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Posts Tagged ‘Tax Competition’

In the world of tax policy, there’s an intense debate about the “border-adjustable” provision that is part of the tax plan put forth by House Republicans, which basically would tax imports and exempt revenues generated by exports.

It’s a bit wonky, but the simplest explanation is that GOPers want to replace the current corporate income tax with a “destination-based cash flow tax” (DBCFT) that would – for all intents and purposes – tax what is consumed in the United States rather than what is produced in the United States.

I’m very sympathetic to what Republicans are trying to accomplish, particularly their desire to eliminate the tax bias against income that is saved and invested. But I greatly prefer the version of consumption-base taxation found in the flat tax.

My previous columns on the plan have highlighted the following concerns.

  • Left-leaning advocates like “destination-based” tax systems such as the DBCFT because such systems undermine tax competition and give politicians more ability to increase tax rates.
  • The “border adjustability” in the plan is contrary to the rules of the World Trade Organization (WTO) and there’s a significant risk that politicians might try to “fix” the plan by turning it into a value-added tax.

Here’s what I said about the proposal in a recent interview for CNBC.

This provision is not in Trump’s plan, but I’ve been acting on the assumption that the soon-to-be President eventually would embrace the Better Way Plan simply because it presumably would appeal to his protectionist sentiments.

So I’m quite surprised that he’s just poured cold water on the plan. Here are some excerpts from a report in the Wall Street Journal.

President-elect Donald Trump criticized a cornerstone of House Republicans’ corporate-tax plan… The measure, known as border adjustment, would tax imports and exempt exports as part of a broader plan to encourage companies to locate jobs and production in the U.S. But Mr. Trump, in his first comments on the subject, called it “too complicated.” “Anytime I hear border adjustment, I don’t love it,” Mr. Trump said in an interview with The Wall Street Journal on Friday. …Retailers and oil refiners have lined up against the measure, warning it would drive up their tax bills and force them to raise prices because they rely so heavily on imported goods.

If we read between the lines, it appears that Trump may be more knowledgeable about policy than people think.

Proponents of the Better Way Plan sometimes use protectionist-sounding rhetoric to sell the plan (e.g., taxing imports, exempting exports), but they argue that it’s not really protectionist because the dollar will become more valuable.

But Trump apparently understands this nuance and doesn’t like that outcome.

Independent analyses of the Republican tax plan say it would lead the dollar to appreciate further—which would lower the cost of imported goods, offsetting the effects of the tax on retailers and others. In his interview with the Journal on Friday, Mr. Trump said the U.S. dollar was already “too strong” in part because China holds down its currency, the yuan. “Our companies can’t compete with them now because our currency is too strong. And it’s killing us.”

I don’t agree with Trump about trade deficits (which, after all, are mostly the result of foreigners wanting to invest in the American economy), but that’s a separate issue.

When I talk to policy makers and journalists about this issue, one of the most common questions is why the DBCFT would cause the dollar to rise.

In a column for the Wall Street Journal, Martin Feldstein addresses that topic.

…as every student of economics learns, a country’s trade deficit depends only on the difference between total investment in the country and the saving done by its households, businesses and government. This textbook rule that “imports minus exports equals investment minus savings” is not a theory or a statistical regularity but a basic national income accounting identity that holds for every country in every year. That holds because a rise in a country’s investment without an equal rise in saving means that it must import more or export less. Since a border tax adjustment wouldn’t change U.S. national saving or investment, it cannot change the size of the trade deficit. To preserve that original trade balance, the exchange rate of the dollar must adjust to bring the prices of U.S. imports and exports back to the values that would prevail without the border tax adjustment. With a 20% corporate tax rate, that means that the value of the dollar must rise by 25%.

This is a reasonable description, though keep in mind that there are lots of factors that drive exchange rates, so I understand why importers are very nervous about the proposal.

By the way, Feldstein makes one point that rubs me the wrong way.

The tax plan developed by the House Republicans is similar in many ways to President-elect Trump’s plan but has one additional favorable feature—a border tax adjustment that exempts exports and taxes imports. This would give the U.S. the benefit that other countries obtain from a value-added tax (VAT) but without imposing that extra levy on domestic transactions.

