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THE GLOBAL CAPITAL MARKET: Fiscal Autonomy and Income Distribution

International Tax Competition

When capital can move freely across national borders, it will flee counties where it is taxed heavily to production locations where taxes are lower. Indeed, accounting practices allow the base for capital taxes to migrate even when capital itself does not. Simply by altering the accounting value attached to intermediate goods being shipped within the company, a multinational enterprise can arrange to book relatively large shares of its worldwide profits in countries with low rates of corporate tax (Tanzi, 1996). Such strategic bookkeeping adjustments can take place even more quickly than capital itself can be transferred between countries.

If capital (or the capital tax base) can migrate very quickly, individual countries lose some of their autonomy with respect to capital tax rates.7 Absent special features making for an attractive investment locale — like a high level of public goods or skilled but inexpensive labor — a country must lower its capital tax rates to match those set by foreign authorities. Otherwise it suffers a diminished tax base and, possibly, a lower domestic living standard. Moreover, individual countries have incentives to tailor their tax policies so as to lure business from abroad. There is potentially a “race to the bottom” as countries competitively offer tax breaks in a collectively selfdefeating scramble for national advantage.

International “tax poaching” is indeed a well-established practice. EU countries are attempting to ban poaching internally, putting heavy pressure on Ireland, for example, to end the preferential 10 percent corporate tax rate it has offered to lure investment from abroad. OECD countries show a clear trend of declining corporate tax rates over the last decade (Tanzi, 1996, p. 14), though it is unclear how important tax competition (as opposed to ideological change, for example) has been in this development. As for the noncorporate sector, it has become increasingly hard these days to tax the income that residents earn on assets held overseas. Scandinavian countries have already moved toward a “dual” income tax, with lower taxation of income from capital than of labor earnings.