Tax Analysts Blog

Business Tax Incentives Create Race to the Bottom

Posted on Dec 10, 2012
Tax competition is a positive force in the global economy, according to Daniel Mitchell of the Cato Institute. He believes that governments competing against each other to attract business makes tax codes more efficient and helps economic growth.

It certainly helps businesses, but it isn’t clear just how beneficial the race to bottom out marginal business tax rates actually is. Tax competition is at an all-time high, but the global and national economies aren’t exactly booming. The New York Times recently ran a story detailing how states have used tax subsidies to provide over $80 billion to companies. The goal of the subsidies is to create, attract, or preserve jobs. The Times was skeptical that most of the incentives did much of anything, and its coverage called out General Motors, among others, for taking the subsidies and then relocating jobs overseas anyway. But even if the tax programs do create jobs in one state, they are questionable tax policy, particularly if the goal is to simply attract jobs in a zero-sum situation.

Tax competition creates a race to the bottom in tax policy. And it isn’t just occurring between states. Throughout the last two decades, many countries have slashed corporate tax rates in an effort to attract relocations. Ireland is probably the most obvious example. It cut its corporate tax rate to 12.5 percent. That put pressure on many European Union nations to do the same. Ireland’s corporate tax cut was so unpopular that many in Germany and France wanted to withold bailout assistance until Ireland agreed to scrap it and move closer to the EU average. Ireland ultimately refused and got bailout assistance anyway, but the episode illustrates just how one nation’s corporate tax subsidies can undermine an entire continent’s tax base.

Across the Atlantic, interstate tax competition is just one of the costs of federalism. If North Carolina lowers its corporate tax rate, South Carolina and Virginia are under pressure to do the same. As the Times points out, the competition is not always so transparent. Most tax subsidies take the form of rebates, sales tax exemptions, or property tax considerations. Those are much harder for the public to track and do not involve the checks and balances that are part of a legislative rate cut. In fact, it is very difficult for taxpayers to make the connection between the grant of a tax subsidy to a corporation and a subsequent cut to education funding, according to the Times story.

Someone pays the price for tax competition. Mitchell and other conservatives might think that it is the bloated bureaucracy of government, but the decline in corporate tax revenues and the explosion in tax credits and incentives have not caused federal or state spending to drop. They have simply created deficits. They have also put pressure on the rest of the tax base (i.e., individual taxpayers) to make up the difference. At the state and local level, the $80 billion granted to businesses is frequently paid for by higher sales taxes, increased fees, excise taxes, and sometimes, large rate hikes.

Ultimately, tax competition creates a prisoner’s dilemma. If every U.S. state would agree to refrain from providing tax subsidies, it is likely that the nation as a whole would be better off. But a single state can reap enormous short-term benefits by cutting tax rates or offering rebates to attract corporate relocations. Globally, the stakes are even higher. The OECD and European Union have attempted to rein in tax competition, but they’ve had limited success. While not everyone has adopted a 12.5 percent rate like Ireland, nations have switched to territorial systems (United Kingdom, Japan), created patent boxes (again the United Kingdom, plus the Netherlands), or used other tax gimmicks to reduce business taxes.

Is tax cooperation the future, or will tax competition continue to shift the burden of financing government from businesses to individuals? That’s hard to say, but it would be difficult to force every state and locality to agree to a sort of tax cease-fire. But state governments in the U.S. would be well advised to more closely scrutinize the tax incentives they are granting corporations, or they might find themselves with a severely contracted tax base and grossly underfunded infrastructure.

Read Comments (1)

Rusty SteeleDec 10, 2012


Its stated purpose is to shrink the size of government until it's small enough
to drown in the bathtub. Only then can the 1% wallow in liberty and do their
happy dance.

Back on planet reality, the RTTB doesn't constrict the size of the public
sector in any meaningful way. EPIC FAILURE w/r/t mitigating the perceived evils
of statism.

If anyting RTTB has the opposite effect. It tells lawmakers that public
spending need not be paid for. Hell, history might view RTTB as the quickest
path to socialism because it cuts the cord between taxing and spending.

All evidence suggests RTTB works like a charm ... at growing the deficit and
feeding our national debt. No surprise really, the whiz-kids behind RTTB are on
record a decade ago as saying that deficits don't matter.

Should we really be taking policy advice from people who think deficits/debts
don't matter?

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