Tax Wars

Tax ‘competition’ – more accurately known as Tax Wars – is the process by which countries, states or even cities use tax breaks and subsidies to attract investment or hot money. In response to ‘competitive’ pressures they cut taxes on wealthy individuals, or on corporations – then make up the difference by hiking taxes on poorer sections of society. Inequality rises.

At a global level, this process is a race to the bottom – and it has no redeeming features. It is always harmful, particularly for larger economies. As well as boosting inequality it erodes democracy, subsidises unproductive rent-seeking, kills jobs by subsidising capital at the expense of labour, and reduces productivity and economic growth. Tax wars bite all countries – but it hurts developing countries particularly hard.

A ‘competitive’ tax system is a bad tax system

At a national level, all the evidence shows that it is a mistake to try and create a ‘competitive’ tax system, strange though that may sound.

Why is this? For two big reasons.

First, tax ‘competition’ bears no economic relation to competition between firms in a market. They are utterly different economic beasts. All that these different processes share is a word in the English language: ‘competition’. Because of this word, many people see this as a beneficial process. We prefer the term, tax wars, which is more like trade wars or currency wars than it is like competition – and which more accurately conveys the harm.

Second, tax is not a cost to an economy, but a transfer within it. Tax cuts for corporations provide subsidies to them, at the expense of another essential wealth-generating mechanism: public spending on roads or courts or education, and s on. So it is not obvious how corporate tax cuts make any country any more ‘competitive’ – whatever ‘competitive’ may mean.

Even if cutting taxes does attract investment – and the evidence out there on this point is very shaky – it attracts exactly the wrong kind of investment: the flighty kind with few productive linkages with the rest of the economy.

The fantasy of beneficial tax ‘competition’

The theory that tax wars are a good thing rests heavily on a paper written in 1956 which relies on unspeakable assumptions – for example, that hordes of perfectly informed citizens flit in great shoals from one country to another, every time the tax rates change. This and other similarly unworldly assumptions in the paper are  nonsense.

Although the arguments can get quite complicated, not least because of the large number of academic studies out there straining the morass of evidence to show that tax wars provide benefits, our short article provides a useful introduction to the issue. We will soon publish research providing a more comprehensive overview of the issues, and explaining why much of the academic literature on this topic is entirely missing the point.

Language is crucial. We urge all to stop referring to ‘tax competition’ and talk about ‘tax wars’ instead. After all, the process is far more akin to currency wars or trade wars than it is to competition between firms in a market. If you really must use the term tax competition, then at least put ‘competition’ in quote marks, to signal that you have understood the fallacies.