Room to Manoeuvre? International Financial Markets and the National Tax State

Abstract

Globalisation has triggered a downwards trend in direct taxation as governments compete for internationally mobile capital. This popular postulation has blurred the attention to potential upward constraints on tax policy-making emanating from globalised capital markets. In this paper, we illustrate when and how capital markets exert an upward pressure on taxes. While the increasing access to international capital allowed governments in developed democracies to indulge their voters with deficit-financed spending, the most recent crisis has shown that this is no panacea. When international loans become costly, governments have to revert to raising revenue domestically. Using comparative time-series data since the 1980s, we investigate how rising bond yields affect the number and the direction of tax reforms, as well as the tax mix in the OECD. The empirical analysis provides some evidence that international capital markets place an upward pressure on taxes, recently above all on consumption taxes. Yet, governments have also retained room to manoeuvre as a number of tax decisions are more dependent on domestic political factors than on pressure from the capital markets.

Keywords:

• globalization
• financial markets
• government bond yields
• taxation
• redistribution

Acknowledgements

The authors claim equal authorship. We would like to thank the anonymous reviewers, Rob Franzese and the participants at the European Political Science Association General Conference 2012 for their helpful comments. We gratefully acknowledge funding from the German Science Foundation via the Collaborative Research Center 597.

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes on contributors

Hanna Lierse completed her Ph.D. at the University of Hamburg in 2011. Since then she works as a research fellow at the centre on the transformation of the state located in Bremen. Her research interests pivot around international political economy, particularly linked to issues of welfare, taxation and redistribution. She has published a book about the evolution of the European economic governance system and is currently expanding the focus to other regions of the world. Two of her current projects address patterns and evolutionary paths of the modern welfare and tax state beyond rich Western democracies.

Laura Seelkopf holds an MA degree from the University of Konstanz and a Ph.D. from the University of Essex. Currently, she works as a postdoctoral fellow at the University Bremen. She focuses especially on The Tax State and International Tax Policies. Laura Seelkopf is mainly interested in international and comparative political economy and quantitative methods. Her substantive focus lies on tax and welfare policies, as well as development aid. She has written on international tax competition and its redistributional consequences – both inside and outside the OECD.

Notes

1. These countries are Australia, Austria, Belgium, Canada, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Iceland, Ireland, Italy, Japan, the Netherlands, New Zealand, Norway, Poland, Portugal, Slovenia, Spain, Sweden, Switzerland and the UK. If we exclude the political control variables, we additionally gain four more OECD countries for our analysis: Mexico, the Slovak Republic, South Korea and the USA.

2. All tax rate information is based on the OECD Tax Database. However, the database for VAT rates is not based on annual information prior to 2000. Hence, we complemented the missing observations by investigating and including the information from the OECD economic country reports. The data can be provided upon request.

3. In terms of policy changes, given the recession, the actual expenditure and revenue levels might still be lower than before. Yet, one would need to compare them to the counterfactual levels in a world without policy change.

4. The appendix is not included in the paper due to a rather long list of tables, but is available upon request by the authors.

5. The insignificant effect for the top PIT in Figure 3 stems partly from the short time intervals and the associated higher standard errors. Over the whole period with a short exception in the 1990s, governments lowered top income tax rates when under financial pressure.

6. The figures and tables of the robustness checks are not included in the paper due to word limitations, but all robustness checks are available online upon request.

7. Please note that the tax rate adjustments only involve the following five tax categories: the top personal and corporate income tax, the rate on small- and medium-sized businesses, the bottom income tax rate and the VAT rate.