Commentary

Like It or Not, More Tax Cuts Are Coming

According to Howard Dean, “putting the U.S. fiscal house in order must be [based on] the repeal of the Bush tax cuts, and returning the tax code to rates that were in effect during the prosperous years of the Clinton-Gore administration.” However, international tax competition is spreading. High-tax jurisdictions, including the United States, may find it difficult to preserve their tax base in the future, because businesses will find investing overseas more profitable.

Despite America’s size and economic prowess, the United States is not immune from the basic laws of economics. All else being equal, capital flows into countries where the returns on investments are highest. As long as the United States remains a profitable place for investment, dollars earned by foreigners through international trade will be reinvested in the American economy.

American workers, it is true, are among the most productive in the world. But productivity is not enough to attract international investors. The fall in the value of the dollar suggests that instead of reinvesting the American currency in the United States, international investors are selling it. That’s happening because many other countries and regions in the world are becoming more attractive to international investors. These countries cannot offer as productive a labor force as the United States, so they are trying to compensate for their shortcomings by cutting taxes.

Tax competition is the most obvious way for a country to gain a competitive edge over another country. Other factors that encourage foreign investment, such as productivity increases and legal reforms, take a long time to come about. A tax cut, on the other hand, can be implemented relatively quickly. The recent spate of tax cutting in Europe serves as an excellent example of this growing global trend.

Ireland set the tax-cutting trend in Europe by reducing its basic tax rate from 35 percent in 1989 to 22 percent in 2001. The Irish also cut their corporate tax rate from 40 percent in 1996 to 24 percent in 2000. Estonia became the first European country to adopt a flat tax of 26 percent in 1994. Latvia followed suit in 1995 with a flat tax of 25 percent. Russia set up a flat tax of 13 percent in 2001 and Ukraine adopted the same flat tax rate in 2003. Also in 2003 the governing Socialists cut the corporate tax rate in the Czech Republic from 31 percent to 24 percent. On January 1, 2004, Slovakia launched its own 19 percent flat tax. Despite heavy opposition from the Left, Chancellor Gerhard Schroeder succeeded in cutting taxes in Germany. Even President Chirac and Prime Minister Raffarin are talking about cutting taxes in France.

The United States is unlikely to buck that trend and neither should it try. Low taxes allow for investment and innovation, which lead to greater productivity and prosperity. Moreover, low taxes help expand human freedom. As Edmund Burke observed more than two centuries ago, questions of human freedom and taxation are often interconnected. “Liberty,” he wrote, “inheres in some sensible object; and every nation has… some favorite point, which by way of eminence becomes the criterion of their happiness. It happened… that the great contests for freedom in this country [United Kingdom] were from earliest times chiefly upon the question of taxing.”

In the United Kingdom, the King lost his head because of his rapacious appetite for other people’s hard-earned money. And, lest we forget, the American Revolution against the British started out as a tax rebellion. The question of low taxes, then, was at the birth of the American Republic and American freedom. Howard Dean, however, claims that low taxes are bad for America. If so, when did things change?

Marian L. Tupy is assistant director of the Project on Global Economic Liberty at the Cato Institute.