The Effects of International Tax Competition on National Income Distribution

Globalization involves increasing freedom of capital movement: both for firms from industrialized countries investing in developing countries, and for financial asset owners in developing countries themselves. Standard principles of international taxation suggest that the tax burden should fall most heavily on those factors of production which are least mobile, in order to maximize government income and minimize the disincentives to economic growth. As global market integration has deepened, tax competition drives down taxes on mobile factors of production (capital and highly skilled labor) and thus tends to both increase taxation on immobile factors (not only land and natural resources, but also unskilled labor and those outside the labor force) and reduce government expenditure—or raise indirect taxation—thus worsening income distribution.

The long-term trend towards lower rates of both corporate income tax (CIT) and personal income tax (PIT) is clear from Figure 1.1 and Figure 1.2. As shown in Figure 1.1, CIT rates have declined by about one-third in all country groups over the past three decades; while, as shown in Figure 1.2, the top marginal PIT rate has declined in almost all countries by a similar proportion. Both forms of income taxation are in fact dominated by capital income—directly in the case of CIT and indirectly in the case of PIT, where higher incomes are dominated by dividend returns and asset gains. The downward trend in statutory rates and the pressure on the taxable base itself is the result of countries competing to attract investment—both by foreign investors and by domestic wealth holders able to move their capital abroad.