The first sentence of the excerpt is correct, but not the second one. A value-added tax does not give nations any sort of trade benefit. Yes, that kind of tax generally is “border adjustable” under WTO rules, but as I’ve previously noted, that doesn’t give foreign production an advantage over American production.

Here’s some of what I wrote about this issue last year.

For mercantilists worried about trade deficits, “border adjustability” is seen as a positive feature. But not only are they wrong on trade, they do not understand how a VAT works. …Under current law, American goods sold in America do not pay a VAT, but neither do German-produced goods that are sold in America. Likewise, any American-produced goods sold in Germany are hit be a VAT, but so are German-produced goods. In other words, there is a level playing field. The only difference is that German politicians seize a greater share of people’s income. So what happens if America adopts a VAT? The German government continues to tax American-produced goods in Germany, just as it taxes German-produced goods sold in Germany. …In the United States, there is a similar story. There is now a tax on imports, including imports from Germany. But there is an identical tax on domestically-produced goods. And since the playing field remains level, protectionists will be disappointed. The only winners will be politicians since they have more money to spend.

If you want more information, I also discuss the trade impact of a VAT in this video.

For what it’s worth, even Paul Krugman agrees with me on this point.

P.S. It is a good idea to have a “consumption-base” tax (which is a public finance term for a system that doesn’t disproportionately penalize income that is saved and invested). But it’s important to understand that border adjustability is not necessary to achieve that goal. The flat tax is the gold standard of tax reform and it also is a consumption-based tax. The difference is that the flat tax is an “origin-based” tax and the House plan is a “destination-based” tax.

P.P.S. Speaking of which, proponents of the so-called Marketplace Fairness Act are using a destination-based scheme in hopes of creating a nationwide sales tax cartel so that states with high rates can make it much harder for consumers to buy goods and services where tax rates are lower.

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Mancur Olson (1932-1998) was a great economist who came up with a very useful analogy to help explain the behavior of many governments. He pointed out that a “roving bandit” has an incentive to maximize short-run plunder by stealing everything from victims (i.e. a 100 percent tax rate), whereas a “stationary bandit” has an incentive to maximize long-run plunder by stealing just a portion of what victims produce every year (i.e., the revenue-maximizing tax rate).

Tyler Cowen of George Mason University elaborates on this theory in this very helpful video.

As you can see, Olson’s theory mostly is used to analyze and explain the behavior of autocratic governments. Now let’s apply these lessons to political behavior in modern democracies.

I wrote last year about a field of economic theory called “public choice” to help explain how and why the democratic process often generates bad results. Simply stated, politicians and special interests have powerful incentives to use government coercion to enrich themselves while ordinary taxpayers and consumers have a much smaller incentive to fight against that kind of plunder.

But what’s the best way to think about these politicians and interest groups? Are they roving bandits or stationary bandits?

The answer is both. To the extent that they think their power is temporary, they’ll behave like roving bandits, extracting as much money from taxpayers and consumers as possible.

Though if you think of democracies as duopolies, with two parties and rotating control of government, then each party will also behave like a stationary bandit, understanding that it’s not a good idea to strangle the goose that lays the golden eggs.

And this is one of the reasons why I’m a big fan of “tax competition.” Simply stated, politicians and special interests constrain their greed when they know that potential victims have the ability to escape.

Here’s a report from the Wall Street Journal that is a perfect example of my argument.

Germany could reduce its corporate tax rate in the wake of similar moves in the U.K. and the U.S., German Finance Minister Wolfgang Schäuble said. Europe’s largest economy should simplify its complex tax system for companies in order to…remain competitive internationally, Mr. Schäuble told The Wall Street Journal in an interview. He also said that while Germany opposed beggar-thy-neighbor tax competition between mature industrial nations, Berlin would also consider cutting tax rates if necessary.

And such steps may be necessary. In other words, Germany may reduce tax rates, not because politicians want to do the right thing, but rather because they fear they’ll lose jobs and investment (i.e., sources of tax revenue) to other jurisdictions.

U.S. President-elect Donald Trump has said he would like to cut the corporate tax rate from 35% to 15% as part of a broader tax overhaul. In November, U.K. Prime Minister Theresa May said the main corporate rate there should fall from 20% to 17% by 2020. These followed announcements about corporate tax-rate cuts by Japan, Canada, Italy and France.

