EFTA00317171.pdf

Department of Economic & Social Affairs CDP Background Paper No. 24 ST/ESA/2014/CDP/24 December 2014 International Tax Cooperation and Implications of Globalization' Leome Ndikumana ABSTRACT Recent developments in globalization raise important issues regarding taxation policy and economic development. First, trends in capital income tax raise concerns about a pos- sible race to the bottom or harmful competition. Second, lack of tax policy coordina- tion results in large losses in tax revenue due to profit shifting by multinational corpora- tions. These practices undermine revenue mobilization in the least developed countries, which also suffer from capital flight and other forms of illicit financial flows. This paper discusses how improved governance of the global financial system and enhanced harmo- nization in taxation policies may help address these important development problems. Keywords: Taxation; tax evasion; globalization; saving; capital; economic development JEL Classification: E21; H26; O16; O19; F13 Leona. Ndikumana is Professor of Economics and Director of the African Development Policy Program at the Political Econ- omy Research Institute (PERT) at the University of Massachusetts at Amherst, E-mail: [email protected]. Comments should he addressed by e-mail to the author. Ibis paper was prepared as a contribution to the work program of the United Nations Committee for Development Policy (CDP) on the United Nations' development agenda for the post-2015 era. This research effort aimed at analyzing and proposing solutions to the current deficiencies in global rules and global governance for development. Additional information on the CDP and its work is available at: http://www.un.orgfenidevelopmentidesa/policy/cdp/indcx.shtml EFTA00317171  CONTENTS 1. Introduction 3 Why care about safe havens 11 2. Tax policy in the context of globalization 4 Institutional mechanisms of secrecy 13 Special goals and challenges associated 5. Global conventions and frameworks for tax with globalization 4 cooperation and against tax evasion .. . . 14 Trends and shifts in tax policy regimes 6 Existing frameworks 14 3. Tax competition and gains from international Limited effectiveness of existing frameworks 15 policy coordination 8 6. International tax cooperation and revenue Distortionary effects of taxation 8 mobilization in developing countries.. . . 16 Evidence: do countries engage in tax• 7. Taxation and global public goods 19 based competition over capital 8. Conclusion 21 and savings? 9 References 22 Gains from tax policy coordination 11 Appendix Tables 24 4. Tax competition, tax evasion and safe havens 11 CDP Background Papers arc preliminary documents circulated in a limited number of copies and posted on the DESA website at http://www.un.org/en/development/desa/papers/ to stimulate discussion and critical comment. The views and opinions expressed herein arc those of the author and do not necessarily reflect those of the United Nations Secretariat. The designations UNITED NATIONS and terminology employed may not conform to Department of Economic and Social Affairs United Nations practice and do not imply the ex- UN Secretariat, 405 East 42nd Street pression of any opinion whatsoever on the part of New York, M. 10017, USA the Organization. email: [email protected] Typesetter: Nang Setterasi http://www.un.org/en/development/desa/papers/ EFTA00317172  Acronyms ADB Asian Development Bank MFN Most Favoured Nation AfT Aid for Trade MoCS Ministry of Commerce and Supplies AoA Agreement on Agriculture MoF Ministry of Finance ASYCUDA Automated System for Customs Data MoFTR Memorandum on the Foreign Trade Regime CSOs Civil society organizations NGOs Non-Governmental Organizations CV Custom Valuation NPC National Planning Commission DAD Department for International Development, United Kingdom NRB Nepal Rastra Bank DSB Dispute Settlement Body NTC Nepal Telecommunication Corporation DTIS Diagnostic Trade Integration Study ODCs Other duties and charges EIF Enhanced Integrated Framework SAARC South Asian Association for Regional Cooperation FAO Food and Agriculture Organization of the United Nations SPS Sanitary and Phytosanitary Measures FTA Free Trade Agreement SWAp Sector-wide Approach TBT Technical Barriers to Trade GATS General Agreement on Trade in Services TPRM Trade Policy Review Mechanism GATT General Agreement on Tariffs and Trade TRIPS Trade-Related Aspects of Intellectual Property Rights GDP Gross Domestic Product TRQs Tariff rate quotas GTZ German Development Agency UNCTAD United Nations Conference on Trade MS Harmonized System and Development IF Integrated Framework UNDP United Nations Development Programme IFC International Finance Corporation UPOV International Union for the Protection ITA Information Technology Agreement of New Varieties of Plants ITC International