Topic: Tax and Budget Policy

Swiss Report Exposes EU’s Hypocritical “State-Aid” Attack against Tax Competition

In a fight that may be a precursor to World Trade Organization battles involving America, the European Commission has been persecuting Switzerland because pro-market cantonal tax laws supposedly are a form of state aid. The EU’s state-aid rules prohibit (at least in theory) handouts to individual companies since subsidies create an un-level playing field, and the EC apparently thinks that low taxes in Swiss cantons are akin to a subsidy. Switzerland is not a member of the European Union, but the EC argues that a trade treaty obliges the Swiss to obey rulings from Brussels. reports on a recent meeting, noting that the Swiss are holding firm against outside interference:

The EC argues these cantonal company tax regulations restrict trade in goods between Switzerland and the EU, and distort competition. … the Swiss delegation, led by Alexander Karrer, Head of the Monetary Affairs and International Finance Division in the Federal Department of Finance, and including representatives from the cantons, argued that Swiss taxes do not distort bilateral trade, because the types of company concerned in Switzerland have no, or at most subordinate, business operations which are taxed normally. … Furthermore, the Swiss emphasised that both domestic and foreign-controlled companies are entitled to take advantage of holding-company privileges. The European Commission is basing its legal argument against Switzerland on the latter’s alleged breach of state aid rules, which, in the EU, are in place to prevent member states from favouring certain companies and industries with beneficial tax rules and subsidies. But the Swiss say that the EC’s arguments rest on shaky very legal ground, pointing out that the country is neither an EU member or part of the Single European Market, nor party to the competition regulations of the EC Treaty, including those on state aid. Moreover, Bern insists that even if the tax laws in question were covered by the 1972 Free Trade Agreement, they would not fall under the EU’s definition of state aid, because they do not favour certain companies or industries.

Interestingly, the Swiss government recently released a report exposing the European Commission’s hypocrisy. The full report is only available in French and German, but Pierre Bessard of the Institut Constant de Rebecque in Switzerland shared with me his useful analysis. On the broader issue, Pierre noted that the report revealed that the EU allows many exceptions to its supposed prohibition of fiscal state aids, and allows generous subsidies while limiting tax competition, while Switzerland does not subsidize businesses but allows greater tax competition, which leads to innovation in the public sector and relative government efficiency.” And on the specific issue of state aid, Pierre also explains that the report reveals that “65% of state subsidies in the EU go to manufacturing and services, and only 26% to agriculture.” In other words, the subsidies for business in the EU, which clearly do create an un-level playing field, are more than twice the size of the widely criticized subsidies from the Common Agricultural Policy. In Switzerland, by contrast, individual businesses do not receive handouts and instead are allowed to compete in a low-tax environment

At first glance, this Swiss-EC spat may seem interesting just to tax geeks, but do not be surprised if the United States is ensnared in this type of fight at some point in the future. Statist academics and policymakers already are making the argument that low tax rates “distort” trade by causing jobs and investment to migrate away from high-tax jurisdictions. It is not inconceivable to think that the European Court of Justice might accept this argument at some point, thus paving the way for more extensive tax harmonization in Europe. The next step would be the World Trade Organization. I hope my fears are misplaced, but experience teaches us that politicians are very clever at expanding the power of the state.

Corporate Tax Lobbying

In the popular media, Capitol Hill is swarming with corporate tax lobbyists pushing lawmakers to enact unjustified loopholes for their businesses. Sometimes that is true, but probably more often businesses are on the Hill fighting against unjustified revenue grabs by politicians trying to soak them with tax hikes invisible to the general public.

