Transcript Alternative Individual Tax Bases

Tax Competition and
International Taxation
George R. Zodrow
Professor of Economics
Rice Scholar, Baker Institute for Public Policy
Rice University
Overview

Basic Tax Competition Models – Primarily METRs

Extension to Statutory Rates, AETRs

Other Extensions

Five Major Qualifications

Empirical Evidence on Tax Competition

Conclusion
2
Basic Tax Competition Models



Simplest models assume taxing jurisdiction (state in
a federation, nation in world economy) is small open
economy – fixed r and fixed p for tradable goods
Cournot-Nash competition in tax rates across
jurisdictions; competitive firms
Assuming tax on local factors available, source-based
tax on internationally mobile capital is undesirable –
the “zero tax” result (Zodrow-Mieszkowski, 1983,
1986; Gordon, 1986; Razin-Sadka, 1991)
3

Logic underlying the zero tax result



Source-based tax on capital income cannot be borne
by perfectly mobile capital
Borne instead by local residents (lower wages, land
rents; higher prices for non-tradable goods)
Indeed, Harberger (2008) argues that burden of
corporate income tax borne more than 100% by labor

Labor in tradable good corporate sector bears all tax

But labor mobile across sectors, wages decline there

So, all labor bears >100% (he estimates 130%)
4

Accordingly, may as well tax local residents directly
and at least avoid efficiency costs of taxing mobile
capital due to

Emigration of capital

Lower K-intensity in production

Tax bias against capital-intensive goods

Inefficient product specialization (Wilson, 1987)
5


Another potential source of economic inefficiency is
public service underprovision
Suppose government constrained to apply sourcebased tax on capital income, e.g., because


Must apply same property tax rates to residential and
non-residential property, or must apply same
corporate tax to both domestic and foreign firms
Wants to tax economic rents, especially locationspecific rents
6



Need backstop for individual income tax
Political constraints favoring some form of business
taxation, especially of foreigners
Then government tends to under-provide public services



Government reduces tax to reduce tax-induced capital
emigration (Zodrow-Mieszkowski, 1986; Wilson, 1986)
Degree of inefficiency may be large (Wildasin, 1989)
Included in under-provision of government services –
reduction in social safety net (Sinn, 1994, 1996, 1997)
7

Both models theoretically can generate “race-to-thebottom” in capital income taxation



Small open economies move toward “zero tax”
As constraints on use of capital income taxes
relaxed in tax competition model, get lower K taxes
Note: Under-provision result does not extend to

Benefit taxes on mobile capital

Taxes on external costs imposed by capital
8

Models with significant spillovers of public goods



With spillovers across jurisdictions, attracting K from
other jurisdictions is less desirable, since lowers their G
With pure public good, no under-provision (BjorvatnSchjelderup, 2002)
Models with rents earned by foreigners


Tendency for under-provision limited by tendency for
over-provision due to tax exporting potential (WagnerEijffinger, 2005; Mintz, 1994; Huizinga-Neilsen, 1997)
Sorensen (2006) still under-provision; big rate effect
(drops 11 % points if foreign share drops 25% to zero)
9
Tax Competition – Statutory Rates



Logic of basic tax competition models applies
primarily to METRs (CRS production functions, PC)
Suggests that cash flow tax with high statutory rate
but METR=0 would not be problematical
But more recent models suggest that tax
competition extends to statutory rates as well,
which may even be more important, due to

1. Competition for firms with firm-specific rents

2. Potential for income shifting
10

1. Firm-specific rents


Many MNCs earn firm-specific rents; rents seem to
be more important in recent years (Auerbach, 2006)
Indeed, such rents are prime rationale for MNCs

unique technological knowledge

superior managerial skills or production techniques

valuable brands, trademarks, reputations

other intangible assets
11




But MNCs with firm-specific rents are also highly
mobile internationally – and especially prized by
national governments due to external benefits
Key tax rate to attract such firms is not METR but
statutory tax rate or AETR that applies to economic
rents
Especially if firm making discrete location choice, e.g.,
to maximize economies of scale to serve multiple
markets (Devereux, et al.)
So, tax competition also applies to statutory rates
(Gordon and Hines, 2002)
12