Trade Centre WP Working Party LDCs Least Developed Countries WTO World Trade Organisation EFTA00317173 This paper was originated as a contribution to the work programme of the United Nations Committee for De- velopment Policy (CDP) on the United Nations development agenda for the post 2015 era. This research effort aimed at analyzing and proposing solutions to the current deficiencies in global rules and global governance for development. Additional information on the CDP and its work is available at: htto://www.un.orden/development/desa/oolicv/cdaindex.shtml. EFTA00317174  Introduction redistribution role, enabling governments to support la livelihoods for low-income segments of the economy. Globalization is viewed as the "increasing interna- Taxation policy is also an important gauge of equity tionalization of markets for goods and services, the considerations in the policy stance. Finally, taxation means ofproduction, financial systems, competition, is an important tool for promoting domestic saving corporations, technology and industries"(UNCTAD and investment, and for attracting foreign capital. It et al., 2002, Glossary, p. 170). It is associated with is in this context that developments in globalization increasing mobility of factors of production — es- are highly relevant for taxation policy. While other pecially capital —, explosion of financial flows, and dimensions of fiscal policy are important, this paper rapid transmission of technological innovation. focuses on the implications of globalization for tax- The integration of product and financial markets is ation policy. facilitated by worldwide adoption of liberalization There are important issues regarding the links be- policies in product and service markets as well as in tween globalization and taxation policy. First, there the financial system, and the general trend towards is increasing evidence that average taxation rates on removal of regulatory obstacles to economic activity capital income have declined over time in developed (UNCTAD et al., 2002, p. 9). and emerging countries (Devereux et al., 2008). While the increase in trade in goods is the bedrock This raises the question of whether this is a result of of globalization, the most rapid expansion has been deliberate attempts by countries to unilaterally use in the area of finance. Over the span of three dec- their tax policy to undercut each other in order to ades between 1980 and 2012, capital flows grew five attract foreign capital and saving. In other words, times faster than exports. Global trade in merchan- are countries engaging in a "race to the bottom" dises increased by 820% overall or 7.2% annually, or "harmful competition" using their tax policies? from $1,979 billion to $18,214 billion. During the Second, with the increasing mobility of capital same period, global (outward) foreign direct invest- and ease of incorporation of enterprises in foreign ment, for example, increased by 5,290% overall or territories, there is concern about multinational 13.3% annually, from $549 billion to $23,593 bil- corporations (MNCs) engaging in profit shifting, lion" Most of capital flows have been directed to the taking advantages of loopholes in tax policy, gaps in service sector, including banking. For example, over regulatory frameworks, and lack of coordination of the 2005-2007 period, services accounted for 60 taxation policy across countries. This has important percent global investment outflows, although they implications for efficiency and equity. The problem is represented only about five percent of global trade exacerbated by the lack of transparency in the global (UNCTAD et al., 2012, p. 12) . At the same time, financial services, especially in safe havens (Shaxson, while there have been substantial efforts to establish 2011). Third, there is a concern that there is no level and strengthen global frameworks for the regulation playing field in the globalization process, and that of trade in goods, much less has been done in terms the least developed countries (LDCs) especially of coordination of trade in services and finance. are substantially disadvantaged in the allocation of capital and saving. In particular, LDCs suffer large These developments in globalization have impor- losses in tax revenue due to profit shifting by MNCs tant implications for taxation. Tax policy remains a operating in the natural resources, manufacturing, central element of national policy in several ways. and service sectors, while at the same time they face It is the main source of revenue mobilization to fi- severe haemorrhage through capital flight and other nance public service delivery and to support coun- forms of illicit financial flows (AfDB and GFI, 2013; ter-cyclical policy interventions. It has an important Ndikumana and Boyce, 2011a; Shaxson, 2011). Data obtained