What is Tax Competition?

What is Tax Competition?

Tax competition broadly refers to the process of national governments and other relevant authorities lowering tax burdens as a means of stimulating and encouraging economic growth, in relation to what the tax rates might be in neighbouring countries.

For example, if there were three countries in close proximity to each other, they might compete with each other with lower corporate taxation rates in order to attract more businesses into their country, thus boosting their economy. If a business could set up in a country with a 20% corporate taxation rate and it is easy to do so, why would they set up where there is a 30% rate?

Thanks to the impact of globalisation on the world economy, it isn’t even the case of having to set up in a neighbouring country anymore, particularly if a business operates predominantly online.

Tax competition is often a controversial topic, as there is widespread debate about whom it benefits, if anyone. On top of looking at what tax competition is, we’ve also broken down the perceived pros and cons of tax competition.

What’s good about Tax Competition?

Those who favour tax competition believe that it helps to create jobs and thus boosts the economy. They believe primarily that:

  • Tax competition attracts businesses, which in turn creates jobs.

  • Increased economic activity increased tax revenues, even with lower tax rates, particularly if the jobs are well paid and a high proportion of workers are subject to higher rates of personal income tax.

It is also argued that tax competition makes governments more accountable as they have to ensure they are using their taxes more effectively. However, this is often contradicted by the argument that lower tax rates can actually raise the total incomes through taxation of a government, although there is little evidence that tax rates have any direct impact on economic growth overall.

What’s good and bad about Tax Competition?

Many financial analysts believe that tax competition is great for investors and for businesses looking at attracting investment. However, several analysts believe this positive is offset in countries where the personal rate of tax is higher in order to balance the revenues that would otherwise have been brought in as corporate taxes.

Those with this viewpoint often argue this is down to shortsighted government, although it has also been seen as a deliberate ploy before. A multinational business will find it easy to relocate to where tax rates are lower, for example, but it is usually less easy for individuals to do so.

What’s bad about Tax Competition?

People who disagree with the principles behind tax competition usually argue that it creates a false economy by attracting investment that otherwise wouldn’t have made its way to a particular country, and that more often than not it increases the tax burden on individuals due to the reduction in corporate taxes. They also argue that it actually reduces the efficiency of capital distribution and can be used a political tool rather than for genuine economically beneficial purposes.