Topic: Tax and Budget Policy

More Fallout from Switzerland’s Tax Fight with Brussels

This site has closely followed the European Commission’s attempt to undermine Swiss tax sovereignty - an effort that has implications for the US since high-tax nations like France and Germany could use the same argument (that low taxes somehow are contrary to free trade) against America at the WTO if the anti-Swiss campaign proves successful. Fortunately, that is not likely to happen. The European Commission ultimately has only one weapon, which is the ability to impose protectionist sanctions against Swiss goods and services. But as Euractiv.com notes, there are EU member states that support tax competition and presumably would not approve an effort to punish Switzerland for the supposed sin of good tax law:

The Commission, on 13 February, accused Switzerland of offering unfair company-tax advantages that it says amounts to illegal state aid, in order to lure multinationals away from the EU. …Member states are likely to give strong backing to the Commission, as frustration has grown with the increasing number of multinationals, including General Motors, Kraft Foods and Procter & Gamble, deserting their EU headquarters to set up in Switzerland. Tax competition is also a problem within the EU, with countries like Ireland and Luxembourg luring companies away from high-tax France and Germany thanks to their low business tax rates. But, a Commission move to harmonise tax systems across the EU is being fiercely resisted by low-tax member states.

Needless to say, the Swiss-EC fight has nothing to do with trade and everything to do with tax competition. Politicians from high-tax nations despise fiscal rivalry since it forces them to lower tax rates (or at least not to raise rates even further) in an effort to prevent the loss of jobs and capital. Switzerland is a beneficiary of this liberalizing process, both because its overall tax burden is low compared to the rest of Europe, but also because the nation has a genuine federal system, meaning that regional (cantonal) and local governments must compete to offer the most attractive fiscal policies. A recent paper published by the Center for Freedom and Prosperity explains the role of intra-national tax competition, and a report from Euro2day.gr shows that Swiss leaders understand the valuable role of their federal structure:

Zug has been particularly exposed. “We don’t understand why the Commission has made these accusations now,” says Peter Hegglin, the cantonal finance minister. …Like most Swiss, Mr Hegglin emphasises the role of tax competition as a cornerstone of Switzerland’s extreme form of devolution, where individual cantons and communities set their own levies, and as an instrument to ensure lean, efficient government. “Tax competition is something that is so deeply ingrained in Switzerland internally that the government has little leeway to negotiate anything,” says Walter Kielholz, chairman of Credit Suisse. …Zug is now the hub for companies from global commodities traders, such as Glencore, to the regional headquarters of leading pharmaceuticals groups. Nord Stream, the Russian dominated consortium planning a new gas pipeline under the Baltic, is the latest of many arrivals. Zug’s appeal lies in its proximity to Zurich, its lawyers, accountants and consultants – and its modest taxes. All companies must pay Switzerland’s nationwide 8.5 per cent federal profits tax. Some others also face cantonal and municipal levies, taking the total to 16-16.5 per cent.

Last but not least, a letter-to-the-editor of the Financial Times mockingly asks whether the bureaucrats in Brussels will extend their complaint about Switzerland’s tax laws to other policies:

The Swiss know many more ways of unfair competition to lure successful businesses to settle there. Take my own typical recent travel experience: Queueing for check-in and security control at Kastrup airport, Copenhagen: 2hr 15min. Queueing at Birmingham international airport: 1hr 45min. I always avoid using Heathrow and BA because it is even worse. No queueing at Geneva airport, check-in and security control completed in less than 20 minutes. …In the UK or Sweden the whole rail system breaks down if 5cm of snow falls. The Swiss trains run 90 per cent on time, even if it is snowing! Another example of unfair efficiency. The political system with its direct democracy is less corrupt in Switzerland than in the UK, Germany and Sweden. Is this not an outrageous example of unfair competition? Because of low taxes the Swiss public services must be well organised and more efficient than in Scandinavia and the UK. The efficiency of public services together with reasonable taxes is Switzerland’s most important advantage.

Senators Introduce Bill Attacking Low-Tax Jurisdictions

Politicians from France and Germany are infamous for whining about “unfair” competition from low-tax jurisdictions. It is embarrassing to note that there are politicians in the United States with the same sore-loser attitude. With Senator Levin of Michigan as the ringleader, three senators have introduced an anti-tax haven bill that would impose onerous new burdens on taxpayers while dramatically increasing the power of the Internal Revenue Service. The sponsors make a number of completely inaccurate assertions, including a claim that so-called tax havens account for $100 billion of lost tax revenue. Even a cursory review of IRS data, however, show that the vast majority of the “tax gap” is from small business taxpayers. But Levin’s attitude apparently is that facts should not get in the way of good press release. The legislation has numerous other problems, most notably the fact that is almost certainly would put the US in violation of World Trade Organization obligations and that it would make foreign-managed hedge funds more competitive by imposing onerous regulatory burdens on US funds (much as Sarbanes-Oxley helped Hong Kong and London become much more attractive places for venture capital business such as IPOs). The Washington Post reports on the bill’s introduction: 

