Globalisation has had positive effects on the development of current tax systems and it has encouraged countries to engage in fiscal reforms that reduce taxation. However, it has also created an environment in which tax havens thrive and governments can be induced to adopt harmful preferential tax regimes to attract investment within their territories.
What Is Tax Competition?
This phenomenon, called tax competition – or tax war by some – is realised with the economic integration of the different tax jurisdictions, thanks to the mobility of production factors and income subject to tax flows. Given these conditions, governments compete with each other in order to increase the level of well-being of their residents.
Tax competition is therefore a process in which states, or even cities, use tax breaks and grants to attract investment, multinational corporations or hot money to create more jobs and higher tax revenues. According to economic theory, jurisdictions that reduce taxation on production factors may increase the level of investment within their economy at the expense of jurisdictions with a higher tax burden. In order to react to the outflow of production factors, the other tax jurisdictions are driven to lower their rates, triggering a downward trend in tax rates.
According to some authors, referring to Cournot Equilibrium and Game Theory, the long-term equilibrium produced by tax competition would be inefficient as the tax burden would become too low. This is referred to as harmful tax competition. Other authors, on the contrary, believe there is beneficial tax competition when the equilibrium produces efficient results as it pushes executive power to pursue collective well-being with the least waste of public resources.
In order to limit the possible negative externalities associated with tax competition, regulators should harmonise tax legislation or devolve their tax sovereignty to a higher level of government. This solution is not always possible because states are reluctant to limit (or lose) their fiscal sovereignty and, secondly, because of the presence of states that do not benefit from tax coordination (so-called free riders). Another problem is that countries with a smaller territorial dimension or population have to support lower public spending and thus have a greater capacity to reduce their rates. In the absence of a central coordination, it is extremely difficult to combat the phenomenon of harmful tax competition. Such considerations also explain the presence and nature of the so-called tax havens.
Horizontal and Vertical Competition
In general, the competition between different tax jurisdictions is called horizontal tax competition because it affects independent and sovereign governments. There is, however, a further form of competition, called vertical tax competition, which affects different levels of the same government. Economic theory considers efficient vertical tax competition, basing this judgment on the model of C.M. Tiebout (1954). According to this model, which takes on the perfect mobility of individuals, citizens who are dissatisfied with the policies implemented by their local governments will reside in other places, thereby creating competition between governments through the mechanism of Albert O. Hirschman known as “Foot Voting”. Local governments, therefore, would be able to better detect citizens’ preferences and offer, with greater efficiency, the public services required by the population.
On the other hand, even the different characteristics of various tax structures can cause alternations on the effects of tax competition. For example, countries such as Denmark and the United Kingdom rely relatively less on direct social charges than countries like France. Factors like this can well explain why tax competition can be classified as “harmful” by a state but not so by another.
Amongst the motivations of tax competition supporters is that tax rates, being lower, encourage investment. It also allows firms to generate more profit that can be used for research and development (R&D) and business investment. On the government side, lower taxation encourages legislators to reduce public spending and increase efficiency.
By doing historical analysis, it can be seen that tax reductions became a major issue in the 1960s and 1970s. Margaret Thatcher rescued the UK economy by reducing taxation from 83% to 40%. Ronald Reagan restored the US economy by cutting the tax rate from 70% to 28%. But the most interesting thing in these tax cuts is that it has seen other nations forced to follow the US and UK: taxes in main industrialised countries have fallen overall by over 65% to about 40%. This leads the competition supporters to say that in this way tax policy has improved and that the global economy is much stronger today than in the 70s.
Similarly, in the plans of Donald Trump’s electoral program, there is the will to cut corporate tax rates from 35% to 15%. This is making governments such as Germany, France and China worry about their own tax regimes.
The Disadvantages of Tax Competition
Some instead argue that tax competition is harmful and argue that there is no gain: ultimately, only a few countries have benefits at the expense of others. In addition, investments prove temporary because multinationals shift their capital every time a country reduces taxation. They are thereby attracted fickle investments that have few productive ties with the real economy.
If corporate tax rates are reduced, other taxes, such as income tax or VAT, will have to rise to face the shortage. This could represent an increase in social inequality and this also means that countries lose the power to choose how to distribute the tax burden on their economy. This, therefore, erodes democracy, reduces productivity and economic growth, promotes capital at the expense of labour, and tightens state budgets.
In this way, those who are against tax competition prefer to call it a “tax war” because it is much more like a trade war or a currency war than a competition in the product market.
Europe, like many other realities, has studied and tried to regulate tax competition. The “Anti-Tax Avoidance Package” adopted on 28 January 2016 is part of the ambitious agenda of the European Commission for a taxation more equitable, simpler and more effective. This package contains concrete measures to prevent aggressive tax planning, increase fiscal transparency and create equal conditions for all EU firms.
