tax conf devereux pres en

TAX COMPETITION: THEORY AND
EMPIRICAL EVIDENCE

Michael P. Devereux
Centre for Business Taxation
University of Oxford
copyright rests with the author


Plan
• A brief introduction to the theory
– should we expect competition?
– should we expect a “race to the bottom”?
– can we distinguish “beneficial” and “harmful”
tax competition

• Evidence of tax competition
– Trends in tax rates and revenues
– Econometric evidence

• Conclusions


Basic tax competition theory
•
•

•

Capital mobile across countries, but
labour immobile

Governments provide a public good paid
for by a source-based tax on the return to
capital
They choose a tax rate to reflect
(a) benefits of higher public good provision
(b) loss of capital abroad

•

Tax rate lower than in a closed economy


Questionable assumptions
• Labour not mobile?
• No other taxes available to governments?
• Labour income tax
• VAT
• Residence-based capital income tax

• No imperfect competition, economic rent,
discrete choices
• No publicly-provided goods for production


Incidence & Some Implications
• Taxes on capital (in small open economy)
cannot reduce the post-tax rate of return to
owners
• So are effectively borne by domestic
residents

• Better to tax them directly and avoid
distortion to location of capital
– ie. better NOT to tax capital income


Extensions to model (1)
Competition over discrete location choices,
where firms earn economic profit
1. If firms want to locate near market, large
countries attract investment, though they
may have to pay a subsidy
2. If firms want to locate away from their
competitors, governments can raise
(some) tax without distorting investment


Extensions to model (2)
• 3 levels of decision:
– Where to locate a new facility – depends on average
tax rate
– How much to invest – depend son marginal tax rate
– How much profit to shift to lower-taxed countries –
depends on statutory tax rate

• Governments could compete over any of these 3
tax rates
– should depend on mobility of firms v capital v profit


Is competition harmful or

beneficial? (1)
Compared to what ?
– Closed economy ?
– Partially co-ordinated group of countries ?
• eg. in capital taxes, but not labour taxes

– Fully co-ordinated group of countries ?
– Countries globally co-ordinated ?


Is competition harmful or
beneficial? (2)
• Competition may be generally good, but
– taxes not like ordinary markets; and governments
provide goods that the private sector cannot
– Is competition over environmental pollution
beneficial?
– Competition over only some taxes distort choice of
instruments

• Is a distinction based on competition for firms &
capital as opposed to competition for profit ?


Is competition harmful or
beneficial? (3)
• All competition acts as a constraint in national
policy setting
• If governments act in national interest then real
harm is where other countries hurt, eg.

– global pollution
– preventing other countries raising taxes on capital ?

• But should we tax source-based profit anyway?
– arguably not on efficiency grounds; and can use other
instruments for equity ?


Empirical Evidence
Do governments compete? Some possible
sources of evidence:
1. Trends in tax rates, and tax reforms
2. Evidence of impact of taxes on business
3. Evidence of impact of foreign taxes on
domestic taxes




Corporation Tax Rate Reductions in EU, 2003-5
Reduction (%)

Year of reform

Austria

34 to 25

2005

Belgium

39 to 33

2003

Cyprus

25 to 15

2003

31 to 28 to 26

2004, 05

Estonia

26 to 24

2005

France

35.4 to 33.8

2005

Greece

35 to 32

2005

Hungary

18 to 16

2004

Italy

36 to 34 to 33

2003, 04

Latvia

22 to 19 to 15

2003, 04

34.5 to 31.5

2005

28 to 27 to 19

2003, 04

Portugal

30 to 25

2004

Slovakia

25 to 19

2004

Czech Republic

Netherlands
Poland



But do trends tell us anything ?
• An implicit hypothesis that (a) globalisation
and hence (b) competition have been
increasing, but
– also requires evidence of pattern of increased
mobility
– theory says little about competition with
imperfect mobility
– tax rates may have moved for other reasons
– tax revenues tell a different story

Outward FDI: US and UK
250

2000 $bn

200
150
100
50
0
1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003
Year
UK

US


But do trends tell us anything ?
• An implicit hypothesis that (a) globalisation
and hence (b) competition have been
increasing, but
– also requires evidence of pattern of increased
mobility
– theory says little about competition with
imperfect mobility
– tax rates may have moved for other reasons
– tax revenues tell a different story

2. Evidence of impact of taxes on
business behaviour (1)
• Plenty of empirical evidence of effect of
taxes, affecting
– location of firms
– direct flows of capital

• Studies use a variety of measures of both
capital and tax rates
– and hence estimates of elasticities vary widely


2. Evidence of impact of taxes on
business behaviour (2)
• Also evidence of effects of tax on the
location of profit, eg:
– Repatriation of dividends to parent companies
– Use of debt in high-tax subsidiaries
– Transfer prices
– Comparison of profit across countries



But evidence of tax competition ?
One more stage required before
governments should respond to
concerns of effects of tax:
• What are the welfare consequences of

the induced behaviour of firms? eg:
– Is the aggregate capital stock lower?
– Are productivity and wages lower?

•

Relatively little research on these issues


3. Evidence of impact of foreign
taxes on domestic taxes
Direct examination of relationship between
tax rates
• very little research
• difficulty in identifying appropriate tax rates
– eg. implicit rates (or revenue/GDP) may show
common movements due to correlation in
economic cycle across countries