The Worldwide Benefits of
International Tax Competition
[A lecture presented at a special meeting of the
International Society of Trust and Estate Practitioners at the Grand
Cayman Marriott Hotel Grand Cayman, 2 September 1998]
U.S. Treasury Secretary Robert Rubin tells us that economic
conditions are "fundamentally sound." The light of history
might have given him pause: that is what one of his predecessors,
Andrew Mellon, told the public in October, 1929. However, it is only
ceremonial, not to be taken literally, or as a guide. If public
officials didn't say it, people would wonder why not, and worry.
We are gathered here tonight because the OECD tells us that
international tax competitition, on which your prosperity rests, is "harmful,"
and should be stamped out. Is this, too, just ceremonial? I fear not.
When a powerful international political organization officially brands
you as "harmful," look out. "The arts of Power and its
minions are the same in all countries and in all ages. It marks its
victim; denounces it; and excites the public odium and the public
hatred, to conceal its own abuses and encroachments." -- Henry
Clay, U.S. Senate, 14 March 1834. Defamation anticipates oppression,
conditioning suggestible minds to accept it. Current signals from
Whitehall suggest that it may cooperate with OECD in the oppression.
I am an outsider here. Like the ardent lover in Lehar's Merry
Widow, my destiny is just to "sing my serenade and part." My
purpose is to begin building a stage on which you, the principal
actors, may perform. Special conditions here have made many of your
largest stakeholders and natural leaders reticent to speak out. I
suggest the current OECD assault on your very being bids you change
that habit, at least on this matter. My goal is simply to articulate
what many of you are already thinking, and offer my back to serve as
your floorboard. You are to be the leads in this drama.
So the OECD tells us international tax competition is "harmful."
You may find their own words in the Report of their Committee on
Fiscal Affairs, Harmful Tax Competition, which the OECD Council
approved on April 9, 1998, and issued as a "Recommendation to the
Governments of Member Countries." Any Caymanian, citizen or
expatriate, who can stay awake through its deadly prose will recognize
a very live assault on your island nation and its economy. You may
find a readable summary in my response of August, 1998, "International
Tax Competition: Harmful or Beneficial?"
The OECD ideal is tax "uniformity" among nations.
This has a familiar ring to any economist who follows fashions in the
ideologies of public finance. For one example, closely analogous, in
1969 or so, Sacramento (California's State Capitol) told us that
interurban tax competition was harmful, because it kept some cities
from raising their sales taxes. To solve this problem, they invoked
the doctrine of "uniformity": if only every city raised the
sales tax, no retailer or buyer could escape it by fleeing to a city
without one. Accordingly, Sacramento forced every city to impose a
sales tax, piggybacking on the existing state sales tax. The State
collects it, and returns it to each municipality of origin. A few
years later California cut its local property tax rates to 1/3 of
their former level, and replaced the funds with state subventions,
financed by raising state sales taxes, subjecting its once-independent
cities and schools to a high degree of state control.
A "uniform" sales tax is not uniform in its
effects. Retailers in rich locations can bear it and survive; those in
marginal locations cannot. The result is especially to penalize poorer
neighborhoods and regions and communities.
It will not surprise any reasonably jaded and sceptical
observer of dirigisme in practice that there were unintended
consequences. Interurban competition survives, but takes the new form
of competing to attract retail trade (and hence sales tax revenues) by
overzoning for it, and by subsidizing new retail outlets in various
ways. Those best able to subsidize retailers are the cities already
richer, adding to the bias against marginal locations. A byproduct of
that is a retail vacancy rate approaching 33%, an enormous private and
social cost. "When will they ever learn?" Not soon,
apparently: the next step will be for the State to preempt local
zoning, centralizing more and more control in Sacramento. Such
centralized control is clearly the aim of the OECD campaign against
tax competition. It is anomolous that those who preach for competition
in the private sector -- what they call "liberalization" --
should suppress competition among governments.
