THE MYTH OF INTERNATIONAL TAX ‘COMPETITION’
By Alex Cobham
One of the most pernicious economic myths of our times is that of international tax ‘competition’—the idea that the process through which countries obtain investment is somehow equivalent to the model of perfect competition between firms which is taught in introductory economics courses. This myth has been given new life by the central myth of austerity, namely that a dramatic economic shock can best be addressed by a fiscal contraction. Needless to say, these myths are not ‘neutral’, in any economic, social or political sense. Their rise reflects an ideological triumph in the face of compelling contrary evidence—and the human impacts are the price.
The myth of international tax competition presupposes an entire agenda. Indeed, the choice of language is itself deliberately misleading. ‘Competition’ conjures up ideas of a productive struggle between companies to find an edge, a process that leads to innovation and better products for consumers at lower prices. We all love competition, right? But even at the level of pure economic theory, only the hypothetical perfect competition among an infinite number of equally sized small firms can (hypothetically) deliver consistent benefits—a situation that can of course never occur among countries, which are limited in number and dominated by a few large and powerful states. As Martin Wolf, the economics sage of the Financial Times (and no left-winger), has put it, ‘The notion of the competitiveness of countries, on the model of the competitiveness of companies, is nonsense.’
The easiest way to see this is a simple comparison. Failed companies can be seen as an unfortunate but necessary part of the competitive process, with good prospects for the people and capital involved to be reallocated to (more efficient) competitors. ‘Failed states’, on the other hand, are the places where many of the most vulnerable, marginalized people in the world live. (The current US and EU fixation on migration shows the extent of rich-country enthusiasm for the ‘reallocation’ of citizens of failed states.)
In the austerity context, tax competition has taken on if anything a more exaggerated form. Following the financial crisis, tax revenues fell off a cliff and debt soared, due to bailing out the banks to protect market actors from their own decisions. But policy-makers were told, and themselves told their citizens, that this was the time to cut corporation tax—that the key to recovery was to attract international investment, and that the key to attracting international investment was to lower taxes.
Both elements of this are straightforwardly false. The crisis threatened confidence and demand, due to the immediate loss of asset values and rise in unemployment. Additional international investment could indicate and support confidence, and generate employment, but both effects would be marginal compared with the overall economy. There was no serious macro-economic contention that governments were other than the only actor big enough to influence confidence and demand at scale. International investment could not be central.
Secondly, tax is not key to attracting international investment—a point so well established that such varied authorities as the IMF, Tax Justice Network and McKinsey’s are in agreement. At most, tax treatment is a secondary concern, once core factors such as market access, human capital and infrastructure have determined the preferred investment location. Theory indicates that such tax ‘competition’ between jurisdictions offering investment incentives will result in a race to the bottom, with the eventual benefits to the ‘winning’ state being zero or even negative, while the investor captures abnormal profits.
In practice, states which have sought to use tax to ‘compete’ their way out of austerity and into prosperity have failed in all aspects. The UK has led the way since 2010, with successive finance ministers committing to lower statutory rates of corporate taxation. As I’ve written for #AltAusterity previously, this led the UK to a uniquely tax-averse approach to austerity—so that the UK made greater cuts to public spending than the eventual deficit reduction. The UN special rapporteur on extreme poverty and human rights, Philip Alston, has catalogued the shocking and entirely unnecessary inequality and vulnerability which have resulted. (In chapter five, Sheila Block shows the effects of spending cuts on society in Greece.)
The UK government’s own analysis, in line with those of the independent budget watchdog, showed in advance that the cuts in corporation tax—from a globally typical 28 percent, down to a most ‘competitive’ 17 percent—were expected to produce an investment impact of precisely zero. But each percentage point is estimated to cost an additional £2 billion or more in lost revenue, and therefore in further cuts to spending or rises in the deficit.
The corporate investment response makes sense in terms of real economic activity in the country—marginal changes in the distribution of potential profit can hardly offset major economic decisions which suppress incomes and demand—and multinationals’ profit shifting. Our analysis with Petr Janský showed that the great majority of profit shifting by US multinationals reached just a handful of jurisdictions, including the Netherlands and Bermuda, where the effective tax rate was around 0-2 percent. Cutting statutory rates from 28 percent to 17 percent simply doesn’t get a country into the game to attract inward profit shifting or remove the incentive for outward shifting.
With no other changes, corporate tax cuts are simply a giveaway of revenue—and an undermining of progressive tax more generally, since corporation tax provides a backstop to income and capital-gains taxation, and differences in rates provide an incentive to reclassify income streams, causing further revenue losses. Indeed, the UK has seen an explosion since 2010 in company formation and a corresponding loss in income tax.
International tax ‘competition’ is a myth. The evidence shows that it is a race which can only be won by companies, while the losers are competing states and the majority of their populations. In the toxic context of austerity politics, the competition myth has been used to justify even more regressive tax and spending shifts, with enormous human costs. This should be understood as purely ideological and debated in terms of preferences for poverty and inequality outcomes. Despite the misleading branding of the concept, there are no genuine competitive processes or benefits to consider.