Three senators proposed legislation that would target what they say is $100 billion a year in tax revenue lost each year because of overseas tax havens, in part by forcing hedge funds to track their foreign investors. The measure would impose tougher requirements on U.S. taxpayers using offshore secrecy jurisdictions, give the U.S. Treasury the authority to take action against foreign jurisdictions that impede tax enforcement, stiffen penalties against abusers and close offshore trust loopholes, according to a summary of the bill released by Michigan Democrat Carl M. Levin. …”We cannot tolerate tax cheats offloading their unpaid taxes onto the backs of honest taxpayers,” Levin said in a joint statement with co-sponsors Norm Coleman (R-Minn.) and Barack Obama (D-Ill.). “Offshore tax havens have declared economic war on honest taxpayers by helping tax cheats hide income and assets that should be taxed in the same way as other Americans.” The Treasury Department and top lawmakers in both houses of Congress have made a priority this year reducing the so-called tax gap, the difference between what individuals and companies owe and what they pay. The IRS said a study of 2001 tax returns shows the tax gap is about $345 billion a year, only $55 billion of which is recovered.

Washington’s Dishonest Budget Math

During fiscal debates in DC, politicians, the press, and interest groups all complain about supposed budget cuts. Yet every year, the budget gets bigger and more expensive. This seeming contradiction is due to the fact that Washington uses a strange form of math called “current services” budgeting. Under this system, a “cut” occurs anytime a budget doesn’t increase as fast as previously projected. This means that programs sometimes grow at more than twice the rate of inflation, but advocates of more spending get to complain that they are being subjected to “cruel” and “savage” reductions. While everyone inside the beltway understands how this game is played, ordinary Americans are completely deceived. They think that spending cuts are actually cuts - i.e., spending will be lower next year than it is this year. Defenders of the current system argue that “current services” budget is justified because it enables policy makers to know how much spending is “requried” because of inflation, demographic change, and previously-legislated program expansions. There is nothing wrong with having that information, of course, but that doesn’t justify dishonest presentation of budget numbers. If a politician or interest group wants to argue that a program should get a six percent increase because of various factors, that is a legitimate debate. But when a politician says that a program is getting a two percent cut because spending is climbing by four percent instead of six percent, that is deceptive. An article in the American Enterprise Institute’s magazine explores Washington’s dishonest budget math:
President Bush is not “cutting” Medicare spending—all the media hype notwithstanding… the President has not been suddenly seized by fiscal conservatism fever and did not, in fact, propose any spending cuts. Under the President’s proposal, federal spending on Medicare and Medicaid is set to increase by $84 billion from 2006 to 2008. That spending increase is certainly not a cut—even when including inflation, it represents a generous increase in entitlement spending. Newsweek confused cutting the rate of spending growth with cutting spending itself. The President’s proposals reveal an interesting picture: instead of growing at a 6.5% rate, the President would have Medicare grow at a 5.6% rate. Medicaid was set to grow at 7.3%; the President has proposed a 7.1% rate of growth. …It’s useful to place this spending restraint in perspective: entitlements face a looming $43 trillion shortage over the next 60 years, and unless entitlement spending is curbed, those programs are headed straight for bankruptcy. What’s fascinating is that if the President’s modest Medicare plans were realized, $8 trillion dollars would already be shaved off of Medicare’s future liability. It’s a hopeful reminder that moderate fiscal restraint can, over time, accomplish a great deal of good.

Some Good News on the Budget

Thanks in large part to the heroic efforts of Senators Jim DeMint and Tom Coburn, the corrupting culture of budget earmarks has hit a big bump in the road. Even more important, government spending is no longer climbing quite as fast. To be sure, it is hardly a victory to hold the growth of annual appropriations to the rate of inflation. After all, many of the programs being appropriated should be completely abolished. Moreover, annual appropriations does not include entitlement programs, many of which are growing at twice the rate of inflation. But in a town enriches itself by transferring income and wealth from the productive to the special interests, even a slowdown in the rate of spending growth is welcome news. The Wall Street Journal explains:

On Thursday, White House budget director Rob Portman issued little-noticed guidance to all federal departments and agencies that no Congressional requests for spending should be accommodated unless they are “specifically identified in statutory text” – which is to say, the law. This may sound like it ought to be regular practice, but it’s a revolution in the Beltway. That’s because, in order to dodge the legislative earmark limits that Mr. Byrd has been bragging about, Members have been speed-dialing executive branch officials and asking them to fund their specific earmark requests out of agency budgets even though they were purged from the larger budget bill. This Congressional lobbying can be hard for the average federal bureaucrat to refuse, since he doesn’t want to offend those on Capitol Hill who control his budget. …this means the Fiscal 2007 federal budget could have the fewest number of these pork-barrel projects in many a year. By the way, thanks to efforts late last year by GOP Senators Jim DeMint of South Carolina and Tom Coburn of Oklahoma to block a last-minute bipartisan spending splurge, the 2007 budget holds overall federal appropriated spending to the rate of inflation; recent years have often seen three times that.