2. Income shifting


MNCs can reallocate profits among countries

Transfer prices

Loans, other transfers between subsidiaries

Allocate general expenses
Also puts downward pressure on statutory rates –
STR is prime determinant of income shifting


Low tax rate attracts revenues, repels deductions
Attracts firms as facilitates use of avoidance
techniques
13

Indeed, tax competition over STRs due to potential
for income shifting or appropriating location-specific
rents may be more important than standard tax
competition over METRs to attract mobile capital

Haufler and Schjelderup (2000) – with income
shifting potential (transfer pricing), can be
desirable to lower statutory rate, even if raises
METR on new I, especially w/ some foreign owners
14



Fuest and Hemmelgarn (2005) – similar result if firms
can easily reallocate debt
Becker and Fuest (2005) – with differentially mobile firms
and differential profit rates, desirable to lower rates and
raise METRs if mobile firm has relatively high profits
Devereux, Lockwood and Redoano (2008)


Construct model with tax competition for mobile capital
(METR) and profit shifting (STR)
Also get similar result: Taxing country may respond to
competitors’ lower statutory rates with lower own
statutory rate but higher METR
15

Much empirical evidence confirms income shifting



Profits tend to be disproportionately reported in lowtax countries (Hines, 1999)
All observed differences in profitability across
countries are due to allocations of intangible income
and debt (Grubert, 2003)
Revenues due to unilateral tax increase are offset by
65% due to additional use of transfer pricing only
(Bartlesman and Beetsma, 2003)
16



Deductible interest payments are concentrated in
high-tax countries while non-deductible dividends
payments are concentrated in low-tax countries
(Altshuler-Grubert, 2002; Hines-Hubbard, 1990;
Grubert, 1998)
Location of debt depends on tax rate differences
(Desai-Foley-Hines, 2004; Huizinga-LaevenNicodeme, 2006)
Inter-firm loans used to reduce tax liability by
German firms (Buettner and Wamser, 2007)
17



Deductible royalties substituted for nondeductible dividends in high-tax countries
(Grubert, Randolph and Rousslang, 1996;
Grubert, 1998)
Location of R&D and other intangibles is highly
tax sensitive (Hines, 1995; Altshuler-Grubert,
2004; Mutti-Gruber, 2006)
Foreign affiliates with nearby tax haven pay lower
taxes (Desai-Foley-Hines, 2006)
18


Bosworth, et al. (2007): 1/3 of “excess” returns
earned by US FDI (relative to foreign FDI in US),
due to income shifting to low-tax countries
And, income shifting is increasing over time
(Altshuler-Grubert, 2006)
19

Similar results in Canada


Income shifting within provinces occurs in
response to tax differentials (Mintz-Smart, 2004)
Debt reallocation across Canada and the US in
response to tax differentials favoring US in mid1980s (Jog and Tang, 2001) – estimate large
effects on Canadian revenues
20
Arguments May Extend to Subsidization

Imperfect competition



Subsidy may be desirable to offset too-high factor
prices if monopoly power in capital markets – and
monopoly profits taxed (Judd, 1997, 2001)
Argues this is especially true in equipment markets
Imperfect information

Subsidy may be desirable to offset foreigners’ poor
information on investment prospects, market
conditions, accounting rules, etc. (Gordon and
Bovenberg, 1996)
21
Other Extensions to Basic Model


Many extensions to the basic tax competition model
(described in Wilson, 1999; Fuest, Huber and Mintz,
2003; Zodrow, 2003; Wildasin and Wilson, 2004)
General tax competition/under-provision results have
been extended to


Labor income taxes (rather than head taxes) as
alternative tax with variable labor supply (Bucovetsky
and Wilson, 1991)
Labor mobility across jurisdictions (Brueckner, 2000)
22