Let’s look at another example.

I made the economic case for Brexit in large part because the European Union is controlled by anti-tax competition bureaucrats and politicians in Brussels.

Well, it appears that the British vote for independence is already paying dividends as seen by comments from the U.K.’s Chancellor of the Exchequer.

Philip Hammond warned yesterday that the Government will come out fighting with tax cuts if the EU tries to wound Britain by refusing a trade deal. …Yesterday, Mr Hammond was asked by a German newspaper if the UK could become a tax haven by further lowering corporation tax in order to attract businesses if Brussels denies a deal. In his strongest language yet on Brexit, the Chancellor said he was optimistic a reciprocal deal on market access could be struck… But he added: …‘In this case, we could be forced to change our economic model and we will have to change our model to regain competitiveness. And you can be sure we will do whatever we have to do. …We will change our model, and we will come back, and we will be competitively engaged.’ …Earlier this year Mrs May committed Britain to having the lowest corporation tax of the world’s 20 biggest economies. The intention is a rate of 17 per cent by 2020.

In other words, yet another case of politicians doing the right thing because of tax competition.

The stationary bandits described by Olson are being forced to adopt better tax policy.

So it’s very appropriate to close with some wise counsel from a Wall Street Journal editorial.

The EU needs more tax competition from government vying to stimulate business investment. …The real tax-policy scandal is that so few European governments understand there’s a cause-and-effect relationship between oppressive tax rates and low economic growth.

P.S. Since we’re looking at tax competition, Europe, and bandits, keep in mind there’s considerable academic work showing that Europe became a rich continent precisely because there were many small nations that competed with each other. Those jurisdictions felt pressure to adopt good policy because the various leaders wanted lots of economic activity to tax. All of which helps to explain why modern statists are so hostile to decentralization and federalism.

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To be blunt, I don’t think the World Bank should exist. We don’t need an international bureaucracy to promote economic development in poor nations. Particularly since the policies that we know will work – free markets and small government – oftentimes are hindered by intervention from multilateral institutions such as the World Bank.

For example, I’ve spent the past few days in Vanuatu, where I’ve been fighting against the adoption of an income tax, and I’ve been repeatedly told that the World Bank is one of the groups (along with the Australian Tax Office) urging the adoption of this anti-growth levy. It is both depressing and upsetting that outsiders are seeking to hinder growth in this poor nation, but what really galls me is that World Bank bureaucrats (like their colleagues at other international bureaucracies) are exempt from paying any income tax.

All this being said, my general philosophical hostility (and, in Vanuatu, targeted genuine anger) toward the World Bank doesn’t preclude me from admitting when the bureaucracy does good work. It has played a positive role in helping some nations set up private retirement systems, and it has produced research warning about the link between corruption and complicated tax systems.

Perhaps most laudable, the World Bank every year publishes Doing Business, an index that dispassionately measures the degree to which government policy imposes costs on those who create and operate companies. Indeed, it was just two months ago that I wrote about the most recent issue (mostly to grouse that America is falling in the rankings, so thanks Obama).

All of which puts me in a strange position, because although I have written that the World Bank is my “least despised international bureaucracy,” I never thought I would dedicate an entire column to defending its work.

But a friend formerly known as the Princess of the Levant sent me an article by José Antonio Ocampo and Edmund Fitzgerald, which attacks Doing Business for…gasp…encouraging tax competition.

Since I’m a knee-jerk defender of tax competition (and bearing in mind that the enemy of your enemy is sometimes your friend), I feel obliged to jump into the debate and defend the World Bank’s report.

Here’s the basic argument of Ocampo and Fitzgerald.

…there is a serious flaw in the report’s formula: the way it treats corporate taxation. …The problem is that “regulatory burden,” according to Doing Business, includes…promoting budget-straining tax competition among countries… This may sound like an argument for overhauling Doing Business’ “paying taxes” indicator. But what is really needed is for Doing Business to drop that indicator altogether…when it comes to the paying taxes indicator, the report has things all wrong. Indeed, it runs counter to the global consensus on the need for effective international cooperation to ensure equitable collection of tax revenues, including measures to limit tax avoidance by multinationals and other private firms. A race to the bottom in corporate taxation will only hurt poor people and poor countries. If Doing Business is to live up to its own slogan, “equal opportunity for all,” it should abandon the tax indicator altogether.

