International Tax Competition: A 21st‐​Century Restraint on Government

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Globalization is knitting separate nationaleconomies into a single world economy. That isoccurring as a result of rising trade and investmentflows, greater labor mobility, and rapidtransfers of technology.

As economic integration increases, individualsand businesses gain greater freedom to take advantageof foreign economic opportunities. That, inturn, increases the sensitivity of investment andlocation decisions to taxation. Countries feel pressureto reduce tax rates to avoid driving away theirtax bases. International "tax competition" isincreasing as capital and labor mobility rises.

Most industrial countries have pursued taxreforms to ensure that their economies remainattractive for investment. The average top personalincome tax rate in the major industrialcountries of the Organization for EconomicCooperation and Development has fallen 20 percentagepoints since 1980. The average top corporateincome tax rate has fallen 6 percentagepoints in just the past six years.

Rising tax competition has caused governmentsto also adopt defensive rules to prevent residentsand businesses from enjoying lower tax ratesabroad. In the United States, such tax rules arehugely complex and affect the ability of U.S. companiesto compete in world markets. Other defensiveresponses to tax competition include proposalsto harmonize taxes across countries and to restrictcountries from offering tax climates that are toohospitable to foreign investment inflows.

Those defensive responses to tax competitionare a dead end. They do nothing to promote economicgrowth or reform inefficient tax systems. Amore constructive response to tax competitionwould be to learn from foreign reforms and adoptpro-growth tax policies at home. The UnitedStates should be a leader but has fallen behind ontax reform. For example, the United States nowhas one of the highest corporate tax rates amongmajor nations. The chairman of the president'sCouncil of Economic Advisers, Glenn Hubbard,believes that "from an income tax perspective, theUnited States has become one of the least attractiveindustrial countries in which to locate theheadquarters of a multinational corporation."

As international capital and labor mobilityrises, the risks associated with not having an efficientfederal tax structure increase. This countryshould respond to rising tax competition by movingtoward a low-rate consumption-based system.