treatment of investment. All legitimate reasons.

In a piece for the Financial Times that focuses primarily on British offshore financial centers, Richard Hay explains why so-called tax havens are so valuable.

Many of those who benefit from offshore centres — including millions receiving workplace pensions — are not aware of the key role they play in their financial affairs. Such financial centres facilitate trade, investment and economic growth. Globalisation has contributed to a doubling of world gross domestic product over the past two decades. Much of the benefit has accrued to developing countries, where dramatic declines in poverty have resulted from connecting local workforces to world consumers. …The true appeal of the UK offshore centres lies in their widely trusted British-inspired laws, courts, and professionals. The predictability and security offered by British institutions make such jurisdictions magnets for investors seeking reliable structures for international investment.

He cites one example of how Jersey (one of the Channel Islands, not the over-taxed New Jersey in the United States) produces big benefits for the United Kingdom.

UK offshore centres support British jobs, increase financing available for investment in the country and elevate the rate of return for savings. A 2013 study conducted by Capital Economics, a research consultancy, found that Jersey supports more than 140,000 British jobs — six times as many as the entire UK steel industry. The study found that Jersey’s contribution generates £2.5bn a year in tax for the exchequer, as much as the UK loses through all tax avoidance, onshore and offshore, combined.

And workers are big beneficiaries.

International investment is pooled in funds in tax-neutral countries like the Cayman Islands. Cost-efficient facilities afforded by such centres boost saving and pension returns, improving the lives of ordinary workers in retirement and easing the welfare burden on cash-strapped governments. Such pooled funds are liable to tax in the countries where their income and gains are earned, and again when received by the ultimate investors.

In a column for City A.M., James Quarmby highlights some of the practical and appropriate business reasons for utilizing so-called tax havens.

…the truth is that the major OFCs are extremely well regulated and have been so for many years. It is far harder to set up a company in Jersey than in the UK, for instance, because of its rigorous “know your client” rules. …most people use companies in OFCs for quite mundane, non-tax reasons. If you are trading or investing internationally, an offshore company is an essential building block for your business. …Experienced business people will tell you that there are certain emerging markets where, under no circumstances, would you want to resolve an investors’ dispute – you would much rather resolve it in a Cayman court where you could be sure of a fair fight. …Another reason for using an OFC is the bi-lateral treaties many of them have entered into with other countries. Mauritius, for instance, has excellent treaties with India and as a consequence it is now the world’s most important financial gateway to the sub-continent. Hong Kong, for similar reasons, is the gateway into China… OFCs are a vital part of our globalised world – without them international trade and investment would seriously suffer, global GDP would be lower, and the world would be a poorer place.

By the way, there is an effective and pro-growth way to boost tax compliance, as explained in another article in the Economist.

Getting rich people to pay their dues is an admirable ambition, but this attack is both hypocritical and misguided. It may be good populist politics, but leaders who want to make their countries work better should focus instead on cleaning up their own back yards and reforming their tax systems. …governments should not bash companies for trying to reduce their tax bills, if they do so legally. In the end, tax systems must be reformed. …Governments also need to lower corporate tax rates. Tapping companies is inefficient: firms pass the burden on to others. …Nor do corporate taxes raise much money: barely more than 2% of GDP (8.5% of tax revenue) in America and 2.7% in Britain. …a lower rate on a broader base…would be more efficient and would probably raise more revenue.

Pierre Bessard of Switzerland’s Liberales Institut looks at the big picture in his monograph on Individual Rights and the Fight Against Tax Evasion. He starts by noting that the entire anti-tax competition campaign is an illegitimate exercise of “might makes right.”

…the G20 as a body lacks democratic or legal legitimacy and is in effect a cartel of governments… The G20…is clearly a departure from the rule of law in international affairs and replaces negotiations with political pressure under the (explicit or implicit) threat of economic and financial sanctions.

He then explains that anti-tax competition advocates rely on laughable arguments about the supposed desirability of bigger government.

