Practice Advice on Public Financial Management
Tax Competition between Sub-Central Governments (OECD)
Summary Advice: The OECD advises countries on techniques for reducing tax competition among their sub-central governments.
Main Points: Countries with sub-central government (SCG) tax autonomy have to cope with SCGs making use of this autonomy. Tax interaction is widespread, and tax competition might have become stronger with the likely increase of tax base mobility. The fiscal and economic crisis might have boosted SCG's incentives for strategic tax policy, as taxation is often one of the most straightforward policy measures a government has to bolster it economy. In most countries, central government constrains sub-central tax competition, often due to the perception that it is “excessive,” although the results of this study question this premise. The paper presents and evaluates the most frequent policies likely to reduce tax competition.
- Move towards property taxation - Countries can reduce SCG tax competition is to change the tax structure and to tax less mobile tax bases. Such a move would mean fostering property taxes and, to a lesser extent, consumption taxes at the expense of corporate and personal income taxes, especially for those countries where personal income taxes and corporate income tax make up a considerable part of SCG tax revenue.
- Harmonise, to some extent, the sub-central tax base - Tax base harmonisation can take on various forms, such as limiting the right to introduce or abolish a tax, the tax object, deductions such as tax creditsand reliefs, limits on special tax benefit packages, and procedural aspects such as tax periods. The central government may either require SCGs to align their tax bases with an upper government level or among each other. With a harmonised tax base, SCGs‟ only policy lever is tax rates. Tax base harmonisation can simplify the tax system and improve coordination across government levels, overcome information asymmetries and increase transparency about effective tax levels. tax base harmonisation deprives SCGs of the possibility to adapt their tax policy to special circumstances. Moreover, it reduces the probability of tax innovations at the local level and hence the virtues of decentralisation as a laboratory for fiscal policy.
- Introduce or amend fiscal equalisation systems - Most countries use fiscal equalisation as a tool for reducing negative impacts of tax autonomy and tax competition. Equalisation reduces – by definition – disparities between SCGs and reduces incentives to lower tax rates, and strong equalisation may result in higher rather than lower tax rates in some SCGs. Most equalisation systems put a higher marginal equalisation rate on poor than on wealthy jurisdictions, which can be particularly detrimental to economic and fiscal development efforts of poor SCGs. Fiscal equalisation has two effects on SCG tax policy: a) it reduces ex post differences in tax raising capacity resulting from tax competition and tax base mobility, and b) it reduces ex ante incentives to engage in competitive tax practices.
- Other constraints on sub-central tax autonomy - Countries have resorted to other policies that limit SCGs‟ ability to compete on tax policy, partially in the wake of the financial and economic crisis. Several countries set maximum and minimum tax rates, thereby limiting sub-central tax autonomy and preventing perceived “excessive” or “predatory” tax rate setting. Another way to limit tax competition is to require SCGs to use progressive taxation, thereby limiting SCG‟s ability to compete for mobile high-income earners. Finally, territorial reforms such as jurisdictional mergers tend to reduce tax competition, especially if SCGs of different sizes and/or of different economic and fiscal wealth are merged.
Source: OECD (2011). Hansjörg Blöchliger and José Maria Pinero Campos, "Tax Competition Between Sub-Central Governments" at http://www.oecd-ilibrary.org/economics/tax-competition-between-sub-central-governments_5kgb1mfm6jnw-en (accessed 28 December, 2012).
Page Created By: Matthew Seddon, 28 December 2012. The content presented on this page is drawn directly from the source(s) cited above, and consists of direct quotations or close paraphrases. This material does not necessarily reflect the official view of the publishing organization.