Adjusting national tax policy to economic internationalization: Strategies and outcomes

Competitive pressures in corporate and personal income taxation have increased the marginal economic and political costs of taxation during the last 25 years. This contributed to the fact that since the mid-1980s, capital income and total tax revenues as well as public expenditures (all as percentage of GDP) of the 18 most advanced OECD countries have, on average, no longer shown a medium-term upward trend. However, contrary to widespread beliefs, the OECD-18 averages for these three variables do not show a downward trend, either. How can this medium-term stability of capital income tax revenues, total tax revenues and public expenditures be explained? On the basis of an investigation of the nature of adjustment pressures and strategies, the paper highlights two explanations. First, competitive pressures on the tax mix, the revenue mix, and the budget size have partly been offset by countervailing - domestic and international - pressures. Second, given strong budgetary constraints on general cuts in effective income tax rates, most governments have pursued three revenue-preserving adjustment strategies that take the precise nature of competitive pressures into account. Governments have pursued a policy of tax-cut-cum-base-broadening, differentiated their income tax treatment according to differences in competitive pressures, and combatted international tax avoidance and evasion with legal and administrative measures. These strategies have been successful in limiting revenue losses. However, increased (explicit) differentiation of income tax treatment does conflict with established principles of neutral and just taxation. Thus, competitive pressures have resulted, in part, in a changed and more controversial structure of taxation rather than large-scale revenue losses.