It is also anomalous for OECD to fault tax havens for "distorting"
world investment patterns when their own internal systems distort
investment on a grand scale. For example, their Report (p.31) brands a
nation as "harmful" if it lets a person deduct costs when
the corresponding income is not taxed. That sounds reasonable, and yet
that is the standard treatment of most real estate income in the
U.S.A., the largest member of OECD. The costs of ownership - interest
and property taxes - are fully deductible. The cash flow is offset by
overdepreciation until the property may be sold. The resulting nominal
gain then gets special treatment as a "capital gain," often
resulting in no tax at all, and at worst in a lower tax rate, at a
deferred date. If it is an owner-occupied residence or country
playground, there is not even a nominal tax on the imputed income.
Thus, OECD members might do well to review the Scriptural
behest: "First pick the beam from thine own eye; then thou may
see better to pick the mote from thy neighbor's eye."
II. What is "harmful"?
OECD says a "harmful tax regime" is one that "attracts
mobile activities." Right away we think of low taxes, and that
may be what OECD means - on p.27 they specify low income taxes.
However, that is too simple by far. A nation may also attract mobile
activities in two other ways: by offering superior public services;
and by a tax structure that favors mobile activities without stinting
on public services.
A. Richness of the tax base
A jurisdiction may enjoy both high public revenues and low tax
rates if it be favored with a high tax base. Alfred Marshall, renowned
Edwardian economist, warned about the excessive magnetism of London,
and, within Greater London, of the richer suburbs. Vancouver, B.C. is
another example of Marshall's principle. It is such a magnet for
Canadians that the Provincial Government deliberately fosters
developments elsewhere in the Province at the expense of Vancouver.
The whole Province of Alberta is another such magnet, thanks to its
monopoly of petroleum in Canada, and its effective system of raising
Provincial revenues therefrom. The State of Alaska is another magnet,
with the highest taxes per capita of any U.S. state. Its magnet is in
the very direct form of an annual "social dividend" of over
$1,000 per man, woman and child, in cash.
In all those cases, the "distortion" caused by high
public revenues is in attracting mobile factors, not repelling them.
It is an advantage enjoyed by the major OECD nations, vis-a-vis those
less favored by nature, by virtue of their occupying the best lands on
the planet. It seems rather mean of them to deny to nations occupying
less favored lands the only compensatory measures available.
Poorer nations may replicate the magnetism given by natural
advantages, and attract mobile activities, in two ways. One is by
maintaining a more efficient government: more service at lower cost.
This is what competition is supposed to achieve in the private sector:
why not in the public, too?
The other way is by adopting a magnetic tax structure. There
are taxes and then there are taxes. The OECD Report was written by
people wearing blinders that keep their eyes and minds fixated only on
kinds of taxes that penalize and repel mobile activities. Let us
liberate ourselves from that fixation. There are taxes that do not
repel mobile factors, but positively attract them. The OECD does not
like them. I will give you some examples.
B. Magnetic tax structures
The spectacular growth of California from about 1900 to 1976
was in part the product of a magnetic tax structure. California's
natural advantages, such as they are, did not promote much growth
during the latter 19th Century. Eventually, though, growth-oriented
forces prevailed. Taxes (of a certain kind) rose, and California
provided superior public services of many kinds: water supply, schools
and free public universities, health services, transportation, parks
and recreation, and others. It held down utility rates by regulation,
coupled with resisting the temptation to overtax utilities to hold
down property tax rates.
California had oil, but did not tax it, and still doesn't.
Its wine industry went virtually untaxed. There was and is hardly any
tax on its magnificent redwood timber. There was no charge for using
falling water for power, or withdrawing water to irrigate its deserts.
All those would have been good ideas, but they are not what California
Its main tax source was another kind of immobile resource:
ordinary real estate. Its tax valuers focused their attention on the
most immobile part of that, the land, such that at one point, 1920,
land value comprised 70% of the "real estate" tax base.
People and capital flooded in, for they are mobile in
response to opportunities. California became the largest state, and a
major or the largest producer of many things, from farm products up to
the "tertiary" services of banking, finance and insurance.
