Tax competition

Tax 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.

Although often presented as a benefit for capital, 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).

History

In the past, governments had more freedom in setting their taxes as the barriers to free movement of capital and people were high. The gradual process of globalization 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
* rising the barriers to free movement of capital
* not allowing companies domiciled in tax havens to bid for public contracts
* political pressure on lower tax countries to “harmonize” (i.e. raise) their taxes

There seems to be reasonable argument that defensive policies have only short term effect. The more proactive reaction to tax competition is to promote other pro-growth policies and reform the tax system.

Application

The European Union (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.

The Organisation for Economic Cooperation 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 nations in 2000. This project has largely faltered, in part because of diminished enthusiasm by the United States, which is the OECD's largest financial supporter. The creation of the Center for Freedom and Prosperity played a key role in mobilizing oppostion to both OECD and EU anti-tax competition efforts. Blacklisted jurisdictions also effectively resisted the OECD by noting that several of the member nations of the Paris-based bureaucracy also were tax havens according to the OECD's own definition.

Related terminology

* Tax avoidance
* Tax exemption
* Tax harmonization
* Tax haven
* Race to the bottom

External links

* [http://ec.europa.eu/taxation_customs/taxation/company_tax/harmful_tax_practices/index_en.htm Harmful Tax Competition (EU DG for Taxation and Customs Union)]