Tax competition is not always harmful, but when it is, cooperation between the parties is essential to counteract it. Tax competition has limited the tax-increasing trend in relatively high-rate countries and has produced convergence within the EU Member States. Coordination and cooperation are justified when the degree of competition produces a potential failure to reap the benefits that the single market provides in terms of growth and employment.
It has not yet come to the definition of a range where the tax rate may change. For example, in the field of VAT, a minimum rate of 15% was set by the EU in 1992 but no proposal for a maximum limit of 20% was approved. It seems therefore that EU legislators want to leave the maximum rates to competition and market forces. In any case, there is an upper natural limit since any possible increase in rates may lead to a fall in the aggregate revenues due to the imposition of taxation.
In any case, the balance between competition and cooperation is crucial. Although it is possible to initiate community action to eliminate obviously harmful tax competition, it is preferable to start a cooperative action. Greater cooperation and exchange of information between tax authorities of the origin and residence countries are considered the correct preservation of national sovereignty and of market forces.
Venezuelan Digital Currency Backed by Oil
Venezuela has announced plans to launch a digital currency, “the petro”, backed by the country’s oil and mineral reserves. The petro aims to help ease the country’s monetary crisis but sceptics claim the proposal has no credibility and will not help those in extreme need.
Why It’s Important
Hyperinflation has eroded the Venezuelan bolivia’s value by 97% this year, making imports incredibly expensive and causing many to abandon trust in the currency. The country’s oil reserves made up 95% of its exports in 2016, while oil and gas extraction accounted for 25% of GDP. Rich supplies of resources provide some initial credibility to the proposal, but President Maduro’s questionable track record when it comes to monetary policy is making many sceptical about the proposal. His currency controls and money printing have only added to the monetary crisis. Maduro has not announced when the digital currency would come into use or any details regarding how the country would create such a system.
Opposition leaders argue the country’s shortages of food and medication are far more pressing and that the digital currency will not address this. The digital currency may provide a more trusted medium of exchange, but it is unlikely to help those in excessive poverty.
The US Senate Approves the Republican Tax Bill
During the early hours of Saturday morning, the Senate passed the Republicans’ landmark bill in what could become the USA’s first tax overhaul since 1986 and the first legislative success of the Trump presidency. Meanwhile, Democrats have denounced the bill as essentially a handout to the wealthy that will disproportionately squeeze other segments of society.
There is also a strong feeling among many Democrats and Republicans that the bill was hastily drafted and improperly thought through. Democrat senator Chuck Schumer said:
“I have not seen a more regressive piece of legislation, so devoid of rational, so ill-suited for the condition of the country”.
For Trump, however, this is a victory and a step towards making good on some of the policy promises that formed his election manifesto. So far, the Trump presidency has been characterised by racial tensions, a failure to repeal Obamacare and no sign of the infamous border wall being built. Accordingly, the President made his feelings known on Twitter following the Senate’s approval of the tax bill.
We are one step closer to delivering MASSIVE tax cuts for working families across America. Special thanks to @SenateMajLdr Mitch McConnell and Chairman @SenOrrinHatch for shepherding our bill through the Senate. Look forward to signing a final bill before Christmas! pic.twitter.com/gmWTny3SfS
— Donald J. Trump (@realDonaldTrump) 2 December 2017
The tax bill is not yet in the clear, however. It will now be amalgamated with legislation that has passed through the House of Representatives. This process will commence next week and it is likely that there will be further complaints from Democrat lawmakers.
Meanwhile, business groups, who will be the primary beneficiary of the tabled plan to reduce corporation tax from 35% to 20%, have welcomed the bill’s progress. Jamie Dimon, JPMorgan’s CEO, congratulated the Senate and said that the reforms would “boost [our] economy and benefit American workers.”
It is yet unclear what impact the tax cuts will have on the USA’s national budget. Despite Trump’s promise to balance the nation’s books, a congressional watchdog has recently said that Trump’s tax plan will send the deficit soaring and only put slightly more cash in the wallets of millions of ordinary American families across the country.
How Trump Inadvertently Prompts Discussions of Unlikely Issues
In 1916, in a letter to David Lloyd George’s daughter, Winston Churchill admitted:
“I think a curse should rest on me – because I love this war. I know it’s smashing and shattering the lives of thousands every moment, and yet, I can’t help it, I enjoy every second of it”
Can Trump be considered the moral equivalent of World War One in terms of the mayhem he has wrought upon civilised notions of the way the world should be? Probably not, but the damage he has caused is nonetheless considerable. The juxtaposition of Trump with Churchill seems appropriate because, as the President dismantles so much of what has come to be normative behaviour in civilised society, he is inadvertently promoting a re-examination of the things that America holds dear – in the same way that the world has re-examined its opinion on war in the 100 years since Churchill made his aforementioned remark.
