Tax Competition and the Myth of the ‘Race to the Bottom’: Why Governments Still Tax Capital

Key points in this Briefing Paper:

The majority of OECD countries have only experienced minor effects of capital market integration and capital tax competition since the mid-1980s. There have undoubtedly been some winners, mainly capital owners in larger liberal market economies, and some losers, especially large continental European welfare states.
Not only have the dire predictions of the early doom theories not materialized; they have failed. Therefore, there is much to be gained in making the key assumptions underlying traditional tax competition models much more realistic, particularly in terms of predicting the impact of globalization on Western democracies.

Tax competition affects countries differently and does not lead to a 'race to the bottom' since capital remains incompletely mobile. The competitiveness of a country determines fiscal adjustment strategies by others. Cutting capital taxes, therefore, will not necessarily generate more capital inflows.

Tax competition and taxation have broader implications for the fiscal responses of countries to globalization and their redistribution efforts. Given that tax competition affects countries differently, governments will choose diverse strategies to cope with these international pressures. Competition will more negatively affect income inequality in countries that predominantly redistribute via the tax system than in those that historically set up a welfare state by redistributing via social transfers.