Countries of different sizes



Asymmetric tax competition – Large jurisdictions with
some market power have t>0, and small jurisdictions
benefit from K flows (Wilson, 1991; Bucovetsky, 1991)
New econ geography models – larger “core” economies
w/ agglomeration economies have higher tax rates, and
higher G, relative to smaller, less developed “peripheral”
economies (Baldwin-Krugman, 2000)
Economies of scale in G reduce underprovision as
population increases (Wilson, 1995)
23

Different alternative taxes – Mendoza-Tesar (2004)




Examine “race to the bottom” in EU in model where
budget is balanced with (1) wage tax, or (2) consumption
tax; countries (UK/Cont Europe) are Nash competitors
Assumed labor supply elasticity is large, following work of
Prescott (2008), and K is less than perfectly mobile
With highly distortionary wage tax, current equilibrium
consistent w/ data – no race to the bottom
Get “staggering” race to the bottom w/ consumption tax
24

Models with both mobile and immobile capital



Clear incentive for differential taxation (preferential
regimes for mobile capital), including mitigation of
public service under-provision problem
Implies zero tax on any perfectly mobile capital, or
lower tax on relatively mobile capital
Achieve directly, or with tax preferences that effectively
apply only to mobile capital, or with mix of lowering
STR and raising METR (Desai, 1999; Gugl-Zodrow,
2006; Haufler-Klemm-Schjelderup, 2006; DLR, 2008)
25

Growing literature on total revenue effects (but not
welfare analyses) of preferential tax regimes



Preferential regimes allow higher tax rate on immobile
capital, but lose revenues on mobile capital
Non-preferential regimes have lower tax rate on
immobile capital, but limit tax comp over mobile capital
Quite varying results (Janeba-Peters, 1999; Keen, 2001;
Janeba-Smart, 2003; Wilson, 2006), depending partly on
mobility assumptions, symmetry assumptions regarding
jurisdictions, whether tax bases are endogenous
26

Marceau-Mongrain-Wilson (2007) – allow asymmetry,
mobile capital, and endogenous tax bases



If constrained to uniform taxation, some countries
have low rates and attract mobile K, others have
higher rates on immobile K
If not constrained to uniform tax, get intense tax
comp for mobile K
Net result: get more total tax revenue with nonpreferential regime, even though get tax havens
27


Low rate countries (“tax havens”) are small (as in
asymmetric tax competition models), as face more
elastic K supply, but “small” in relative endowment of
immobile K – which explains data better than using
population, where empirical results are mixed
Also, less productive countries set lower tax rates,
and productivity differentials tend to make
preferential regimes more attractive
28


Tax competition literature focuses on inefficiencies,
especially downward pressure on public services,
including social welfare expenditures
But some models stress positive aspects of tax
competition


Limit “Leviathan,” special interest overspending on
public sector (Edwards-Keen, 1996)
Encourage use of desirable user charges/benefit
taxes (McLure, 1986; Huber-Runkel, 2004)
29


Limit tendency to over-tax K that is immobile in the
short run (Janeba, 2000)
Limit generally undesirable taxation of capital
income (consumption tax arguments, reductions in
national/federation capital stocks)
30

Hong and Smart (2006) – Tax competition with income
shifting desirable because moves economy toward zero
tax on mobile capital




GE model with tax planning (inter-affiliate borrowing)
Allowing some MNC tax planning may increase home
country welfare, as I and productivity gains outweigh
limited revenue losses
FDI is less sensitive to tax rates in model
Potential for tax planning can raise corporate tax
rates, since FDI costs of high rates are lower
31

Peralta, Wauthy and van Ypersele (2003)


Can achieve similar results by not enforcing transfer
pricing rules
But, Slemrod-Wilson (2006) argue that allowing tax
havens and tax planning reduces welfare

