John Blundell is this week's European Observer

The Global Tax Cartel Cometh - Wall Street Journal Europe

Europe's remorseless quest for tax harmonization shows no sign of abating. The EU already has an agreed minimum VAT rate of 15% and the European Commission is currently seeking to harmonize taxes on corporate income, tobacco, energy and digital products. It has also won a WTO ruling to end tax breaks for U.S. companies competing in foreign markets.

Its latest tax-harmonization initiative - the Savings Tax Directive - seeks to obtain wide international agreement on the need for collecting and swapping confidential financial data on nonresidents. This would enable high-tax nations such as France and Germany to tax outside their borders and would go a long way toward creating a global tax cartel - or what one U.S. commentator has described as "a kind of OPEC for politicians."

The EU, of course, lacks direct means to influence tax rates outside its borders. But the Savings Tax Directive will give participating states the means to impose home-country taxes on citizens regardless of where they save or invest.

In order to make everyone comply with the terms of the directive, big EU states such Britain have subjected small tax jurisdictions such as the channel islands of Guernsey and Jersey to a shameful campaign of hectoring. (Britain is far from being enthusiastic about the scheme but wishes to appear "a good European." ) After holding out over many months the two British dependencies have effectively given in. Much more crucial to the success of the scheme is the participation of Switzerland and the U.S. For that reason Switzerland has been coming under mounting pressure to participate.

Talks between the commission and the U.S. government have been proceeding over many months. Recently Frits Bolkestein, the internal market commissioner, announced the U.S. and the EU were at one on the matter. His talks with Kenneth Dam, the deputy U.S. secretary for the Treasury, he said, had showed that Europe and America had set themselves the same goal -- "to fight tax evasion."

The reality is that America, like Switzerland, is stalling on the issue. Some within the Internal Revenue Service bureaucracy want to maximize tax revenues and seem content to allow the OECD to settle the issue. Should the U.S. acquiesce in EU plans, the pressure on the Swiss would become more severe and perhaps impossible to resist in the long term.

The irony is that it is not just "tax havens," -- the pejorative term normally applied to small, low-tax countries -- that could be hugely damaged by progress in the drive to eliminate tax competition. The U.S. tax burden is dramatically lower than that of the EU, representing 29% of GDP, compared to the EU's 42% average. Partly as a consequence, the record for annual foreign investment into America -- a key determinant of recent U.S. prosperity -- has been broken on an almost monotonous basis. Total foreign investment in the U.S. now amounts to a staggering $9 trillion. It is one reason per capita income is 50% higher than the EU average. Veronique de Rugy, a policy analyst at the Washington-based Cato Institute, has estimated that U.S. participation in this EU initiative would drive $1 trillion from the American economy.

Britain would also lose out. Although it's under constant pressure to raise taxes in line with those of its major EU partners, the U.K. tax burden represents about 37% of GDP, compared to over 45% for France. Along with its relatively light burden of regulation, this helps explain why the U.K. enjoys the lion's share of foreign investment into the European Union (and why its recent record on growth and jobs is superior to most of its EU partners). Ireland, which has enjoyed the most rapid economic growth of any EU nation in recent times following the introduction of a radical tax-cutting agenda, and a consequent dramatic inflow of capital, would face severe economic consequences.

Even leaving aside the important issues of privacy and national sovereignty raised by the Savings Tax Directive, it is time for America to offer more principled objections. It should assert, loudly and clearly, that tax competition is healthy, while tax harmonization is bad for the economic health of almost everyone.

Tax harmonization drives taxes up; tax competition drives them down. The Thatcher-Reagan tax reforms were imitated across the world. This was not because politicians wished to reduce the mounting tax burden on their citizens and companies, but because the stimulus of competition obliged them to follow suit, often reluctantly -- or risk an outflow of capital and the export of jobs.

These days even center-left governments are prepared to pay lip service to the role of competition as a means of ensuring the most efficient use of resources -- but, like many others, politicians dislike competition in their own lives. Unlike the rest of us, however, they are well placed to prevent it through measures that they claim to be in the public interest.

But as tax specialist Barry Bracewell-Milnes recently pointed out, tax cartels tend to be far more harmful than commercial cartels. This is because elections at which it may be possible to express a view about taxes occur only infrequently whereas there are many commercial decisions every day; because government activity involves coercion; and because reducing taxes even at the national level is far harder than competing by price in the marketplace.

Moreover, there is a simple response to the argument advanced by Commissioner Bolkestein that the Savings Tax Directive is necessary to stop tax evasion. The best remedy for tax evasion -- indeed the only proven way of discouraging it -- is to reduce taxes and simplify the tax system. Instead, those European governments behind the directive are seeking to solve problems of their own creation by expecting more efficient low-tax competitors to act as vassal tax collectors.

Economic history teaches that, although they can do great damage, cartels of whatever kind do not last long. This one cannot even come into existence without the active participation of the U.S. It is difficult to think of a single good economic reason the U.S. should participate. But there is every reason for believing that opposition to this harmful and deeply illiberal measure should not be left to small nations with a fraction of U.S. economic and political muscle. This is no time to be mealy mouthed: the Bush administration should stress that in opposing the measure it is doing millions of over-taxed Europeans a big favor as well enhancing its own interest and that of a liberal global order

John Blundell is the general director of the Institute of Economic Affairs in London.