Anti-Tax Competition Schemes by High-Tax Nations Will Expand the Underground Economy

Regular readers know that I am a big supporter of international tax competition as a mechanism to limit the greed of the political elite. Unfortunately, the statists are having some success in their efforts to undermine the fiscal sovereignty of low-tax jurisdictions. Even the Swiss have been forced to weaken their human rights policy of protecting financial privacy. So does this mean the politicians from high-tax nations will get more money to spend? Probably not. One reason is that "better" enforcement of high tax rates on saving and investment will have the same economic impact as an increase in tax rates. This, of course, will mean less saving and investment, which translates into slower growth and a smaller tax base. Another reason is that restrictions on the ability to shift economic activity across border to escape oppressive taxation will lead many people to find domestic strategies as a substitute means of protecting their income and assets. An article by a Romanian academic explains further and notes that low-tax jurisdictions will continue to enjoy better economic performance.

It is of course illegal not to declare assets and income held abroad, but the fact that some people are driven to this extreme suggests that in some countries taxes have reached unacceptably high levels. In exactly the same fashion, people are also driven to hide some of their economic activity from the tax man, giving rise to the well known phenomenon of the underground economy. In fact, tax evasion is as old as taxes themselves, and the best way to minimize it is to levy reasonable taxes. International tax evasion and the local underground economy provide the two main escape routes. In modern democratic times, they also set implicit limits to the growth of government. They are both illegal, but the local shadow economy is now so widespread that governments know that they cannot enforce compliance without becoming hugely unpopular (suggesting that high taxes are, in fact, not as widely accepted by the population as some would like to think). Limiting international tax competition looks a much easier bet. However, if high-tax countries are successful in stopping the shift of savings to tax havens by enforcing transparency and information exchange, they will displace, but not halt, tax evasion and fiscal competition. The underground economy, both local and international, will grow. In the meantime, wealthy people and their assets will continue to move from high to low tax environments. Over time, the economically more attractive places will still enjoy much higher rates of economic growth.