Since about 1980 it has been the tax policy of the United States and many other OECD member states not to have full income tax treaties with any of the smaller Caribbean jurisdictions. Instead, they want to have only tax information exchange agreements (TIEAs) with those nations. Existing tax treaties with many Caribbean countries were arbitrarily and summarily terminated during the 1980s because some third-country residents had used, or abused, the treaties to reduce withholding taxes on investments in OECD countries.

This policy has turned out to be self-defeating. In hindsight, it would have been more appropriate to block the alleged misuse of tax treaties by other means such as legislation and treaty renegotiation. Many smaller Caribbean countries that once imposed normal income taxes have found it necessary to change their tax systems. Some abandoned their income taxes altogether. Others began to impose their taxes only on a territorial basis, exempting all income from foreign sources. Those jurisdictions that were dumped as treaty partners, because they were considered tax havens, became even more successful as offshore financial centers (OFCs) and have caused even greater problems for tax officials in the United States and other OECD countries.

Most tax treaties have two basic goals. They are supposed to eliminate double taxation and prevent fiscal evasion. A TIEA has only one of these goals, the prevention of fiscal evasion. It not only ignores the prevention of double taxation, it also ignores the imposition of outrageously high single taxation by the other party to the TIEA.

The typical income tax treaty prevents double taxation on passive income such as dividends, interest, and royalties by allowing the source country to impose only a low rate of tax on the relevant income and allowing the taxpayer's country of residence to impose an additional tax on such income after giving the taxpayer a foreign tax credit for the tax paid to the source country. The source country normally collects its portion of the tax by imposing a withholding tax at the rate allowed by the treaty. In some cases, the residence country chooses to eliminate double taxation by exempting the relevant income, with or without taking that income into account in determining the taxpayer's tax rate on his other income

When source countries first began to impose withholding taxes to collect tax from foreign persons the withholding tax rates were quite low. Source countries learned, however, that it was to their advantage to increase these rates to levels much higher than they were entitled to keep. By doing so they forced residence countries to negotiate tax treaties with them to reduce or eliminate confiscatory taxation by the source countries.

Using the United States as an example, there was no withholding tax on payments of passive income to foreigners until 1937. At that time, after careful study, Congress imposed a 12.5 percent withholding tax on all such payments. In 1942, as a temporary wartime measure, the withholding rate was increased to 30 percent. In 2002, we celebrate the 60th anniversary of that "temporary" wartime increase. The reason it was never reduced is that the U.S. Treasury Department determined that excessively high withholding taxes forced other countries to seek tax treaties with the U.S. government. This enabled the United States to obtain treaty concessions from those countries.

A 30 percent tax may be appropriate for certain types of passive income but it is confiscatory for other types of income, especially for dividends, interest, and royalties. Treasury and the U.S. Congress have recognized that a 30 percent withholding tax is excessive by granting much lower rates on those same types of income in tax treaties that are now in force with over 60 other countries.