Why Angela Merkel Hates Tax Competition
European political leaders gathered in Malta last month to discuss the future of the European Union. During the meeting, German Chancellor Angela Merkel made sure to denounce any post-Brexit move on the part of the United Kingdom to lower corporate taxes. (Merkel condemned efforts by the US to cut corporate taxes as well.) Merkel called any such move a "race to the bottom."
With these comments, Merkel was echoing earlier comments by German Finance Minister Wolfgang Schäuble who in January employed the same "race to the bottom" phrase and harangued the UK on the matter, claiming that any attempt to lower taxes would be in violation of international agreements. Besides, lowering taxes is retrograde and non-progressive thinking, Schäuble noted, stating that "A truly global economy must think of global governance."
This controversy helps to reveal how the European Union has been a useful tool in preventing tax competition between member states.
By threatening retaliation from EU institutions, and by resorting to claims that international agreements cancel out national policy, EU bureaucrats have long used the EU as a stick to beat potential tax-cutters into submission.
What Is Tax Competition?
Richard Teather explains:
Tax competition occurs when a government uses its tax system to try to attract capital, business activity, or wealthy individuals from other countries. At its most obvious this could be a "tax haven" with very low (or even zero) tax rates, but it could include more subtle provisions such as tax breaks for specific businesses relocating into a country. Game theory suggests that if the low-tax countries successfully attract international investment then other governments will respond, leading to a competitive spiral of tax reductions as they all compete for mobile capital.
Once upon a time, Europe was notable for its frequent use of tax competition. As Ralph Raico noted in his seminal essay "The European Miracle," a central phenomenon behind the unprecedented economic growth and wealth-building that occurred in early-modern Europe was the common use of tax competition.
Thanks to the presence of a very large number of small states in Europe at the time, many European political rulers competed with each other to attract the most productive people and the most productive enterprises. Those tone-deaf princes and rulers who insisted on raising taxes to levels higher than their neighbors lost both residents and profitable businesses to neighboring states.
The European Union, on the other hand, has long attempted to end this sort of tax competition, as Louis Rouanet recently noted:
It has now become clear that in many ways the European Union is a cartel of high-tax governments whose goal is to restrain tax competition. The EU's supposedly free — this is, regulated — trade policy is none other than an excuse to homogenize the tax and regulatory regimes of the nation-states.
The ultimate goal of the high-tax member states such as France is to use the EU to milk as much as possible from the productive members of society without losing their tax base.
Thus, no one should be surprised that Europhiles like Merkel and Schäuble are now condemning the very idea of a "rogue" government like that of the United Kingdom lowering taxes.
Indeed, so long as the EU included the UK — one of the worlds largest and most productive states — the EU could exercise a degree of control over domestic tax policy above and beyond the tax-funded remittances the UK government must pay into the EU's common purse.
Now, with the UK on its way out of the EU, the EU faces the threat of a competitor right next door which might entice EU businesses and citizens to relocate to the UK in order to escape higher taxes in the EU. Nor is this any minor threat, considering the UK's advantages as an island of English-speakers with easy access to global shipping lanes.
Even worse for the Europhiles is the fact that the US now might be headed in the direction of reducing some taxes as well. Trump has expressed an interest in reducing the US government's corporate tax — one of the highest in the world — to attract businesses to the United States. This would come as a break with the policies of Barack Obama who was committed to both high tax rates and working in concert with his fellow interventionists in the EU establishment.
Such a move by the US would present an additional threat to the EU's hegemony, and thus Merkel has hit the panic button, declaring tax cuts to be a "race to the bottom" as if tax cuts were anything but a laudable move upward into the light.
Moreover, the entire affair illustrates yet again that one of the biggest problems with states in the world is that there are too few of them. To the extent that the EU constitutes a single state on tax policy, the creation of another state through the UK's secession created competition for the EU and increased the potential to reduce taxes and create more tax competition. One could only imagine how much worse tax policy would be if the US had to reply on approval from the EU to engage in its own tax cuts. To further increase the potential for greater tax competition, of course, both the US and the UK should be broken up into still smaller states, thus further reducing the monopoly powers currently enjoyed by the mega-states that rule us from Brussels and Washington, DC.