from UNCTAD's statistical database (on- From a global perspective, taxation policy can also line) at http://unctad.org/en/PagestStatistics.aspx. play an important role in advancing global initiatives. EFTA00317175  CDP BACKGROUND PAPER NO. 24 This is at two levels. At the first level, taxation can In the context of globalization, national fiscal policy generate valuable resources to support the financing design and management is guided by two important of 'global public goods'. At the second level, targeted objectives. The first is to improve the competitiveness taxation can help discipline the production of 'global of national enterprises relative to foreign companies. public bads' such as pollution. Achieving these goals In this respect, fiscal policy uses two main tools: the requires a high level of coordination and political statutory tax rate on capital and corporate profit; and commitment by national governments. the effective marginal tax rate on business income. The second objective is to attract foreign capital and This paper discusses these issues with a view to shed saving while retaining domestic capital in the local light on ways to improve global institutional mech- economy. This objective is challenged by the fact that anisms and frameworks to increase efficiency and tax policy is a sovereign policy and therefore there is equity in taxation in the context of globalization. The no expectation that countries will automatically har- next section describes the main features and develop- monize their policies. In fact, more often than not, ments in tax regimes under globalization. Section 3 tax policies are not harmonized, and this is not new. discusses tax competition and potential gains from international coordination in tax policy. Section The lack of harmonization of tax policy is partly due 4 explores the linkages between tax competition, to the fact that economies are characterized by dif- transparency and the emergence of tax havens as fa- ferent levels of productivity of capital and different cilitators ofprofit shifting, transfer pricing, and other rates of economic agents' intertemporal substitution illicit financial flows. Section 5 reviews the existing between saving and consumption. However, even global institutional frameworks for tax coordination taking into account these considerations, the evi- and anti-tax evasion conventions, examines their dence tends to show that substantial disparities in effectiveness and discusses their potential. Section 6 taxation rates arc not backed by these fundamental examines the implications of international tax coop- characteristics. Take the example of tax on capital. eration for revenue mobilization in developing coun- One would expect that differences in tax rates across tries. Section 7 briefly discusses the potential benefits countries would reflect differences in productivity of from international coordination of taxation policy for capital. Figure 1 suggests that this is not systemati- financing global public goods. Section 8 concludes. cally the case. Fiscal policy in the context of globalization is con- fronted with the reality of increased cross-border © Tax policy in the context of globalization Figure 1 Effective corporate tax rate (EATR) and productivity of capital in the US and EU, 1991 Special goals and challenges associated with globalization Sweden, In addition to its traditional role in the domestic Finland economy, tax policy takes on an expanded role in Denmark the context of globalization. It is a tool for managing Italy the country's trade and investment relations with the Austria rest of the world, including protecting the domestic ■ productivity economy against external shocks. At the global level, France of capital taxation is also a tool for (1) setting up incentives for Ireland ■ EATR discouraging the production of public 'bads such as 0 20 40 60 80 100 120 pollution and (2) for mobilizing financing for public EATR (%); productivity ratio (96) goods. This is further elaborated in Section 7. Source: Sorensen (2000). EFTA00317176  INTERNATIONAL TAX COOPERATION AND IMPLICATIONS OF GLOBALIZATION capital mobility, following the gradual deregulation tax rates compared to other OECD countries. This, of capital account regimes. If domestic tax rates arc as the argument goes, would be one of the major perceived as being higher than in other countries, reasons why American businesses have been relo- then businesses will be tempted to move abroad cating production abroad, especially in developing either or both their investments and their business and emerging countries to reap the benefits of lower profits. This raises policy concerns as such decisions effective costs of capital and labour. Recent evalua- affect the country's potential for growth and em- tions tend to lend some support to the claim