Singapore Cuts Corporate Tax

If the average state levy is included, the U.S. corporate tax rate is about 40 percent, which is higher than the coporate rate in every European welfare state. American companies also must endure heavy regulatory burdens — especially in the aftermath of Sarbanes-Oxley.

Politicians fret that America is losing manufacturing jobs and they complain when American companies build plants overseas. Contrast the short-sighted behavior of U.S. lawmakers with those in Singapore. As noted by tax-news.com, the government of Singapore has just announced that the corporate tax rate is being reduced to 18 percent to boost international competition. The government also is boosting the value-added tax, so Singapore is not a perfect role model, but at least lawmakers understand the negative impact of high corporate tax rates:

In his Budget Statement for the Financial Year (FY) 2007, Second Minister for Finance, Tharman Shanmugaratnam announced a two percentage point reduction in the corporate income tax rate to 18% to sharpen Singapore’s competitive edge. However, the corporate tax cut will be balanced against a number of revenue raising provisions, such as…an increase in the GST rate from 5% to 7%.

OECD Says Sweden Should Consider Abolishing the State Income Tax

In a report on the Swedish economy, the Organization for Economic Cooperation and Development revealed more of its schizophrenic nature (see this article for more information on the OECD’s Jekyll and Hyde personality). While the Paris-based bureaucracy has become infamous for its so-called harmful tax competition project that seeks to penalize jurisdictions with pro-growth tax law, the economists at the OECD often write studies and reports that reflect a solid understanding of the negative impact of government intervention. The Policy Brief on the Swedish economy is a good example. As excerpted below, it notes the problems of high tax rates and excessively generous welfare benefits. It calls for the elimination of the wealth tax and reductions in punitive marginal tax rates. It even suggests that Sweden abolish the state income tax:

…the new government has renewed the commitment for sound macroeconomic framework conditions and will stick to the target for general government net lending of 2% of GDP over the cycle which is necessary to keep public finances on a sustainable path. Underlying this target is the assumption that taxes can be sustained at current levels which could be difficult in the future, not least due to mobile tax bases and international tax competition. …the share of 20 64 year olds who depend on public income transfers has declined to 20% in 2006, but it remains well above the 15-16% of 1990-91. …Sickness absence among those employed and the number entering disability pension increased rapidly from the late 1990s. The numbers are now falling, although the stock of disability pensioners remains among the highest in the OECD. …Letting people keep a bit more of the value they create is vital to encourage both labour supply and entrepreneurship. The plans to abolish the wealth tax should therefore be endorsed, as it sets in at a rate of 1½ per cent already from wealth slightly above the average price of a metropolitan-area one-family house. Abolition of the wealth tax might lead to repatriation of capital, possibly making more investment capital available for new small firms. Marginal income taxes are also important, though, because high rates kick in already from slightly above average full-time earnings. The combination of social contributions, income and consumption taxes drives the effective marginal tax rate above 70% for over a third of the full-time employed, helping to explain why working hours for those employed are below the OECD average. …Moving up the threshold by SEK 100 000 from 105% to 135% of average full-time earnings, for example, would halve the number of persons exposed to the above-70% combined marginal tax rate, which results when the state income tax sets in on top of social contributions, municipal income tax and consumption taxes. …In fact, completely abolishing the state income tax would cost just 1½ per cent of GDP.

French “Conservative” Candidate Calls for Hedge Fund Tax

While most nations are trying to liberalize their economies, both major candidates in France are competing to promise higher taxes and more spending. Sarkozy is supposed to be the market-oriented candidate, but he has endorsed higher taxes on financial services - and is suggesting sympathy for a higher VAT, according to MSNBC:

Nicolas Sarkozy will push for a European tax on “speculative movements” by financial groups, such as hedge funds, if he wins this year’s French presidential elections. …his plan to tax financial flows is likely to dismay US and UK financial groups, as well as parts of the French business community, which largely prefers him to Ms Royal. …His comments echo the traditional Gaullist suspicion of capitalism and financial investors, for which Mr Chirac has become well known. Mr Sarkozy’s attack on speculative finance mirrors the views of some business leaders. Claude Bébéar, chairman of insurer Axa, France’s biggest institutional investor, yesterday pilloried the “dictatorship of the market” and the “short-term interests” of hedge funds. …[Sarkozy’s] record as finance minister was notably dirigiste. He intervened to save Alstom, the engineering group, from bankruptcy and brokered an all-French merger of Aventis and Sanofi to avert a takeover by Switzerland’s Novartis. …Mr Sarkozy admitted he was watching Germany’s three percentage point increase in VAT with interest.

The story also notes that Sarkozy also was an interventionist finance minister. The net result is that France almost surely will continue to stagnate, regardless of who replaces Jacques Chirac.