To make the G20 governments’ war against citizens protecting wealth and resources in “tax havens” more palatable, the OECD  has initially argued that governments “need every tax dollar legally due to combat the world recession”. As this argument lost its credibility as the evidence  increasingly showed that Keynesian-style fiscal interventionism worsened and prolonged the crisis, the OECD now holds that tax avoidance and tax evasion mean fewer resources “for infrastructure and services such as education and health, lowering standards of living in both developed and developing economies”. This statement, however, contradicts all theoretical and empirical evidence, which shows that a smaller scope and size of government go hand in hand with higher  economic growth and living standards.

And he also explains why tax competition leads to better tax policy and more growth.

By restricting government’s capacity to indefinitely raise the tax burden, the diversity of jurisdictions and systems unquestionably contributes to greater prosperity. The most obvious consequence of tax competition is its beneficial impact on saving, since lower taxes encourage capital accumulation. This in turn leads to more investment, more jobs and more economic welfare. …Experience shows that “tax havens”…play at most a preventive or corrective role of arbitrage in the face of excessive taxation. In general, tax competition from “tax havens” leads to a better balance between public services and the tax burden. …From an economic perspective, the use of “tax havens” facilitates capital accumulation and improves economic prosperity in the high-tax countries where the capital is eventually repatriated to be invested in factors of production. “Tax havens” therefore increase the efficiency of international  capital markets and thus the efficiency of capital allocation to the most productive investments, thereby contributing to raise overall living standards. As a result, “tax havens” benefit all residents, whether they make use of them directly or not. They serve to channel capital and avoid double or even triple taxation in high-tax countries and lead to better economic performance in those countries.

The bottom line is that tax competition protects individuals by at least partially constraining the greed of the political class.

…tax diversity is an essential condition for the preservation of individual liberty. Competition tends to restrict the predatory potential of the territorial monopoly on the use of coercion (which defines government). …An individual’s freedom of choice and legitimate rights to the fruits of his or her labor and property are thus better protected in a world with strong tax competition.

And Pierre closes by noting the powerful intellectual lineage in favor of systems diversity as a driver and protector of liberty.

…jurisdictional competition and the advantages of smaller, open territorial monopolies controlled by governments are important ideas of the intellectual liberal tradition. Such diverse thinkers as David Hume, Adam Smith, Montesquieu, Alexis de Tocqueville, Immanuel Kant, Wilhelm von Humboldt, and Turgot insisted on the role of institutional diversity and the right to exit for individual freedom.

P.S. Pierre also wrote a superb column a few years ago about tax competition, fiscal sovereignty, and financial privacy for the New York Times.

P.P.S. Here’s my video on the economic case for tax havens.

P.P.P.S. Let’s not forget that the Paris-based Organization for Economic Cooperation and Development is the international bureaucracy most active in the fight to destroy tax competition. The is doubly outrageous because, 1) our tax dollars subsidize the OECD, and 2) those bureaucrats get tax-free salaries!

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Why do many people engage in civil disobedience and decide not to comply with tax laws?

Our leftist friends (the ones who think that they’re compassionate because they want to spend other people’s money) assert that those who don’t obey the revenue demands of government are greedy tax evaders who don’t care about society.

And these leftists support more power and more money for the Internal Revenue Service in hopes of forcing higher levels of compliance.

Will this approach work? Are they right that governments should be more aggressive to obtain more obedience?

To answer questions of how to best deal with tax evasion, we should keep in mind three broad issues about the enforcement of any type of law:

1. Presumably there should be some sort of cost-benefit analysis. We don’t assign every person a cop, after all, even though that presumably would reduce crime. Simply stated, it wouldn’t be worth the cost.

2. We also understand that crime reduction isn’t the only thing that matters. We grant people basic constitutional rights, for instance, even though that frequently makes is more difficult to get convictions.

3. And what if laws are unjust, even to the point of leading citizens to engage in jury nullification? Does our legal system lose moral legitimacy when it is more lenient to those convicted of child pornography than it is to folks guilty of forgetting to file paperwork?

Now let’s consider specific tax-related issues.