C. Was tax competition "harmful"?
If California competition was harmful to the world as a
whole, we would have to conclude by analogy that the discovery of the
new world was, too: Columbus should have stayed at home. While it is
PC today to stress the negative side of the migration of European
people and capital to the New World, I doubt if many people, on
balance, would prefer a world shrunk to its eastern hemisphere.
California became the largest producer of cotton, for example,
displacing a good deal of eastern cotton. The damage to eastern
producers was offset by an equal gain to cotton buyers, with a net
gain from higher usage due to the lower price. Eastern cotton lands
were released for other uses, like reforestation of lands marginal for
California attracted eastern workers, tending to draw up
eastern wage rates. The damage to eastern employers was offset by an
equal gain to their workers, with large net gains from two sources.
One is a more equal distribution of wealth; the other is a drop in
welfare costs and social problems like crime that would have ensued
had the "Okies," for example, had to remain in the Dust Bowl
instead of finding new lives in California. Even the braceros, the
Hispanic "guest-workers" who toil in the fields, send money
home, relieving problems in their homelands. What is involved here, in
spite of its well-publicized abuses, is turning useless people into
As to capital, California offered a higher return on that,
too. There emerged "the continental tilt of interest rates,"
higher in the west, to overcome the frictions of space and draw
eastern capital to where it was more welcome. Over time, buildings
that wore out in the east were replaced in California.
Did this in California seem ambitious in any way damaging to
others? It did tend to pull up interest rates back east, hurting
borrowers. These losses, however, were offset by equal gains to
savers, with a net bonus from the rise of saving caused by higher
interest rates. There are those who would intuitively assume that the
distributive effects are regressive, but that is doubtful. In this
case the truth is counter-intuitive. Equity earnings in stocks and
real estate vary inversely with interest rates. Equity values are
impacted even more, because higher interest rates translate into
higher capitalization rates, which mean lower P/e ratios and lower
capital gains. This is too big an issue to settle here, but on
balance, in my opinion, a rise of interest rates has an equalizing
effect on the distribution of wealth.
The net effect of higher interest rates is to move capital
into higher uses, as directors impose higher "hurdle rates"
on their managers. Hurdle rates rose, not because there was less
capital overall, but more opportunities to invest it productively.
Basically, California's remarkable 20th Century growth
extended the American tradition of the western frontier, in the spirit
of Thomas Jefferson, as a "safety-valve" for mobile
resources oppressed in the older states. It limited the power of the
haves over the have-nots, with net gains all around.
D. Recent changes.
In 1978, California took a giant step backwards by enacting
its "Proposition 13," capping property tax rates at about
1/3 of their previous level. The national ranking of its services
began a precipitous fall; so did its per capita income. Struggling to
maintain itself, the State has raised sales and income and business
taxes to unprecedented levels. These are taxes that "shoot
anything that moves," and spare immobile resources that don't.
The result is the rapid "Alabamization" of California, as we
descend to join Alabama with the worst school system in the nation.
Today if we look for a new frontier we find it in, of all
places, one of the original 13 colonies, New Hampshire, with its poor
soils, harsh climate, impassable mountains, and lack of natural urban
confluences. What New Hampshire has is the least repellent tax
structure in the nation: it does not tax income, while 2/3 of all its
state and local revenues come from the property tax. Richard Noyes and
I have spelled out the details in our chapter in Fred Harrison (ed.),
1998, The Losses of Nations.
IV. Is Competition Beneficial?
A more efficient government would offer superior public
services without higher taxes; or the same services with lower taxes.
Is this harmful? Those who sanction competition to regulate private
enterprise to attract suppliers and customers, and undercut
monopolies, should by the same reasoning also endorse competition
among governments to attract people and capital. Such competition is a
major line of defense against the tyranny that a monopoly government
Every government has some latent monopoly power by its nature
- a monopoly of power over certain lands. The behavior of OPEC during
the 1970s, and the threat posed by Saddam Hussein more recently,
illustrate the point, but by no means exhaust it. Governments try
especially to attract industries that are clean, safe, and generative
of fiscal surpluses. Tertiary industries like yours are what they
cherish most. Through OECD, they will fight to keep them from
The benefits of intergovernmental competition are exemplified
in European history. The 16th Century, the age of nation-building,
also saw a worsening in the returns to the mobile factor, labor.
