Tax competition
Encyclopedia
Tax competition, a form of regulatory competition
, exists when governments are encouraged to lower fiscal burdens to either encourage the inflow of productive resources or discourage the exodus of those resources. Often, this means a governmental strategy of attracting foreign direct investment
, foreign indirect investment (financial investment), and high value human resources by minimizing the overall taxation level and/or special tax preferences, creating a comparative advantage
.
Some observers suggest that tax competition is generally a central part of a government 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 higher redistribution of wealth) if it was not for tax competition lowering taxation on corporation.
Many economists also argue that tax competition is beneficial in raising total tax intake due to low corporate tax rates stimulating economic growth.
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.
and people were high. The gradual process of globalization
is lowering these barriers and results in rising capital flows and greater manpower mobility.
Governments typically react with "carrot-and-stick" policies such as:
(EU) 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 a value-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 for tax harmonization
extends beyond EU borders. Some neighbouring countries with special tax regimes
(e.g. Switzerland) were already forced to some concessions in this area.
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-called tax haven
s in 2000. Blacklisted jurisdictions effectively resisted the OECD by noting that several of the member nations of OECD also were tax havens according to the OECD's own definition.
Left-wing economists generally argue that governments need tax revenue to cover debts and contingencies, and that paying to fund a welfare state
is an obligation of social responsibility
. Right-wing economists argue that tax competition means that a taxpayer can vote with their feet, choosing the region with the most efficient delivery of governmental services. This makes the tax base of a state volition
al, because the taxpayer can avoid tax by renouncing citizenship
or emigrating
and thereby changing tax residence
.
Regulatory competition
Regulatory competition, also called competitive governance or policy competition, is a phenomenon in law, economics and politics concerning the desire of law makers to compete with one another in the kinds of law offered in order to attract businesses or other actors to operate in their jurisdiction...
, exists when governments are encouraged to lower fiscal burdens to either encourage the inflow of productive resources or discourage the exodus of those resources. Often, this means a governmental strategy of attracting foreign direct investment
Foreign direct investment
Foreign direct investment or foreign investment refers to the net inflows of investment to acquire a lasting management interest in an enterprise operating in an economy other than that of the investor.. It is the sum of equity capital,other long-term capital, and short-term capital as shown in...
, foreign indirect investment (financial investment), and high value human resources by minimizing the overall taxation level and/or special tax preferences, creating a comparative advantage
Comparative advantage
In economics, the law of comparative advantage says that two countries will both gain from trade if, in the absence of trade, they have different relative costs for producing the same goods...
.
Some observers suggest that tax competition is generally a central part of a government 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 higher redistribution of wealth) if it was not for tax competition lowering taxation on corporation.
Many economists also argue that tax competition is beneficial in raising total tax intake due to low corporate tax rates stimulating economic growth.
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.
History
From the mid 1900s governments had more freedom in setting their taxes as the barriers to free movement of capitalCapital (economics)
In economics, capital, capital goods, or real capital refers to already-produced durable goods used in production of goods or services. The capital goods are not significantly consumed, though they may depreciate in the production process...
and people were high. The gradual process of globalization
Globalization
Globalization refers to the increasingly global relationships of culture, people and economic activity. Most often, it refers to economics: the global distribution of the production of goods and services, through reduction of barriers to international trade such as tariffs, export fees, and import...
is lowering these barriers and results in rising capital flows and greater manpower mobility.
Impact
With tax competition in the era of globalization politicians have to keep tax rates “reasonable” to dissuade workers and investors from moving to a lower tax environment. Most countries started to reform their tax policies to improve their competitiveness. However, the tax burden is just one part of a complex formula describing national competitiveness. The other criteria like total manpower cost, labor market flexibility, education levels, political stability, legal system stability and efficiency are also important.Governments typically react with "carrot-and-stick" policies such as:
- reduction of both personal and corporate income tax rates
- tax breaks/holidays (i.e. time limited tax exemptions)
- favorable tax policies for non-residents
- raising the barriers to free movement of capital
- not allowing companies domiciled in tax havenTax havenA tax haven is a state or a country or territory where certain taxes are levied at a low rate or not at all while offering due process, good governance and a low corruption rate....
s to bid for public contracts - political pressure on lower tax countries to “harmonize” (i.e. raise) their taxes
Application
The European UnionEuropean Union
The European Union is an economic and political union of 27 independent member states which are located primarily in Europe. The EU traces its origins from the European Coal and Steel Community and the European Economic Community , formed by six countries in 1958...
(EU) 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
Republic of Ireland
Ireland , described as the Republic of Ireland , is a sovereign state in Europe occupying approximately five-sixths of the island of the same name. Its capital is Dublin. Ireland, which had a population of 4.58 million in 2011, is a constitutional republic governed as a parliamentary democracy,...
