March 2, 2009 12:14PM

Switzerland Should Stiff‐​Arm the IRS

In a classic display of arrogant imperialism, the Internal Revenue Service is running roughshod over existing treaties and demanding that a Swiss bank disgorge confidential client data to American tax collectors. As a former U.S. ambassador to Switzerland warns in the Financial Times, this is a remarkably ill‐​considered approach to bilateral relations:

When Eveline Widmer‐​Schlumpf, the Swiss federal councillor in charge of police and justice, meets Eric Holder, US attorney‐​general, the final item for discussion – according to her ministry’s press release – will be US demands for data on American holders of accounts at UBS, the Swiss bank. …intense anger has…been directed at the US government, which – via the justice department and the Internal Revenue Service – rode roughshod over two bilateral agreements to which it is a signatory. That is, the US ignored formal, negotiated understandings with a long‐​time friend, a constitutional federal republic where rule of law is enshrined… The Swiss Confederation’s first experience with the new administration is of a superpower exerting raw Goliath power, ignoring its own diplomatic undertakings and taking advantage of Switzerland’s size and the stereotypical misunderstanding of Swiss bank secrecy laws. US authorities are seen in this instance as being once again arrogant and bullying. …UBS and Swiss officials were stunned when the IRS, within days, filed a civil complaint that included a demand for information on 52,000 American UBS customers. A Swiss financial oversight court has ordered UBS not to fulfil this demand. Thus the bank is in the awkward position that its officers would have to violate Swiss banking law to fulfil the US demand.

The more fundamental issue, of course, is how to solve the conflict between America’s bad tax system (with its pervasive double taxation of saving and investment, and its taxation of “worldwide” income) and Switzerland’s admirable human rights policy of protecting financial privacy. The obvious answer is that the U.S. should fix its bad tax system. For instance, the conflict between the U.S. and Switzerland would disappear if the Internal Revenue Code was replaced with a simple and fair flat tax (which taxes income only once and taxes only income earned inside U.S. borders).

If the IRS prevails in this battle, it will be terrible news for people in all nations. As I explain here, here, and here, the ability to escape bad tax policy is a critical restraint on the power of politicians to fleece taxpayers.