IREF - Institut de Recherches Économiques et Fiscales
Pour la liberté économique et la concurrence fiscale
Let us welcome tax competition ! - by Pierre Garello
Today, the level of taxes in the most European countries is probably higher than it has never been in the history of those societies. Simultaneously, partly as a consequence of globalization and democratization, tax competition is becoming more intense. This relatively recent evolution has led to various reactions. In particular, inside the European Unions, some (like the OECD) have warned us against the dangers of such competition, and Bulgaria, who just cut its corporate tax down to 10% (the lowest rate in Europe), surely knows what I am talking about ! But, as I will show, such worries are unfounded, and we should welcome and whole heartedly embrace competition in all fields, including taxation.
To understand the effect of tax competition it is useful to recall, first, the nature of taxation and, second, the nature of competition. Taxation has been used for centuries to finance the production of various goods and services. Historically, the first service financed through taxes (often in kind taxes) was probably physical security : the lord was protecting his vassal against aggressive neighbours. Then, throughout centuries, as the power to tax increased (due in part to technological progress, in part to democratization and majority voting, and in part, of course, to increased wealth), the list of services financed this way kept increasing. Today, taxes are used not only to provide physical security (justice, national defence, police), but also to promote growth (via public investment), and to offer a large array of goods and services which, although they can be provided by private means, are judged to be so essential to our societies that taxation is justified. This list of goods and services is virtually endless and includes education, health insurance, retirement plans, leisure (public swimming pools, theatres, etc.), culture, garbage collection, water and energy supply, roads and bridges, transportation, Christmas decoration… and, a fair amount of redistribution towards the poor.
It is not the place here to develop a detailed analysis of this expansion of state prerogatives. Two general remarks must be made, however, because they are directly related to our topic. Firstly, the financing and the production of services are two separate things which should not be confused. Whenever it is decided that taxation should be used to finance some services, it is always a good idea to have it produced by private companies which will compete to offer the best price/quality ratio. Secondly, and more importantly, it should never be forgotten that taxation relies on coercion. This, indeed, has heavy consequences, starting with the obvious fact that, since citizens do not voluntary contribute, some will try to avoid the constraint. As a matter of fact, the favourite national game, in many countries, appears to be how to pay as less tax as possible (tax avoidance and tax evasion) ! But, to resort to coercion has another important consequence : contrarily to what happens when people freely engage in trade, when actions are taken under coercion one does not know what individual really want. In other words, to rely on a political decision process backed by the use of force makes it virtually impossible to know what individuals prefer. It is therefore likely that people don’t get what they want, and, as we will see, this is precisely why tax competition must prevail.
Competition is freedom, and those who do not like competition are those who don’t like freedom. Indeed, when I am free to choose, I can say no to A and yes to B, so that, A and B are, in a way, competing. The immediate consequence of this obvious fact is clear. If they wish to trade with me, A, B and all the others will have to take my preferences seriously into consideration. They will have to do their best to satisfy my needs because this is the surest way for them to satisfy their own needs. This is why competition is a remarkable discovery process ; an unsurpassed engine for growth. But, of course, competition—that is, freedom—is demanding. As we just say, when you are free, you are free to say no, and people must therefore accept the idea that you don’t want to buy what they have to offer. As a matter of fact, a free environment gives you incentives to anticipate, to innovate, to adjust rapidly, and it requires that you accept setbacks and move forwards. For all those reasons, it is no wonder that societies which have welcomed competition have developed more rapidly and more peacefully.
Having clarified the true nature of taxation and of competition, we are now in a position to evaluate the merits of tax competition. Taxation, as recalled above, relies on the monopoly of force given to the taxing jurisdiction (If you don’t pay your tax you go to jail !). How, then, can freedom be part of the story ? Where is your freedom to choose in tax matters ? Economists have, I believe smartly, summarized the situation by saying that the tax payer can express his choice by one of two ways : voice or exit. Voice : the tax payer is free to participate to the political decision process fixing the level and nature of public spending and taxation. Exit : the tax payer is free to leave the jurisdiction for a jurisdiction where, in his view, the level and nature of public spending is more to his liking. Now, it is essential to note that the two dimensions through which individual can express their preferences—voice and exit—reinforce each others. To the extent that they have no possibility to exit, tax payers’ voices will have little power. If, on the contrary, the cost they have to pay for exit is low, then they can credibly threaten to stop paying tax in this jurisdiction so that their voices are more likely to be heard. Hence, freedom to choose in tax matters—and therefore competition, and all the positive dynamics attached to it—will be increased each time the costs of exit will be reduced. More generally, democracy (in the sense of respect for individual rights) will have little or no meaning without a real possibility to exit, that is, without tax competition.
To the extent that we wish to promote freedom, prosperity, peace and democracy, the only coherent attitude is therefore to welcome tax competition and everything promoting it. Fiscal decentralization within a sovereign tax jurisdiction is, for that reason and to the extent that it is well done, a move in the right direction. The cost of moving from one municipality or district to another is lower than the cost of moving from one country to another. In the same vein, tax competition between nations within the European Union is also something to be cherished. But why, then, was the recent decision made by the Bulgarian parliament to reduce corporate taxes so harshly criticized by some EU members ? I think the answer is clear. As was recalled earlier, freedom is demanding. When some heads of States realize that exit costs are lowered and that some of their tax payers are ready to leave (because, in their judgment, the public services they get do not justify the tax they pay) ; those heads of States tend to organize themselves to stop competition and increase those costs of exit. This is what tax harmonization within the EU would do for us. Tax harmonization does not mean more, but less freedom. It does not bring harmony but uniformity : if successful, everyone will have to “buy” the same type of public policies and this, we know from logic and from experience, mean lower quality in the long run.
Voices in favour of tax harmonization and tax centralization at the EU level are libertycide and we must hope that many individuals will join Bulgarian MPs and speak against them.
Recording of the conference can be heard here :