Tax Competition Between Sub-Central Governments

Tax competition is the strategic interaction of tax policy between sub-central governments (SCG)with the objective to attract and retain mobile tax bases. Tax competition rests on firms’ and households’willingness and ability to shift the tax base – i.e. profits, capital, income, consumption etc. – after SCG taxpolicy changes. There is no tax competition without tax base mobility. The views on the benefits and costsof tax competition differ widely: while some consider that tax competition brings sub-central fiscal policycloser to citizen’s preferences, increases the efficiency of the public sector and avoids tax and spendingexcesses, others argue that tax competition leads to a distorted tax structure, to growing tax rate disparitiesand to an under-provision of publicly provided services. The degree of tax competition is likely to varyacross countries and over time and is strongly shaped by the fiscal and institutional framework. Taxcompetition is not only an issue for federal countries, but also for unitary countries where localgovernments often have far-reaching tax autonomy.