I’ve written before that “tough on crime” is the right approach, but only if laws are legitimate. And that leads to a very interesting set of questions.

4. Is it appropriate to track down every penny, even if it results in absurdities such as the German government spending 800,000 euros to track down 25,000 euros of unpaid taxes on coffee beans ordered online?

5. Or what about the draconian FATCA law imposed by the United States government, which is only projected to raise $870 million per year, but will impose several times as much cost on taxpayers, drive investment out of American, and also causing significant anti-US resentment around the world?

6. And is there perhaps a good way of encouraging compliance?

The purpose of today’s (lengthy) column is to answer the final question.

More specifically, the right way to reduce tax evasion is to have a reasonable and non-punitive tax code that finances a modest-sized, non-corrupt government. This make tax compliance more likely and more just.

Here’s some of what I wrote back in 2012.

I don’t blame people from France for evading confiscatory taxation. I don’t blame people in corrupt nations such as Mexico for evading taxation. I don’t blame people in dictatorial nations such as Venezuela for evading taxation. But I would criticize people in Singapore,Switzerland, Hong Kong, or Estonia for dodging their tax liabilities. They are fortunate to live in nations with reasonable tax rates, low levels of corruption, and good rule of law.

Let’s elaborate on this issue.

And we’ll start by citing the world’s leading expert, Friedrich Schneider, who made these important points about low tax rates in an article for the International Monetary Fund.

…the major driving forces behind the size and growth of the shadow economy are an increasing burden of tax and social security payments… Several studies have found strong evidence that the tax regime influences the shadow economy. …In the United States, analysis shows that as the marginal federal personal income tax rate increases by one percentage point, other things being equal, the shadow economy grows by 1.4 percentage points.

With this bit of background, let’s look at the magnitude of non-compliance.

The Wall Street Journal reports on the history of dodging greedy governments.

Tax evasion has been around since ancient Mesopotamia, when the Sumerians were cheerfully working the black market. …The Romans were the most efficient tax collectors of all. Unfortunately Emperor Nero (ruling from A.D. 54 to 68) abandoned the high growth, low-tax policies of his predecessors. In their place he created a downward spiral of inflationary measures coupled with excessive taxation. By the third century, widespread tax evasion forced economically stressed Rome to practice expropriation. …Six hundred years later, during the Heian period (794-1185), Japan’s aristocracy acted in a similar manner and with similar consequences. …China’s Qing Dynasty (1644-1912) waged a harsh war against the tax-dodging gentry.

These same fights between governments and taxpayers exist today.

In a column published by the New York Times, we got some first-hand knowledge of the extraordinary steps people take to protect themselves from taxation in China.

In China, businesses have to give out invoices called fapiao to ensure that taxes are being paid. But the fapiao — the very mechanism intended to keep businesses honest — is sometimes the key to cheating on taxes. …My company would disguise my salary as a series of expenses, which would also save me from paying personal income tax. But to show proof of expenses, the accountant needed fapiao. It was my responsibility to collect the invoices. …But evading taxes in China was harder than I expected because everyone else was trying to evade taxes, too. …Though businesses are obligated to give out fapiao, many do not unless customers pester them. They are trying to minimize the paper trail so they too can avoid paying taxes on their true income. …some people are driven to buy fake invoices. It’s not hard; scalpers will sell them on the street, and companies that specialize in printing fake fapiao proliferate.

The author had mixed feelings about the experience.

I couldn’t figure out whether what I was doing was right or wrong. By demanding a fapiao, I was forcing some businesses to pay taxes they would otherwise evade. But all of this was in the service of helping my own company evade taxes. In this strange tale, I was both hero and villain. To me, tax evasion seemed intractable. Like a blown-up balloon, if you push in one part, another swells.

Meanwhile, Leonid Bershidsky, writing for Bloomberg, reviews what people do to escape the grasping hand of government in Greece.