The fact that Trump was elected notwithstanding the revelations in the Access Hollywood tape has likely been responsible for women finally declaring enough to be enough. Would Harvey Weinstein, Kevin Spacey, Louis CK, Matt Lauer have been exposed in a Hillary Clinton administration? The fact that Trump’s tweets are ill-considered, often factually wrong and inflammatory, has promoted a sober discussion of how to deal appropriately with the issues of racism and immigration.
The fact that Trump is actively withdrawing from the theaters of international endeavor – trade, diplomacy and climate change – has led to a careful consideration of why those things might be important to Americans. The fact that Trump shamelessly panders to his base, regardless of collateral damage to broader public opinion, has resulted in a careful review of the stakes involved in tribal loyalty.
Sexual Assault and Tax Reform
Susan Collins, one of the senators for Maine, was asked at a recent Christian Science Monitor Breakfast whether, if Roy Moore were elected to fill the Alabama Senate seat vacated by Jeff Sessions, he should be unseated by the Senate. She stressed, firstly, that she protested his candidacy even before the allegations of sexual assault. She went on to say that the question of whether the Senate would have the right to unseat him if he were to be elected by the people of Alabama, accusations of sexual assault notwithstanding, was a very difficult one.
She is right. A trial in the court of public opinion has a different standard and different procedures from a trial in the justice system. An election is perhaps the most exacting kind of public opinion trial. An acquittal by the voters does not preclude future legal proceedings, but, while it is clear that NBC is within its rights to fire Matt Lauer, it is less clear that the US Senate or House of Representatives has the right to unseat Moore – if elected – or, respectively, John Conyers as Nancy Pelosi has urged.
Tax reform is currently top of mind in DC and, as this article is written, the Senate is close to passage of its bill. As it stands, neither Moore not Conyers will be voting for tax reform: Moore because the vote will likely pre-date his election; Conyers because he is a Democrat and votes for the bill that is presented to both Houses of Congress, after it has been to conference committee to sort out the differences between House and Senate versions, are expected to proceed along party lines.
Hypocrisy and Principle
Fitness to serve and uphold the values for which representatives are elected are both called into question by the context in which the current tax reform legislation is proceeding.
Mitch McConnell, Senate Majority leader made it clear in an interview in May 2017 that he believed any tax overhaul could not add to the growing budget deficit. Steve Mnuchin, Treasury Secretary, claimed the proposed tax reforms, which include a reduction in the corporate tax rate from 35% to 20% would pay for themselves.
The Joint Committee on Taxation was asked to conduct a macroeconomic analysis of the impact of the Senate Tax Cuts and Jobs Act bill – the so-called dynamic scoring report that would validate Mnuchin’s statements. The report revealed approximately $458bn of savings due to economic growth. That left a deficit increase over the next ten years of $1trn.
The report leaves the Republican party with the uncomfortable choice of passing a bill that contradicts its stated, fiscally prudent governing principle of not increasing the deficit or failing to pass tax reform, which, it is assumed, would have dire electoral consequences in 2018.In the court of public opinion as it stands in 2017, hypocrisy and lack of principle may prevail.
Churchill was a little ashamed of enjoying World War One. Should one be equally ashamed while watching the unravelling of the hypocrisies of the elite-world order? Perhaps, but there is a decent chance that, as public officials (Mike Flynn, for example) are convicted of lying in the service of their president and the unwinding of male privilege rolls through the power venues of Hollywood and Washington DC, hypocrisy and abandonment of principle may extract a price and the Republican Party may find that it has made a profound mistake.
More on Tax
Taxation and Morality: What Underpins the US Tax System?
Governments need money to fix the roads; to keep airports running; to keep bridges safe; to pay the armed forces;...
The Paradise Papers: The Impact of Large-Scale Tax Avoidance
The Paradise Papers are the next instalment of the Panama Papers. The Panama Papers were a leak from Mossack Fonseca,...
Sell Your Tax Losses Here!
In 2015, in the wake of the financial crisis, the Treasury Inspector General for Tax Administration published a report, detailing...
Cryptocurrencies2 days ago
SALT – A Technology Bringing New Opportunities?
Cryptocurrencies2 days ago
Indian Tax Authorities Swoop in on Bitcoin Exchanges
Cryptocurrencies2 days ago
South Korea Bitcoin Regulation on the Horizon
Asia2 days ago
Google to Open Artificial Intelligence Centre in China
Companies1 day ago
Cryptocurrency as Collateral for Loans: Risky Business?
Global Affairs1 day ago
Breakfast Briefing: Space Race, Google in China and Zuckerberg
Companies20 hours ago
Crypto Briefing: Bitcoin Futures, Scams and ICOs
Companies1 day ago
Telegram Is Not for Sale