Wow. I find it remarkable that leftists openly argue in favor of suppressing information on tax policy because of their ideological hostility to tax competition.

For all intents and purposes, they’re admitting that taxes do matter.

The article also makes some other assertions that deserve a bit of attention. Most notably, the authors repeat the silly claim by some leftists that the way to get more growth is with a bigger government financed by higher taxes.

…taxes that are necessary to fund public infrastructure and basic social services – both of which are critical to enhance growth and employment. Even the report recognizes that, for most economies, taxes are the main source of the government revenues needed to fund “projects related to health care, education, public transport, and unemployment benefits, among others.”

Yet if it’s true that big government stimulates growth, why did the world’s richest nations become rich when government was very small and taxes were largely nonexistent?

Ocampo and Fitzgerald somehow want people to believe that if a little bit of government spending is associated with good economic results, then this somehow means a lot of government must be associated with better economic results.

Maybe somebody should introduce them to the concepts of diminishing returns and negative returns. And once they master those concepts, they’ll be ready to learn about the Rahn Curve. Heck, there’s even a World Bank study I can recommend for them.

Though the authors do raise one semi-decent point. Some of the taxes paid by companies actually are borne by workers. Ocampo and Fitzgerald don’t seem to understand how this works since they jumble together some taxes that are borne by labor with other that are borne by capital, but there is a kernel of truth in their argument.

Doing Business exaggerates the tax burden on companies. For one thing, it considers all the kinds of taxes firms might pay – not just corporate income tax. Specifically, the report’s estimates for “total tax rate as a proportion of profits” include taxes for employees’ health insurance and pensions; property and property transfers; dividends, capital gains, and financial transactions; and public services like waste collection and infrastructure. Those are taxes that should be categorized as social contributions or service charges.

Having bent over backwards to say something nice about their article, let’s now close by highlighting the most preposterous assertion in their piece.

They basically reject the entire field of microeconomics and the underlying principles of price theory – not to mention reams of academic evidence – by denying that tax rates have any impact on behavior.

…the assumption underpinning it – that low corporate taxation promotes growth – does not withstand scrutiny. Research conducted by the International Monetary Fund and others indicates that tax competition does not promote productive investment worldwide.

Remarkable. They even think citing the IMF somehow strengthens their case, when that’s actually more akin to citing Dr. Kevorkian.

P.S. Just in case anyone is worried that this pro-Doing Business column means I’m getting soft on the World Bank, rest assured that I will never be a fan of a bureaucracy that equates higher taxes with a good report card. But I’ll always be the first to admit when an international bureaucracy does good work.

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There are several features of President-Elect Trump’s tax plan that are worthy of praise, including death tax repeal, expensing, and lower marginal tax rates on households.

But the policy that probably deserves the most attention is Trump’s embrace of a 15 percent tax rate for business.

What makes this policy so attractive – and vitally important – is that the rest of the world has been in a race to reduce corporate tax burdens.

Ironically, the U.S. helped start the race by cutting the corporate tax rate as part of the 1986 Tax Reform Act. But ever since then, policy in America has stagnated while other developed nations are engaged in a virtuous contest to become more competitive.

And that race continues every day.

Most impressively, as reported by the Financial Times, Hungary will cut its corporate tax rate from 19 percent to 9 percent.

Hungary’s government is to cut its corporate tax rate to the lowest level in the EU in a sign of increasingly competitive tax practices among countries seeking to lure foreign direct investment. Prime Minister Viktor Orban said a new 9 per cent corporate tax rate would be introduced in 2017, significantly lower than Ireland’s 12.5 per cent. …The government said the new single band would apply to all businesses. “Corporation tax will be lowered to single digits next year: a rate of 9 per cent will apply equally to small and medium-sized enterprises and large corporations,” a statement said. …Gabor Bekes, senior research fellow at Hungary’s Institute of Economics…said the measure would likely provoke complaints of unfair tax competition from western capitals.

Needless to say, complaints from Paris, Rome, and Berlin would be a sign that Hungary is doing the right thing.

Croatia also is moving policy in the right direction, albeit in a less aggressive fashion.

