Can tax competition boost demand? Causes and consequences of the global race to the bottom in corporate tax rates

Corporate tax rates have been consistently falling around the world for decades now. This paper aims to explain the causes and consequences of this ‘global race to the bottom’. In particular, the author wishes to test the hypothesis that this race to the bottom is driven by demand-boosting corporate tax competition, where, contrary to traditional Kaleckian theory, lower corporate taxes may positively affect demand through increased investment due to multinational enterprises (MNEs) that seek higher net profits through (re)locating in low-tax jurisdictions. In order to do so, the author builds a general theory of the effect of average effective corporate tax rates (AECTRs) on MNE location. This theory is used to justify the addition of a tax-sensitive foreign direct investment channel in the investment function of a canonical Kaleckian model. As a result, this paper determines the conditions under which a country may be ‘tax-competition-led’, where lowering AECTRs increases demand through increased MNE investment and in spite of the negative effect on government expenditure given a balanced budget. The findings of this paper are that it is possible for an economy to be tax-competition-led, though it is unlikely in many cases given the existence of a coordination problem that lessens or nullifies the effect of lowering AECTRs when many countries do so simultaneously. The author refers to this problem as the ‘paradox of tax competition’, since, like other fallacies of composition commonly identified in Post-Keynesian thought, this is a phenomenon where the benefits of one country acting alone are reduced or eliminated if other countries act the same way at the same time. Based on this model, crude but nonetheless informative estimates are given that indicate that the race to the bottom has had a negative effect on demand in the vast majority of OECD countries. In this sense, the author finds that the persistence of policymakers to continue to compete on corporate taxes ‘imprudent’. Model-consistent policy recommendations are offered, chief among which are tax coordination or, failing that, technical changes in how individual countries collect corporation tax.