The taxing of nations.

• Author: Rahn, Richard W.

FOR THE last decade, the high-tax countries of the European continent have been engaged in an aggressive and largely unknown war against low tax-rate countries around the world. This is not just a war of rhetoric, but one in which Continental governments are trying to destroy the economic livelihood and prospects of many smaller and poorer countries. The war has the goal of stemming the flow of savings and investment to low-tax entities from the high-tax countries.

These governments are using two basic strategies. The first is to try to force low-tax countries to raise their tax rates, particularly on capital--that is, taxes on individual and corporate income, including taxes on interest, dividends and capital gains. They argue that low-tax countries are economic free-riders, enjoying the protections of the welfare state paid for by higher-tax countries while avoiding taxing their own citizens at high rates. The second strategy is to make it difficult for savers and investors to move their capital freely around the world to its best use. To do so, high-tax countries are attempting to force their capital-friendly neighbors to report what funds they receive from citizens and companies of high-tax countries so they can be "properly" taxed--in their home countries.

Economists have long known that taxing capital is economically destructive. Nobel Prize-winning economist Robert Lucas, after carefully reviewing relevant economic studies, concluded in 2003 that reducing capital-income taxation from its current level to zero (using other taxes to support an unchanged rate of government spending) would result in overall welfare gains of "perhaps 2 to 4 percent of annual consumption in perpetuity." As a result of the accumulation of this and other economic evidence of the destructive effects of taxes on capital, countries around the world have been reducing their tax rates for the last couple of decades. The tax revolution started with Prime Minister Thatcher and President Reagan. Now, a quarter of a century later, some of the most aggressive tax-cutting states can be found in eastern Europe, where low-rate flat taxes have taken hold. The best economic performance the world has ever experienced has occurred during this period, in large part because of the global reduction in destructive tax rates. But France and Germany, with their high-tax, statist economic policies, have been trying to stop and reverse the tax revolution.

EUROPE IS losing the economic race to the United States and Southeast Asia. Since 1982, the U.S. economy has been growing at a rate about 50 percent higher than Europe's. The French and Germans, having made great economic progress in the 1950s, 1960s and 1970s, are now keenly aware that they have been getting poorer in relation to Americans since the time of Ronald Reagan. Parts of Europe, most notably Ireland and to a lesser extent Britain, have pulled ahead of euro-zone countries like Germany, France and Italy.

Twenty years ago, the Irish were one of the poorest people in Europe. Now they have a per capita income that is higher than all of the major European countries. The British, as a result of Margaret Thatcher's economic reforms, have also done relatively well. In 1980 the per capita income in Britain was below that of the Germany and France. Now it is higher, making Britain (on a per capita basis) the wealthiest major European country. The Irish and the British succeeded by cutting tax rates and deregulating their economies. The supply-side revolution that changed America, Britain and Ireland for the better barely breached the shores of the Continent. (1)

It is often said that demographics drive history and, to a considerable extent, the lower-than-replacement birth rates on the Continent are at the root of the tax-rate war. Starting in the 1960s, these countries built welfare states with generous retirement systems. Such systems are barely sustainable, even with rapidly growing populations. "Defined benefit" systems are in essence Ponzi schemes that require the number of new workers to grow as fast, if not faster, than the retirees, because it is the taxes of the working population, not any sort of savings, that are used to finance the payments to retired workers. Europe is plagued with stagnant or falling populations, which means that the proportion of the elderly is increasing rapidly.

Many countries are moving to a "defined-contribution" system, much as Chile did a quarter of a century, ago (and as President Bush is now advocating for the United States). In such a...