Globalization is widely seen as contributing to clear increases in economic growth. Yet many governments view this development as a poisoned chalice. Politicians and bureaucrats fear that eliminating exchange controls and removing barriers to capital flows will lead to extensive revenue losses from tax avoidance and evasion.

One response to these fears has been the establishment of an agency within the Organization of Economic Cooperation and Development to provide guidelines for combating international tax avoidance and evasion. The main thrust of the agency’s efforts is to enhance cooperation between governments to share fiscal information in order to boost compliance on cross-border income flows.

Meanwhile, finance ministers from the European Union are threatening to impose penalties on countries that facilitate money laundering and tax evasion. They would place restrictions on financial transactions to stop companies and individuals from those countries opening bank accounts in the EU. For instance, the EU may pass a law to invoke a reporting system to support withholding taxes on cross-border interest income.

It seems of no concern to OECD or EU officials that attempts by governments to expand their powers to collect information on taxpayers could severely curtail individual rights. Similarly, the quest to make collection systems more efficient is undertaken without regard to the fairness of those systems.

The OECD/EU approach misses the point behind much evasion and avoidance behavior. It is misleading to demonize all of it as the work of criminals.

Stopping money laundering by drug barons may be a legitimate step for governments to take. However, many citizens with legally earned income may try to evade tax authorities for understandable reasons. For example, otherwise law-abiding citizens may seek shelters against arbitrary or uneven enforcement of public levies. A similar reaction can be expected when there are imbalances between tax rates and quality of public services or if there are perceptions of misuse of public funds by government officials.

In sum, evasion can be a rational reaction to poor governance and public-policy failures. Fraud perpetrated by public officials is more egregious than attempts by citizens to adjust their tax burden in response to unfair or inappropriate takings by their government. Surely Dante would place corrupt politicians in a lower circle of Hell than hard-working citizens who engage in tax evasion.

And then there is avoidance in response to tax competition allowing corporations and individuals to establish tax homes in order to minimize their tax liabilities. This sort of competition is healthy and encourages government efficiency. It is not surprising that many governments, especially those with high taxes and low-quality public services, prefer not to be held accountable for their fiscal misdeeds.

As such, tax competition undermines the power of politicians and weakens the ability of special-interest groups to direct public policy in their favor. The tradeoff is that parasites lose while the wider community benefits.

If the OECD program or EU proposals were to succeed, they would weaken an important alternative to citizens’ electoral franchise. As it is, the defects of representative democracy may dilute the value of voting. This is because special-interest groups are able to shape public policy in ways that work against the interests of most other citizens. Similarly, populist platforms can pervert electoral outcomes and cause economic distortions.

Another option open to dissatisfied citizens is “voting with their feet.” Internal migration can inspire tax competition among municipal or regional governments within a country to avoid potential losses in their tax bases. In small countries, this option may be limited to emigration. But international migration may be restricted to the wealthy or educated.

Thus, it is left to capital flight to serve as a safety valve open to all citizens who feel their vote goes unheeded but do not wish to give up their citizenship. Taking away this “voice” undermines the fundamental democratic principle of self-determination.

As it is, high tax rates are actually self-defeating, creating avoidable distortions that only increase economic activity in the informal sector, far removed from the beady eyes of tax collectors. A study by Swedish economist Kurt Wickman proposes that every country has an “optimal” tax rate. This will differ from country to country as citizens develop their own tolerance for taxes on the basis of local culture or history.

It works like this. If taxpayers consider official rates too high, they will find ways to adjust their reported income and spending to bring their effective tax rate into line with the optimal rate. This will favor professionals and private entrepreneurs who can arrange their own invoicing.

The end results of excessive taxes are discriminatory and destructive. Those on fixed salaries will be disadvantaged, since they will find it difficult to arrange side payments. And a substantial amount of economic activity will be choked off.

In the end, money laundering and tax evasion cause fewer problems than do confiscatory taxes, corruption and excessive public-sector debt. Instead of blacklisting offshore tax havens, the OECD and other organizations might more fruitfully spend time identifying and promoting policy changes to correct misbehavior by member governments. Improving governance would ease the consciences of productive citizens who would then be more willing to shoulder a reasonable tax burden.

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