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Tax Competition Is a Feature, Not a Bug

Competition is a wonderful thing. Competition between businesses, industries and even nations creates pressure in a positive direction toward lower prices, better service, higher quality, more innovation, and greater efficiency. Businesses and industries have to compete because consumers have choice and can easily shift their economic behaviors.

Nations also compete—to attract global financial investment, to attract human capital, to trade their exports under favorable conditions. Nations have to factor in the policies and practices of their global competitors, because investment capital and human capital are also mobile. Poorly performing countries commonly complain about “brain drain” because their best and brightest often choose to relocate to other countries where their economic prospects are better.

One way governments compete for investment and human capital is through tax policy. When governments embrace tax policies that are competitive with their neighbors, we call that tax competition. And we chose the term “governments” rather than nations because it’s not just nations that engage in tax competition—states and even cities and counties also compete with each other on tax policy.

Some cities purposely keep their sales tax rate lower than neighboring cities to attract consumer spending. States certainly engage in tax competition. Several states have no state income tax, for instance, and others are trying to phase out their state income taxes.

Lower taxes encourage economic growth by attracting an influx of companies and workers. Census data tell us conclusively that Americans are migrating from high-tax states to low-tax states, which is why lower-tax states are gaining congressional seats while higher tax states are losing them.

Sounds great, right? Well, there’s one class of people that hates tax competition—the Government Class. They want Big Government with higher taxes and higher spending, and they fear that tax competition restrains taxes and spending. High-tax states hate having to compete with low-tax states, and high-tax nations hate competing with low-tax nations. Treasury Secretary Janet Yellen calls tax competition a “race to the bottom” (i.e., lower taxes).

That’s why she wants a “global minimum tax” and is pushing the G-20 nations to adopt the idea. The Government Class wants to eliminate tax competition so they can coordinate and collude to increase tax revenue. Were private businesses to do that, governments would prosecute them. But governments are allowed to conspire and collude with impunity.

Tax competition is a feature, not a bug, and it should be encouraged, not colluded out of existence. Low business taxes in Canada and the U.K. helped encourage lower business taxes in the U.S., and low taxes in Ireland helped drive down taxes in the U.K. It’s understandable why the Government Class doesn’t like it, but never confuse what’s best for the Government Class with what’s best for you. They call it a race to the bottom, but that sounds to us like limited government.