Is tax competition really so bad?

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Forget something as simple as a tax hike. There’s a growing movement not only to raise but also to fix tax rates on a global scale.

The G-20 is pursuing a so-called “global minimum tax,” which would establish a specific taxing level in the world’s largest economies. While the proposal is thus far limited to the tax rate imposed on company profits, this is very likely just the opening salvo in pushing for global minimum tax rates of all kinds.

Proponents of global minimums claim that tax competition creates a “race to the bottom.” They dislike it when countries cut taxes to entice businesses and people to locate within, or not leave, their boundaries. When one country cuts its taxes, other countries face competitive pressure to do likewise. As a result, the overall global tax level, and hence the size and scope of government, is kept lower.

In any other context, such competition would be welcomed. Take retail. Firms would prefer to boost their profits by colluding to fix high prices. But a long-held staple of economic theory is that collusion harms society and competition maximizes social well-being. That is why we have antitrust laws.

While economists of all flavors broadly promote the benefits of competition, some are claiming an exception for taxation. In their telling, tax competition harms society rather than helping it. If all countries could collude to raise their tax rates simultaneously, the theory goes, they could all raise revenues without losing any output or jobs.

The implicit assumption here is that taxes negatively distort economic behavior only with respect to where businesses locate and not whether they will operate at all. Tax more of something, and you will not get less of it so long as others simultaneously tax it more. Apparently, global economic output is a static, zero-sum game.

I disagree. Innovation creates the positive-sum outcome of economic growth. But entrepreneurs take risks only if they feel the tax-adjusted expected value of the reward justifies it. Incentives matter, and tax rates are a large part of the entrepreneurial calculus. Raising taxes globally will reduce entrepreneurial behavior and, hence, slow global economic growth.

Removing the competitive pressure for governments to keep tax rates low seems to be a dangerous game. Imagine if high-tax states such as California and New York succeeded in imposing on the nation a state income tax minimum of 20%. Sure, this would reduce the steady stream of businesses leaving those states for low-tax ones. But it certainly doesn’t follow that people would be better off.

Government taking in more tax revenue doesn’t automatically enhance social welfare. Were these funds left in the private economy, entrepreneurs could more effectively deploy them to create innovations that improve lives and grow the economy. With that money taken away, those innovations are harder to come by, and so are the entrepreneurs who could have developed them.

Collusion simply cannot create a fairer, more equitable system, either with taxes or any other kind of economic activity. In 1897, shortly after the United States passed the Sherman Antitrust Act, a large group of railroads were charged with colluding to fix prices. In their defense, they argued that they were fixing prices at reasonable rates. The Supreme Court rejected this argument and ruled that it was the role of competition to determine what rate is reasonable.

What is true for companies is equally true for countries, not only as a matter of policy but also as a matter of basic economics. The U.S. and the G-20 may think the laws of economics don’t apply in this case, but they have yet to make that case effectively. Regional tax competition promotes bigger economies, higher wages, and faster growth.

Jason E. Taylor is professor of economics at Central Michigan University and member of the Mackinac Center’s Board of Scholars.





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