Tax competition and the race to the bottom

The idea that countries can "compete" like companies in a market is a deeply incorrect analogy that has been used to sugar-coat harmful tax cuts and deregulations, and to spur countries into a race to the bottom.

The world is awash with mobile financial capital. Countries and states “compete” to attract this capital to their shores, using a wide variety of different lures.

For example, a tax haven may craft strong secrecy laws to allow wealthy criminals to help them hide their activities. Or a jurisdiction may offer lax financial regulation, or weak corporate governance rules, to attract banking activity which wants to escape rules and financial regulations elsewhere. It may have a permissive regime on corporate mergers and acquisitions, so that companies may monopolise markets without any interference from competition authorities. It may try to be a “data haven”, with weak data privacy protection, to lure big tech companies with promises of no oversight. And perhaps the best-known dimension of this competition comes in the area of tax. Tax havens also offer tax cuts and tax loopholes (and secrecy) for multinationals or wealthy individuals who locate themselves or activities there.

These strategies are usually pursued in the name of a euphemism like “competitiveness” or “open for business”, which may sound appealing but in fact is a woolly-headed concept that is the core tax haven model: they provide facilities to help mobile capital prosper. These facilities are provided at the expense of others: citizens, consumers, civil society, smaller businesses, ordinary taxpayers, and so on. The results are invariably greater inequality and loss of confidence in democracy.

These “competitive” incentives are always directly harmful to the wider public interest.

And this is hardly surprising. Tax, for instance, is not a cost to an economy but a transfer within it. Tax cuts for corporations provide subsidies to them, at the expense of other essential wealth-generating mechanisms: public spending on roads or courts or education, and so on. Corporate tax cuts do not make any country more ‘competitive’.

Even in the cases where tax cuts do attract investment – and the evidence on this point is extremely shaky – it attracts exactly the wrong kind of investment: the flighty kind with few productive linkages with the rest of the economy. These “competitive” strategies represent unnecessary giveaways to the owners of capital.

As a businessman I never made an investment decision based on the tax code. if you are giving money away I will take it. If you want to give me inducements for something I am going to do anyway, I will take it. But good business people do not do things because of inducements.

Paul O’Neill, former chairman of Alcoa

Survey after survey shows that what companies really want from countries is good infrastructure, the rule of law, a healthy and educated workforce, and other public goods – which require tax.

The theory that tax wars are beneficial thing rests heavily on a paper written by Charles Tiebout in 1956 which relies on insane assumptions – for example, that hordes of perfectly informed citizens flit in great shoals from one country to another, every time the tax rates change. (Tiebout admitted himself that he had written the paper as a “joke” – see the Charles Tiebout chapter in the Finance Curse book for more.)  

Yet when countries provide these incentives to lure global capital to their shores. a second round of damage ensues. Once one jurisdiction offers a law to protect secrecy, for instance, others will try to match it or exceed it: providing an even stronger or more devious secrecy law. The first jurisdiction may feel it is losing out in a kind of “global race” to attract criminal capital so it offers something even more beneficial to the owners of capital (and by extension, even more harmful to the wider public interest.)

As this dynamic process continues, a race to the bottom ensues. This gets called “competition” but it has nothing to do with competition between firms in a market. To get a first sense of the difference between the two forms of competition, ponder the difference between a failed company and a failed state.

“The notion of the competitiveness of countries, on the model of the competitiveness of companies, is nonsense.”

Martin Wolf,  chief economics commentator, Financial Times

To repeat: while market competition between companies can provide many benefits, this very different global race between countries is always harmful.  (We prefer to talk of ‘tax wars’ instead of ‘tax competition,’ for example.)

This harmful dynamic has been a counterpart of ideological changes since the 1960s espousing corporate deregulation and tax cuts for the wealthy: a real-world battering ram that has steadily forced countries to cut back on taxes and remove legal protections for workers, consumers, and the environment.

As well as boosting inequality this general race to the bottom in areas like tax erodes democracy, subsidises unproductive rent-seeking, weakens national safety nets, kills jobs by subsidising capital at the expense of labour, allows elites to escape the rule of law, and reduces productivity and economic growth. Tax wars bite all countries – but harm developing countries particularly hard.

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