Globalization and Taxation

Globalization is leading to a restructuring of taxation. The increasing mobility connected with globalization is fundamentally altering governments' capabilities to tax, thereby limiting governmental spending.

More than ever before, companies have found themselves with the choice between locations in different countries for investment. The countries are then faced with two alternatives: either they receive the investment (and the associated tax returns) or it goes elsewhere. Countries aim to do their utmost to make their countries desirable locations to invest. One of the major ways this is done is through lowering taxes. If they receive more business as a result, lowering taxes paradoxically leads to greater tax revenues.

The clearest example of this trend has recently been found in Europe, where the superstate of the EU has caused actual conditions to be more similar to the idealised theories of globalization than anywhere else. That capital and labor flows more easily through Europe than between, for example, the United States and China, hardly comes as a shock. Inside the open markets of the EU, however, are great variations in labor costs and capital: broadly speaking, Eastern Europe has lower labor costs and less capital than Western Europe. As a strategy to develop their economies, many of the governments of Eastern Europe have simplified and lowered their taxes in order to get investment from the wealthier economies of Western Europe. In countries such as Slovakia, which has adopted a 19% (very low) flat tax rate, the strategy has been successful, with many companies shifting investment from more expensive countries, such as Germany and Austria. This led to a rise in tax receipts for Slovakia because of the new investment and jobs. The real question remains, however, whether this is a long-term solution.

In response to the competitive low taxes and capital flight, many Western European countries have lowered their taxes in order to maintain their competitiveness. Germany's corporate rate dropped from 39% to 30%, and Austria's from 34% to 25%. The issue is that of a shrinking pie: as countries compete for a limited amount of investment (on the whole, low taxes do much more to redirect investment rather than to create it), the fear is that tax revenues will fall below the minimum required to provide essential state services. This downward trend, especially in corporate taxes seems unlikely to end any time soon. There have been some tentative attempts to compromise and gradually harmonise tax policies across the EU, but they have been entirely ineffectual.

How governments might restructure their finances in light of the increasing competitiveness of taxation remains to be seen. Even income taxes, especially at higher income brackets, are somewhat vulnerable. The critical criteria is mobility; both multi-national companies and the super-rich have a mobility which is unavailable to poorer tax-payers. Does this mean that tax burdens will progressively shift towards the relatively immobile lower classes? It is a possibility. In an effort to reduce tax-evading emigration by wealthy French people, President Nicholas Sarkozy eliminated the highest income tax bracket in order to encourage wealthy citizens to return and pay French income tax. Certainly the falling tax revenues will continue to put pressure on the funding of social safety networks upon which the disadvantaged in wealthy countries often rely.

This trend is liable to be affectected by the ongoing economic crisis. It is difficult to determine exactly how, but there are numerous possibilities. In the medium term, the lower tax rates recently instituted in many countries will exacerbate the enormous budgetary deficits caused by economic contraction and fiscal stimuli. Most importantly, the eventual fate of globalization and non-state capitalism will have a profound effect on tax policies. If, as some predict, the current crisis leads to a withdrawal from the liberal economic policies of the past 30 years which have led to globalization, it is quite likely that the competitive pressures on corporate taxes will ease. There is even the possibility that taxes might climb quite significantly in the wealthy world to match the rising cost of social welfare programs brought about by ageing populations. Alternatively, if the recent trend towards globalization remains more or less intact, it follows that there is a great likelihood of continued tax decreases and the retreat of the state from more and more aspects of society. If ever there was an exciting period for taxation, this is it.