In gross domestic product terms, Greece has the second biggest shadow economy among European Union countries without a Communist past…unreported revenue accounts for 23.3 percent of GDP, or $55.3 billion. …Had it been subject to taxes — at the prevailing 40 percent rate — the shadow economy would have contributed $22 billion to the government’s coffers.

Bershidsky cites some new academic research.

…researchers used loan application data from a big Greek bank. …The bank…regards the reported income figure as a fiction, as do many other banks in eastern and southern Europe. As a result, it uses estimates of “soft” — untaxed — income for its risk-scoring model. Artavanis, Tsoutsoura and Morse recreated these estimates and concluded that the true income of self-employed workers in Greece is 75 percent to 84 percent higher than the reported one.

Greek politician have tried to get more money from the shadow economy but haven’t been very successful.

Even the leftist government of former Prime Minister Alexis Tsipras, which came up with unworkable schemes to crack down on tax evasion — from using housewives and tourists to inform on small businesses to a levy on cash withdrawals — failed.

Bershidsky notes that some have called for indirect forms of taxation that are harder to evade.

The researchers suggest the government should sell occupation licenses through the powerful professional associations: a harsh but effective way to collect more money.

Though his conclusion rubs me the wrong way.

The shadow economy — and particularly the contributions of professionals — is an enormous potential resource for governments.

At the risk of editorializing, I would say that the untaxed money is “money politicians would like to use to buy votes” rather than calling it “an enormous potential resource.” Which is a point Bershidsky should understand since he wrote back in 2014 that European governments have spent themselves into a fiscal ditch.

Now let’s shift to the academic world. What do scholars have to say about tax compliance?

Two economists from the University of Rome have authored a study examining the role of fiscal policy on the underground economy and economic performance. They start by observing that ever-higher taxes are crippling economic performance in Europe.

…most European economies have been experiencing feeble growth and increasing levels of public debt. Compliance with the Stability and Growth Pact, and in particular with the primary deficit clause, has required many governments to raise taxes to exceptional high levels, thus hindering business venture and economic recovery.

And those high tax burdens don’t collect nearly as much money as politicians want because taxpayers have greater incentives to dodge the tax collectors.

…between a country’s tax system and the size of its shadow economy is a two-way relationship. …there exists a positive relationship between the dimension of the tax burden on economic activity and the size of the informal economy. …various tax reform scenarios, recently advocated in economic and policy circles as a means to promote growth, such as…ex-ante budget-neutral tax shifts involving reductions of distortionary taxes on labor and business compensated by an increase in the consumption tax or counterbalanced by decreases of government spending. We will see that all these fiscal reforms give rise to a resource reallocation effect from underground to official production or vice versa and have rather different implications in terms of output, fiscal solvency and welfare.

The authors look at the Italian evidence and find that lower tax rates would create a win-win situation.

Our main results can be summarized as follows. …the dimension of the underground sector is substantially decreased by fiscal interventions envisaging sizeable labor tax wedge reductions. Finally, all the considered tax reforms have positive effects on the fiscal consolidation process due to a combination of larger tax revenues and positive output growth. …consider the case in which the decrease of the business tax is met by a public spending cut…an expansionary effect on output, consumption and investments, and, despite the overall reduction of tax revenues, the public-debt-to-output ratio falls. However, we notice that the expansionary effects are…magnified on consumption and investments. In this model, in fact, public spending is a pure waste that crowds out the private component of aggregate demand, therefore it comes as no surprise that a tax cut on business, counterbalanced by a public spending reduction, is highly beneficial for both consumption and investments. …the underground sector shrinks.

The benefits of lower tax rates are especially significant if paired with reductions in the burden of government spending.

When the reduction of the business tax, personal income tax, and employers’ SSC tax rates are financed through a cut in public spending…we observe positive welfare effects… The main difference…is that consumption is significantly higher…due to the fact that this reform leaves the consumption tax unchanged, while public spending is a pure waste that crowds out private consumption. …all the policy changes that lower the labor tax wedge permanently reduce the dimension of the underground sector. Finally, all the considered tax reforms positively contribute to the fiscal consolidation process.

Let’s now look at some fascinating research produced by some other Italian economists.