The big tax bill recently introduced by House Ways and Means chairman, Charles Rangel, provides many examples of unjustified revenue grabs. A corporate tax lawyer sent me a one-pager on proposed changes to LIFO inventory accounting:

LIFO in a Nutshell

Among provisions of Chairman Rangel’s “Tax Reduction and Reform Act of 2007” is repeal of the LIFO method of valuing inventory. According to scoring by the Joint Tax Committee, repeal would raise additional tax revenue of over $100 billion over ten years. Although complicated in its details, the rationale for LIFO is both simple and sensible – the best way of measuring the income of businesses with rising costs of supplies … LIFO is an abbreviation for “last-in-first-out”. This is opposed to the other common inventory accounting convention which is “FIFO” for “first-in-first-out” … LIFO is considered a more accurate accounting method when inventory costs are rising, by taking into account the greater costs of replacing inventory. This gives a better measure of both the financial condition of the business … After thorough consideration of the issue by the Congress, LIFO came into the tax law in 1939.

To sum up: Out of the view of average voters, Mr. Rangel wants to change established law of seven decades to shake an added $100 billion (that’s with a “b”) out of U.S. manufacturers, in a way that apparently doesn’t make any economic sense and will damage their competitiveness, while federal revenues are pouring into the Treasury and have already risen above historically normal levels.

Three cheers for the corporate tax lobbyists who fight this sort of nonsense!

Tax Agency Failures

Laptops lost with taxpayer personal information. Sluggish bureaucracy. Massive fraud from tax credit schemes. Tax credits called a “nightmare” of complexity. Thousands of administrative errors and unwarranted penalty notices.

Sounds like the IRS. But it’s another country with a high-rate, loophole-ridden income tax. The United States is not the only country that needs a flat tax.

Derek Jeter Battles the New York Tax Bureaucracy

The Wall Street Journal opines on the New York government’s attempt to extort more money from the Yankee shortstop. The most interesting revelation is that Jeter apparently followed the rules and avoided being in the state for more than 183 days, but the tax collectors want to apply a different rule simply because Jeter has expressed his “love for New York.” Who knew free speech could be so expensive?

New York’s tax bureaucracy…has made a refugee out of one of its most famous icons. …Who can blame him? Florida has no personal income tax, while New York’s rate for the top bracket is 6.8%, rising to [10.5]% in New York City… That makes for one of the worst tax burdens in America – and politicians are proud of it. …New York tax laws also take a notoriously wide view of “residency.” Literally tens of thousands of people only work in-state Tuesday to Thursday each week to avoid spending the requisite 184 days per year that would subject their full income to the state tax regime. And Albany’s taxmen try to catch them with things like travel records, credit-card usage and phone logs. …state auditors don’t dispute that his primary residence was in Florida before 2001 or after 2003, or even that he spent most of the year down south over the target period. Rather, they’re employing the more subjective “domicilery test.” They point to Mr. Jeter’s Manhattan apartment, his “numerous public statements professing his love for New York,” and allege he has “immersed himself in the New York community.” Gosh. Yankee owner George Steinbrenner is also a primary resident of Florida, no doubt for the same reasons as Mr. Jeter and who knows how many other professional athletes.

There are broader lessons to be learned from this episode. First, taxpayers respond to incentives, even if politicians like to pretend that high tax rates don’t impact behavior. Second, federalism is a good idea because it creates both good examples and bad examples. Third, maybe if New York wasn’t such a high-tax hell-hole, my beloved Yankees could concentrate on reclaiming their birthright by winning the World Series.

Baseball Star Tries to Avoid New York’s Oppressive Tax Burden

Derek Jeter of the New York Yankees has been a Florida resident since 1994, doubtlessly attracted to the Sunshine State because it has no personal income tax. But since he spends at least 81 days in New York City for Yankee home games, New York already has the right to tax at least half of his baseball salary. But this is not enough for the greedy politicians in Albany. They are trying to make Jeter a permanent New York resident so they can grab a much bigger share of his income. Depending on state rules, the ultimate decision may rest on how many days each year Jeter actually spends in New York. But the legal wrangling misses a bigger point. If New York didn’t treat wealthy people like fatted calves, the politicians would not have to worry about the geese that lay the golden eggs flying across the border. reports:

