Britain’s Labor leaders Tony Blair and Gordon Brown have long boasted how successful and sure-footed they have been in making London one of the World’s preeminent financial centers. Brown, who served as the Chancellor of the Exchequer until he succeeded Blair as Prime Minister, was more responsible than any politician in helping London leapfrog up the league tables in the financial market to challenge New York.

Financial regulation has been lighter in the UK than the US, especially since the post-Enron Sarbanes-Oxley reform, and the tax authorities have been welcoming of rich foreigners, helping to attract many of the world’s wealthiest entrepreneurs and investors to the UK, including Greek shipping magnates, American hedge-fund traders and Russian oligarchs.

But in a bid to outdo the British Conservatives, who have joined the bandwagon of economic populism, Brown has threatened London’s role as a global finance center with talk of a tax crackdown on rich foreigners.

He has provided — also inadvertently — a major object lesson on the importance of tax competition.

Unnerved by the Conservatives, who promised that in government they would impose a levy on rich foreigners, Brown and his Chancellor, Alistair Darling, announced just before Christmas that come spring, tax rules on foreigners resident in the UK would change. Under the previous regime, foreign residents could claim “non-domiciled” status and avoid paying tax on overseas earnings and offshore assets. Only money brought into the UK or generated there was liable to income tax or capital gains tax.

Brown’s new proposal would have all non-domiciled foreigners resident in the UK for more than 7 years paying an annual tax charge of 30,000 pounds ($60,000).

According to the government’s theory, hugely wealthy foreigners wouldn’t up and leave just because of a mere $60,000, although, of course, for families it could be a lot more than $60,000, if spouse and adult children are taken into account.

To make matters much worse, the British government also started to talk about introducing new residency rules and rules on taxing offshore trusts.

Government spokesmen, along with supporters of the tax crackdown, including rather strangely the editorial writers at the Financial Times, pooh-poohed the notion there would be an exodus of the wealthy and entrepreneurial just because of the tax changes. They have been arguing that London is too important, what with its deep pool of financial and international legal expertise. Low-tax cantons in Switzerland or non-tax Monaco or offers of generous tax treatment in, say Greece, would hardly compensate for what London has to offer.

Foreigners apparently have been thinking otherwise. Many of the country’s richest foreigners have already started to relocate to Geneva, Zurich, Barbados or Ireland. This week, Irish paper king Dermot Smurfit announced he was planning to move to Switzerland and there were reports that dozens of Greek shipping magnates were exploring the possibility of moving back to Athens – a transfer that would cost the British economy annually $10 billion alone, and in the long term maybe two or three times more. The $60,000 annual levy per non-domiciled foreigner would bring in annually $1.6 billion.

Belatedly, the alarm bells have started to ring. The British government is poised to announce, possibly tomorrow, an embarrassing back-down. Taxing offshore trusts is now likely not to happen, although the $60,000 levy per non-domiciled foreigner will remain.

The reversal highlights the importance of tax competition. But there still might be long-term consequences from Brown’s botched handling of the affair. Non-doms who have already moved overseas are unlikely to return and the London-based Greek shipping magnates, who control a quarter of the Greek shipping industry, are now being courted energetically by Athens, with offers of generous tax treatment and subsidies.