They look at factors that lead to higher or lower levels of compliance.

…a high quality of the services provided by the State, and a fair treatment of taxpayers increase tax morale. More generally, a high level of trust in legal and political institutions has a positive effect on tax morale. …two further institutional characteristics that are likely to negatively affect an individual’s tax morale: corruption and complexity of the tax system.

By the way, “tax morale” is a rough measure of whether taxpayers willingly obey based on their perceptions of factors such as tax fairness and waste and corruption in government.

And that measure of morale naturally varies across countries.

…we examine how people from different countries react to varying tax rates and levels of efficiency. …We focus our analysis on three countries: Italy, Sweden and UK. …these three countries show differences concerning the two institutional characteristics we are focused on. Italy and Sweden show a high tax burden while UK shows a low one. Whereas, Sweden and UK can be considered efficient states, Italy is not.

By the way, I don’t particularly consider the United Kingdom to be a low-tax jurisdiction. And I don’t think it’s very efficient, especially if you examine the government-run healthcare system.

But everything is relative, I guess, and the U.K. is probably efficient compared to Italy.

Anyhow, here are the results of the study.

Experimental subjects react to institution incentives, no matter the country. More specifically, tax compliance increases as efficiency increases and decreases as the tax rate increases. However, although people’s reaction to changes in efficiency is homogeneous across countries, subjects from different countries react with a different degree to an increase in the tax rate. In particular, participants who live in Italy or Sweden – countries where the tax burden is usually high – react more strongly to an increase in the tax rate than our British subjects. At the same time, subjects in Sweden – where the efficiency of the public service is high – react less to tax rate increases than Italian subjects.

So low tax rates matter, but competent and frugal government also is part of the story.

In all 3 countries, higher tax rates imply lower compliance. This is in line with experimental evidence: as Alm (2012, p. 66) affirms: “most (but not all) experimental studies have found that a higher tax rate leads to less compliance” and “The presence of a public good financed by voluntary tax payments has been found to increase subject tax compliance”. …The stronger negative reaction of Italian subjects to an increase in the tax rate may be due to the fact that in everyday life they suffer from high tax rates combined with inefficiency and corruption. …In fact, in the final questionnaire, 67.5% of Italian participants state that people would be more likely to pay taxes if the government were more efficient (vs 34.4% and 30.3% in UK and Sweden respectively) and 54.6% would comply with their fiscal obligations if they had some control over how tax money were spent (vs 30.8% and 25.8% in UK and Sweden respectively)… No way to impose a high tax burden on citizens if the tax revenue is wasted through inefficiency and corruption.

Here’s one additional academic study from Columbia University. The author recognizes the role of tax rates in discouraging compliance, but focuses on the impact of tax complexity.

Here’s what he wrote about the underlying theory of tax compliance.

The basic theoretical framework for tax evasion was derived…from the Becker model of crime. This approach views tax evasion as a gamble. …when tax evasion is successful, the taxpayer gains by not paying taxes. In other cases, tax evasion is uncovered by tax authorities, and the taxpayer has to pay taxes due and fines. The taxpayer compares the expected gain to the expected loss. …This approach highlights a number of factors that determine whether and to what extent taxes are evaded. These are: the magnitude of potential savings (which, on the margin, is simply equal to the tax rate)… This model therefore highlights…natural policy parameters that can affect evasion. …the marginal gains from tax evasion could be reduced by imposing lower marginal tax rates.

Interestingly, he doesn’t see much difference between (illegal) evasion and (legal) avoidance.

The ideal compliance policy should target both tax avoidance and tax evasion. While there is a legal distinction between the two, from the economic point of view the difference is less explicit. Both types of activity involve a loss of revenue and both involve a loss of economic welfare.

He then brings tax complexity into the equation.

…the appropriate extent of tax enforcement critically depends on the underlying tax structure. In particular, the role of complexity in the tax system as a factor influencing the size of the tax gap, as well as legal but undesirable tax avoidance, are highlighted. Two principal implications of tax complexity are stressed here. First, complexity permits additional ways to shield income from tax and, consequently, complexity increases the overall cost of taxation. … Reasonable simplification can more adequately combat tax evasion and avoidance than traditional enforcement measures.

