Globalization and tax
competition
Alexander W. Cappelen
Econ 4620
Plan
1. What is globalization?
2. How does globalization affect pre-tax income
inequality?
3. How does globalization affect redistributive
policy?
4. Possible solutions.
Globalization
• What is globalization?
– Economic integration
• Increased international mobility of capital,
commodities/services and people.
– But globalization also has other, social and cultural
dimensions.
• Two types of causes
– Technological and social changes
• Reduced costs of transportation and communication
• Lower social barriers and increased language skills.
– Political reforms
• Reduction in import tariffs and other barriers to trade.
• Increased number of market economies.
What is new about the current
globalization process?
• Globalization is not new phenomenon.
– According to some measures the world was equally
integrated before the first world war.
• The process of globalization is different
today.
– It is primarily capital, not labour that has experienced
increased international mobility.
– The composition of trade has changed
• Intraindustri trade
– The size to the welfare state and the average tax levels
have increased.
Globalization and development
• Globalization creates a potential for growth and
development.
• Increased trade and international investments give
new countries access to
–
–
–
–
New technology
New products
New markets
New information
What are the consequences of
globalization?
• As a result of economic integration the world has
– Experienced a unique growth in international trade
– Increased economic growth
– Reduced national autonomy
• The growth has not been equally distributed
– Increased inequality?
• Nationally?
• Internationally?
Increased pre-tax inequality
•
There is considerable evidence that income
inequality has increased in the developed
countries
Globalization can create increased pre-tax
inequality in at least three ways:
•
–
Equalization of international factor prices.
•
The way level of unskilled workers might fall while the wage
level of the high skilled might increase as a result of trade with
less developed countries.
–
However, the major part of international trade takes place
between rich industrialized countries.
Cont.
– Reduced power for the labor unions.
• Firms can move their production to other countries and
this increases their bargaining power with respect to the
labor unions.
– The winner takes all society
• In some markets we have ”winner”. When markets are
integrated several national winners are replaced by one
international winner.
Globalization and redistribution
• Globalization will also reduce the governments
ability finance welfare services and redistribute
income.
– Economic integration and increased mobility makes it
easier for mobile tax bases to move to another country.
• This gives rise to so-called tax competition
between countries.
– A ”race to the bottom”
– Cross-border shopping and capital taxation
A simple model
• Consider an economy which produces a homogenous
output using capital K and labor L, according to the
linearly homogenous production function f(K, L).
• We have that
– fK = r
– fL = w
• The aggregate supplies of labor and capital are
constant. Ensures that factor prices are constant.
Cont.
• The labor supply, X, of an individual is a
product of two stochastically independent
random variables D1 and D2. Where D1
describes inborn characteristics and D2
captures factors later in life that explain
variations in wages, e.g. promotion and health
risks.
X = D1D2
EX = ED1 = ED2 = 1
Cont.
• Private insurance can first be made at the
beginning of adult life, i.e. after D1 is known.
• Individuals also face another risk C in addition
to the wage risk
• All individuals have assets K that are invested
with a return equal to r.
• Before taxation and insurance a person’s
income is given by
Y = D1D2w – C + rK
Cont.
• The risk C can be insured in the private market and
we will assume everybody buys this insurance.
• However, it is impossible to get a private insurance
for D1 and (consequently) D2
• Since people are assumed to be risk averse – the
government can improve welfare by introducing a tax
financed insurance.
– One justification for the welfare state.
• The government budget constraint is
T = wt
Cont.
• Net income after distribution is
Y = D1D2w(1-t) + T – EC + rK
• The mean and the standard deviation of Y are given
by
Y = w – EC + rK
SY = (1-t)w S(D1D2)w
By redistributing income, the state can improve total
welfare. Optimal tax is t = 1
Tax competition
• Assume a world with n identical countries
where goods, capital and people can move
freely and without any migration cost. We then
have that (by the factor price equalization
mechanism)
r i = rj = r
wi = wj = w
• Since people can move we also have that
D1D2w(1-tj) +Tj = D1D2w(1-tj) +Tj
Cont.
• Which, because Tj = wtj, is equivalent to
tj(w - D1D2w) = ti(w - D1D2w)
or
tj = ti
• The tax rate in all countries thus have to be the same in all
countries.
• The equal tax will be zero due to tax competition between
countries
– A country will have incentive to reduce its tax levels in a situation of
equal taxes.
• The welfare state does not survive international mobility.
Tax externalities
• In general, increased mobility makes tax jurisdictions become
more interdependent and this interdependence gives rise to
both negative and positive tax externalities.
• Tax policy in one country might affect the welfare of other
countries:
– Directly trough the prices faced by foreigners
– Indirectly through the effect on foreign governments tax revenues.
• Tax externalities introduce a gap between the marginal cost of
public funds that is borne by the taxing country and the
marginal cost of funds that would be faced if the countries
cooperated.
A positive tax externality
• Mobility generally makes it easier for tax bases to
escape taxation by moving to another jurisdiction.
– The migration of tax subjects or tax objects
– Through a shift in production or sale from domestic firms
or markets to foreign firms or markets.
• This situation is often referred to as tax competition
since each jurisdiction will have an incentive to lower
its tax rate in order to attract mobile tax bases.
• Conversely, an increase in one country's tax rate will
result in an increase in other countries tax revenues: a
positive indirect tax externality.
Double taxation and tax exporting
• Tax exporting and double taxation, can also be
viewed as international tax externalities.
– Tax exporting refers to the possibility that the tax policy in
one country affects the prices faced by non-nationals. This
can be viewed as a negative direct tax externality because it
shifts some of the tax burden onto foreigners.
– Double taxation arise when two countries can tax the same
tax base. This is also a negative tax externality and might
result in overtaxation.
• These effects might counteract the tax competition
effect.
Political economy issues
• Some economists have argued that the public
sector has a tendency to overexpand,
– Due to the self-interests of politicians and
bureaucrats who benefits from large budgets.
• If this is correct then tax competition might
improves welfare, because the size of
government would be excessive in the absence
of this competition.
International cooperation
• One way to avoid the problems described in this
lecture is to introduce an international tax authority
– Secure international harmonization of taxes
• E.g. a minimum tax on alcohol in the EU
• The mobility of the tax base is not only determined
by factors that is outside the control of the
governments. National governments can affect the
possibility to move commodities and factors of
production in and out of the country trough direct
regulation or other unilaterally measures.
Cont.
• The distribution of tax base entitlements is closely
related to the problems of tax externalities
• By defining tax rights in such a way as to make it
more costly to escape taxation by moving capital to
another jurisdiction, these problems can be reduced.
The attraction of the residency principle lies in the
fact that people are less mobile than capital.
• The home country principle removes this problem
completely in the model studied earlier.