Regular readers know that I am a tireless advocate for tax competition, which exists when governments are encouraged to adopt better tax policy in order to attract/retain jobs and investment. In other words, I want governments to compete with each other because that leads to better policy, just as we get better results as consumers when banks, pet stores, hairdressers, and grocery stores compete with each other.
There is powerful evidence that tax competition has generated very good results in the past 30 years. Top personal income tax rates averaged more than 67 percent back in 1980, but thanks in large part to tax competition, the average top tax rate on individuals has fallen to about 41 percent. Corporate tax rates also have dropped dramatically, from an average of around 48 percent (this data is not as easy to pin down) in 1980 to 25 percent today. And we now have more than 30 flat tax nations today, compared to just 3 in 1980.
That’s the good news. The bad news is that greedy politicians don’t like being constrained by tax competition. Politicians didn’t lower tax rates because they wanted to. They only made their tax systems better because they were afraid that jobs and investment would escape to lower-tax jurisdictions. They resent the fact that tax competition makes it hard to engage in class-warfare tax policy.
That’s why many of these politicians are seeking to replace tax competition with some sort of tax cartel. They want to impose rules on the entire world that will make it hard for taxpayers to benefit from better tax policy in another jurisdiction. In effect, they want some form of tax harmonization, which would create an “OPEC for politicians.” And just as the real OPEC extracts more money from energy consumers, a tax cartel would grab more money from taxpayers.
One aspect of this battle is the way proponents of higher taxes try to demonize so-called tax havens. Many of these jurisdictions are very small, but the smart ones nonetheless defend themselves against the attacks coming from the world’s major welfare states. Here’s a good example. Tony Travers of Cayman Finance, the association representing the financial services industry in the Cayman Islands, recently spoke about the left’s campaign against low-tax jurisdictions.
Travers said he believed the widespread negativity was part of well organised and powerful public relations campaigns driven by onshore Treasury, and supranational and domestic regulatory bodies. British politicians such as Emma Reynolds and former Prime Minister Gordon Brown and even US President Barack Obama were, he said, examples of politicians that were “blame deflecting … and anxious to obfuscate the failures of their domestic regulatory systems … by suggesting that in some way it is the tax or regulatory system of the offshore financial centre that is at fault.” He claimed the problems they were trying to conceal by their demonisation of offshore centres had their source onshore. He described various socialist activist movements, such as the trade unions, major charities such as Oxfam, and Travers arch nemesis, Richard Murphy of the Tax Justice Network as the “Tax Taliban” .
This fight is occurring at all levels. A new scholarly study from the Instituto Bruno Leoni in Italy digs into the academic debate about tax competition. Written by Dalibor Rohác of London’s Legatum Institute, the report debunks the argument that tax competition somehow is economically inefficient.
The first common argument is that tax competition distorts the allocation of mobile factors of production across countries. The second argument recurrent in the literature says that tax competition can reduce tax revenue and endanger the stability of public finances. The troublesome feature of both of these arguments is that they start from the assumption of government benevolence and omniscience. For instance, the first argument presupposes that the initial allocation of capital between the two countries was optimal and that tax competition is driving it away from the optimum. Likewise, the second argument implicitly assumes that the initial amount raised in taxes corresponded to some well-defined social optimum and therefore that tax competition drives revenue below that optimal level. Hence neither of these arguments holds in the light of basic public choice theory which convincingly demonstrates that governments do have a tendency to overspend and overtax.
Rohác cleverly exposes the other side’s statist agenda. He explains that their main argument is based on the idea that different tax rates in different nations will lead to an inefficient allocation of investment. He then points out that there is a pro-growth way and an anti-growth way of dealing with this supposed problem.
…if the problem of capital misallocation is caused by differences in tax rates among countries, than introducing a maximal rate is a solution that would be equally appropriate. …tax competition might well offer a solution to the alleged problem of misallocation of capital caused by tax differentials. If tax competition was a “race to the bottom,” then the final outcome would actually be a tax rate harmonized across countries and harmonized at a rate of zero per cent, thus eliminating capital tax distortions altogether.