Arguments against Tax Competition

Proponents of the free market generally believe that competition is good for the economy. They argue in favor of the competition every time.

Hence, it is natural for them to feel that competition in taxes is also good. The general argument is that competition forces the governments to rationalize and become more efficient.

However, there are many economists in the world who believe that the general rules of competition cannot be applied to taxation. This is because taxation is a totally different kind of economic subject.

Hence, what may be good for the market, in general, may not be good when it comes to setting up a tax system. This is the reason why they have listed down some of the negative points which tax competition brings along.

This article explains some of the common arguments which are made against tax competition.

  • Beggar Thy Neighbor System: Economists who criticize the tax competition system believe that it is an extension of the beggar thy neighbor philosophy. They are of the opinion that tax competition puts undue pressure on the governments to keep reducing their tax rates to unreasonable levels.

    A country does not have the option to avoid tax competition if its peers are indulging in it. Economists have studied tax wars between different nations, wherein each kept lowering the rate to undercut the other.

    In the end, one party gains by a marginal amount. However, both participants lose much more, and the real winner is the corporation who benefits by playing the nations off against one another.

  • Lower Levels Of Services Offered: If countries experience an unreasonable rush to lower tax rates, then they will also have to cut their expenses.

    Lower revenues mean that the country will have to either lower their expenses, or they will have to pick up even more debt. Now, when governments want to cut expenses, obviously they cannot reduce expenses on infrastructure or any other service that corporations require.

    This is because that would also trigger the flight of capital. As a result, governments are forced to lower the level of services offered to their civilians.

    The education and health facilities of the country start taking the hit. This is also a form of wealth transfer from the poor to the rich.

  • Burden Falls on the Poor: If countries have to lower their corporate tax rates without lowering their service levels, then the country is forced to levy more taxes on the workers.

    Any shortfall induced by not taxing capital is made whole by increasing the taxes on labor. This is what is happening in most developed countries in the world.

    The tax on corporations has reduced from 35% to 24% in the past five years. However, during the same period, the taxes on the poor have either stagnated or steadily increased.

    Tax competition leads to regressive tax systems around the world, which actually defeats the purpose of the competition.

  • Mobile Capital: Tax competition also prevents companies from investing their wealth in immovable assets. Multinational companies generally want to own assets that are movable or liquid.

    Hence, if the government of a nation tries to increase taxes after inducing them to invest under the pretext of lower taxes, they would just exit the nation.

    This is detrimental for the economy as multinationals do not invest in infrastructure assets, which form the basis of the growth of any economy.

  • Kills Small Businesses: Tax competition generally entails a complicated taxation system. Such a system is generally created to favor the rich big corporations.

    When the system is designed, several loopholes are created, which allow bigger corporations to get away after paying a lower effective rate of tax.

    As a result, the bigger corporations end up having a tax advantage over the smaller business. This tax advantage allows them to drop prices and gain even more market share.

    This leads to even more revenue for them in the future. This technique has been used by companies like Wal-Mart and Amazon, who have gained an unassailable price advantage over smaller firms because of tax competition.

    It is ironic that states strike these deals with mega-corporations in order to improve the lives of their citizens. However, over the long term, the end up hurting their livelihood.

  • Rich Get Richer: Lastly, any benefits that accrue because of tax competition are not split amongst the population. They accrue only to the higher classes, which comprise of rich people.

    Hence, over a period of time, tax competition exacerbates the wealth gap between the rich and the poor. The advantages are reaped by the rich, whereas the costs are borne by the poor worldwide.

    Hence, economists argue that tax competition ends up widening the wealth gap, which is the exact opposite of what this law intends to do.

The bottom line is that many countries have seen their tax revenues dwindle. This is particularly true of countries that are in the vicinity of other tax havens.

As a result, these countries want to eradicate this idea of tax competition. They are of the opinion that tax competition is a failed economic experiment, which is costing the global economy dearly.

However, the problem is that no country can end tax competition of its own. They will have to team up with several other countries before a critical mass is reached, and tax competition is eradicated, which is unlikely to happen in the short term.

❮❮   Previous Next   ❯❯

Authorship/Referencing - About the Author(s)

The article is Written and Reviewed by Management Study Guide Content Team. MSG Content Team comprises experienced Faculty Member, Professionals and Subject Matter Experts. We are a ISO 2001:2015 Certified Education Provider. To Know more, click on About Us. The use of this material is free for learning and education purpose. Please reference authorship of content used, including link(s) to and the content page url.