Tax competition occurs when a government uses its tax system to try to attract capital, business activity, or wealthy individuals from other countries. At its most obvious this could be a "tax haven" with very low (or even zero) tax rates, but it could include more subtle provisions such as tax breaks for specific businesses relocating into a country. Game theory suggests that if the low-tax countries successfully attract international investment then other governments will respond, leading to a competitive spiral of tax reductions as they all compete for mobile capital.

A market restraint on government

For a supporter of Misesian theory, any mechanism that puts pressure on governments to lower taxes has to be good news. Often the only incentives for government activities and spending seem to be upward ones, as lobby groups and politicians seek to extend the power of the State. Hence the historical trend for taxes to increase, and anything that helps counter this will be beneficial.

Even better, this is a market mechanism to limit taxes, not a political one; tax competition effectively sets up a market for governments, who are forced to compete for "customers" (whether businesses or individuals). Competition will have the same effects on governments that it has on businesses — they will be forced to be more efficient, and to be more responsive to "customer" preferences. At its best, competition should result in genuine choice of governments, with different countries offering different levels of taxation and government activity to suit different preferences.

Tax competition does not prevent citizens, through electing their governments, from setting whatever tax systems they prefer. However it does mean that countries will face the consequences of their choices, and it gives an exit mechanism for minorities to protect themselves from victimization. It also helps to counter the democratic deficit caused by the political class offering a very limited choice of policies that does not reflect the range of the electorate. Unfortunately this makes tax competition as popular amongst governments as other forms of competition are amongst large corporations, and so often their reaction is to form a cartel to guard their patch from upstart smaller competitors.

Tax competition was significant in the 1980s, as capital and import controls were relaxed and international markets (including capital and labor markets) were freed from the post-War restrictions. As the United Kingdom and then the United States reduced their tax rates (especially the punitive taxes on capital popular in the 1970s), the improved capital mobility allowed tax competition to spread these reforms (to varied extents) around the world. More recently in a similar way the reforms in the ex-Communist countries of central Europe (led by Estonia with its 0% corporate tax and flat rate personal tax) are prompting the countries of "old" Europe to examine their own tax systems.

The European governments' desire for high taxes

In response to this tax competition we have seen several recent attempts to form an international tax cartel, all led by some of the high-tax European Union countries. The European Union is not merely a trading bloc but a political construct, based on a supposed shared "Social Model," and in recent years this has become a far more explicit policy objective; as the European Commission (the EU's bureaucracy) said recently:

First, national economic and social policies are built on shared values such as solidarity and cohesion, … adequate health and safety, … universal education and healthcare … a choice in favour of a social market economy.

Second, European citizens have greater expectations of the state than their equivalents in … Asia or America. The public sector tends to play a big role, either through regulation or government spending…

This "Social Model" needs high (and seemingly ever-higher) taxes, and so tax competition puts it at risk; raising taxes would mean a loss as investment moves to other countries. The European Union therefore wants to prevent tax competition, to keep its taxes high to fund the supposed "shared values" of its citizens for a high-tax, high-regulation state.

In fact it is not clear that the "shared values" really exist outside the European political class.

Mr. Teather goes on to explain why common Europeans are not happy about these anti-tax competition, high tax policies. He also outlines how the EU is trying to impose their high tax policies nonetheless, on a continuing and expanding basis.

Nevertheless, he gives us hope, for tax competition continues, the tax havens are not being shut down, and the U.S. has not gone along with supporting the EU either.

Read the rest of this fine article.

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