Adjustment or Voice? Corporate Responses to International Tax Competition
| Published date | 01 March 2004 |
| DOI | 10.1177/1354066104040569 |
| Date | 01 March 2004 |
| Subject Matter | Journal Article |
Adjustment or Voice? Corporate Responses
to International Tax Competition
THOMAS BERNAUER and VIT STYRSKY
Swiss Federal Institute of Technology (ETH)
International tax competition may result in uneven tax burdens
among firms competing in the same market. Disadvantaged firms can
respond with market-based strategies (adjustment) or with lobbying
for changes in taxation policy (voice). We draw on theories of trade
policy, industrial organization and collective action to explain when
and why firms respond with adjustment or voice. In this demand-side
explanation, corporate responses are accounted for in terms of
potential benefits of voice, the collective action capacity of firms and
preferences of policy-makers. To show that international tax competi-
tion does not necessarily lead to downward convergence of tax
burdens, we derive conditions under which disadvantaged firms are
likely to demand more government intervention and, by implication,
a higher overall tax burden on the industry affected. We assess the
plausibility of the explanation with an analysis of political lobbying by
US property and casualty insurers aimed at offsetting tax advantages
by Bermuda-based insurers operating through subsidiaries in the
United States.
K
EY
W
ORDS
♦international tax competition ♦globalization ♦fiscal
policy ♦insurance ♦political economy
Introduction
Research on international tax competition is a crucial building block in the
ongoing effort to better understand the political consequences of economic
globalization. Collecting resources from people and firms and (re-)allocating
these resources to the production of public goods and mechanisms for the
redistribution of wealth are the most basic functions of the state. Despite
large-scale privatization and other economic reforms in recent years, most
European Journal of International Relations Copyright © 2004
SAGE Publications and ECPR-European Consortium for Political Research, Vol. 10(1): 61–94
DOI: 10.1177/1354066104040569]
states continue to collect and allocate around 30 to 50% of their gross
domestic product.
Studies on the extent and effects of international tax competition have
focused primarily on the ‘supply-side’ of the issue — that is, policy-makers’
responses to the problem in terms of tax reforms and variation in tax rates.1
The ‘demand-side’ of the issue — when and why increasing economic
openness and international tax competition, to the extent we observe them,
lead to which types of responses (political demands) by which economic
actors — remains largely unexplored.2
In this article, we develop a demand-side explanation that accounts for
corporate responses to international tax competition. The starting point is
that economic openness amplifies the competitiveness effects of differences
in firms’ tax burdens. Besides its general effect of promoting competition
among firms, economic openness creates new possibilities for firms operat-
ing out of lower tax jurisdictions to enter markets in higher tax jurisdictions.
And it creates new possibilities for firms domiciled in higher tax jurisdictions
to engage in tax avoidance by redomiciling or shifting taxable profits
through other means to lower tax jurisdictions.
Assuming profit-maximizing behaviour of all firms, one might expect that
all firms adopt the same or very similar strategies for reducing their
respective tax burden. In the real world, this is often not the case. A
frequently observed pattern is that, as economic openness increases, some
firms begin to exploit more actively than others inter-jurisdictional differ-
ences in tax burdens, thus creating uneven de facto tax burdens for firms
operating in the same market. The extant literature provides no explanation
of the economic and political processes that may then unfold. In principle,
‘run-away’ firms may trigger a chain reaction of tax avoidance that leads to
lower corporate taxes across the board (de facto and/or in terms of nominal
tax rates). Or they may trigger political reactions that prevent an erosion of
the tax base.
Our explanation focuses on three possible responses by firms experiencing
a disadvantageous tax burden. Such firms can engage in tax avoidance as well
(adjustment). Or they can lobby policy-makers to reduce taxes towards the
level tax avoiders would be willing to pay (voice option one) or to curb tax
avoidance through new regulation and/or stricter enforcement of existing
regulation (voice option two).3Drawing on theories of trade policy,
industrial organization and collective action we argue that corporate
responses are shaped by potential benefits of voice, the collective action
capacity of firms, and preferences on the supply-side (policy-makers).
We then assess the empirical plausibility of this explanation. First we derive
conditions under which firms are more likely to request more government
intervention and, by implication, a higher overall tax burden on the industry
European Journal of International Relations 10(1)
62
concerned — an outcome that most observers of the world economy may
regard as less probable (see e.g. Tanzi, 1995; Rodrik, 1997). We then
examine an area of international business activity where that outcome has
materialized and assess whether the values on the explanatory variables are
the ones predicted by the explanation. In that business area US property and
casualty insurers have lobbied US policy-makers to offset tax advantages of
Bermuda-based insurers operating in the United States.
The analysis produces preliminary support for the proposition that firms
are more likely to lobby for more government intervention if: (a) the
potential benefits of voice are high (indicated by low international mobility
of firms in the voice group); (b) collective action capacity is high (indicated
by large size of the average firm in the voice group, small group size and
ability to exclude free-riders); and (c) policy-makers have, on average,
signalled that they are willing to curb tax avoidance or take no action, rather
than level the playing field downward by cutting taxes.
In its generic form, our explanation can account for corporate demands
for tax cuts, tax increases or other tax policy changes. Additional empirical
work will have to show whether adjustment or voice in favour of tax cuts is
the dominant real-world pattern, or whether and to what extent voice in
favour of more government intervention to halt an erosion of the corporate
tax-base occurs.
Demand-Side Gap
The prisoner’s dilemma captures what many political scientists and econo-
mists believe to be the logic of international tax competition (see Tanzi,
1995; Wilson, 1999; Thomas, 2000).4Recent theoretical work has chal-
lenged this view by showing that the assumptions in the prisoner’s dilemma
model, as applied to international tax competition, are too rigid and
simplistic (e.g. Persson and Tabellini, 1992; Dehejia and Genschel, 1999;
Hallerberg and Basinger, 2000; Basinger and Hallerberg, 2001). Empirical
work has shown that the effect of international tax competition on states’ tax
revenues has been weaker than suggested by the prisoner’s dilemma.5
Arguably the most important limitation of this research is its strong focus
on the supply-side of the issue — it explains why and how governments
respond to exogenously given international pressure on domestic tax
regimes by ‘supplying’ tax reforms, tax cuts or other changes in fiscal
behaviour. To the extent that the demand-side appears in these explanations,
its analysis remains limited to assumptions and, in rare cases, empirical
measures of capital mobility, democracy, veto-players, partisanship or
domestic costs of tax reform more broadly.
Bernauer and Styrsky: Adjustment or Voice?
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