Before that, during the anarchic Wars of the Roses, dozens of petty
tyrants competed to hold onto their retainers and archers, making the
14th and 15th Centuries a golden age for English labor. Economic
historians have shown that the material living standards of labor in
this golden age were higher than in the 19th Century, for all its
technical progress. The Church used its vast landholdings to provide
the welfare system of the period. The Tudor monarchs then put an end
to such wasteful competition among tyrants. They let their favorites
enclose the commons, and replace people with sheep. They let thousands
be cast loose to roam as "sturdy beggars," and then whipped
them back, bereft of bargaining power, to serve their masters on the
masters' terms. Thus was the modern age born in agony, an agony
brought on by ending competition among governments.
V. Should tax regimes be the same everywhere?
Uniform taxation does not produce uniform results, a
phenomenon that tax-economists acknowledge in their theorizing as "The
Ramsey Rule." Having nodded to it in theory, many of them then
pass over it in prescribing actual tax policy - a strange ambivalence
that I will not try to explain here, but only deplore. They would
improve their policy prescriptions if they gave more weight to the
Ramsey Rule. In some disfavored regions, or "lean territory,"
at the edges of settlement, the land generates little or no surplus
above the opportunity cost of the mobile factors. Labor just makes
wages; capital just makes enough to pay interest. Impose a uniform
GST, PAYE or VAT and it makes economic life non-viable at these lean
edges, because there is no taxable surplus.
An example is "the bush" of South Africa. South
Africa imposed a VAT with the very purpose of extracting taxes from
poor blacks in the bush. The result was to sterilize the bush
economically, to scorch the earth and drive its people away to squat
in extra-legal shacktowns like Soweto, near Johannesburg, and The
Crossroads near Cape Town. It forced them to survive doing business in
gray markets on the streets and roadsides, turning also to drugs,
prostitution, and crime. What else were they to do?
A rich place like, say, Vancouver might impose a VAT and
survive, but it is not clear that it should, even so. Hong Kong is the
sparkling paragon of a rich territory that embraced magnetic tax
policies. As a Crown colony, it redoubled its natural magnetism by
shunning repellent taxes of most kinds. Its public coffers overflowed,
nonetheless, because the Crown owned all the land there, and did a
tolerable job - not excellent, but better-than-average - of collecting
much of the rent for public purposes. With a land area about the same
as the Cayman Islands, it became a world center of both secondary and
tertiary industry, with a large population, and a high per capita
income by world standards. Those who have eyes to see, let them see.
Nations not owning their own land can replicate the Hong Kong
effect simply by emulating California of yesterday, and New Hampshire
of today, basing most of their taxes on the immobile factor, real
VI. Choices for OECD nations
If OECD nations are concerned about tax competition, they
have at least three choices.
A. They could impose exchange controls to prevent capital
export, as attempted by various authoritarian states before world war
II, and some less authoritarian welfare states afterwards. This
approach had its day, and is now a proven failure, although that is
not stopping several desperate failing Asian nations now from giving
it another whirl.
B. They can try muscling small nations into copying, and
helping them enforce, their own repressive tax systems. This means and
requires extending their sovereignty worldwide, as envisioned in the
OECD Report we are discussing. It is in the spirit of the times, in
this age of world cartels, MNCs, the International Telecommunications
Union, world radio and TV networks, the IMF, the World Bank, the WTO,
the MAI, the Trilateral Commission, Interpol, the world war on drugs,
the U.S. as world policeman, etc. It is something like the Holy
Alliance that undertook to police each aberrant nation of
post-Napoleonic Europe, only more ambitious: its turf is the whole
world, with no exceptions or refuges, not even this speck of coral
amid a great Sea. Any independent force threatens the whole structure,
so it demands nothing short of worldwide domination: a megalomaniac
C. They could reform their own domestic tax systems along the
lines demonstrated by California before 1978, by Hong Kong before
1997, and by New Hampshire today. They could lead us to a world of
benign tax competition. They are not headed this way today, obviously,
but if the little Cayman Islands can face them down, they will have no
other choice. Freedom anywhere foils tyranny everywhere. Tax tyranny
must seal every leak, or it collapses.
