Tax competition: Can it be regulated? The invisible hand

In every issue, IEFA magazine publishes a discussion on one of the main questions affecting the global economy. This time, the topic is taxation.

On October 3, 2018, a debate took place during a TaxCOOP session at IEFA’s The Conference of Paris. Tax justice activist and researcher Richard Murphy and renowned economist Arthur B. Laffer discussed one of the major tax problems of the post-crisis world: tax competition.

For Richard Murphy, while competition may be a positive force in the business world, competition between states is different. Competition involves possible failure, and “there is no alternative or parallel state to replace the failed state: there is just economic, social and humanitarian disaster.” For Arthur Laffer, competition is essential between governments to ensure their effectiveness and prevent them from exploiting their citizens; he states that “[…] while failure is part of the private enterprise system of competition, […] without competition amongst governments, failure is assured.”

Arthur Laffer points to the need for incentives to control spending and taxation by governments, and declares that harmonization can only lead to higher taxes and inefficient decisions. Furthermore, high taxes are damaging to businesses and increase tax avoidance. Richard Murphy believes it is relevant to regulate tax competition so governments have the necessary leeway to govern and enact policies, in which case the citizens’ vote serves as a control mechanism for governments’ decisions.

The text of the discussion has been edited and condensed for clarity.

Arthur Laffer – Regulating tax competition is too costly as it would lead to more taxation, and high tax rates are detrimental to the economy.

Let me just say that the private sector is flawed. There are many failures in the competitive model, and we could see these failures as evidence of stark problems with the competitive free market enterprise system.

But just because the free market and the private enterprise system fail doesn’t mean it would therefore be better for the government to come in and change it. Let me just say that the failures of the private system are no less severe than the failures of the public system. In fact, I would argue that the public system is far more prone to failure than the private system because, in the public sector, there are no incentives. Public employees are spending other people’s money, so they have much less incentive to control spending – and, by extension, to control taxation on other people – and the potential for corruption, bribery and malfeasance is much greater in government than it is in the private sector. There is no self-correcting mechanism in a government system.

It’s very hard to explain something to people when their livelihood depends on their not understanding it. And that is really what you have in a government system, because you have a system where public employees – whether they be academics, or OECD or civil-service employees – are living in a world where there are no incentives and where they don’t know their customer.

The invisible hand

If I may go back to Adam Smith, the invisible hand is really the most powerful force in economics and good government. The role of government must be the role of referee. When you allow the referee to choose the proper way for the private sector to behave, this becomes really, really problematic. When the referee becomes a participant in the game, it’s very hard to expect that referee to behave well.

Let me give you an example. When the tax rate is 50%, I’m going to spend 50% of my time trying to figure out how to get around paying taxes, and 50% of my time trying to figure out how to increase output. I just want to say that the OECD has done a great job of exposing all the problems related to the issue of tax avoidance: the literature is replete with such studies. Private entities do huge amounts of tax avoidance.

The effective tax rate in the US is one third the statutory tax rate, which means that two thirds of the tax base has been sheltered. In that light, Austan Goolsbee shows how amazing it is that businesses focus on taxes as the key issue when choosing their organizational form.

Tax evasion

Tax evasion alone explains all the static tax revenue losses. This is where the private sector shows its expertise. As for tax inversion (the practice of relocating a corporation’s headquarters to a lower-tax country), there were many such relocations out of the US when we had the highest tax rate in the OECD; since 2017, when the US lowered its corporate tax rate, they are coming back.

When you look at secondary, tertiary, quaternary revenues, you know it’s not just corporate tax revenue. If you look at payroll taxes, income taxes, corporate profit, all of these other taxes – they all increase when economic growth is enhanced. State and local taxes as well. These are areas where the private sector gets around paying taxes and behaves as it should.

Then look at harmonization in other areas, not just with taxes. Look at it with tariffs. Do you like this free trade world? Do you think Japan is behaving correctly? I mean, when you look at what government does when it has total control, more often than not it behaves very improperly.