) 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 a value-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
Euro
The euro is the official currency of the eurozone: 17 of the 27 member states of the European Union. It is also the currency used by the Institutions of the European Union. The eurozone consists of Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg,...
), growth of e-commerce and geographical proximity.
The political pressure for tax harmonization
Tax harmonization
Tax harmonisation refers to the process of making taxes identical or at least similar in a region. In practice, it usually means increasing tax in low-tax jurisdictions, rather than reducing tax in high-tax jurisdictions or a combination of both. The best example is the European Union where all...
extends beyond EU borders. Some neighbouring countries with special tax regimes
Tax haven
A tax haven is a state or a country or territory where certain taxes are levied at a low rate or not at all while offering due process, good governance and a low corruption rate....
(e.g. Switzerland) were already forced to some concessions in this area.
Criticism
The Organisation for Economic Co-operation and DevelopmentOrganisation for Economic Co-operation and Development
The Organisation for Economic Co-operation and Development is an international economic organisation of 34 countries founded in 1961 to stimulate economic progress and world trade...
organized an anti-tax competition project in the 1990s, culminating with the publication of "Harmful Tax Competition: An Emerging Global Issue
Harmful Tax Competition: An Emerging Global Issue
Harmful Tax Competition: An Emerging Global Issue is a report issued by the Organization for Economic Co-Operation and Development.In the report, the OECD groups countries into three categories: member country preferential regimes, tax havens, and non-member economies, and extablishes criteria for...
" in 1998 and the creation of a blacklist of so-called tax haven
Tax haven
A tax haven is a state or a country or territory where certain taxes are levied at a low rate or not at all while offering due process, good governance and a low corruption rate....
s in 2000. Blacklisted jurisdictions effectively resisted the OECD by noting that several of the member nations of OECD also were tax havens according to the OECD's own definition.
Left-wing economists generally argue that governments need tax revenue to cover debts and contingencies, and that paying to fund a welfare state
Welfare state
A welfare state is a "concept of government in which the state plays a key role in the protection and promotion of the economic and social well-being of its citizens. It is based on the principles of equality of opportunity, equitable distribution of wealth, and public responsibility for those...
is an obligation of social responsibility
Social responsibility
Social responsibility is an ethical ideology or theory that an entity, be it an organization or individual, has an obligation to act to benefit society at large. Social responsibility is a duty every individual or organization has to perform so as to maintain a balance between the economy and the...
. Right-wing economists argue that tax competition means that a taxpayer can vote with their feet, choosing the region with the most efficient delivery of governmental services. This makes the tax base of a state volition
Volition
Volition may refer to:*Volition , the cognitive process by which an individual decides on and commits to a particular course of action...
al, because the taxpayer can avoid tax by renouncing citizenship
Renunciation of citizenship
Renunciation is a voluntary act of relinquishing one's citizenship . It is the opposite of naturalization whereby a person voluntarily acquires a citizenship, and related to denaturalization where the loss of citizenship is not voluntary, but forced by a state.-Historic practices:The old common law...
or emigrating
Emigration
Emigration is the act of leaving one's country or region to settle in another. It is the same as immigration but from the perspective of the country of origin. Human movement before the establishment of political boundaries or within one state is termed migration. There are many reasons why people...
and thereby changing tax residence
Tax residence
Definitions of residence for tax purposes vary considerably from state to state. For individuals, physical presence in a state is an important factor. Some states also determine residency of an individual by reference to a variety of other factors, such as the ownership of a home or availability...
.
Related terminology
- Tax avoidanceTax avoidanceTax avoidance is the legal utilization of the tax regime to one's own advantage, to reduce the amount of tax that is payable by means that are within the law. The term tax mitigation is a synonym for tax avoidance. Its original use was by tax advisors as an alternative to the pejorative term tax...
- Tax exemptionTax exemptionVarious tax systems grant a tax exemption to certain organizations, persons, income, property or other items taxable under the system. Tax exemption may also refer to a personal allowance or specific monetary exemption which may be claimed by an individual to reduce taxable income under some...
- Tax harmonizationTax harmonizationTax harmonisation refers to the process of making taxes identical or at least similar in a region. In practice, it usually means increasing tax in low-tax jurisdictions, rather than reducing tax in high-tax jurisdictions or a combination of both. The best example is the European Union where all...
- Tax havenTax havenA tax haven is a state or a country or territory where certain taxes are levied at a low rate or not at all while offering due process, good governance and a low corruption rate....
- Race to the bottomRace to the bottomA race to the bottom is a socio-economic concept that is argued to occur between countries as an outcome of regulatory competition, progressive taxation policies and social welfare spending...
External links
- Harmful Tax Competition (EU DG for Taxation and Customs Union)
- International tax competition: globalisation and fiscal sovereignty, Rajiv Biswas, Commonwealth Secretariat, 2002, ISBN 0850926882
- International Financial Centres (IFC) Forum on tax competition