- The Washington Times - Friday, March 31, 2000

Communism has collapsed, the social welfare states in Western Europe are moribund, and the planned economies of Asia have suffered a meltdown. The United States and other free market nations, by contrast, are enjoying strong growth. The lesson, needless to say, is that capitalism is the best way to promote prosperity.

This creates a good-news-bad-news situation. The bad news is that politicians do not like capitalism because it means less power for government. As such, they fight against reform and use the most absurd demagoguery to thwart tax cuts and preserve outmoded and counterproductive programs.

The good news, however, is that the politicians are fighting a losing battle. Technology and global competition are combining to penalize nations that overtax and overregulate their citizens. At least, that is the obvious lesson from two recent studies published by the International Monetary Fund (IMF).

According to Friedrich Schneider and Dominik Enste, authors of "Shadow economies around the world: Size, causes and consequences," ill-advised government policies are forcing more and more people around the world to hide their economic activity from government. More specifically, the authors write that "the increase of the tax and Social Security contribution burdens is one of the main causes for the increase of the shadow economy."

Vito Tanzi, meanwhile, points out that politicians may have no choice but to reduce the burden of government. His article, "Globalization and the future of social protection," discusses how it is becoming increasingly possible for people to protect their assets and income from government. This means, Mr. Tanzi notes, that "it becomes more difficult and more costly for a country to maintain high taxes and more regulations."

Consider the implications of the information in these two articles. The Schneider-Enste article reports a huge amount of economic activity already has gone underground, often accounting for an astounding share of gross domestic product (27 percent in Italy, 20 percent in Sweden, and 15 percent in Germany). Mr. Tanzi demonstrates that globalization gives people another escape hatch since they can move their assets to other countries. Indeed, Mr. Tanzi actually warns "the welfare states to begin preparing themselves for what could prove to be significant falls in tax levels in future years."

While the combination of domestic and international tax evasion is bad news for politicians, it is good news for taxpayers. If all else fails, it means people will have a way to protect their money if governments persist in being oppressive. More importantly, however, it means politicians probably will be forced to lower tax rates and reduce the burden of government. Not because they want to, but because it is the only way to keep the goose that lays the golden eggs from flying the coop.

To some degree, these changes already are happening. When President Reagan lowered tax rates in the 1980s, almost every other country in the world followed his example. This was not because politicians in other countries suddenly grasped the logic of supply-side economics. Instead, they lowered tax rates because their citizens began to invest in the United States and they had to cut taxes to remain competitive.

Likewise, global competition is helping to spur the worldwide trend in Social Security privatization. Nations realize private retirement systems increase national savings, increase labor supply, and reduce long-term budgetary pressures. Yes, some lawmakers also want to privatize because it means a safer and more comfortable retirement for workers, but economic competition is a driving force.

To be sure, there is no guarantee lawmakers will learn the right lessons and do the right thing. Some politicians are resisting. Indeed, the Organization for Economic Cooperation and Development has published papers on the need to stamp out "harmful tax competition." Translated into English, this means they want all governments to agree to keep taxes high so that people have no choice but to pay sort of like an OPEC for politicians.

Of course, this dangerous idea can only work if all escape hatches are bolted shut. That is why the same folks are trying to demonize tax havens like Bermuda, the Cayman Islands, and the Netherlands Antilles. Mr. Tanzi reports there may already be $5 trillion of wealth hidden offshore, and politicians realize that any international agreement to keep taxes high will founder as long as these outposts of freedom remain.

America is the 800-pound gorilla in the world economy. If we do the right thing privatize Social Security, replace the Internal Revenue Service with a flat tax, other countries will face immense pressure to do the same thing. By any definition, that is a win-win situation.



Daniel J. Mitchell is the McKenna senior fellow in political economy at the Heritage Foundation.

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