Why Tax Competition Is Good for You

Today's comment is by Bob Bauman, Legal Counsel and Senior Writer for The Sovereign Society.

Dear A-Letter Reader,

What's "tax competition" and why should you care about it?

In a nutshell, (which is where Will Rogers said all economic theories originate), tax competition exists when national governments lower taxes, specifically to encourage investments and cash flow or to urge financial resources to stay at home.

Usually this means a government creates an official strategy to attract foreign direct and indirect investment into the country.

The government also might invent tax incentives to attract high value human resources (bankers, investment firms) to the country. These tax incentives might include low corporate and individual income taxes and/or special tax preferences for foreigners. And low taxes keep locals at home.

The Birth of Tax Havens

Thus "tax havens" were born. All over the world, tax havens are places where foreigners can house their assets, do business and pay little or no taxes.

Good example: Panama, a nation that has a "territorial tax" policy. Panama only taxes business and personal income actually earned within its borders. You can base your business in Panama, but you and your business can earn tax-free income from offshore sources.

Other no or low tax jurisdictions include Monaco, Andorra, Belize, Singapore, the Channel Islands and the Isle of Man. And - for foreigners only - the United States and the United Kingdom are also tax havens.

Prudent individuals look at taxes as a business cost that either adds to subtracts from their desired profits. Thus smart folks looking for more profits go where there are no taxes or low taxes.

Let the Tax Competition Begin

Two good examples of tax competition were in the news this week.

From Amsterdam, a new poll showed that many wealthy Dutch residents want to move elsewhere in 2008 to escape the higher income taxes. At least 4% of those polled are considering leaving and becoming a taxpayer in another, lower tax country.

The Netherlands is an EU member state, so Dutch citizens have the option to make their home in any other EU nation. And some EU states, like Ireland and Cyprus, have much lower taxes.

Among the wealthiest Dutch polled, almost 10% say they are considering moving to avoid the proposed new taxes. (This relocation tactic won't work for U.S. persons, because U.S. income tax laws apply to all income, no matter where the U.S. person lives.)

The second example comes from Washington, D.C. The U.S. Treasury Department released a report alleging that American-owned companies that use tax havens are shifting "substantially all of their income out of the United States."

While this is legal under U.S. tax law, the report to Congress claimed that a dozen companies are using a technique known as "earnings stripping" to avoid or minimize taxes on their U.S. profits.

The study looked at companies that have their headquarters in offshore tax havens, while also continuing to operate out of the United States. Of course, the U.S. imposes one of the highest corporate taxes (35%) in the world. No doubt these higher corporate taxes inspired these tax-saving offshore moves.

In both cases, tax competition attracts smart folks to go where taxes are lower - as well they should.

Furious Tax Collectors

Naturally, this tax competition and taxpayer mobility infuriates tax collectors in the socialist welfare states, including the U.S. IRS.

The leftist big spenders claim that what we all need is "tax harmonization." In other words, they want high taxes everywhere for everybody.

For example, the paid propagandist, the Organization for Economic and Community Development (OECD), claims, "tax should not be the dominant factor in making capital allocation decisions." The OECD also says that low-tax policies "distort the location of capital and services."

Instead, the OECD wants nations to have the power to impose taxes on worldwide income. In doing so, tax collectors could ensure that taxpayers always face the same tax rate regardless of where they earn their income or where they live.

European nations generally have very high tax burdens. (One nation, Ireland, has very low taxes and has the greatest prosperity as a result.) Government spending consumes nearly half of economic output in EU countries, compared to one-third of GDP in the United States.

Not surprisingly, this translates into a higher tax burden, which means jobs and investment capital generally flee Europe. Tax harmonization is an attempt to stop labor and capital from escaping by creating, for all intents and purposes, a "fiscal fence" to force tax slaves to stay at home.

A Positive Good

For U.S. persons, (citizens and resident aliens), there are minimal tax savings by going offshore - but there are some. There is also far better asset protection and financial privacy guaranteed by the local's laws.

That's why tax competition is a concept to be encouraged - only because it forces all nations to keep taxes lower than they would be otherwise.

BOB BAUMAN, Legal Counsel

Commodities Will Sail Past
Stocks Once Again in 2008

As oil goes, so goes the commodity markets...

Major commodity indices are outpacing U.S. and global major market stocks in 2007. The commodity indices are soaring on the heels of surging crude oil prices, strong precious metals gains and a huge rally in the grains complex.

The benchmark CRB Index gained 11% in 2007 - while the S&P 500 gained just 5% in 2007. Meanwhile, the MSCI World Index also didn't beat commodities with an 8.5% gain.

