1. TAX COMPETITION: THEORY AND EMPIRICAL EVIDENCE
Michael P. Devereux
Centre for Business Taxation
University of Oxford
copyright rests with the author

2. Plan A brief introduction to the theory Evidence of tax competition
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

3. 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
benefits of higher public good provision
loss of capital abroad
Tax rate lower than in a closed economy

4. 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

5. 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

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

7. 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

8. 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 ?

9. 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 ?

10. 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 ?

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

14. Corporation Tax Rate Reductions in EU, 2003-5
Year of reform
Austria
34 to 25
2005
Belgium
39 to 33
2003
Cyprus
25 to 15
Czech Republic
31 to 28 to 26
2004, 05
Estonia
26 to 24
France
35.4 to 33.8
Greece
35 to 32
Hungary
18 to 16
2004
Italy
36 to 34 to 33
2003, 04
Latvia
22 to 19 to 15
Netherlands
34.5 to 31.5
Poland
28 to 27 to 19
Portugal
30 to 25
Slovakia
25 to 19

16. 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

18. 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

21. 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

22. 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

24. 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

25. 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

26. One study Devereux, Lockwood & Redoano (2005)
examine effective marginal tax rate and statutory tax rate in OECD countries
find a significant effect on the statutory rate of statutory rate in other countries
Consistent with competition for firms (via the effective average tax rate)
Consistent with competition for profit
Overall, results suggest significant competition, which more than explains reforms up to 2000

27. Conclusions (1)
Governments do compete in statutory corporation tax rates
EU statutory rates of corporation tax have fallen steadily, and go on falling
new member states increasing competition
But revenues have remained buoyant; can this continue?

28. Conclusions (2) Does it matter?
Depends on what is the “optimal” rate of source-based corporation tax
arguably it is zero anyway
harmonisation of CT may lead to competition in public services used in production
if harmonisation were possible, why not consider residence-based tax within the EU?
Or are political considerations paramount?

29. Conclusions (3)
Longer term issues arise with increasing labour mobility
less easy to rely on taxes on residents if they are more mobile
may eventually imply need to restrict labour mobility, or agreement on income tax rates