Thursday, October 14, 2021
James Hines (Michigan; Google Scholar) presents Evaluating Tax Harmonization at Georgetown today as part of the OMG Transatlantic Tax Talks Series (OMG = Oxford-Michigan-MIT-Munich-Georgetown):
Tax harmonization can address downward rate pressure due to tax competition, but does so by imposing a common rate that may not suit all governments. A second-order Taylor approximation yields the simple rule that tax rate harmonization advances collective government objectives only if tax competition reduces average tax rates by more than the standard deviation of observed tax rates. Consequently, any objective-maximizing harmonized tax rate must exceed the sum of the observed average tax rate and the standard deviation of tax rates. In 2020 the standard deviation of world corporate tax rates weighted by GDP was 4.5%, and the mean corporate tax rate 25.9%, so if competition sufficiently depresses tax rates then governments may find it attractive to harmonize at a corporate tax rate of 30.4% or higher. The minimum tax rate that most effectively advances collective objectives equals the average effect of tax competition plus the average tax rate in affected countries. Hence there are dominated regions: in the 2020 data, there is no degree of tax competition for which a world minimum corporate tax rate between 4% and 27% would be consistent with maximizing collective objectives.
Countries choose tax policies based on many considerations, including revenue needs, economic conditions, distributional preferences, and prevailing notions of sound fiscal policy. Some governments tailor business taxes to make their countries attractive investment locations; and even countries without explicit tax-based economic development strategies generally try to avoid adopting tax systems that would excessively discourage business activity. Tax competition appears to reduce business tax rates to levels below those that countries would otherwise choose. Coordinated action can address the effects of tax competition, but common coordination methods such as tax harmonization or minimum taxation require strict adherence to uniform rules that limit their appeal. As a result, tax harmonization can advance collective objectives only if the standard deviation of tax rates is less than the average effect of tax competition. Minimum tax rules afford greater flexibility, though here too the average effect of tax competition is of central concern, since it plus the average tax rate of affected countries equals the minimum tax rate that most effectively advances collective objectives. It is evident that a sound understanding of the impact of tax competition is an indispensable element in evaluating tax harmonization alternatives.