The implications of tax competition and “race to the bottom”
3. Tax competition – pros and cons
3.2. The advantages and opportunities of tax competition and reduction in taxes
The reduction in taxes may provide corporations with an incentive to make investments which stimulate economic activity. This could gen-erate additional taxable income which could gengen-erate more public revenue than was collected at the higher rate. The reduction in taxes has the effect of increasing GDP via the fiscal multiplier. The tax cuts give a greater stimulus to the economy than that of increases in a gov-ernments spending [Fox, 2007].
Proponents of the tax competition indicate the most important benefits of a reduction in taxes are [Baldwin, Krugman, 2001]:
1) the low tax burden (reduced tax rates and a limited range of taxes) increases a company’s disposable income that contributes to the development of the entrepreneurship and stimulates eco-nomic growth,
2) the process of reducing taxes as the primary element of tax competition by reducing the government revenues encourages countries to rationalize public spending and to reduce the scope of budget redistribution,
3) the tax competition and tax cuts reduce the politicians and deci-sion-makers influence on the economy. If the tax competition did not exist, there would not be pressure to reduce taxes and thus politicians would have more flexibility to raise taxes with-out fear of the consequences of their decisions,
4) the reduction in taxes in some cases may be necessary, because the level of taxation may compensate the low attractiveness of the country due to a poor infrastructure, inconvenient or periph-eral location of the country and low-skilled labour,
5) the tax competition leading to lower taxes encourages the for-eign capital inflow, which accelerates the economic develop-ment and reduces the gap between better and less developdevelop-ment countries. The confirmation of this argument, among others, are the results of research carried out by R.E. Baldwin and P. Krug-man, which show a decrease in the most development EU coun-tries advantages compared to peripheral councoun-tries, including Greece, Portugal, Spain and Ireland.
Moreover, A. Bénnasy-Quéré, N. Gobairaja and A. Trannoy have suggested that the international tax competition is an important factor that forces public sector efficiency. The tax competition is seen as a positive incentive for the many reasons, primary because of the need for public debt reduction. Significant benefits of tax competition is that the governors are under pressure to keep tax rates at a reasonable level, so that taxpayers will not be forced to move their business to countries with lower taxes. Thus, tax competition leads to greater gov-erning accountability in policy to attract and retain foreign investors [Orziak, pp. 9394].
4. Conclusion
The goal of this paper has been to examine the relationship between economic growth and taxation. The reduction in taxes could lead to increased economic growth and prosperity, but an uncontrolled reduc-tion in taxes could lead to negative budget effects, such as the so-called “race to the bottom.”
An important factor for the harmonization of corporate taxation in the European Union is to prevent the situation, when the tax competi-tion between member states, that usually leads to a “race to the bot-tom,” results in the erosion of tax revenues in the government’s budget. The loss of revenue resulting in risk to the public services and other government expenditure. The countries, where government ex-penditures and services financed from public funds are expanded,
have serious problem with government budget balancing. In order to stimulate economic activity, attract foreign investors and local entre-preneurs, countries undertake activities aimed at reducing the burden of corporate taxation. Opportunities of such activities are limited, be-cause of high budget deficits and the need to comply with the Stability and Growth Pact. Another barrier in reducing the corporate income tax is public defiance of budget expenditure cuts.
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