Presentation on theme: "TAX COMPETITION: THEORY AND EMPIRICAL EVIDENCE"— Presentation transcript:
1 TAX COMPETITION: THEORY AND EMPIRICAL EVIDENCE Michael P. DevereuxCentre for Business TaxationUniversity of Oxfordcopyright 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 competitionEvidence of tax competitionTrends in tax rates and revenuesEconometric evidenceConclusions
3 Basic tax competition theory Capital mobile across countries, but labour immobileGovernments provide a public good paid for by a source-based tax on the return to capitalThey choose a tax rate to reflectbenefits of higher public good provisionloss of capital abroadTax rate lower than in a closed economy
4 Questionable assumptions Labour not mobile?No other taxes available to governments?Labour income taxVATResidence-based capital income taxNo imperfect competition, economic rent, discrete choicesNo 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 ownersSo are effectively borne by domestic residentsBetter to tax them directly and avoid distortion to location of capitalie. better NOT to tax capital income
6 Extensions to model (1)Competition over discrete location choices, where firms earn economic profitIf firms want to locate near market, large countries attract investment, though they may have to pay a subsidyIf 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 rateHow much to invest – depend son marginal tax rateHow much profit to shift to lower-taxed countries – depends on statutory tax rateGovernments could compete over any of these 3 tax ratesshould 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 taxesFully co-ordinated group of countries ?Countries globally co-ordinated ?
9 Is competition harmful or beneficial? (2) Competition may be generally good, buttaxes not like ordinary markets; and governments provide goods that the private sector cannotIs competition over environmental pollution beneficial?Competition over only some taxes distort choice of instrumentsIs 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 settingIf governments act in national interest then real harm is where other countries hurt, eg.global pollutionpreventing 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 EvidenceDo governments compete? Some possible sources of evidence:Trends in tax rates, and tax reformsEvidence of impact of taxes on businessEvidence of impact of foreign taxes on domestic taxes
14 Corporation Tax Rate Reductions in EU, 2003-5 Year of reformAustria34 to 252005Belgium39 to 332003Cyprus25 to 15Czech Republic31 to 28 to 262004, 05Estonia26 to 24France35.4 to 33.8Greece35 to 32Hungary18 to 162004Italy36 to 34 to 332003, 04Latvia22 to 19 to 15Netherlands34.5 to 31.5Poland28 to 27 to 19Portugal30 to 25Slovakia25 to 19
16 But do trends tell us anything ? An implicit hypothesis that (a) globalisation and hence (b) competition have been increasing, butalso requires evidence of pattern of increased mobilitytheory says little about competition with imperfect mobilitytax rates may have moved for other reasonstax 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, butalso requires evidence of pattern of increased mobilitytheory says little about competition with imperfect mobilitytax rates may have moved for other reasonstax revenues tell a different story
21 2. Evidence of impact of taxes on business behaviour (1) Plenty of empirical evidence of effect of taxes, affectinglocation of firmsdirect flows of capitalStudies use a variety of measures of both capital and tax ratesand 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 companiesUse of debt in high-tax subsidiariesTransfer pricesComparison 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 ratesvery little researchdifficulty in identifying appropriate tax rateseg. 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 countriesfind a significant effect on the statutory rate of statutory rate in other countriesConsistent with competition for firms (via the effective average tax rate)Consistent with competition for profitOverall, results suggest significant competition, which more than explains reforms up to 2000
27 Conclusions (1)Governments do compete in statutory corporation tax ratesEU statutory rates of corporation tax have fallen steadily, and go on fallingnew member states increasing competitionBut revenues have remained buoyant; can this continue?
28 Conclusions (2) Does it matter? Depends on what is the “optimal” rate of source-based corporation taxarguably it is zero anywayharmonisation of CT may lead to competition in public services used in productionif 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 mobilityless easy to rely on taxes on residents if they are more mobilemay eventually imply need to restrict labour mobility, or agreement on income tax rates