Tax competition, a form ofregulatory competition, exists when governments use reductions in fiscal burdens to encourage the inflow of productive resources or to discourage the exodus of those resources. Often, this means a governmental strategy of attractingforeign direct investment, foreign indirect investment (financial investment), and high value human resources by minimizing the overall taxation level and/or special tax preferences, creating acomparative advantage.
Scholars generally consider economic development incentives to be inefficient, economically costly, and distortionary.[1]
From the mid-1900s governments had more freedom in setting their taxes, as the barriers to free movement ofcapital and people were high.[citation needed] The gradual process ofglobalization is lowering these barriers and results in rising capital flows and greater manpower mobility.
Governments can respond in varied ways to mitigate the adverse effects of tax competition. Governments can take unilateral action, make bilateral agreements, or rely on an overarching tax authority:[2]
According to a 2020 study, tax competition "primarily reduces taxes for mobile firms and is unlikely to substantially affect the efficiency of business location."[3] A 2020 NBER paper found some evidence that state and local business tax incentives in the United States led to employment gains but no evidence that the incentives increased broader economic growth at the state and local level.[4]
TheEuropean Union (EU) also illustrates the role of tax competition. The barriers to free movement of capital and people were reduced close to nonexistence. Some countries (e.g.Republic of Ireland) utilized their low levels of corporate tax to attract large amounts of foreign investment while paying for the necessary infrastructure (roads, telecommunication) from EU funds. The net contributors (like Germany) strongly oppose the idea of infrastructure transfers to low tax countries. Net contributors have not complained, however, about recipient nations such as Greece and Portugal, which have kept taxes high and not prospered. EU integration brings continuing pressure for consumption tax harmonization as well. EU member nations must have avalue-added tax (VAT) of at least 15 percent (the main VAT band) and limits the set of products and services that can be included in the preferential tax band. Still this policy does not stop people utilizing the difference in VAT levels when purchasing certain goods (e.g. cars). The contributing factor are the single currency (Euro), growth of e-commerce and geographical proximity.
The political pressure fortax harmonization extends beyond EU borders. Some neighbouring countries withspecial tax regimes (e.g. Switzerland) were already forced to some concessions in this area.[citation needed]
Advocates for tax competition say it generally results in benefits to taxpayers and the global economy.[5]
Some economists argue that tax competition is beneficial in raising total tax intake due to low corporate tax rates stimulatingeconomic growth.[6][7]
It has also been argued that just as competition is good for businesses, competition is good for governments as it drives efficiencies and good governance of the public budget.[8]
Others point out that tax competition between countries bears no relation to competition between companies in a market: consider, for instance, the difference between a failed company and afailed state—and that whilemarket competition is regarded as generally beneficial, tax competition between countries is always harmful.[9]
Some observers suggest that tax competition is generally a central part of agovernment policy for improving the lot of labour by creating well-paid jobs (often in countries or regions with very limited job prospects). Others suggest that it is beneficial mainly for investors, as workers could have been better paid (both through lower taxation on them, and through higherredistribution of wealth) if it was not for tax competition lowering effective tax rates on corporations.
TheOrganisation for Economic Co-operation and Development (OECD) organized an anti-tax competition project in the 1990s, culminating with the publication of "Harmful Tax Competition: An Emerging Global Issue" in 1998 and the creation of a blacklist of so-calledtax havens in 2000. Blacklisted jurisdictions effectively resisted the OECD by noting that several of the member nations also weretax havens according to the OECD's own definition.[citation needed][needs update]
Left-wing economists generally argue that governments needtax revenue to cover debts and contingencies, and that paying to fund awelfare state is an obligation ofsocial responsibility. Another argument is that tax competition is azero-sum game.[10] Right-wing economists argue that tax competition means that taxpayers can vote with their feet, choosing the region with the most efficient delivery of governmental services. This makes thetax base of a state volitional because the taxpayer can avoid tax byrenouncing citizenship oremigrating and thereby changingtax residence.
In April 2021,US Secretary of the TreasuryJanet Yellen has proposed a globalminimum corporate tax rate, to avoidprofit shifting by companies toavoid taxation.[11]
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Treasury Secretary Janet L. Yellen made the case [...] for a global minimum tax, kicking off theBiden administration's effort to help raise revenue in the United States and prevent companies from shifting profits overseas to evade taxes. Ms. Yellen, in a speech to theChicago Council on Global Affairs, called for global coordination on an international tax rate that would apply tomultinational corporations regardless of where they locate their headquarters. Such a global tax could help prevent the type of "race to the bottom" that has been underway, Ms. Yellen said, referring to countries trying to outdo one another by lowering tax rates in order to attract business.