New York state tax officials want Jeter to fork over what could be hundreds of thousands — even millions of dollars— in back taxes and interest for the years 2001 to 2003, when the baseball shortstop claimed residency in Florida, despite his high-profile presence in New York’s sports and gossip pages during that time. … Jeter’s agent, Casey Close of Creative Artists Agency Sports, disputed tax officials’ claim that the baseball star lived in New York during the time in question. “As a Yankee, Derek has great affection for the people of New York and its amazing fans, but since the mid-1990s, he has made his home in Tampa, Florida,” Close said in an e-mail to … The ruling shows that Jeter has actually claimed Florida residency since 1994, though he first came up with the Yankees late in the 1995 season. State officials aren’t disputing those filings, even though Jeter became an increasingly prominent presence around town during that time period, often in the company of young starlets and other New York celebrities. But the team captain’s headline-grabbing purchase in 2001 of a $13 million apartment at the ultra-exclusive Trump World Towers on Manhattan’s East Side may have been too much for tax collectors to ignore.

The Flat Tax Club Should Get Another Member Tomorrow

It’s not quite time to play the theme song of the global flat tax revolution, but a Bulgarian news source indicates that the Parliament will approve a 10 percent flat tax tomorrow:

Bulgarian lawmakers from the ruling three-way coalition are expected to rubber stamp on Friday the introduction of the flat tax in the country starting from next year by amending the Taxation Act. In summer, the leaders of the coalition have agreed to scrap the existing progressive taxation system with three income brackets and introduce a flat income tax of 10% starting from 2008.

Depending on how the list is compiled, this will mean 22 flat tax jurisdictions, up from three just 15 years ago. The main country to adopt a flat tax this year (effective on January 1) is the Czech Republic. The top target next year is Poland. By 2050, France may join the club. By 2100, North Korea will be among the final dominoes to fall. Then maybe we can overcome the special-interest opposition in Congress.

Treating Successful Taxpayers Like Piñatas

New data from the Internal Revenue Service confirm that the so-called rich are paying a huge share of the tax burden. As Richard Rahn explains in the Washington Times, “The IRS just released the numbers for 2005, and they show the top 1 percent of taxpayers paid almost 40 percent of the nation’s total income tax bill, and that the top 5 percent paid 60 percent of the taxes.” This is normally considered an economic issue since people on the left argue that higher tax rates on the rich are a never-ending source of money for politicians, while people on the right explain that low tax rates encourage productive behavior and boost growth. But the disproportionate tax burden on successful taxpayers, combined with the fact that a huge share of the population does not pay any income tax, also is a moral or philosophical issue. As Walter Williams writes:

The fact that there are so many American earners who have little or no financial stake in our country poses a serious political problem. The Tax Foundation estimates that…”When all of the dependents of these income-producing households are counted, there are roughly 122 million Americans – 44 percent of the U.S. population – who are outside of the federal income tax system.” These people represent a natural constituency for big-spending politicians. In other words, if you have little or no financial stake in America, what do you care about the cost of massive federal spending programs?

Jonah Goldberg also is concerned about this development. In his column, he explicitly warns that the nation’s social capital will be eroded if a large share of the population learn that the tax system is nothing more than a way to confiscate other people’s money:

…our politics seem to be suffering from a “rich people curse.” We treat the rich like a constantly regenerating pinata, as if they will never change their behavior no matter how many times they get whacked by taxes. And we think everyone can live well off the treats that will fall to the ground forever. … Democrats keep telling the bottom 95 percent of taxpayers that
America’s problems would be solved if only the rich people would pay “their fair share” of income taxes. Not only is this patently untrue and a siren song toward a welfare state, it amounts to covetousness as fiscal policy. … it’s unhealthy for a democracy when the majority of citizens don’t see government as a service they’re reluctantly paying for but as an extortionist that cuts them in for a share of the loot.

These concerns may be somewhat overstated because there is still considerable income mobility in the United States, so many people who today are not paying tax presumably envision that they will be swept in the tax net in the future. But there probably is a tipping point, a level of taxation and redistribution that results in a permanent economic sclerosis. Indeed, some speculate that nations such as Italy are now incapable of reform because the electorate is dominated by people who have concluded that they have a right to live off the income of others.