about ployment creation. US tax rates being higher than in comparable coun- The competitiveness implications of fiscal policy tries. In 2013, the average effective corporate tax rate have come to the centre stage in the wake of the 2008 was 39.1 percent in the United States, followed by global financial crisis in developed countries as they Japan at 37% (Figure 2). All the other major OECD struggled to ignite and sustain economic recovery. In countries had lower rates. In the UK, the rate was the United States, the crisis has re-energized claims a full 16 percentage point lower than in the United from the business community and the conservative States (23%). In all OECD countries except Chile, political establishment that American companies arc the tax rates have declined since 2000, and quite penalized by relatively higher statutory and effective substantially in some countries. The United States Figure 2 Effective corporate tax rates in selected OECD countries, 2000-201 3 United States -0.2 39.1 Japan -3.8 r. 36.9 France -3.3 mi 34A Belgium -6.2 33.9 Portugal -3.7 315 Germany -21.8 30.1 Spain -50 30.0 Mexico -5.0 30.0 Australia -4.0 30.0 Luxembourg -8.2 292 Norway 0 28.0 New Zealand -5.0 28.0 Italy -9.5 275 Canada -16.2 26.1 Greece -14.0 26.0 Netherlands -10.0 r. 25.0 Denmark r change -7.0 25.0 Austria (percentage points) -9.0- 25.0 Finland 2000-2013 -4.5 24.5 United Kingdom si 2013 rate -7.0 23.0 Sweden -6.0 22.0 Switzerland -3.7 21.1 Turkey -13.0 20.0 Chile 5 20.0 -40 -20 0 20 Source: OECD, Centre for Tax Policy Administration (online data: hup://vnvw.oecd.orgictor). EFTA00317177  6 COP BACKGROUND PAPER NO. 24 experienced a smaller decline in corporate tax rate through various 'tax planning' mechanisms and out- compared to other countries. right tax evasion (discussed later in the paper). A recent report by PriceWaterhouseCoopers (2013) The differences in effective corporate income tax rates finds that in the past years, effective corporate income across countries could be a result ofmany factors. The tax rates have gone up in the majority of sectors in first is, obviously, the statutory tax rate. However, the United States. For example, the average effective these differences arc also driven by the overall struc- corporate income tax rate for companies in the third ture of the tax regime. In other words, these differ- top quartile in the aerospace and defence industry ences are a result of cross-country variations in both increased by 1.6 percentage point from 32.3% in the tax rate as well as the base. This involves consider- 2010 to 33.9% in 2012 (Table 1). The data also indi- ations on what activities arc taxed or not, what provi- cates that the increase in the burden of taxation has sions are available for tax deductions and allowances, been uneven, falling disproportionately on smaller and differential treatment of income on the basis of companies. To use the example of the aerospace and where it was earned — domestically or abroad. These defence industry, the average effective corporate tax considerations arc central to tax competition; they rate for companies in the bottom first quartile in- arc elaborated in Section 3 further below. creased twice as much as in the third quartile: by 4.5 percentage points from 19.5% to 24% during Trends and shifts in 2010-12. The larger companies have experienced tax policy regimes a relatively smaller increase in the tax burden. The increase in the tax burden should be even smaller The configuration of tax regimes around the world for MNCs, which arc able to take advantage of low has experienced three main developments over the taxation in foreign territories where their branches last five decades. The first was the introduction of and affiliates arc located in addition to tax avoidance the Value Added Tax (VAT), which is now the most Table 1 Effective corporate tax rates in selected US corporate sectors, 2010 and 2012 sector Quartile 2010 2012 Aerospace and defence Q3 32.2 33.9 O1 19.5 24.0 Industrial products and automotive sector O3 34.1 35.2 O1 16.4 20.4 Automobile sector O3 35.5 34.4 O1 16.1 18.4 Chemicals O3 32.1 33.9 O1 20.8 23.0 Transportation and logistics O3 38.3 38.5 O1 8.7 15.5 Industrial manufacturing and metals O3 33.6 36.0 O1 22.9 24.1 Source: Price Waterhouse Coopers 12013). EFTA00317178 INTERNATIONAL TAX COOPERATION AND IMPLICATIONS OF GLOBALIZATION widespread form of consumption tax. The ration- Under the 2005 United Nations Millennium Project, ale for this form of taxation was that it is the least a minimum of 4 percentage-point increase in the tax distortionary way of taxing private consumption. to GDP ratio was deemed necessary for developing The second major development has been the general countries to achieve the millennium development lowering and flattening of statutory income tax rates goals. This meant that