INTERNATIONAL TAX COMPETITION

International Tax Competition

International Tax Competition

Introduction

Globalization is knitting separate national economies into a single world economy. This is occurring as a result of rising flows of trade and investment, greater labor mobility, and rapid transfers of technology. Deregulation of Financial markets, reductions in trade and investment barriers, and reduced communications and transportation costs have spurred those trends (Easson 2004, 12-65).

Discussion

High tax rates are more difficult to sustain in this new economic environment. As economic integration increases, individuals and businesses gain greater freedom to take advantage of foreign economic opportunities. That increases the sensitivity of decisions about investment and location to taxation. As a result, high tax rates cause large economic losses when borders are opened up, giving countries strong incentives to reduce rates. International “tax competition ” is increasing as capital and labor mobility rises. Most major countries have pursued tax reforms in recent years to ensure that their economies remain attractive for investment. The average top personal income tax rate in the industrial countries of the Organisation for Economic Cooperation and Development (OECD) has fallen 20 percentage points since 1980. The average top corporate income tax rate has fallen 6 percentage points in just the past six years (Smyth, Soberman, Easson 2004, 10-96).

Pressure to reduce tax rates stems from the direct loss of capital and skilled labor from countries that do not reform their tax systems and from the example of countries that are prospering under low tax regimes. For example, Ireland's recent economic success has been much heralded. This small country of 3.8 million people has attracted more foreign direct investment than either Japan or Italy in recent years. The main draw for foreign investors has been a 10% corporate tax rate on manufacturing and Financial services. As a result, Ireland has boomed and now has one of the highest standards of living in the world (Easson 2000b,10-63).

Nonetheless, stories of such successful tax cuts concern some economists who view tax competition as distortionary. One concern is that, if differing tax rates cause capital and labor to migrate across borders, resources may not end up in the most productive uses. So Ireland is receiving “too much” investment because of its low tax rates, according to this view. But, this loses sight of a larger issue: high tax rates stunt economic growth. Thus, to the extent that tax competition creates pressure to reduce tax rates globally, all countries gain from increased growth and higher incomes. Political concerns are behind much of the opposition to international tax competition. A high-profile 1998 report from the OECD argued that coordinated global action was needed to limit “harmful tax competition. ” (Easson 2000a, 10-65) One concern is that tax competition may reduce governments' ability to redistribute income. With greater international economic freedom, businesses and individuals that are heavily taxed will naturally look to better locations for working and investing. The OECD calls such tax avoidance “free riding” that “may hamper the application of progressive tax rates and the achievement of redistributive ...