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July 22, 2002, 8:45 a.m. Bringing Us All Down The Europeans want to sink global tax competition.

recently traveled to Panama to meet with their top government officials, bankers, and international lawyers as a member of a U.S. delegation that included public-policy analysts and congressional staffers. During that trip I learned that, while excessive government taxation and regulation of the financial markets may be burdensome to the U.S. economy, it can be downright deadly to an emerging economy like Panama's.

My experiences also reminded me why tax competition is so important to developing countries, as a large section of Panama's economy is reliant upon its ability to compete in the international financial markets.

Nobody needs to remind the Panamanians of this, however. Panama's appreciation for tax competition and financial privacy stem largely from the fact that international government bureaucracies like the Organization for Economic Cooperation and Development (OECD) and the European Union (EU) are attempting to punish Panama for its competitive markets by imposing onerous reporting requirements on its banking industry — all in an effort to make the small country less attractive to investors from Europe.

First some background. Thanks largely to their excessive tax regimes, many European countries are losing billions of dollars a year in capital flight as their citizens choose to invest in countries with preferable tax codes — countries like the Cayman Islands, Panama, and even the United States. The end result is that the massive welfare states that currently exist in Europe are withering on the vine, thanks in large part to the lost revenues from their own short-sighted tax policies.

Now, most reasonable people would study this situation and conclude that countries like France that aren't competing in the global market for capital should lower their rates so they will be competitive with so-called "tax havens" like the U.S. and Panama.

But European bureaucrats are very rarely confused with reasonable people; so instead they are attempting to allow French tax collectors to reach out and tax their citizens who invest in countries such as Panama — thus eliminating the tax haven's competitive advantage. In other words, instead of improving their tax regimes to compete with Panama's, they're simply attempting to take Panama down with them. This is why international tax competition is so important for developing countries — without it many won't develop.

As the late, great economist Peter Bauer made clear during his lifetime of scholarship, the key to economic success for developing countries is not centralized planning dictated by foreign bureaucracies (combined with an endless steam of foreign aid), as is often thought. Instead, the keys are open markets, foreign trade, and free enterprise. It is the free market that makes developing countries richer, not the paternalistic patronization of international organizations with their regulations and handouts.

That is why it is imperative that the U.S. — as the most powerful potential defender of free markets and tax competition in the world — stand up to the OECD and EU, by rejecting tax "harmonization" and promoting tax competition throughout the globe.

There is significant evidence that tax competition benefits not only taxpayers and businesses, but governments as productive economies produce more tax revenues. In fact, several examples exist here in America.

In 1991, Michigan was in dire straits. Its economy was in free-fall and deficits were predicted for the foreseeable future. But Michigan Gov. John Engler, a free-market proponent, was convinced that tax competition was the answer. The governor proceeded to cut taxes 30 times during the 1990s — providing a vastly improved economic environment for businesses and people alike.

The results were overwhelming. Between 1990 and 1996, unemployment fell from 11% to 4.5%. The state budget went from $2 billion in the red in 1990 to a $1.1 billion surplus in 1996 — the third largest in the country.

The correlation between a competitive tax regime and economic success continued in other states throughout the 1990s. For example, the ten states that significantly cut taxes during the '90s grew their economies nearly 25% faster than tax-raising states. Further, income for a family of four grew by $1,600 more in tax-cutting states than in tax-raising states.

The same held true for global tax competition in the 1980s. Following the Reagan/Thatcher tax cuts of the early '80s, many other nations of the industrialized world felt they had no choice but to cut their tax rates as well in order to remain competitive (this was apparently before they got the idea of bullying everyone else into raising their rates instead). The end result was the worldwide economic boom of the 1980s.

Yet there continue to be those who eschew competition. While a rising tide may lift all boats, the boats that are taking on water like France and its EU buddies won't benefit nearly as much as buoyant ships like Panama, the Caymans, and even the old U.S.S. America.

Europe realizes this and that's why they're trying to sink global economic tax competition. That's unfair to the taxpayers of the world, emerging economies like Panama's, and the global economy overall. America's leaders should do whatever is necessary to stop this dangerous trend.

— Eric V. Schlecht is director of congressional relations for the National Taxpayers Union.