Due to costs of both planning and limiting avoidance

Aggravate tax competition problems

Especially costly since labor income taxes also avoided
– make case for some K taxation to reduce labor tax
avoidance problems
32
Five Primary Qualifications


Clear that prediction of zero (or negative) sourcebased tax rate on internationally mobile capital is
counterfactual, but suggests downward pressure
Five primary qualifications

Capital taxes may not be fully shifted to labor

Treasury transfer arguments

Backstop argument

Implications of tax avoidance

Taxation of location-specific economic rents
33

1. Tax is not all shifted to local factors (Gravelle and
Smetters, 2006) – in US context, labor bears >50% in
most simulations, because

Not small economy, so capital bears burden equal to
fraction of world output



But share of world output < 3% in Canada
Canadian and US capital are close substitutes
(Cummins, 1997; Altshuler-Cummins, 1997)
Canadian capital markets integrated with
international capital markets (Mintz, 2006)
34


Most models assume capital supply is highly or
perfectly elastic (Finance Canada; Cox; Cox-Harris)
Imported goods are not perfect substitutes for
domestic goods, so can shift capital tax to prices,
borne in part by capital owners

Older import substitution elasticities estimates in
Canada vary from low – 0.1-1.5 by Roland-Holst,
Reinert and Shiells (1994) – to moderately high –
1.0-4.8 by Cox and Harris (1992) and Cox (1994)
35



But trade economists argue that these are too
low, as imply too much local market power
(McDaniel-Ballistreri, 2002; Harberger, 2008)
Several recent studies get higher estimates, with
many industries in 6-13 range (Erkel-Rouse and
Mirza, 2002)
Recent estimates for Canada-United States:

Head-Ries (2001): 7.9-11.4

Clausing (2001): around 10
36

And, structure of model is critical



Randolph extends the Gravelle-Smetters model to
include domestic corporate sector with two goods,
one perfect substitute with import, one imperfect
Import substitutability becomes far less important
(no effect if K/L same for two goods)
If world output share is small, labor bears >100%
of corporate income tax
37

Empirical evidence generally consistent w/ significant,
though not complete, shifting of CIT to labor



Devereux, et al. (2008) – long run shifting to wages of
92% (in context of a wage bargaining model), using
data from 9 EU countries over 1996-2003
Hassett and Mathur (2006) – using data from 72
countries over 1981-2002, find wages very responsive
to CIT rate, but somewhat less so to AETR, METRs,
especially in small countries
Desai-Foley-Hines (2007) get 45-75% shift to L in US
38

On balance, suggests importance of GravelleSmetters argument limited in Canada in long run


In any case, in long run tax on capital may be
undesirable (consumption tax arguments)
But imperfect mobility of capital in SR provides a
powerful argument for capital taxation in SR
39

2. Treasury Transfer Argument



US (and UK, Japan) allow FTCs for foreign taxes
paid, up to US tax assessed on US-defined income
(Earnings and Profits definition)
Suggests corporate tax at rate near US rate is
desirable, as pure transfer from US treasury, with no
disincentive effects on FDI
BUT, many qualifications to this “free revenue”
argument
40


Irrelevant for territorial countries or those that grant
“tax sparing”, but not important in Canada as US, UK
and Japan are 74% of FDI (US=64%), and 82% of FDI
in “footloose” manufacturing
FTCs received only when funds repatriated to parent


Thus, treasury transfer effect arguably relevant only for
FDI financed with new contributions of equity
For investment financed with retained earnings, foreign
taxes on dividends are irrelevant (controversial “new
view” of dividend taxes, supported by recent evidence)
and only host country tax matters (Hartman, Sinn)
41

Many firms in excess foreign tax credit position – so
lower host country tax desirable as uses excess
credits without incurring further domestic taxes

Virtually all resource firms in Canada are in E-FTC

>50% of others are in E-FTC (though fluctuates)

AND, avoidance techniques appear to allow
creation of E-FTCs at will, using “reverse hybrids”
made possible with US “check the box” rules that
allow free designation of entity as taxable
corporation or pass through “disregarded” entity
42


