Apr 18 2013

Heard that countries should ‘compete’ on tax? Wrong

Posted by: Nick Shaxson in: Thoughts

Updated: the longer article is now available, here.

An article on tax competition in The Guardian, co-authored by Ellie Mae O’Hagan and me.

It’s subtitled “Tax ‘competition’ – in which countries fight to lower taxes – not only hits the poor, it doesn’t even help the economy grow.”

Which is exactly right. Our article starts like this:

“A myth we’re repeatedly told is that a country must be “tax competitive” in order to support a successful economy. It sounds so reasonable. We’re taught that competition between companies keeps them on their toes and pressures them to produce better products and services, at better prices.

But here’s the problem: competition between companies in a market bears no economic resemblance whatsoever to “competition” between countries on tax. They are utterly different economic beasts.”

Now read on. This is one of the most important myths out there on international tax.

The published article is somewhat shorter than the original. Here’s one bit that was cut out, but that we’d like to highlight.

“Let’s tackle the economic illiteracy behind those calls for a ‘competitive’ tax system. If you write about it, always put ‘competitive’ in quote marks, to signal that you understand. And when a politician wheels out the ‘C’ word – get them to explain exactly what they mean. Or run for the hills.”

The longer article supporting these conclusions is here or here.

12 comments so far

La Chupacabra 4th April, 2013 11.48 am

Nick –

There are a few elementary errors in your article.

First, your graph of the growth in GDP/head versus average Government revenue/GDP is a statistical horror show. You are comparing a second-degree (growth) with a first-degree (revenue) variable. That is a big no-go in statistics, which a freshman in any statistics or economics program is taught to avoid. You really should compare growth in GDP/head versus change in Government revenue/GDP.

Economists may be illiterate, but they would not commit schoolboy error like this one.

There is also the issue of the sample. Your graph only shows Western nations in long-term relative decline. Why don’t you show some nations with real GDP/head growth: China (where Government revenue/GDP is less than 10%), Taiwan (c. 13%), Singapore (14%), Chile (18%), or even Korea (25%).

It really feels like you are selecting your statistical sample to fit your conclusions, another schoolboy error a freshman would not commit.

Finally, there is that contention that people do not move because of changes to the tax system. Well unfortunately for you, they do. It does not happen from one day to the next, but over the mid-term, the trend is unmistakable. This happens between countries (eg French moving to Switzerland) and even between US states (although the impact of local and state taxes is relatively small compared to Federal taxes), as per the link below.

http://news.investors.com/032813-649561-republican-states-more-freedom-attract-more-people.htm?p=full

Your paper will probably get a good response from Guardian readers, but it does not stand any scrutiny.

La Chupacabra 4th April, 2013 11.49 am

Nick –

There are a few elementary errors in your article.

First, your graph of the growth in GDP/head versus average Government revenue/GDP is a horror show. You are comparing a second-degree (growth) versus a first-degree (revenue) variable. That is a big no-go in statistics, which a freshman in any statistics or economics program is taught to avoid. You really should compare growth in GDP/head versus change in Government revenue/GDP.

Economists may be illiterate, but they would not commit schoolboy error like this one.

There is also the issue of the sample. Your graph only shows Western nations in long-term relative decline. Why don’t you show some nations with real GDP/head growth: China (where Government revenue/GDP is less than 10%), Taiwan (c. 13%), Singapore (14%), Chile (18%), or even Korea (25%).

It really feels like you are selecting your statistical sample to fit your conclusions, another schoolboy error a freshman would not commit.

Finally, there is that contention that people do not move because of changes to the tax system. Well unfortunately for you, they do. It does not happen from one day to the next, but over the mid-term, the trend is unmistakable. This happens between countries (eg French moving to Switzerland) and even between US states (although the impact of local and state taxes is relatively small compared to Federal taxes).

http://news.investors.com/032813-649561-republican-states-more-freedom-attract-more-people.htm?p=full

Your paper will probably get a good response from Guardian readers, but it does not stand any scrutiny.

Nick Shaxson 4th April, 2013 1.19 pm

Edouard, actually no. You are mistaken. Taxes as a share of GDP doesn’t change that much, and it’s the overall share of taxes that matter, not whether a country is moving from 39 to 41 percent over time. And this is just one of several graphs that could have been selected (you should actually take this argument up with Martin Wolf, the FT’s chief economics commentator, who produced a series of graphs including one like this here http://blogs.ft.com/martin-wolf-exchange/2012/05/31/taxation-productivity-and-prosperity/ It tells the same story – though for some reason the outlier of Ireland did get cut off by the graph-makers, which was annoying; I have asked if they can reinstate it. I will also produce a graph which, for what it’s worth, shows ‘competitiveness’ (WEF version) versus taxes, which couldn’t go in for space reasons.)

And you are quoting from a study by the Mercatus center, a lobbying organisation? Have you see CTJ’s skewering of these studies?

But still this is a useful reminder for me to expand this on the blog.

La Chupacabra 4th April, 2013 2.45 pm

Nick – there are several reasons why barely anybody reads the FT here in the US, and Martin Wolf is definitely one of them (compounded by the fact that you actually are supposed to PAY to read his stuff). So I will have this conversation with you.

You are missing the point about the statistics. The fact is that it is simply mathematically spurious to regress or analyze variables of different orders. Arguing against it amounts to arguing against Newton’s gravity. Even if your mistake were not to affect the validity of your argument, you should try to reach your conclusions in a way that is mathematically correct.

In any event, the bigger issue is the bias in your sample. Where are Singapore, Taiwan, Hong Kong etc., all countries or territories with explosive growth rates, higher prosperity than almost all EU nations on your graph, and dramatically lower shares of Government revenues?

