The Merits of Tax Competition in a Globalized Economy

Since the turn of the current century, leading transnational organizations and academic scholarship have identified tax competition among countries as one of the scourges of the international tax regime. Both the EU and the OECD have warned that tax competition erodes the tax bases of Member States and impedes their ability to provide essential services. Commentators have argued that unrestrained competition is driving tax rates on mobile sources of income to (or close to) zero, a process that jeopardizes the very existence of the welfare state, exacerbates problems of global poverty, and deprives developing countries of funds that they desperately need in order to improve their physical infrastructure and human capital. Tax competition is also said to misallocate economic resources by driving investment to where the tax rate is lowest rather than to where the return on investment is highest. Most proposals for reform suggest that, to one extent or another, countries harmonize their tax policies with the aim of mitigating the threat of mutually harmful tax competition. One prevalent theme in reform proposals is that countries be prohibited from offering foreign investors a more lenient tax regime than that which applies to their own residents (“ring fencing”). The argument is that ring fencing is a predatory form of tax competition that allows foreign investors to benefit from government services for which they do not pay, erodes the tax base of other countries, and, by encouraging other countries to follow suit, instigates a “race to the bottom” to the detriment of all. This Article argues that, not only is international tax competition inevitable, but that free and fair tax competition, far from misallocating resources, is necessary in order to allocate resources efficiently and to maximize global welfare. It argues that limiting tax competition, particularly by restricting ring fencing, will likely exacerbate problems of global poverty and will lead to a more unequal distribution of wealth. Its thesis, therefore, is that tax reform should encourage, rather than discourage, international tax competition and that transnational organizations should focus their efforts on improving the competitive atmosphere