Specifically, rules allow creation of hybrid entities (a
foreign corporation but a US pass-through entity),
and reverse hybrid entities (foreign pass-through
entity but a US corporation)
US MNC can “separate” taxes paid to hybrid
(foreign holding company, deemed responsible for
all taxes paid) and deduct currently, from income
earned by reverse hybrid (foreign operating
company), which is deferred, perhaps indefinitely
43

AND, rules for defining income to determine FTC are
harsh, resulting in larger “deemed income” and
lower “deemed taxes” paid, and thus more taxes
leading to E-FTCs and double taxation



Definition of income uses less generous CCAs
General expenses allocated to foreign firms,
including very harsh “water’s edge” interest
allocation rules – to be replaced by fairer
“worldwide” allocation rules in 2009
Finance Canada estimates need rate in Canada of
23-25%, even w/ new interest rules, to avoid E-FTCs
44

Most empirical work suggests treasury transfer effects
not important – General tentative conclusions:



FDI responsive primarily to host country rates, not
home country tax rates
FDI financed with retained earnings is more sensitive
to host country tax rates than if financed with debt
or new equity transfers (new view)
Conclusion: Treasury transfer effect not critical in
designing CIT in Canada at current rates (but depends
on US policies regarding avoidance and FTCs)
45

3. The backstop argument


A CIT is necessary to prevent accumulation of
untaxed labor returns within a corporation (although
often evaded in any case)
A low corporate rate, relative to personal rate, implies


Personal taxation of some returns is deferred until
paid as dividends (fully integrated in Canada)
Some retained earnings taxed at personal level as
capital gains, but others subject to exclusion will
avoid tax
46




Shifting between bases is large in the US (GordonSlemrod, 2000)
Taxable income elasticity of self-employed high in
Canada (>1) (Sillamaa and Veall, 2001)
Small business sector important in Canada – small
Canadian controlled private corporations provide
18.5% of CIT revenues
So want to limit differential between PIT/CIT rates,
but “optimal” differential unclear
47

4. Implications of corporate tax avoidance



Provides another dimension of tax competition, as
discussed previously
BUT, also suggests that negative effects on FDI of
high rates mitigated through avoidance
Indeed, MNC avoidance allows differentiation
between immobile domestic firms and more mobile
foreign firms, within a “uniform” corporate tax –
desirable on efficiency grounds (Desai, 1999; GuglZodrow, 2006; Hong-Smart, 2006)
48


Altshuler-Grubert (2006) argue that tax competition in
allowing avoidance is increasingly important,
especially income shifting to tax havens
Stress incentives for all three parties



MNCs – lower tax burden
Host countries – attract internationally mobile capital
while taxing immobile domestic capital and capital
earning location-specific rents w/ “uniform” CIT
Home countries – increase in MNC returns, including
due to more efficient I allocation > tax rev losses
49

Facilitated by US with “check-the-box” rules


Example: Subsidiary in high-tax country is a “hybrid”
(treated as corporation by host country but is passthrough entity with a tax haven finance subsidiary)
Tax haven finance subsidiary

gets equity from US parent

loans to hybrid entity in high-tax country
50



Get interest deductions in high-tax country, but
payments to tax haven finance subsidiary do not
trigger CFC (controlled foreign corporation)
rules, so taxed only at tax haven rates, and not
taxed currently in US
Hybrids also used to shift dividends, royalties
without triggering CFC rules
So, case for low rates mitigated to extent that
increased tax avoidance reduces negative effects of
high tax rates on FDI
51

5. Taxation of location-specific rents

Location specific rents may arise due to



Access to consumers, markets (including US mkt)
Agglomeration economies (technology, knowledge
spillovers)

Low transport costs

Skilled but relatively inexpensive factors

Productive infrastructure
Make higher capital tax rates desirable, as
52

Desirable to tax location-specific rents

Efficient source of revenue

Likely to be important due to access to US market


Especially desirable politically if earned by
foreigners, as is increasingly likely as globalization
advances (Huizinga-Nielsen, 1997)
Countries with large foreign ownership share have
higher corporate tax burdens (Huizinga-Nicodeme,
2006)
53

Can some rents be taxed with alternative instrument,
reducing argument for taxation with CIT?