Corporate income tax will…be cut from 20 to 18 per cent for large companies and from 20 to 12 per cent for small and mid-level companies whose income is no higher than 400,000 euros annually.

Though the Croatian government also plans to lower tax rates on households.

Before the reform, people with salaries between 300 and 1,750 euros a month were taxed at 25 per cent, while now everyone earning up to 2,325 euros a month will be taxed at a 24 per cent rate. People earning more than 2,325 euros a month will have a 36 per cent tax rate, replacing a 40 per cent tax rate for anyone earning over 1,750 euros a month.

But let’s keep the focus on business taxation.

Our friends on the left don’t like Trump’s plan for a corporate tax cut, but here are there things they should know.

  1. A lower corporate tax rate won’t necessarily reduce corporate tax revenue, particularly over time as there’s more investment and job creation.
  2. A lower corporate tax rate will dramatically – if not completely – eliminate any incentive for American companies to engage in inversions.
  3. A lower corporate tax rate will boost workers wages by increasing the nation’s capital stock and thus improving productivity.

If you want more information, here’s my primer on corporate taxation. You can also watch this video.

Or, to make matters simple, we can just copy Estonia, which has the world’s best system according to the Tax Foundation.

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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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Working the world of public policy, I’m used to surreal moments.

Such as the assertion that there are trillions of dollars of spending cuts in plans that actually increase spending. How do you have a debate with people who don’t understand math?

Or the oft-repeated myth that the Reagan tax cuts for the rich starved the government of revenue. How can you have a rational discussion with people who don’t believe IRS data?

And let’s not overlook my personal favorite, which is blaming so-called tax havens for the financial crisis, even though places such as the Cayman Islands had nothing to do with the Fed’s easy-money policy or with Fannie Mae and Freddie Mac subsidies.

These are all example of why my hair is turning gray.

But I’ll soon have white hair based on having to deal with the new claim from European bureaucrats that countries are guilty of providing subsidies if they have low taxes for companies.

I’m not joking. This is basically what’s behind the big tax fight between Apple, Ireland, and the European Commission.

Here’s what I said about this issue yesterday.

There are three things about this interview are worth highlighting.

  • First, the European Commission is motivated by a desire for more tax revenue. Disappointing, but hardly surprising.
  • Second, Ireland has benefited immensely from low-tax policies and that’s something that should be emulated rather than punished.
  • Third, I hope Ireland will respond with a big corporate tax cut, just as they did when their low-tax policies were first attacked many years ago.

I also chatted with the folks from the BBC.

I’ll add a few comments on this interview as well.

Here’s an interview from the morning, which was conducted by phone since I didn’t want to interrupt my much-needed beauty sleep by getting to the studio at the crack of dawn.

Once again, here are a few follow-up observations.

  • First, I realize I’m being repetitive, but it’s truly bizarre that the European Commission thinks that low taxes are a subsidy. This is the left-wing ideology that the government has first claim on all income.
  • Second, it’s a wonky point, but Europe’s high-tax nations can use transfer pricing rules if they think that Apple (or other companies) are trying to artificially shift income to low-tax countries like Ireland.
  • Third, the U.S. obviously needs to reform its wretched corporate tax system, but that won’t solve this problem since it’s about an effort to impose more tax on Apple’s foreign-source income.

The Wall Street Journal opined wisely on this issue, starting with the European Commission’s galling decision to use anti-trust laws to justify the bizarre assertion that low taxes are akin to a business subsidy.

Even by the usual Brussels standards of economic malpractice, Tuesday’s €13 billion ($14.5 billion) tax assault on Apple is something to behold. …Apple paid all the taxes it owed under existing tax laws around the world, which is why it hasn’t been subject to enforcement proceedings by revenue authorities. …Brussels now wants to use antitrust law to tell Ireland and other low-tax countries how to apply their own tax laws. …Brussels is deploying its antitrust gnomes to claim that taxes that are “too low” are an illegal subsidy under EU state-aid rules.

This is amazing. A subsidy is when government officials use coercion to force taxpayers (or consumers) to pay more in order to line the pockets of a company or industry. The Export-Import Bank would be an example of this odious practice, as would ethanol handouts.

Choosing to tax at a lower rate is not in this category. It’s a reduction in government coercion.