VII. Tax intelligence
A cognate concern of the OECD is extending the sovereign
powers of its members to pry into private dealings in other nations.
The French verb percevoir has two meanings: one, of course, is "to
perceive"; the other is "to tax." How very perceptive
of the French to see that connection. To tax it you must first see it
and understand it. Income-tax agents are necessarily insatiable
voyeurs. They are frustrated and offended by privacy provisions in
other nations and, as the OECD Report makes clear, they believe they
have the moral authority to pierce those veils, and to invoke
political force for the purpose.
Must it be so? Is taxation always at war with personal
privacy and national sovereignty? Fortunately, no. The OECD Report
makes the unfortunate tacit premise that all taxes must or should be
on a personal (or corporate) basis: what the lawyers call in personam.
Some other taxes, however, are levied on a thing, or in rem. Import
duties, for example, are levied on the simple act of bringing in
dutiable goods, regardless of who does it, or where they come from
(although sometimes this is considered). No deep inquisition is
required into all the personal affairs of the importer. They are
enforceable simply by refusing admission until the duty is paid or, in
extreme cases, seizing the goods. Only in criminal cases are persons
as such penalized or jailed.
There are upper limits on feasible tariff rates. Many
national borders, unlike those here, are long and penetrable. Many
nations are lowering or avoiding import duties in the interests of
freer world trade, the strong trend of the times. Many groups, as
here, are rebelling against high domestic consumer prices. The weight
of opinion is that import duties, and all such consumer taxes, are
regressive, and socially undesirable.
A purer case of in rem taxation is the tax on real estate.
Such taxes are a lien on the land, not the person who owns it.
Sovereignty over land is unambiguous. It is either inside or outside
the taxing jurisdiction, regardless of who owns it, or where he or she
resides, or what other assets he or she may own, or other income he or
she may receive, here or elsewhere. No international tax treaties are
needed in order for a nation or smaller jurisdiction to tax its own
land. No information need be demanded of any other nation or its
Adam Smith wrote in 1776 that if you tax stock (movable
capital) it will be concealed or removed. Worse, some forms of capital
are more concealable and removable than others, so a tax is
necessarily nonuniform. Knowing the quantity of mobile capital
requires a deep inquisition "as no people could support"
(Wealth of Nations, p. 800). Capital is never uniformly taxed, and
never can be, even within one nation. In today's world economy, with
instant electronic encrypted international fund transfers, the ability
to avoid and evade taxes on mobile capital has outrun even Smith's
OECD's response is to call for more enforcement, and to
scapegoat small tax havens. To enforce an income tax today calls for
nothing less than a worldwide intelligence network with vast powers of
search and seizure.
It also calls for worldwide thought-control to give it moral
authority and general support. The end of this thought-control is to
criminalize income. Since that is too absurd to proclaim in so many
words, the OECD nations have added a step: it is not criminal to earn
income, but it is criminal to do so and then fail to admit it.
People's minds have been conditioned to accept tarring that as "cheating,"
as though it were a kind of moral lapse. It is roughly parallel with
Kenneth Starr's approach to President Clinton: what you did was not
criminal, nor public business; but failing to report it was both, and
impeachable. The OECD Report is the latest move in a longtime
thought-control campaign to universalize that attitude toward earning
income. Considering that one earns income mainly by producing goods
and services, that mindset is stiflingly counterproductive.
We have come a long way since Adam Smith gave people credit
for not supporting deep inquisitions into their affairs. How he would
boggle at the inquisitions "supported" or tolerated today.
However, now it has become clear that income taxation cannot endure
without a worldwide intelligence network: a worldwide inquisition by
the revenue agents of every nation into the records of every other
nation. Here, I submit, is where to draw the line. Here is where a
determined small nation, jealous and precious of its sovereignty, can
defy, puncture and collapse a puffed-up world tyranny. It's been done