countries were expected to on high income individuals and corporations (Bird, raise their tax/GDP ratios from an average of 17-18% 2012). The third noteworthy development is a recent to 22%. This goal proved to be rather ambitious and push for more equity considerations in tax policy. even unrealistic. In fact, no LDC achieved this tar- These changes and trends reflect, to some extent, get. In 2011, the IMF recommended a less ambitious shifts in views of what good tax policy is within the goal of 2 percentage increase in the tax/GDP ratio, academic community and the policy arena. and suggested that most countries could achieve this increase with VAT alone "with no great effort" (Bird, In the 1960s, it was all about income tax. Under 2012, p. 8). what is referred to as Development Tax Model 1.0, progressive comprehensive personal income tax was More recent debates about taxation regimes exhib- deemed to be the ideal tax regime (Bird, 2012). In it increasing attention to the fiscal exchange and particular, such a regime was considered especially equity dimensions of taxation. Specifically, this is appropriate and preferred for developing countries illustrated by reforms in the tax system that seek to (Bird, 2012; Bird and Zolt, 2005; Kaldor, 1963). In- achieve a better balance between resource mobiliza- direct consumption tax was considered as 'necessary tion and income (re)distribution through changes in evil'. International and sub-national aspects of taxa- corporate income tax, personal income tax, tax on tion were relegated to the margin and were not con- wealth, and others. sidered important in tax policy design. This model The evidence, however, shows that these shifts in of taxation eventually proved ineffective in helping taxation regimes have not produced commensurate developing countries in the mobilization of tax reve- effects in effective tax revenue collection. In fact, the nue. Tax to GDP ratios did not increase, which was evidence indicates substantial 'fiscal revenue inertia' an important cause of the fiscal challenges faced by (Bird, 2012) and there has been little progress in developing countries in the 1980s in addition to ex- raising tax/GDP ratios, especially in sub-Saharan ternal debt crisis. Africa (Table 2). The leading region in terms of In the 1980s, the thinking on taxation underwent growth of tax/GDP ratio is developing Asia where an important shift in the context of market-oriented the ratio grew by nearly 3 percent annually during policy reforms enshrined in the so-called Washing- the 2000-12 period. However, this region continues ton Consensus. The prescription was that a broad- to trail other regions in tax mobilization, with a based low tax rate model — Development Tax Model 21.7% tax/GDP in 2012 (up from 15.4% in 2000). 2.0 — was the most appropriate for developing and In Sub-Saharan Africa, there has been virtually no change in the tax/GDP ratio over the past decade. developed countries (Bird, 2011). It is in this con- The best performers in this respect are Latin America text that the preference shifted to VAT as the more and the Middle East and North Africa with ratios preferable form of taxation. However, like under above 30%. Model 1.0, the premise remained that "more tax is better"; thus, the objective remained to increase Several factors have been advanced to explain the tax revenue. Note, however, that even with the shift poor performance in tax revenue mobilization in de- towards VAT, income taxes remained important. veloping countries. These include lack of economic What changed was that the rates were declining, as transformation that perpetuated the dominance of were tax incentives, but the bases were broadening. low-tax generating sectors such as agriculture, and EFTA00317179  8 COP BACKGROUND PAPER NO. 24 Table 2 General government revenue in developing regions, percentage of GDP Annual Average change Group 2000 2005 2010 2011 2012 2000-12 2000-12 (%) Developing Asia 15.4 18.4 20.5 21.5 21.7 18.9 2.9 Latin America and Caribbean 24.5 27.2 301 30.9 31.3 27.7 2.0 Middle East and North Africa 30.5a 40.4 34.7 37.8 37.8 36.9 2.2 Sub-Saharan Africa 25.9 27.6 25.4 28.6 27.9 26.8 0.6 For comparison: Emerging market and 23.6 27.6 27.0 28.3 28.3 26.6 1.5 developing economies European Union 44.7 43.6 43.5 44.1 44.3 43.8 -0.1 Source: IMF, World Economic Outlook database, accessible online at: httryilwww omf ors/external/nehtfiteeen/2014/01/weedetehnelex Atp Note a: In 2002. inefficiencies in tax administration, some of which In addition, the evidence also indicates 'fiscal struc- are due to lack of technical capacity. In the spirit of ture inertia" (Bird, 2012). Despite the various chang- Kaldor (1963), it may be argued that taxation has es in the tax rates and legislations, there has been no not increased as expected "because it is seldom in