The heavily energy-weighted S&P/Goldman Sachs Commodity Index beat them all. With 70% of its constituent benchmark in West Texas crude, the S&P/Goldman Sachs Commodity Index soared 33% this year! That's huge.

And the combination of tight supplies and geopolitical risk continues to put upward pressure on oil prices.

OPEC now supplies about 70% of the crude oil market. And it's essentially tapped out. Saudi Arabia, the world's largest oil producer, is now very close to production limits. They can't crank out significantly more supply to meet an extremely tight market approaching 90 million barrels per day.

If winter turns extremely cold, oil prices will blast through US$100 per barrel as we turn up thermometers here in the Western hemisphere. That's very possible considering the past three winters have been unseasonably warm.

Plus, any confrontation with Iran and the West will also catapult oil prices to new highs. Though a major wildcard in my 2008 oil forecast, any military confrontation between the United States and Iran remains a distinct possibility. That mere possibility continues to apply upward pressure to prices.

On the other hand, next year is a Presidential election year. So it's possible that oil prices might soften, however moderately. The United States government will attempt to increase oil supplies as voters head to the polls under the weight of soaring gasoline prices.

The government has one way they can temporarily cushion the blow from rising prices. Policymakers can start unloading supplies from the U.S. Strategic Petroleum Reserve. As prices come close to testing the magic US$100 level, political pressure will increase in Washington next year to increase supplies.

That said, I don't expect any initiative to end this oil bull market for. But it might dampen higher prices, even temporarily.

I would not buy oil at these levels, including most energy stocks. But natural gas prices look extremely attractive compared to crude oil. Despite trading at its highest differential compared to oil in history, the "crack spread" between oil and gas implies a narrowing in that gap - eventually. Natural gas prices remain more than 50% below their December 2005 highs.

ERIC ROSEMAN, Investment Director

EDITOR'S NOTE: Since 2001, Eric has kept his eye on every commodity trend so he maximize your profits during this decade's epic commodity bull market. He's known for finding and exploiting the most undervalued commodity plays in his service, Commodity Trend Alert. While the CRB index has brought in 11% gains in 2007, Eric's equally weighted Commodity Trend Alert has gained an impressive 22% in this volatile year for stocks, commodities and everything in between. Click here to find out more about CTA.

Bonus Wealth

Reading the Tea Leaves in U.S. GDP Data

Some good news just cheered up Wall Street investors: the third-quarter GDP numbers, which included some surprisingly strong revisions. But if you look closer at the data, you'll notice a few interesting points.

First, there's been a strong boost from exports lately, thanks in large part to the lower dollar. If not for those profits earned from overseas buyers, the U.S. might already be mired in recession.

Second, the consumer still rules the roost, and so far Mr. U.S. Consumer continues to spend, but at a slower pace.

A breakdown of the major components of GDP is shown in the graph below. As you can see, the first and by far biggest line-item in the list is Personal Consumption Expenditures (PCE). This is essentially consumer spending and accounts for 70% of total economic output in the U.S.

Many talking heads on TV have been moaning for months about an imminent decline in consumer spending. But so far it hasn't materialized. Consumer spending grew about 2.7% in the three months ended September. That was actually revised down from 3% growth originally reported, and it's less than trend growth seen in recent quarters.

However this figure also represents a nice rebound from spending growth of just 1.4% in the second quarter of this year.

Meanwhile, real final sales to domestic purchasers, which is the best overall data on domestic demand, came in at 2.4% for the quarter.

This indicates that the U.S. still has healthy core consumer demand. Although it is slowing due to the impact of high consumer debt and falling home prices, spending hasn't fallen off a cliff. Not yet anyway. However, the housing recession is just getting started. So far, the year over year price decline in home prices stands at -5%, but is likely to get worse in 2008.

Eventually this may drag core consumer spending down closer to 2%, or perhaps a bit less. As long as employment holds up, this is no disaster scenario. But keep a sharp eye on the monthly jobs report due out tomorrow morning.

Meanwhile, the falling U.S. dollar is having the desired effect on boosting U.S. exports, while reducing imports. Plus, U.S. corporate profits earned from overseas are booming, even as overall profits look pretty dismal.

In fact, exports increased nearly 19% in the third quarter,. That's the fastest export growth since 2003, and accounts for a record 12.1% of total GDP.

We are increasingly living in a global economy. Although U.S. consumers are still in the driver's seat here at home, U.S. assets, goods and services are also in high-demand around the world.

In fact, given the recent decline in the buck, U.S. assets are on sale this holiday season. Just ask the Abu Dhabi Investment Authority!

MIKE BURNICK, Senior Editor & Global Markets Analyst