• Competition And International Tax Policy

    By Mark Keightley

    25-05-2016

    * The views expressed herein are those of the author and are not presented as those of the Congressional Research Service or the Library of Congress.

    Competition is a term that appears frequently in debates and discussions about various economic policies around the world. Recently, the term has appeared more often as the spotlight has turned toward international tax issues. Possible modifications to a country's tax system are often argued using some sort of competition criteria: if Country A were to lower their tax rates they could compete economically with Country B, so goes the argument. It is less often asked: What does competition mean in a real economic sense for a country, and what does it imply for tax policy prescriptions?1

    In general, competition implies that two or more parties are involved in a contest. A contest, in turn, implies there will be a winner and loser(s), with the gains of the former exactly offsetting losses of the latter. For example, there is only one NBA champion, one World Series Champion, and one Master’s Champion at any given time. That is, competition is a zero-sum game; it does not allow for two winners (note, the outcome is still zero-sum in a draw).

    So do countries as a whole compete in an economic sense? Traditional economic theory says no. Instead, countries trade. Nearly 200 years ago, David Ricardo pointed out that even if a country is more efficient than other nations at producing everything, it is still beneficial for them to focus their production efforts on those goods that they are relatively most efficient at producing, and trade for items that they are relatively least efficient at producing. According to Ricardo's theory of comparative advantage, divvying up production and then trading increases the well-being of all trading partners. That is, trade allows for multiple winners. The reason is because trade effectively acts as a technological innovation, whereby real resources (capital and labor) are able to be used more efficiently, resulting in greater overall production, wider variety, and lower prices than countries could produce in isolation. In some instances, particular industries and groups within a county can be harmed by trade. Government assistance may be justified to assist these groups. A detailed analysis of the costs and benefits of trade and related policy issues, however, is beyond the scope of this post.

    The lens through which economic policies are viewed may explain where some of the confusion over national economic competition comes from. Firms undoubtedly compete against each other - if a consumer buys an iPhone it is at the expense of Apple's competitors such as Samsung or LG in the form of profits, customers, and market share.  It is understandable that the next logical step is to assume that if competition exists between individual firms, than the same must hold for entire nations participating in the world economy. Economics gives guidance. Making such a connection between firms and nations leads one into the "fallacy of composition" pitfall - drawing the conclusion that something is true for the whole (i.e., nation) because it is true for the individual parts (i.e., firms).

    Using national competition as a criteria for evaluating international policies can lead to conflicting policy prescriptions. For example, tax incentives designed to help domestically-based multinational firms compete with foreign rival companies are often deemed desirable. Adopting this type of incentive would likely require lowering taxes on the foreign operations of domestically-based firms relative to domestic operations. The result would be more investing and hiring abroad.

    At the same time, policymakers also often express the desire to promote domestic investment and keep jobs at home. This, however, would likely require lowering taxes on domestic operations relative to foreign operations. In relative terms, taxes cannot be both lower at home and abroad at the same time; something has to give. In short, the national economic competition criteria is not well defined.

    Traditional economic theories of taxation provide three useful criteria for evaluating tax options: efficiency, equity, and simplicity. Tax efficiency refers to the degree to which taxes distort the allocation of resources and production. Tax equity refers to the degree to which equally situated taxpayers are treated similarly. And simplicity refers to the amount of resources that must be devoted to administer a particular tax system. There is plenty of debate among well-respected economists over how well various international tax systems - territorial, worldwide, minimum tax, formulary apportionment, etc. - stack up against these three criteria. The key is that these criteria provide logical boundaries based on fundamental economic theories within which these debates can be had.2 In contrast, the concept of national economic competitiveness is not particularly useful or well defined in international tax policy debates, and it can result in conflicting policy recommendations.


    1. For a more in-depth discussions about national economic competition, see Gravelle, Jane G. "Does the Concept of Competitiveness Have Meaning in Formulating Corporate Tax Policy?," Tax Law Review, vol. 65 (2012), pp. 323-348.
    2. These debates will be addressed in future posts.
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  • The information provided in this article is for general information purposes only. The information is not intended to be comprehensive or to include advice on which you may rely. You should always consult a suitably qualified professional on any specific matter.

  • Mark Keightley

    Mark Keightley is an economist with the Congressional Research Service (CRS) in Washington DC. His research areas include corporate and business taxation, housing taxation, financial securities taxation, and macroeconomics. He serves as an adjunct professor in the School of Policy, Government, and International Affairs at George Mason University where he teaches graduate-level courses in macroeconomics, microeconomics, and investment. Mark was previously an associate at the Congressional Budget Office, a visiting scholar at the Federal Reserve Bank of Saint Louis, and an adjunct professor in the economics department of The George Washington University. He earned a BS in economics from the College of Charleston, and an MS and PhD in economics from Florida State University.

    * The views expressed herein are those of the author and are not presented as those of the Congressional Research Service or the Library of Congress.

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