Resource rents – federal production taxes, sectorspecific cash flow tax?
Rents in protected financial sector – cash flow tax on
net interest (report of President’s panel in US)
But rents due to access to US market presumably
must be taxed with CIT, providing strong argument
for taxation of capital income
54
More Empirical: FDI Tax Sensitive?




Perfectly elastic supply not likely
But, much evidence of significant elasticity,
increasing over time
Gordon and Hines (2002): “econometric work of the
last fifteen years provides ample evidence of the
sensitivity of the level and location of FDI to its tax
treatment”
Similar conclusions by de Mooij and Ederveen
(2003, 2005)
55



De Mooij and Ederveen (2003) calculate median
investment tax elasticity of 3.3; nearly double that
for new plants; most recent studies have largest
elasticities (although considerable variance)
Altshuler, Grubert and Newlon (2001) estimate
investment tax elasticity has increased from 1.5 in
1984 to 2.8 in 1992
Altshuler and Grubert (2004) get estimates near 4
for 2000
56

In Canada,



Iowerth and Danforth (2004) estimate a combined
domestic and foreign investment elasticity of
approximately 1
Department of Finance Canada (2007) estimates a
a combined domestic and foreign elasticity of 0.7
In US, Hassett and Newmark (2008) confirm
sensitivity of investment to tax factors
57


Devereux and Griffith (2003) find significant tax
effects of AETR in attracting investments that
generate above-normal returns (firm-specific rents)
Measured AETR is weighted (by above-normal and
normal returns) average of STR and METR

STR key in choice among competing locations

METR key in level of investment, given location
58
Is There Evidence of Tax Competition?

Various attempts to measure tax competition

Changes in corporate statutory tax rates


Average statutory tax rates in OECD dropped from
about 40% (1965-late 1980s) to 32% in 2004
(Devereux, 2007) – roughly constant since 1993
Average statutory tax rates in EU and U.S. fell even
more dramatically, e.g., 48% in 1982 to 35% in
2001
59



In early 1980s, CIT statutory tax rate in OECD was
50% greater than labor tax wedge, but by 2000
roughly equal, with larger drops in smaller
countries (Haufler, Klemm, Schjelderup, 2006)
Reduction in combined federal + provincial
statutory corporate income tax rate in Canada from
45% in 1980 to 35.0% in 2006 to 27.6% in 2012,
with goal of 25%
Similarly, average tax rates on highly profitable I
declined
60



But marginal effective tax rates declined relatively
little, much less than might have, due to basebroadening reforms (dispersion of allowances down)
Corporate tax revenues/GDP roughly constant for 40
years and indeed increased slightly (Devereux,
2007; Stewart and Webb, 2006)
Corporate income tax share of tax revenues also
roughly constant in OECD; in US and Canada,
increased over the past 20 years (Auerbach, 2006)
61




So, tax comp as measured by rates limited primarily to
reductions in STRs in OECD (income shifting tax comp)
Not yet a race to the bottom among OECD countries
But average foreign corporate tax burdens on US foreign
affiliates have declined markedly – 43% in 1982 to 26%
in 1999 (Hines, 2008)
And much smaller differences in STRs, AETRs across
large and small countries, by population, suggesting more
tax competition over time for larger countries (Hines,
2008)
62

Note: Many potential reasons for constant CIT/GDP

Increased relative profitability

Increased investment with lower rates

Increased above-normal returns for profitable firms


Increased income shifting from individual income
taxes
Increased profit shifting as rates decline (if average
CIT/GDP is unweighted, increased by income
shifting to smaller lower-rate countries)
63

Increased openness results in lower corporate income
tax rates, tax burdens

Winner (2005)