You and I have spoken previously about the minimum wage, the tyranny to spend and to regulate. No one is correcting governments’ behaviour in any of these areas. I guess when I look at it in Europe, it bothers me even more than it does in the United States. At least we elect our president. When I looked at how many votes Jean-Claude Juncker got, was it 40 votes? Maybe 50? Excuse me, I’m just joking. If I remember correctly, he was elected in Luxembourg with just a few thousand votes and now he’s head of the EU.

It’s not a democratic process. To my way of thinking what you really want is to have as little regulation as possible, and it’s impossible to try to control that without destroying the economy. Thank you.

Richard Murphy – Regulating tax competition is beneficial as it gives governments the necessary leeway to design appropriate policies for their citizens.

Arthur, I hear what you’re saying but I have to say I don’t agree. I think constraints on government is the most fundamental control of all, and we all have access to it: it’s a cross on a ballot paper. [He waves a large black cross on a napkin, a nod to Laffer’s own napkin-related antics when he sketched the now famous Laffer curve.]

Democracy is the control on government.

Is there a cost to controlling tax competition if democratically elected governments choose it? Yes, of course there is. There’s a cost to securing international agreements at the OECD. There’s a cost to monitoring it. There’s a cost to exchanging information. There’s a cost to reinforcing regulation, both domestically and internationally – because tax competition is domestic as well as international – and there’s a cost to enforcing regulations against those who persist in flouting them. But it is the citizens’ vote that matters when controlling government, not the action of tax havens for big business or professional accountants who choose to serve the law. That, to me, is upholding the rule of law.

And I would argue that the cost to government of controlling tax competition is well worth it. Why? Because we get effective markets that allocate capital to those best able to exploit it to meet end-user needs. We’ll have competition in the marketplace rather than in regulatory arbitrage, and the law will be upheld.

That, to me, is fundamental. One of the big issues in tax competition is that abusers have been very much in the public eye, and that has given the rest of society a very bad impression. No wonder evasion is rampant when avoidance is being encouraged amongst so many, including large companies!

We need to ensure that the state can deliver services. We all rely on the state. There isn’t a single person here who doesn’t, and I believe that we need to support the state in delivering those services, from protecting private property to all those other things it supplies.

We need to prevent tax competition so that we can prevent market failure due to externalities. One of the reasons for taxes, of course, is to price externalities out of the market, which the market itself cannot deal with. Income and wealth should be redistributed. This, of course, is now one of the core objectives of those hotbeds of international socialism: the IMF, the World Bank and the OECD, who all believe this is the basis on which we must move forward to create inclusive growth – and I share that belief.

The future of monetary policy

We must defeat tax competition to support fiscal policy. It’s clear Arthur and I do not agree on this, but if we look at macroeconomics now, there is no future for monetary policy. This is precisely because we are going to remain somewhere near the zero-bound with regard to interest rates. As a result, effective fiscal policy will be the only way to create stable, secure markets where inflation is under control. In other words, we control tax competition so governments can make their own decisions.

We need to control tax competition to support the value of local currencies. We see what happens in countries where the local currency is devalued. Precisely because tax is paid in local currency, those currencies have value even though the dollar might appear to rule supreme in so many other places. So, regulating tax competition is essential to avoiding currency degradation, which has adversely affected so many societies around the world.

Finally, we must defeat tax competition so that the ballot box reigns supreme. To put it another way, defeating tax competition is a necessary condition for effective economic management. Or, to misquote Oliver Wendell Holmes: “The cost of defeating tax competition is the price we pay for living in a civilized and prosperous society.” 

TaxCOOP’s objective is to hold the first global conference on tax competition and cooperation in Québec in 2020. TaxCOOP began working on this major project in Montréal in 2015 and, since then, has travelled the world. TaxCOOP is the only public conference to feature in the prestigious International Tax Review’s Global Tax 50, which lists the 50 most influential individuals and organizations in the world on global tax policy, practice and administration.

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