Here are some of his findings.

Tax avoidance is a function of ambiguity in the tax system. …Administrative investment in enforcement becomes more important when the tax system is more distortionary. One way to reduce the need for costly tax enforcement is to reduce distortions. … Higher complexity induces tax avoidance and other types of substitution responses. A tax system that allows for many different types of avoidance responses is likely to cause stronger behavioral effects and therefore higher excess burden. …Shutting down extra margins of response can be loosely summarized as expanding the tax base by eliminating preferential treatment of some types of income, deductions, and exemptions. …One of the consequences of complexity is that it makes it difficult for honest taxpayers to fulfill their obligations. …The bottom line is that complexity makes relying on penalties a much less appealing approach to enforcement. …From the complexity point of view, itemized deductions add a multitude of tax avoidance and evasion opportunities. …They stimulate avoidance by introducing extra margins with differential tax treatment.

Sounds to me like an argument for a flat tax.

Incidentally (and importantly), he acknowledges that greater enforcement may not be a wise option if the underlying tax law (such as the code’s harsh bias against income that is saved and invested) is overly destructive.

…tax avoidance—letting well enough alone—may be a simple and practical way of addressing shortcomings of an inefficient tax structure. For example, suppose that, as much of the optimal taxation literature suggests, capital incomes should not be taxed, or should only be taxed lightly. In that case, the best policy response would be cutting tax rates imposed on capital income. If it is not politically feasible to pursue such policies explicitly, a similar outcome can be accomplished by reducing enforcement or increasing avoidance opportunities in this area. …The preferred way of dealing with compliance problems is fixing the tax code.

Amen. Many types of tax evasion only exist because the politicians in Washington have saddled us with bad tax policy.

And when tax policy moves in the right direction, compliance improves. Consider what happened in the 1980s when Reagan’s reforms lowered the top tax rate from 70 percent to 28 percent. Rich people paid five times as much to the IRS, in large part because they declared 10 times as much income.

But it’s very unlikely that they actually earned 10 times as much income. Some non-trivial portion of that gain was because of less evasion and less avoidance.

Simply stated, it makes sense to comply with the tax system when rates are low.

Let’s close by addressing one of the ways that leftists want to improve compliance. They want to destroy financial privacy and give governments near-unlimited ability to collect and share financial information about taxpayers, all for the purpose of supposedly bolstering tax compliance.

This agenda, if ultimately successful, will cripple tax competition as a liberalizing force in the global economy.

This would be very unfortunate. Tax rates have fallen in recent decades, for instance, largely because governments have felt pressure to compete for jobs and investment.

That has led to tax systems that are less punitive. And politicians really can’t complain about being pressured to lower tax rates since these reforms generally led to more growth, which generated significant revenue feedback. In other words, the Laffer Curve works.

There’s even some evidence that tax competition leads to less government spending.

But these are bad things from a statist perspective.

This helps to explain why politicians from high-tax governments want to eviscerate tax competition and create some sort of global tax cartel. An “OPEC for politicians” would give them more leeway to impose class-warfare tax policy and buy votes.

The rhetoric they’ll use will be about reducing tax evasion. The real goal will be bigger government.

I’m not joking. Left-wing international bureaucracies such as the Organization for Economic Cooperation and Development have justified their anti-tax competition efforts by asserting that jurisdictional rivalry “may hamper the application of progressive tax rates and the achievement of redistributive goals.”

I suppose we should give them credit for being honest about their ideological agenda. But for those who want good tax policy (and who also understand why that’s the right way to boost tax compliance), it’s particularly galling that the OECD is being financed with American tax dollars to push in the other direction.

P.S. I don’t know if you’ll want to laugh or cry, but here are some very odd examples of tax enforcement.

P.P.S. Here’s more evidence that high tax rates and tax complexity facilitate corruption.

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