Tax Competition and Global Interdependence

What taxes to levy, and at what rate, are among the most important decisions governments face. These decisions determine the size of their budget, and who foots the bill. But states do not make decisions about taxation in a void. Tax policy has repercussions beyond borders, enticing companies and individuals from elsewhere to evade or avoid taxation they are currently subject to. For instance, companies or individuals may tax assets or activities in lower-tax locations, even though the underlying economic activity takes place in a higher-tax location, or they may relocate to a lower-tax jurisdiction altogether. Because relative tax rates matter when companies and individuals decide where to tax assets and activities, states find themselves competing for tax base. States compete by designing taxation to attract wealth and economic activity, or at least to be the location where assets and activities are taxed. The ensuing growth for the successful tax competitor occurs at the expense of states that lose out in the competition. An obvious adverse effect is that some states see their base decline. States also lose out by reducing taxes in the attempt to protect their tax base.