That doesn’t necessarily mean we’re necessarily talking about good policy since there are plenty of preferential tax laws that should be wiped out as part of a shift to a simple and fair flat tax.

I’m simply pointing out that lower taxes are not “state aid.”

The WSJ also points out that it’s not uncommon for major companies to seek clarification rulings from tax authorities.

Brussels points to correspondence between Irish tax officials and Apple executives to claim that Apple enjoyed favors not available to other companies, which would be tantamount to a subsidy. But all Apple received from Dublin, in 1991 and 2007, were letters confirming how the tax authorities would treat various transactions under the Irish laws that applied to everyone. If anyone in Brussels knew more about tax law, they’d realize such “comfort letters” are common practice around the world.

Indeed, the IRS routinely approves “advance pricing agreements” with major American taxpayers.

This doesn’t mean, by the way, that governments (the U.S., Ireland, or others) treat all transactions appropriately. But it does mean that Ireland isn’t doing something strange or radical.

The editorial also makes the much-needed point that the Obama White House and Treasury Department are hardly in a position to grouse, particularly because of the demagoguery and rule-twisting that have been used to discourage corporate inversions.

As for the U.S., the Treasury Department pushed back against these tax cases, which it rightly views as a protectionist threat to the rule of law. But it’s hard to believe that Brussels would have pulled this stunt if Treasury enjoyed the global respect it once did. President Obama and Treasury Secretary Jack Lew have also contributed to the antibusiness political mood by assailing American companies for moving to low-tax countries.

Amen.

It’s also worth noting that the Obama Administration has been supportive of the OECD’s BEPS initiative, which also is designed to increase corporate tax burdens and clearly will disadvantage US companies.

A story from the Associated Press reveals the European Commission’s real motive.

The European Commission says…it should help protect countries from unfair tax competition. When one country’s tax policy hurts a neighbor’s revenues, that country should be able to protect its tax base.

Wow, think about what this implies.

We all recognize, as consumers, the benefits of having lots of restaurants competing for our business. Or several cell phone companies. Or lots of firms that make washing machines. Competition helps us by leading to lower prices, higher quality, and better service. And it also boosts the overall economy because of the pressure to utilize resources more efficiently and productively.

So why, then, should the European Commission be working to protect governments from competition? Why is it bad for a country with low tax rates to attract jobs and investment from nations with high tax rates?

The answer, needless to say, is that tax competition is a good thing. Ever since the Reagan and Thatcher tax cuts got the process started, there have been major global reductions in tax rates, both for households and businesses, as governments have competed with each other (sadly, the US has fallen way behind in the contest for good business taxation).

Politicians understandably don’t like this liberalizing process, but the tax competition-induced drop in tax rates is one of the reason why the stagflation of the 1960s and 1970s was replaced by comparatively strong growth in the 1980s and 1990s.

Let’s close by looking at one final story.

Bloomberg has a report on the Apple-Ireland-EC controversy. Here are some relevant passages.

Irish Finance Minister Michael Noonan on Tuesday vowed to fight a European Commission ruling… The country’s corporate tax regime is a cornerstone of its economic policy, attracting Google Inc. and Facebook Inc. to Dublin. …While the Apple ruling doesn’t directly threaten the 12.5 percent rate, the government has promised to stand by executives it says are helping the economy. “To do anything else, it would be like eating the seed potatoes,” Noonan told broadcaster RTE on Tuesday, adding a failure to fight the case would hurt future generations.

Kudos to Noonan for understanding that a short-term grab for more revenue will be bad news if the tradeoff is a more onerous tax system that reduces future growth.

I wish Hillary Clinton was capable of learning the same lesson.

Also, it’s worth noting that Apple is just the tip of the iceberg. If the EC succeeds, many other American companies will be under the gun.

The iPhone-maker is one of more than 700 U.S. companies that have units there, employing a combined 140,000 people, according to the American Chamber of Commerce in Ireland.

And when politicians – either here or overseas – raise taxes on companies, never forget that they’re actually raising taxes on worker, consumers, and shareholders.

P.S. Just in case you think the Obama Administration is sincere about defending Apple and other American companies, don’t forget that these are the folks who included a global corporate minimum tax scheme in the President’s most recent budget.

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