II Policy Fields

Taxation and Inequality: How Tax Competition Has Changed the Redistributive Capacity of NationStates in the OECD

Laura Seelkopf and Hanna Lierse

Tax policy is of central importance to every state. Without tax revenue, all other government policies, including welfare policies such as transfers in case of illness (Chap. 6), old age (Chap. 7) or unemployment (see Chaps. 9 and 10), are bound to fail. In addition to providing the financial basis for the welfare state, the tax system is potentially the most powerful governmental instrument for income redistribution (Musgrave 1959). With the move in the nineteenth century towards the modern tax state, many governments introduced tax reforms that had the objective

The authors claim equal authorship.

L. Seelkopf (*)

Robert Schuman Centre for Advanced Studies,

European University Institute, Fiesole, Italy Socium, University of Bremen, Bremen, Germany e-mail: This email address is being protected from spam bots, you need Javascript enabled to view it

H. Lierse

CES, Harvard University, Cambridge, MA, USA

© The Author(s) 2016 89

M. Wulfgramm et al. (eds.), Welfare State Transformations and Inequality in OECD Countries, Transformations of the State,

DOI 10.1057/978-1-137-51184-3_5

of equalizing income differences. Income tax in particular was a means of better tapping into the income and thus the wealth of the rich (Seelkopf et al. 2016). Yet, recent inequality trends show that income inequality has been on the rise in most OECD countries since the mid-1980s (Fig. 5.1). Although real disposable household incomes have increased at large, incomes of the richest decile have grown faster than those of the poorest. According to the OECD (2011), this trend is partially due to the fact that income taxes have become less effective in reducing market income inequality. The Tax Justice Network (2014) attributes this ineffectiveness to the competitive pressure governments face:

Tax ‘competition’ (...) is the process by which countries, states or even cities use tax breaks and subsidies to attract investment or hot money. In response to ‘competitive’ pressures they cut taxes on wealthy individuals, or on corporations—then make up the difference by hiking taxes on poorer sections of society. Inequality rises.

This citation captures the fear of social scientists and politicians alike that tax competition marks the end of governments’ capacity to raise sufficient revenue to maintain their welfare states and to redistribute income via progressive taxation (Zodrow and Mieszkowski 1986; Rixen 2011). Internationalization is clearly seen as the single most important factor in recent decades influencing the tax systems of advanced economies. Yet, how exactly has globalization affected tax policy, and what impact have these changes had on economic inequality? Are these effects the same across the advanced democracies of the OECD?

Figure 5.1 provides a glance at OECD trends in inequality and tax revenues and reveals three interesting facts. First, both market inequality (gross Gini)[1] and net income inequality (net Gini) have gone up since the mid-1980s. Second, market income inequality has increased at a much faster rate than inequality after redistribution through taxes and transfers. Third, tax revenues have risen from an OECD average of about 25 per cent of GDP in the early 1980s to about 37 per cent in 2009. Thus, despite international tax competition, governments are still capable of raising a significant and even increasing

Economic inequality and tax revenue in the OECD since 1980. Source

Fig. 5.1 Economic inequality and tax revenue in the OECD since 1980. Source: OECD 2011

amount of public revenue. In addition, the graph suggests that OECD governments are still able to conduct redistributive policies as the difference between gross and net Gini; hence, redistribution is higher now than in the 1980s. Yet, redistributive policies fail to compensate fully for the massive increase in market inequality, at least in the majority of OECD countries. These trends suggest that there is a strong relationship between taxation and inequality, but also that this relationship is much more complex than is often assumed.

This contribution sheds light on the effects of tax competition on economic inequality by mapping the co-development of changing tax systems and income (re)distribution since the 1980s. It is our main argument that governments’ tax strategies and their effect on inequalities are much more complex and heterogeneous than is often acknowledged. Despite the common constraint emanating from global capital markets, governments still have room to manoeuver. The extent to which OECD governments have used this room, however, varies considerably. In this chapter we first outline our analytical foundation by describing three principles of tax equity: vertical, horizontal and international. We follow this outline by a literature overview of the link between tax competition and inequality.

Last, we provide some empirical evidence and draw a conclusion on the link between the transformation of the tax state and economic inequality.

  • [1] The Gini coefficient is a measure of inequality in a given society. It ranges from 0 (full equality) to100 (full inequality). The gross Gini measures the inequality in the market income of citizens, whereasthe net Gini measures the inequality of disposable income, that is, after (direct) taxes and transfers.
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