“Benefits or evils” of Tax Competition

“Tax competition exists when people can reduce their tax burden by shifting their resources – whether financial capital, intellectual capital, physical capital, or labour – from a high tax jurisdiction to a low one. The ability of people and companies to shift their resources in this way imposes a discipline on profligate governments. Tax competition is critical in the world economy of today and is being embraced by many of the most successful economies in Europe, including many from the former Soviet block who want to be a magnate for capital and labour to drive forward economic growth. Of course high tax countries don’t like tax competition. And they work through bureaucracies of all kinds to try and dampen it. But Governments everywhere should realise, to quote Milton Friedman “that competition among national governments in the public services they provide and in the taxes they impose is every bit as productive as competition among individuals or enterprises in the goods or services they offer for sale and the prices at which they offer them”. For my part, I merely want to re-state clearly my support for tax competition.”

The author of these wise words was Charlie McCreevy, European Commissioner for Internal Market and Services in a recent speech (9 December 2005), significantly called Ireland: Making the Most of the Internal Market. No wonder the Taxation Commissioner (Mr. Kovacs) has increasing issues to worry!

The EU and the OECD have visible work on the issue of tax competition. The special forum, "Forum on Harmful Tax Practices" created after the 1998 report ("Harmful Tax Competition: An Emerging Global Issue") has focussed on (i) Harmful tax practices in Member Countries; (ii) Tax havens; and (iii) Involving non-OECD economies. The EU most visible contribution to the fight against tax competition has been the Code of Conduct for business taxation of 1 December 1997. The Code of Conduct requires EU Member States to refrain from introducing any new harmful tax measures ("standstill clause") and amend any laws or practices that are deemed to be harmful in respect of the principles of the Code ("rollback mechanism"). In addition, the EU has also the State Aid rules to attack certain measures relating to direct business taxation.

Over the last decade, the OECD initiative has slowly lost its power, due to outside attack (for example see arguments The Case for International Tax Competition:A Caribbean Perspective) or even from inside pressure (e.g. Luxembourg and Switzerland). In fact, the OECD is now concentrating on forcing low-tax jurisdictions to exchange information, by providing extensive information to the tax authorities in its member high-tax jurisdictions, to enable them to collect taxes from their residents.

The EU project has also slowly lost its initial track. Although the work under the State Aid rules closed several of the most controversial tax regimes in existence in Europe, recent disagreements have shown that perhaps some EU countries are revaluating their position on the “benefits or evils” of tax competition. For example, during the ECOFIN (EU finance ministers) meeting of December 5 and 6, 2005 the Dutch Under Minister of Finance stated to disagree with the Code of Conduct Group’s preliminary negative opinion regarding the Hungarian interest regime(*). Apparently, that intervention was supported by several Member States and resulted in the referral of the report back to the Code of Conduct Group with the following enigmatic words: “It is useful for the code of conduct group to reflect on the discussion at this Council in considering the future of the code of conduct".

This note serves to highlight a recent monography by Richard Teather on the “The Benefits of Tax Competition” (20 December 2005). This book, which the author provided a large part online, appears to be an interesting read for persons with an interest in tax competition and tax policy issues. According to the author, most governments have laws to prevent cartels and ensure competition, but most governments do not apply the same logic of competition policy to their own activities. This argument is enough for me to order a copy!

(*) Under the Hungarian interest tax regime, a taxpayer (i.e. economic association, cooperative or foreign entrepreneur) may deduct 50% of the difference between the interest received from its associated enterprises and the interest paid to its associated enterprises, provided the former amount is larger (i.e. the difference is positive). As a result, only 50% of the interest so received is taxable. The amount so deducted together with the 50% deduction for capital gains and royalties may not exceed 50% of the taxpayer's before-tax profit (i.e. positive result).