Measures capital mobility across sample of 23 OECD
countries, using S-I correlations
Finds decreasing capital tax burdens and increasing
labor tax burdens, increasing over time, especially for
small countries
Similar results on CIT rates Bretschger-Hettich (2002)
64

Haufler, Klemm and Schjelderup (2006)


Larger share of mobile capital (modeled as share
of value added in manufacturing relative to
services) has significant negative impact on
revenue mix (corporate revenues/wage taxes)
Slemrod (2004)

STRs decrease with measure of openness

But, not CIT revenues/GDP
65

Most direct evidence of tax comp (Devereux-LockwoodRedoano, 2008): among (10) OECD nations, find tax
comp in STRs – defined as reduction in STR in response
to reduction in weighted average STR of competitors



Find weaker evidence for tax competition in METRs
Argue that tax competition in STR is dominant form –
trying to attract mobile firms with firm-specific rents,
while maintaining revenues
Also find that the empirical pattern of recent STR
reductions consistent with their theory
66

Tax competition also tested directly by Heinemann,
Overesch and Rincke (2008)



Examine discrete tax reform events – statutory ratecutting reforms (sample of 32 European countries)
Also get significant reforms involving reductions in
own STRs likely in response to STRs of neighboring
countries, relative to own rate (cut rates by 1.5-3.2
points if competitors cut by 1 point)
Rate cuts more likely during election campaigns
67

Broadly similar results



Altshuler and Goodspeed (2002) – EU has a positive
tax reaction function, with US a Stackelberg leader in
tax rates after 1986, and EU-US tax competition
increasingly intense
Besley-Griffith-Klemm (2001) – CIT capital tax rates
positively related to same tax rates in other
countries, especially in EU, but not for other taxes
Many similar results for states/provinces, local govts
68

Evidence of more rapidly declining ATRs in smaller
less developed countries


Sample of 60 countries indicates decline of 10
percentage points between 1984-1992, with larger
declines in small, open and relatively poor
economies (Grubert, 2001)
Decline continued but moderated through 1997, and
stopped 1998-2000 (Altshuler and Grubert, 2006)
69

From early 1990s to early 2000s, revenues and AETRs
have declined in developing countries primarily due to tax
holidays, tax incentives for FDI (Keen-Simone, 2004)

Average STRs declined by 6 percentage points (16%)

CIT Revenues/GDP declined by 20%

Significant expansion of tax holidays, tax incentives,
especially in poorest developing countries
70



Similarly, Huizinga-Nicodeme (2006) find CIT/GDP
declines with size, if size is measured as GDP, and tax
rate reductions yield revenue declines in new
members of EU
Suggests more of both STR and AETR/METR tax
competition in developing countries
But questioned by Hines (2006), who argues that for
longer time period and different sample of non-OECD
countries that CIT/GDP and CIT/Total TR roughly
constant over 1972-2004 (but not if start in early
1980s, especially for former)
71

Similarly, Garretson and Peters (2006) argue tax
competition varies across OECD countries




Increased capital mobility, defined as larger fraction
of FDI/I or capital mobility restrictions
Find evidence of tax competition in statutory rates
But much less intense for “core” countries with
agglomeration economies (large market potential)
Canada – low to moderate tax competition because
3rd or 9th of sample of 19 in agglomeration
economies (depending on measure)
72

Altshuler-Grubert (2006) measure of tax comp:

Find that ATRs on US multinationals decrease
significantly if a country is losing share of US
foreign capital stock to others

Especially true if small, by population

(But relationship stops after 1997)
73
Alternative Explanations


STR reductions reflect not tax competition, but
common intellectual trends, especially for classic
base-broadening, rate-lowering reform, following
UK and US examples in mid-1980s
STR reductions reflect not tax competition, but
“yardstick” competition where lower rates mimic
low rates of nearby countries used as benchmarks
by residents
74

