A Race to the Bottom

Could it be that governments around the world are competing so hard for investment that they are actually going to bottom out on business taxation one day soon? This is the best sign I have seen in some time - since the big trend toward flat taxes by former communist countries - that indeed a small-government world is possible.

Note that I am not saying that tax trends overall have been good, but consider the evidence regarding business tax competition.

(1) Corporate income taxes are lower in all except four OECD countries than they were in 1986 -- unfortunately, overall taxes as a percent of GDP have gone up in every one. Seven OECD countries cut corporate rates between 2006 and 2007.

(2) The reduction in rates since 1986 and the low rates in OECD countries today are the result of conscious competition among countries for investment income. Because of this competition Germany, which has lagged other European Union countries in lowering corporate tax rates, wanted to force tax harmonization among member countries to prevent investment from fleeing. When this strategy failed, Germany was forced to start lowering its own corporate rate.

(3) The intent to compete ferociously, and without respite, is spelled out. In a testimony to the Canadian Senate Committee on Banking, Trade and Commerce, it was recommended that “the Canadian capital gains tax rate should be quickly be lowered to match the rate in the United States.”

The report then added that “the Committee also recommends that international competitiveness be the criterion guiding the choice of a capital gains tax regime, and that federal government be prepared to lower the tax until that criterion is met.” Canadians listened, and the current capital taxation in Canada is falling fast. By 2012 the federal corporate income tax rate will be 15% and the overall effective corporate rate will be the lowest in the G7 and, as the budget report gloats, it will be over 9 percentage points lower than in the US.

How low can they go? Maybe a little vicious competition can help bring a more reasonable tax system and lead to smaller government. Sadly, it may only be on the business side that government will care to compete. Yet "brain drain" does occur when individual income taxes are too high. As any anarcho-capitalist will tell you, competition is the best way to keep government in line. Let's hope we're beginning to see a trend toward tax competition.