the major change in the structure of the tax system. In interest of those who dominate the political institu- particular, the share of consumption taxes — share tions to increase taxes" (Bird, 2012, p. 8). of VAT and customs revenues in total tax revenues Moreover, performance in tax revenue mobilization -- has not substantially increased following the in- reflects the degree ofcompliance by tax payers, which troduction of VAT, as increases in VAT revenues in turn is influenced by the public's perception of the have been offset by declining customs revenues due efficiency of utilization of resources as illustrated in to trade liberalization (MartinezNazquez and Bird, the supply and quality of public services. In general, 2011). As for personal income tax collection, there accountable states have more leverage in mobilizing is no systematic common trend across countries; the tax revenue. In particular, successful strategies for ratio of personal income to GDP has increased in raising tax revenues must be backed by enhanced some countries and decreased in others (Table Alin rule of law, reduction of corruption, improved tax the Appendix). The same goes for corporate income morale, and contraction of the shadow economy. tax as a share of GDP (Table A.2 in the Appendix). Obviously these are not easy to accomplish, but "some countries may find it easier to do such things than finding oil — and they may well be better off by doing so since oil wealth may solve the revenue El Tax competition and gains from international policy problem only at the cost of exacerbating substan- tially the governance problem" (Bird, 2012, p. 8). In coordination fact, in the case of developing countries, those that 'have found oil' have performed worse in tax revenue Distortionary effects of taxation mobilization than their less 'lucky' non-oil counter- The substantial variations in statutory and effective parts (see Ndikumana and Abdcrrahim (2010) for tax rates across countries suggest that there arc scopes evidence in the case ofAfrican countries). for competition for capital and savings on the basis EFTA00317180 INTERNATIONAL TAX COOPERATION AND IMPLICATIONS OF GLOBALIZATION of fiscal policy. These disparities may, in fact, be a taxed as residents on income earned from domestic result of active attempts by governments to compete sources. If all countries adopted the same approach, over mobile capital and savings. This implies that then marginal intertemporal rates of substitution as globalization increases the distortionary effects of well as marginal products of capital would be unaf- taxation. In the context of a closed economy, tax- fected by tax considerations and savings and capital ation can create a wedge between consumer-saver's would be allocated according to country-specific marginal intertemporal rate of substitution and the fundamentals; taxation would not be distortionary producer-investor's marginal productivity of capital. in an open economy context. But in practice, there is This can affect the allocation ofcapital across sectors no coordination in foreign income taxation. and activity. The second possible dimension of tax competition is In the open economy context, there arc two addi- the treatment of debt and equity in taxation. Corpo- tional potential distortions due to taxation (Razin rations can (legally) use clever financial accounting and Sadka, 1991). Under globalization, residents in to take advantage of allowances for deduction of any country may engage in rate of return arbitrage interest payments not only by increasing the use of on capital (firms) and saving (households and firms) debt relative to equity, but also through intra-corpo- on the basis of differences in taxation between their ration lending to minimize the overall tax burden. home country and the rest of the world. Their ob- The latter is an avenue for 'thin capitalization' as well jective is to maximize the returns to savings and as profit shifting across territories, resulting in overall capital regardless of the country where they choose lower effective tax payments for the corporation as a to locate their investments and channel their savings whole. Therefore, the data on effective corporate tax or profits. Differences in taxation, therefore, can rate may be misleading with respect to the level of create disparities in the intertemporal marginal rate statutory taxation in a country. This also means that of substitution, which may result in misallocation countries have more tools at their disposal when they of savings across countries. Similarly, differences in use tax policy to compete over capital and savings. taxation may drive disparities in marginal product of capital, resulting in misallocation of capital or Evidence: do countries engage in investment across countries. tax-based competition over capital