Tax competition is not a ‘race to the bottom’: it is a necessary constraint on government, and provides indispensable information about the real demand for public goods...
The finance ministers of the world’s seven richest countries, the G7—Canada, France, Germany, Italy, Japan, the United Kingdom and the United States—took a big step in the wrong direction at their meeting in London in early June 2021. They agreed to a proposal by the U.S. government to impose a global corporate tax rate of at least 15 per cent. German Finance Minister Olaf Scholz warmly welcomed the American initiative. ‘It is very good news for tax justice and solidarity and bad news for tax havens around the world,’ he said. ‘Companies will no longer be in a position to dodge their tax obligations by booking their profits in the lowest-tax countries.’ U. S. Treasury Secretary Janet Yellen said that such a global measure would end the ‘race to the bottom’ in corporate taxation.
One problem with this proposal is that it rests on a false factual premise. Since the massive Reagan tax reductions in the 1980s, most countries have indeed engaged in tax competition, lowering their corporate tax rates in order to attract capital and corporations. But there has been no ‘race to the bottom’. Quite the opposite. For 22 leading OECD countries the average corporate tax rate fell from 47 per cent in 1980 to 25 per cent in 2019. In the same period corporate tax revenues in these 22 countries rose on average from 2.2 per cent to 3.0 per cent of GDP. There was an increasing yield for government from a decreasing rate, not least because the tax reductions, combined with the expansion of free trade, acted to stimulate Western economies and to enlarge the tax bases. This encouraged research and development, innovation, and the production of intangible goods.
Another false premise of the proposal made by the G7 finance ministers is that somehow their countries have not yet reached the level at which the production of public goods is optimal. Additional taxation would therefore add to the general welfare. But as eminent French economist Pascal Salin points out, the only plausible theoretical justification for taxation is that it is required to pay for goods which are necessary, indeed indispensable, for a well-functioning society whereas such goods can hardly be produced on the free market and have therefore to be made available by government. Examples are defence, policing, the judicial system, and possibly education and a safety net. They are called public goods because they are non-exclusive: Their benefits are either enjoyed by all or by none. A strong argument can be made that most Western countries, including all the G7, have long since passed the point at which the production of public goods would be optimal (which is when there is unanimous or at least wide agreement on the extent to which such goods are produced). There is no moral justification for taxing hard-working people in order to provide demagogues with sufficient money to bribe voters.
A third false premise of the proposal is the idea that there exists a stockpile of money out there, lying in an open chest on some Treasure Island, just waiting to be grabbed by the governments of the G7 countries. The OECD estimates that corporate tax avoidance or profit shifting deprives governments of revenue amounting to $100–240 billion annually, or 4–10 per cent of global corporate income tax revenue. It should be noted that $240 billion is a negligible fraction, 0.002 per cent, of annual gross world production, which is around $128 trillion. For argument’s sake, though, assume that the highest OECD estimate is more or less correct, $240 billion. But such money, in the accounts of highly mobile corporations and imaginative venture capitalists, supported by swarms of lawyers and accountants, will largely disappear before it can be collected by governments. It is like congealed snow, melting in the hands of tax collectors, to borrow an expression from Dorothy Parker. Corporations do not really pay any taxes: they are most often shifted to their workers (in lower salaries), or to their customers (in higher prices) or, less frequently, to their shareholders.
Moreover, this initiative is not likely to succeed. The G7 are not going to obtain agreement on their global minimum corporate tax from the many small nations which are competing for mobile multinationals by offering them favourable tax regimes. The most conspicuous, and successful, case is Ireland with her 12.5 corporate income tax. This has turned the Irish economy into a powerhouse. I would not be surprised if some other European countries, such as Estonia, Poland, the Czech Republic, and Hungary, would also strongly resist the attempt by the two high-tax countries dominating the E.U., Germany and France, to establish what is in effect a tax cartel. The more countries which would be forced to participate in such a tax cartel, the more benefits could be reaped by countries standing outside.
The technological innovations of the last three or four decades, not least the increased mobility of both capital and skilled labour, have greatly facilitated tax competition. Indeed, it could be argued, as American economist Charles Tiebout did in a celebrated paper long ago that it is only through tax competition between many political entities that the citizens can roughly set the optimal level for the production of public goods. You vote with your feet. You move, either in person or with your money, from a country or a region where you find the bundle of taxes and services on offer to be unsatisfactory to a place where you deem the terms to be better. Tax competition thus provides indispensable information about the real demand for public goods and acts at the same time as a constraint on government which, if left unchecked, has a tendency to grow far beyond what would be necessary, even turning into ‘the coldest of all cold monsters’ (as invariably happens in war). It is not the benevolence of the baker next door which provides me with cheap and good bread. It is the fact that if I am not satisfied with his product I can go to another baker down the street.
However, a distinction has to be made between tax evasion and tax avoidance. Tax evasion, when you basically cheat on the public, is undesirable and immoral. The burdens of taxation should be fairly distributed. There is nothing wrong, on the other hand, with tax avoidance, when you shift your efforts and activities from highly-taxed channels to moderately-taxed ones. It should be stressed that tax avoidance is not only about moving assets from a high-tax country to a low-tax one, or from France to Monaco. It is also about changing personal preferences: If your direct income is heavily taxed, then you will try to boost it not by pay rises, but by the addition of indirect benefits. You will also put in less work and hence you will earn less, while the government will see its tax base erode. This is the explanation Nobel Laureate Edward C. Prescott suggests for the fact that Americans work much more than Europeans: they are on average taxed less on their income. Therefore, the Americans not only have higher disposable income, but the tax base itself is larger. Not many people realise that if Sweden would join the US as the 51st state, then it would be in the lower half of the states in terms of average income (between Nevada and Louisiana, all three with around $58,000 GDP per capita in 2019). Moreover, heavy taxes not only induce people to work less and to prefer indirect benefits to cash: ultimately they make tax evasion more tempting.
Examples abound. In Iceland, for example, in the 1990s we decided to tax rental income no longer as personal income, with a marginal tax rate of around 50 per cent, but rather as capital gains, with a flat rate of 15 per cent. The revenue from the tax initially went down, but it soon rose up to the previous level for two main reasons: Tax returns become much more accurate because people are less inclined to cheat for a gain of 15 per cent than for that of 50 per cent; and the supply of housing increased markedly because now the income was taxed at a much lower rate than before; in other words, the tax base grew.
The American economy has been more dynamic and flexible than its European counterpart because of lower taxes and a less regulated labour market. When President Donald Trump in 2017 lowered the corporate income tax from 35 per cent in most cases to 21 per cent, he certainly moved in the right direction. Now President Joseph Biden wants to reverse this tax reform and to eliminate the possibility of exit, your most effective way of expressing dissatisfaction and disciplining people in power. A crafty old Washington insider, he knows that multinationals are not popular. It is a pity that the United Kingdom is participating in this attempt to organise a tax cartel. I myself have little sympathy personally for Google, Apple, Amazon, Facebook and some of the other giant corporations that the G7 say they are targeting. But that is irrelevant: Economic policies should not be judged by public proclamations, but rather by their likely results. It should also be recalled that the United States and the European Union are not the only players in the international arena. It is crucial in the contest which China has started with the West to maintain free, strong and vibrant economies, encouraging investment, research and development, innovation and entrepreneurship.
Ulderico de Laurentiis • 16.10.2021.
Leo Valerio Paggi • 15.10.2021.
Ulderico de Laurentiis • 16.10.2021.
Leo Valerio Paggi • 15.10.2021.