Tax competition between states presents an important obstacle to states in pursuing their policy agendas. It involves the strategic, non-cooperative setting of taxes by governments with the aim of attracting capital from other jurisdictions. Individual and corporate taxpayers shift their capital in response to the fiscal policies adopted by governments.
This capital can take various forms: portfolio capital of individuals (think of secret bank accounts in tax havens such as Switzerland or the Cayman Islands); the profits of multinational enterprises (Apple and other major corporations have used loopholes to channel taxable income through Ireland to the Caribbean, for example); and foreign direct investment (FDI). Ireland, with its low corporate tax rate of 12.5 percent, is an example of a country competing to lure FDI.
Downward pressure on tax rates on mobile capital both undermines states’ capacity to provide public goods and tends to make tax systems more regressive. Rich countries have