New OECD rules strike at the foundation of tax competition

The Organization for Economic Cooperation and Development (OECD) claims that new rules in its recently published Common Reporting Standard for Automatic Exchange of Financial Account Information are necessary to eliminate tax evasion. They’ve used the same argument in the past to justify numerous other demands, and each time when low-tax jurisdictions undertook the costly process of meeting OECD mandates, the goal posts were subsequently moved. 

Jurisdictions surprised by ever evolving standards make the mistake of taking OECD claims at face value. Far from being motivated primarily by reducing tax evasion, their true objective is to eliminate tax competition so that the world’s largest welfare states can maximize the extraction of wealth from the global economy.

Tax evasion is not a very complicated problem to solve. Nations with the highest compliance rates tend also to be those with the least burdensome tax code. If members of the OECD took the sensible route of lowering tax rates and ending double taxation on capital, they could achieve the twin objectives of increasing both prosperity and fairness.

Unfortunately, politicians in high tax nations have other goals. Chief among them is collecting every potential tax dollar they can get their hands on. This includes dollars that might otherwise be attracted, even legally, to jurisdictions offering more favorable tax rates or more efficient regulations. The OECD is not aiming to even the playing field, in other words, but to kneecap the competition.

Evidence of this agenda is simple to find. Numerous OECD documents refer favorably to the theory of capital export neutrality (CEN), which asserts that economic efficiency is best promoted by harmonizing tax rates between domestic and international investments. The argument is that so-called neutrality promotes the making of investment decisions on business rather than tax considerations, which in turn enhances economic efficiency. But CEN fails to account for the negative economic impact of high tax rates, and thus the legitimate reasons for considering the impact of taxes not just as a fundamental part of choosing an investment, but simply of running a successful business. CEN also ignores the positive impact of tax competition as a pressure for the adoption of pro-growth fiscal policy.

Elements of CEN theory were featured prominently in the OECD’s 1998 and 2000 anti-tax competition reports. While the anti-tax competition initiative was shelved after a backlash from both the U.S. and low-tax jurisdictions, subsequent OECD efforts – in particular those of the Global Forum on Transparency and Exchange of Information for Tax Purposes – continue to move in the direction of reducing or eliminating the ability of capital to gravitate toward more favorable tax structures.

Subsequent OECD efforts to pressure low-tax jurisdictions to sign tax information exchange agreements have not proven to be a mutually beneficial endeavor. While large nations have sought to acquire the information they desire in order to impose onerous tax rates no matter the location of their citizens or their money, low-tax jurisdictions which have no desire to double tax capital receive only the benefit of avoiding punishment for noncompliance.

This dynamic is not indicative of a healthy relationship built upon mutual respect between nations, and should provide low-tax jurisdictions with no stronger sense of security than the store operator feels after he’s paid the latest round of protection money to the local mafia.

Despite the asymmetry of benefits, it was nevertheless easy for low-tax jurisdictions to justify compliance. After all, if a nation presents evidence of wrongdoing on the part of a specific individual, it is not unreasonable for another to assist in the enforcement effort. Sure, the OECD’s tactics – including threats of blacklisting and economic sanctions – were both deplorable and an affront to national sovereignty and international camaraderie, but despite being also costly, the demands hardly appeared an existential threat to tax competition.

The current initiative is not so well disguised. Despite getting everything it has thus requested, the OECD remains unsatisfied. The new standard’s demand for automatic transmission of bulk taxpayer data is aimed squarely at the heart of tax competition – and also the continued vitality of jurisdictions that rely on investment attracted by pro-growth tax policies and streamlined regulatory systems.

The U.S. is currently the only OECD nation that taxes the income of its citizens no matter where it is earned, but that will likely change with the widespread adoption of automatic exchange. OECD hand-wringing over so-called “double non-taxation” makes clear the distaste with which bureaucrats and finance ministers from high tax nations view the choice of other jurisdictions not to impose exorbitant tax rates on every type of economic activity. Widespread adoption of the new standard will allow them to rectify this perceived oversight.

Despite being the world’s largest (de facto) tax haven, attitudes in the U.S. have changed considerably since it helped torpedo the OECD’s anti-tax competition initiative in the early 2000’s. With passage of the Foreign Account Tax Compliance Act (FATCA), the U.S. has led the way on fiscal imperialism and the effort to globalize tax administration, which provided the opening the OECD needed to press ahead on its quest to eliminate tax competition.

The OECD acknowledges that FATCA “acted as a catalyst for the move towards automatic exchange of information in a multilateral context.” By unilaterally subjecting institutions to costly reporting requirements and draconian penalties for noncompliance, the United States inadvertently managed a feat in making the OECD seem reasonable that international bureaucrats couldn’t have dreamed possible.

In hopes of sparing the world from a proliferation of FATCA-like laws, some jurisdictions seem to have calculated that the OECD is the lesser of two evils. But if history is anything to go by, the costs of acquiescing to the OECD’s new initiative will be significantly higher than they first appear.

The new OECD standard, which is based largely on the model FATCA agreements, is being sold as a means to prevent the spread of FATCA-like laws and thus the need to comply with a hodgepodge of different rules and requirements. Even ignoring the obviously superior solution of standing up against fiscal imperialism and demanding that the U.S. stop its assault on the global financial sector, the OECD provides a poor alternative.

The new standards are themselves just a minimum requirement, and some nations will no doubt have demands that go above and beyond.

In other words, the new standard will do little to reduce the costs of complying with a multitude of different standards. But it will ensure the flow of information to high tax nations, which in turn will be used to facilitate the flow of tax dollars. Where will this leave low-tax jurisdictions?
After its initial defeats, the OECD realized that the way to boil a frog is not to dump it in blistering hot water, as it will simply jump out.

Rather, if the water is initially cool and the temperature raised gradually over time, the frog won’t notice the danger and will eventually boil alive. For more than a decade, the OECD has been slowly raising the temperature on tax competition and low-tax jurisdictions. They’ve so far played along and, like the frog, have yet to jump out of the water. But the water is no longer cool, and the new requirements threaten to send bubbles rippling toward the surface.

The time for low-tax jurisdictions to save themselves is now, but they must both recognize the gravity of the danger and possess the necessary fortitude to jump from the water.