As for Mercatus, I am well aware that it is an advocacy group, but so are CTJ, ITEP and the TJN. They all are guilty of the bending the data to support their agenda.

Nick Shaxson 4th April, 2013 3.38 pm

You are right on Mercatus vs TJN. OK. Your airy dismissal of Wolf is misguided. But I’m happy to have a brief conversation.
“You really should compare growth in GDP/head versus change in Government revenue/GDP.” Now here you are guilty of what you accuse me of. The numbers are large, and the change is small. To measure change in government revenue/GDP is to measure the difference between two large numbers: small percentage changes in the numbers themselves can create violent swings in the difference. This would be more acceptable if something was rising from 100 to 1,000 – but not from 39 to 40. It’s perfectly reasonable to ask “have the high-tax countries been growing faster than the low-tax countries?” The data set is from G20 countries for which comparable data is available, there was no selection involved here at all. But now you suggest adding in your own pet bias: let’s chuck in all the ones you like. But here’s the problem with that approach. Let’s say we take a selection of every country in the world, poor and rich. You then plot government revenue/gdp versus GDP growth. You will get (I guess, though I have never seen such a graph) a bunch of poorer countries (with lower gdp/capita) growing faster than richer countries (with higher gdp/capita). But that doesn’t get you very far, for it tells you nothing about causation. It will most likely show that the poorer countries will naturally be growing faster than rich ones, because they are playing catch-up. Not because they levy less tax. (That correlation/causation thing is true of my graph too, but my graph shows that there isn’t an obvious relationship, so we’re not trying to pin any causation onto the correlation.)

Nice try, though.

La Chupacabra 4th April, 2013 4.36 pm

Nick –

There are various ways that statistical analysis can deal with the problem you are describing (that the variables being compared are of different magnitude), that do not involve making the entire analysis spurious.

If you insist on trying to make a point about the difference in well-being between high- and low-tax countries, you probably ought to compare time series of absolute GDP/head versus Government revenue/GDP. That would be an acceptable statistics.

Regarding the sample, I am surprised about your statement that it is based on G20 data. Several countries on your graph are not even members of the G20 (Switzerland, Austria, New Zealand, all the Nordics…), but several G20 coutries are omitted (China, Korea, Turkey etc). I am puzzled.

The interesting takeaway from your graph (whatever its defaults may be) is that all countries to the right of Spain (included), with the possible exception of Canada, are the ones that I have most suffered from the financial crisis. Maybe the conclusion should be, unsurprisingly, that high-tax regimes are fair-weather regimes, but that they do not take shocks very well.

Nick Shaxson 4th April, 2013 1.21 pm

Hmm but that isn’t the right graph to produce those conclusions, I don’t think. (One only has to say “Ireland” or “Spain” to doubt your conclusion.) One of Wolf’s other conclusions from the collection of graphs he produced was this: “many of today’s most solvent countries are highly taxed. Indeed, among the eurozone countries shown, crisis-hit Ireland, Spain and Italy had relatively low average tax rates. (They also had fiscal surpluses or negligible fiscal deficits, prior to the crisis. But that is a topic for another occasion.) The heavily taxed eurozone countries on the right hand side of the chart (from Germany on up) are all now relatively crisis-free.” Yes on g20, i hastily wrote that on my comment, from memory, but i was wrong. but that is not an issue: this is the prosperous western democracies (if you count Japan as ‘western’) The thing you need to do is compare like(ish) with like, so that you don’t mix poor with rich and then get get ‘economic catch-up’ and other stuff playing havoc with your conclusions.

edi 4th April, 2013 6.59 pm

From the article: “Tax “competition” is economic warfare, where countries fight over businesses by lowering taxes”

Agreed. But what I lack in the article is more clarification of when you argue from a global point of view and when you argue from the perspective of a single country.

To make a comparison, many armed conflicts are overall bad, for all parties involved. But during the escalation phases each party may still find it rational at each step to proceed, because not doing so would risk letting the other parties get the upper hand, which could risk even worse outcomes for the country (total defeat).

Is your stance that it is never beneficial, even in this game theoretic way, for a single country to lower taxes as a response to other actors in the international arena? Or is it only that the combined effects of many countries acting like so is bad?

Nick Shaxson 4th April, 2013 8.23 am

Edi, it’s both – see the longer paper, which explores this. It also makes a case – though that’s more open to interpretation – that businesses themselves are in many cases harmed by this.
http://www.taxjustice.net/cms/upload/pdf/TJN_NEF_130418_Tax_competition.pdf

La Chupacabra 4th April, 2013 11.21 am

Nick –

One of the many problems with Wolfe’s analysis is its narrow European focus (Europe is where he finds an audience dumb enough to want to pay to read him, so that is not surprising).

By focusing on a narrow sample of mostly Western European nations, the analysis misses the big picture: The EU15’s share of world GDP has gone down from 35% in 1970, to around 20% now. It will be less than than 10% in 2030. The entire growth in world GDP is happening outside of Europe, in locations that all have much less punitive taxation regimes.

Even Northern European nations, including Germany, are neither sustainably solvent nor prosperous. They are only doing relatively well currently by sucking the life out of even less competitive Southern European nations, thanks to the disaster that is the common currency project.

By the way, Taiwan, Hong Kong, Korea and Singapore are definitely not poor. They should be on this graph.

Nick Shaxson 5nd May, 2013 7.42 am

those countries are firmly in the ‘catch-up’ brigade in the time scale studied, and so they would not be appropriate to include. and the single currency thing – that is another argument entirely. And it’s not (Tom?) Wolfe but (Martin) Wolf.

[…] tended to outperform or match lower-taxed states and are better able to weather downturns; or this, on tax ‘competition’ between states, or this, showing that cutting top tax rates […]

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