Tax competition exists when politicians feel pressure to lower tax rates because they’re concerned that jobs and investment capital may cross borders,—a process that has become much easier in recent decades because of globalization.
In other words, tax competition exists when governments compete with each other. The economic analysis of this process is very straightforward. Monopolies are bad, competition is good.
Consumers benefit when banks compete for their business. They benefit when grocery stores compete for their business, and they benefit when pet stores compete for their business. Likewise, taxpayers benefit when governments compete.
Let’s use an analogy. Imagine a town with just one gas station. That one gas station could charge high prices, maintain inconvenient hours, and offer shoddy service. But what if there are five stations in that town? Consumers then are free to choose, and this means gas stations will compete to offer the best product at the best price with the best service.
The same process exists with governments.
In the absence of any constraints, politicians will continuously raise tax rates because it’s in their self-interest to have bigger, more intrusive government.
This is why tax competition is such an important force for good policy. Even bad lawmakers are compelled to do the right thing when they fear that the geese that laid the golden eggs will fly across the border.
Ireland really deserves a lot of the credit here. By slashing the corporate rate from 50% to 12.5%, Irish leaders turned their economy from the sick man of Europe into the Celtic tiger. But the global effect is even bigger. In order to compete with Ireland, nations all over Europe and around the globe are racing to lower their corporate tax rates.
Tax competition is also playing a role in the global flat-tax revolution. 25 years ago, Hong Kong was the only recognizable flat-tax jurisdiction. Today, there are dozens of flat-tax jurisdictions, including Russia, Slovakia, Iceland, and Estonia.
Now for the bad news. Not surprisingly, politicians from high-tax nations don’t like tax competition. They resent being forced to lower tax rates. Much like the owner of a town’s only gas station, they want captive customers who have no choices. These politicians are trying to undermine tax competition. Working through the Organization for Economic Cooperation and Development (OECD), an international bureaucracy based in Paris, they want to hinder the flow of jobs and investment from high-tax nations to low-tax nations.
Source: International Man