Arguments in Favor of Tax Competition

Before the advent of globalization, every country in the world was working in a vacuum when it came to taxes. This is because the companies which operate in these countries did not have any choice when it came to tax rates.

Their only choices were to accept the tax rates or to stop production. If they did not like the tax policy of the country, they could undertake political protests.

However, there was nothing else they could do to increase their own financial gain. In economic terms, it can be said that the government is the monopoly supplier.

Hence, like all monopoly suppliers, the government has no incentive to reduce its costs, and hence inefficiency becomes the norm.

All this changed with globalization. After globalization, countries were free to incorporate and operate in different parts of the world. If they did not like the tax policy of a country, they could simply move to another country. This policy of free movement of capital gave rise to tax competition.

Tax competition means that countries have to compete with each other in order to get companies to incorporate and operate within their boundaries. Since countries now had to attract companies, a wave of rationalizations and tax cuts followed. There are several benefits to tax competition. Some of them have been explained in this article.

  • Rationalization of Government Expenses: When governments had the unchecked power to tax people, they had bloated budgets. Governments did not have any real incentive to cut down their budgets.

    As such, they would keep increasing budgets by incurring non-productive expenses for personal political gains. Without tax competition, politicians are free to channel the resources of the country in the backward direction i.e., from the industrious to the idle.

    Tax completion encourages the government to be lean. Only if a government can reduce its wasteful expenditure can it lower the tax rate, and only after the tax rate is lowered can more companies be attracted.

  • Efficient Allocation of Capital: As mentioned above, politicians were using the national resources to further their own political agenda. The impact of this was falling back on the general public in the form of higher taxes.

    Then, politicians would selectively give tax breaks to certain companies and distort capital allocation in the economy. This chain has been broken by globalization. This is because firstly, entrepreneurs nowadays are not restricted to domestic capital.

    If they provide an efficient product or service, they can obtain money from foreign investors as well. The capital pool is much larger. Also, if the government’s tax policy is not efficient, then the company can simply migrate to a different country. Hence, government interference in the allocation of capital is minimized.

  • Better Services: Governments are supposed to provide services in lieu of taxes that they take. For instance, they are supposed to provide a judicial system wherein contracts can be enforced.

    They are supposed to provide services such as electricity and transport at low rates. With the advent of tax competition, companies now look at countries where they can get the best value for money.

    Hence, sometimes companies may choose to go for a country with a higher tax rate if that means getting access to better public services such as an educated workforce that has access to a good healthcare system.

  • Increases Economic Productivity: Corporate taxes can essentially be seen as transaction costs that hinder the economic activity in the country. The transaction costs can never go to zero because governments do provide some services, and there is a cost to that.

    However, it can be brought to a minimum. The lower the taxes in an economy, the more productively the resources are used.

  • Higher Disposable Incomes: Tax competition forces countries to lower their corporate tax rates. It is often argued that at least a part of the corporate taxes is paid out of the pockets of workers of the company.

    Hence, if the tax is reduced, it leads to more money in the hands of the workers. This higher disposable income can then lead to increased consumption. This increases the overall economic activity in a nation, which leads to the collection of more taxes.

  • Balanced Development: Tax competition allows the different regions of the globe to be developed in a balanced manner. For instance, in Europe, Ireland was not as developed as other countries.

    Hence, it lowered its tax rates. Now, there are a lot of companies which have headquartered in Ireland. Therefore, low tax rates have been the main reason why companies have migrated to Ireland, which has led to economic development in that region.

The good thing about tax competition is that once a few governments adopt this model, the others do not have a choice. This is what has happened in the modern world.

After most of the western governments adopted tax competition, other developing countries had to follow suit. Also, countries cannot stop tax competition unilaterally.

They have to get other governments to agree. For instance, European governments have been trying to harmonize their tax rates to eliminate tax advantages but have not been able to do so.

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