Devereux, Lockwood and Redoano (2008) test these
possibilities



Analyze level of capital controls in taxing country
and its neighbors
If tax competition is common intellectual trends or
yardstick, argue capital controls should be irrelevant
Instead, they find tax competition exists only
between countries without capital controls
75

Altshuler-Grubert (2006): Empirical evidence that tax
competition as tax avoidance more important >1997


Reported profitability of tax havens increased

Intercompany transfers increased considerably


Correlation between statutory and effective tax rates
declined significantly
In 2002, estimate US MNCs saved 15% of foreign
tax burden ($7 billion)
But no international evidence yet that sensitivity of
FDI to host country tax rates is declining over time
76
Conclusion


Should tax competition be a significant factor in
determining corporate income tax policy, including in
Canada?
Certainly, to some extent



Very difficult to test for tax competition, BUT
Much evidence of tax sensitivity of FDI – essential
assumption of tax competition for real investment
Much evidence of income shifting, and greatly
facilitated by US policy choices
77



Much evidence of tax competition in form of
statutory tax rates (both STR patterns and tax
reaction functions), and ATRs, especially effective
tax rates on highly profitable investments
But little on the METRs, that are a key factor of tax
competition for real investment
Suggests tax competition most fierce for paper
profits, and firm-specific economic rents that
generate important externalities
78


A plausible explanation of events thus far – i.e.,
find ways to lower tax mobile capital, while
maintaining revenues from taxing relatively
immobile capital
Analogous to tax competition in US states – state
and local government provide multitude of
individualized tax incentives to highly mobile
capital (Zodrow, 2003)
79

BUT, to explain STR declines, METR constancy





Common intellectual trends argument likely to
have some validity
Most of STR reductions in 1980s
Base-broadening rate-reducing reforms driven
primarily by domestic concerns
Plus, treasury transfer effect pressures on rates
In US, revenue neutrality requirement increased
attractiveness of base broadening with rate
reduction, coupled with many standard arguments
80



Arguments for lower rates not affected much by
Gravelle-Smetters arguments, treasury transfer
effect or, to a smaller extent, backstop PIT
But significantly tempered by benefits of taxing
location specific rents, esp. w/o alternative taxes,
And perhaps by role of avoidance techniques
81

Role of tax avoidance is complex




Encourages tax competition in STR
Reduces importance of treasury transfer argument
for higher rates
BUT, mitigates costs of high rates – find evidence on
declining sensitivity of investment with avoidance?
And US rules could change, especially if new
Democratic administration
82


Also, constancy of CIT/GDP reflects many non-tax
factors that may change (esp. high profitability, more
incorporation)
Keen: Tax competition in STRs shows no signs of
abating – with Canada a recent example


But scope of base-broadening with further STR
reductions is limited – likely to affect METRs, ATRs
much more if trend continues
And revenues, especially if profitability declines
83

Recently enacted Canadian reforms seem a good
response to current environment



STRs and METRs are lowest of G-7
Comparable to smaller developed countries and
emerging/developing countries (with lower METRs
but other disadvantages) that are likely to become
more significant competitors for mobile capital
BUT, tax competition likely to continue, especially if
US lowers CIT rate, as increasingly discussed
84

Will result in tougher future choices



Decline in STR will reduce taxation of rents (might
be mitigated with alternative tax instruments) and
AETRs and METRs, as CCAs are generally
appropriate
Competition with smaller developing countries and
emerging nations may become more intense with
more globalization, lower transport costs,
digitization
Further reductions may be appropriate by 2012
85




Lower tax rates at corporate level may be accompanied
by higher tax rates at personal level, on labor or capital
income, as former determine both real FDI and income
shifting
Or may consider more drastic reforms – consumptionbased taxes or dual income taxes
Key question: Will competition in STRs in fact continue,
given fewer opportunities for base-broadening
Key research areas: Models that simultaneously include
all aspects of various forms of tax competition; better
understanding of impact of developing, emerging nations
86
The End
Last Revised:
June 6, 2008