Globalization and tax competition

1
Globalization and tax competition

• Alexander W. Cappelen
• Econ 4620

2
Plan

• What is globalization?
• How does globalization affect pre-tax income
  inequality?
• How does globalization affect redistributive
  policy?
• Possible solutions.

3
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.

4
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.

5
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

6
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?

7
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.

8
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.

9
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

10
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.

11
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

12
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 persons income
  is given by
• Y D1D2w C rK

13
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

14
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

15
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)
• ri rj r
• wi wj w
• Since people can move we also have that
• D1D2w(1-tj) Tj D1D2w(1-tj) Tj

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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.

17
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.

18
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.

19
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.

20
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.

21
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.

22
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.