We need more tax competition between nations – not less

Published in Financial Times

Sir, Corporate tax evasion is always a popular political target, and so it proved to leaders at the recent Group of Eight summit. Cheating on taxes is bad form, whether done by individuals or corporations. But countries need to be careful that the rightful war against tax cheats does not descend into a misguided campaign against tax competition.

Hardly any aspect of the corporate tax structure is worth saving. The tax has huge distortionary effects and drags down useful investment. Contrary to popular belief – and unlike the individual income tax – the corporate tax does little or nothing to reduce inequality between households. The faster corporate tax rates are slashed, the better for economic performance. In the real world, corporate tax rates are cut not because ministers take a refresher course in public finance but because investment migrates to competing jurisdictions that offer lower tax rates.

Fortunately, three decades of tax competition between and among OECD nations and the Brics – Brazil, Russia, India and China – have sharply lowered statutory corporate rates, roughly from the 40 per cent range to the 20 per cent range. In a long but misguided campaign, the OECD has tried to put an end to tax competition between its member countries. So far, thankfully, the campaign has failed, but in the current malaise it seems to be gathering lip service.

As the world grapples with sluggish growth, it needs more tax competition between sovereign nations, not less. The US, for example, should look north and cut its 35 per cent federal rate to the combined federal plus provincial rate in Canada, about 25 per cent. Evidence shows that a cut of this magnitude would not reduce US tax revenue. Conversely, raising the corporate rate in the US or elsewhere will not raise much revenue, but it will push investment into “pass-through” forms – master limited partnerships, real estate investment trusts (Reits) and the like – and spur the search for avoidance techniques.

Governments that need revenue to cover their entitlement costs (surely the US) should look to consumption taxes, not higher corporate taxes.

Gary Clyde Hufbauer, Reginald Jones Senior Fellow, Peterson Institute for International Economics, Washington, DC, US