If countries choose to compete over capital and sav- and savings? ings using fiscal policy, their tool kit include more The question of whether countries effectively engage than the rate of taxation. In addition to setting in tax-based competition has been motivated, in the tax rate, governments can choose what to tax, part, by the substantial variations of tax rates across when and how much to tax it. From the tax pay- countries as well as the steady decline in effective er's perspective, this affects the taxable income and marginal tax rate on capital and corporate profits the tax base. There arc two important dimensions (Devereux et al., 2008). Obviously, the decline in besides the tax rate along which governments can the tax rate is a concern because it implies loss in compete to attract and retain capital and savings in government revenue. But, at least in principle, these the context of globalization. The first is the treat- losses may be compensated by gains arising from ment of foreign-earned income. Here governments increased economic activity due to inflows of foreign can choose between two approaches. The first is the capital if, in fact, the tax provisions do succeed in residence-based taxation whereby residents are taxed enticing increased capital inflows. on their world-wide income, regardless of whether the income is earned at home or abroad. Foreigners The research community has attempted to shed arc not taxed at all in this approach. The second is light on the question above by combining theoret- the source ofincome approach where residents are not ical modelling and empirical analysis to search for taxed on foreign-earned income and foreigners arc evidence of effective tax competition (Devereux et EFTA00317181  CDP BACKGROUND PAPER NO. 24 al., 2008; Huizinga and Laeven 2008; Marceau et be displaced due to disparities in taxation policies al., 2010; Paeralta et al., 2006; Wilson and Wildasin, (Dcsai et al., 2006). There are also possibilities of 2004). To get a handle on the question, one must misallocation of capital and savings across countries consider the interplay between the decisions by the as discussed earlier. Information plays a key role in government regarding taxation and the reactions of the decisions by firms and savers to allocate capital private sector actors (firms and individual savers) and saving. This happens at two levels. First, accurate with regard to the levels and allocation of capital and information on the true content of taxation policy saving. The interplay can be conceived as a two-stage — statutory as well as effective tax rates — is impor- game between private actors and the government. tant in the determination of the optimal level and This is summarized in Figure 3. location of capital. Second, the extent of disclosure of information, or transparency, affects incentives of The outcomes of these interrelated decisions by the firms and savers in determining the location of eco- government and private sector actors arc critically nomic activity (capital), savings and profits. important for the relative economic performance of countries with accompanying welfare implications. The literature on tax competition provides some These decisions imply that economic activity may consistent evidence that demonstrates the important Figure 3 Government, firms, savers and taxation: a game theoretical representation 2" stage High statutory rate Level of capita (investment) ► Low Tax rate Effective Firms Location of Home marginal rate capital Government Abroad Breadth Location of Home profits Tax base Abroad Exemptions and Arms-length exonerations Transfer price High High Level of saving Low Short-term Households Term structure (Savers) of saving Long-term Home Location of saving Abroad Source:Author'sdesign. EFTA00317182 INTERNATIONAL TAX COOPERATION AND IMPLICATIONS OF GLOBALIZATION role of globalization. The evidence confirms that between gains from harmonization and payoffs from capital and profits have become more mobile across differentiated regimes. In making these decisions, countries, as illustrated by the massive capital flows economic and financial calculus is often be trumped towards both developed and developing countries, by political considerations. This may explain why although the lion share is still at the advantage of ad- international conventions and protocols on taxation vanced economies. The evidence also confirms that take long to design and are difficult to implement governments do use taxation policy to compete over and enforce. This is further discussed in Section 5. capital, profits and savings. Among the tools that are Coordination and harmonization of tax policy may at the disposal of the governments, the key factor take place at the regional and international levels. that seems to be determinant in tax competition is