Is tax competition bad?

Competition is good, right?

Market competition can be good, but tax ‘competition’ – which we also sometimes call 'tax wars' – is a completely different beast. And it is always harmful.

In markets, firms compete to offer better goods and services at lower prices, and this is generally beneficial. Tax 'competition,' by contrast, is the process by which countries, states or even cities offer tax breaks, subsidies and other facilities to tempt investment or hot money or financial capital from elsewhere. (To get a first sense of how completely different the two processes are, ponder the comparison between a failed company (like Toys R Us, which could not compete with Amazon), and a failed state, like Syria amid civil war.) 

When one jurisdiction offers tax breaks, subsidies and other enticements to wealthy individuals or multinational enterprises, other jurisdictions often follow suit, egged on by private sector bankers, lawyers, accountants and lobbying firms. They will be offering even more attractive loopholes, subsidies, and so on. 

At a global level, this process degenerates into a race to the bottom. As a result, tax rates on multinationals and on mobile capital fall ever lower, allowing them to free-ride on public services (like the roads they use, the health and education systems that prepare and care for their employees, or the courts that underpin their contracts.) Or, to make up the lost corporate tax revenues, poorer sections of society must pay higher taxes.  It is also important to note that the race to the bottom does not stop at zero, as tax cuts and loopholes give way to outright subsidies to try and persuade companies or profits to relocate there. There is literally no limit to which multinational enterprises would like to free-ride off the services paid for by others.

As all this happens, economic inequality rises, and societies and democratic systems are undermined, as citizens perceive one set of easy rules for rich folk and multinationals, and another set of rules for everyone else. The process effectively subsidises unproductive rent-seeking, kills jobs by prioritising capital at the expense of labour, and reduces productivity and economic growth. 

Tax wars bite all countries – but hurt developing countries particularly hard.

Tax "competitiveness" is also bad

It is often asserted that it is a good idea for a country to have a "competitive" tax system. It sounds fabulous, and it is easy to persuade people of this. They may consequently support corporate tax cuts and loopholes.  However, this argument rests on fallacious reasoning.

One reason is that a corporate tax (or any tax) is not a cost to an economy, but a transfer within it. Tax cuts for corporations provide subsidies to them, at the expense other essential wealth-generating mechanism: public spending on roads or courts or education, and so on. So it is not obvious how corporate tax cuts make any country any more ‘competitive’ – whatever ‘competitive’ may mean. This is a complex area, however: for an introduction, see our document Mythbusters: "a competitive tax system is a good tax system."

Further reading

  • For more details on tax 'competition' and the race to the bottom, click here.

  • For an exploration of the history of the 'tax competitiveness' ideology, see the chapter on Charles Tiebout, here, and the Fools' Gold blog, here.