The furor over taxing unrealized capital gains of Canadians holding "foreign investment entities" (FIEs) arose as a by-product of the Department of Finance's attack on offshore tax havens.

As is so often the case when a few bad apples make things worse for the masses, what we're seeing is hundreds of thousands of law-abiding citizens who wish merely to create tax-effective non-registered retirement savings programs being punished. Why? So the tax-hungry government can zero in on a few fat cats with the means to use offshore tax havens to shelter their large incomes.

While it has been estimated that more than $1-billion has been squirrelled away by affluent Canadians, that number pales compared with what the U.S. and other nations are losing to these havens. The Organization for Economic Co-operation and Development (OECD) estimates more than US$1-trillion is invested in offshore funds, and the number of funds has increased by more than 1,400% over the past 15 years.

To fully understand the proposal to tax capital gains on FIEs on a mark-to-market annual basis, therefore, it's necessary to examine what the Finance Department released late in June relative to parallel developments in dozens of other offshore jurisdictions.

Just four days after Finance issued its June 22 bombshell, the OECD released a report entitled "Towards global tax co-operation," which calls for dozens of offshore havens to clean up their tax policies or face severe fiscal sanctions by the OECD member nations.

Toronto tax lawyer David Louis (editor of the Tax Letter and a partner with the law firm Minden Gross) nicely summarized the issue in a recent issue of CCH's Tax Notes. The OECD issued a list of 47 preferential tax regimes which it said are "potentially harmful" to the tax-gathering efforts of the major tax-hungry developed democracies. It also singled out 35 jurisdictions that Louis describes as a "black list."

Louis says 14 of the blacklisted countries are in the Caribbean, notably Barbados (which has a tax treaty with Canada). They are not OECD members and have been given till 2005 to eliminate their supposedly "harmful practices." Harmful, that is, to the welfare state democracies.

Many of these blacklisted nations have thrived as emerging financial centres catering to wealth fleeing from the big democracies. It's arguable that their laissez-faire tax policies are quite healthy to these nations' economies as well as their affluent global customers.

Nevertheless, the OECD appears to hate competition and the notion of affluent citizens voluntarily leaving their shores for more reasonable tax jurisdictions.

The way the OECD puts it on its Web site at www.oecd.org is this: It wants to "restrain harmful tax practices that erode the tax bases of other countries, or that direct mobile investment from one location to another; that distort trade and investment patterns; that increase the administrative costs and compliance burdens; and that undermine the fairness and neutrality of tax systems."

This war between threatened industrial democracies and the offshore havens was predicted three years ago in the book, The Sovereign Individual, written by James Davidson and Lord William Rees Mogg (Simon & Schuster, New York 1997). The authors described democracy as "the fraternal twin of communism" and suggested that with the rise of the Internet that mass democracy would be incompatible with the Information Age.

The theme is also explored in the Davidson/Rees Mogg monthly newsletter, Strategic Investment (details at www.strategicinvestment.com).

Louis notes the OECD blacklist contains some "interesting" omissions: Ireland, Russia, Luxembourg, Switzerland, Hong Kong, Singapore and Israel, all countries found by other studies to sanction harmful tax evasion and/or money laundering. Others were left off the blacklist because they signed co-operation statements: Bermuda, Cayman Islands and Cyprus.

Louis takes the OECD to task for interfering with the revenue-generating policies o "imposes no more than nominal taxes; allows non-residents to escape taxation in their country of residence, and engages in harmful tax practices, characterized by either a refusal to exchange information, a 'lack of transparency' or a desire to attract 'businesses with no substantial activities'."

The OECD makes the point that for decades, these havens have eroded the tax bases of industrial nations and that in turn has increased the taxation burden on honest taxpayers. That much is true: The Canadian government's attack on capital gains taxes on exchange-traded funds and U.S. mutual funds is a classic example of how going after the bad-guy tax evaders is also hurting the many more honest taxpayers.

Perhaps if they got to the root of the problem -- realizing that its high-spending, high-taxing ways forced the high earners into tax havens in the first place -- they might achieve a more fair solution.

The mushrooming growth of offshore tax havens are a symptom of the real problem: Affluent citizens are voting with their feet and delivering a message to politicians that the tax burden has long since passed the level of being bearable or reasonable.