Tax competition

Question 1

Tax competition

Answer 1

The reduction of tax burden by a state via tax incentives in order to
attract foreign investments and/or increase competitiveness of
domestic business.

Question 2

Tiebout hypothesis (good tax competition)

Answer 2

Households and firms can vote with their feet—leave the country if
the tax burden is too high

• Competition: states can provide better public goods/lower tax rate
• Not to spend too much
• Better public administration for taxpayers

Increase efficiency

when it is efficient to have multiple jurisdictions providing local public goods, then competition between jurisdictions for residents will lead to a near-optimal outcome.

Question 3

Better allocation of resources (good tax competition)

Answer 3

Correcting market failures & support infant industries
* Resources go to places where market does not favor
* E.g. R&D, SME, environment, less developed regions—need public
goods and services
* Increase equity
* Increase domestic competitiveness—attract investment & export

Question 4

Harmful tax competition (Distortion of resource allocation)

Answer 4

Selective tax advantages to certain companies or regions
* Tilt the level playing field

Government failures: lobby and rent seeking

Harm tax neutrality: capital moves only for tax reasons

Question 5

Harmful tax competition (Race to the bottom)

Answer 5

States compete to give lower tax rate
* Governments are forced to give similar tax incentives
* Without coordination, everyone ends poorer

Question 6

OECD harmful tax competition 1998

Answer 6

• No or low effective tax rates
• Specific tax incentives for foreign taxpayers
• Lack of transparency
• Lack of effective exchange of information
• Artificial definition of tax base
• Failure to adhere to transfer pricing rules
• Exemption of foreign-source income

Question 7

Tax haven

Answer 7

a country that imposes low or no tax on income

Question 8

Portfolio investment

Answer 8

Investment in financial asset such as stock, bond, securities, to gain
return or grow.

Question 9

Passive income

Answer 9

Parent can bring large amount of cash into the subsidiary with portfolio investment

Question 10

Base haven

Answer 10

No or low tax on all business income
* E.g. Caribbean and Pacific islands
* Not many DTTs

Question 11

Treaty haven

Answer 11

Has broad and favorable treaty networks
* Suitable for intermediary holding companies
* Due to DTT, low withholding tax on money in and out
* E.g. NL, Lux

Question 12

State aid law: Article 107 (1) Treaty on the Functioning of the European Union (TFEU)
(2012)

Answer 12

Any aid granted by a Member State or through State resources in any
form whatsoever which distorts or threatens to distort competition by
favoring certain undertakings or the production of certain goods shall, in
so far as it affects trade between Member States, be incompatible with
the internal market.

Question 13

Four criteria: Applying state aid law

Answer 13

1. By a State or through State resources:
   * Tax reduction means less tax revenue received by the State
   * 2. Advantage in any form:
   * Tax exemption, tax credit, tax deduction etc.
   * 3. Selectivity:
   * Certain tax advantage to specific enterprises or regions
   * 4. Affect competition and trade:
   * Affect fair tax competition—harmful tax competition