By David Henderson
In a recent NBER working paper, “How Globalization Affects Tax Design,” (WP # 14664), James R. Hines, Jr. and Lawrence H. Summers point out that the increasing mobility of capital makes economic activity more sensitive to tax rates, thus increasing the deadweight loss from a given tax rate. The rapid pace of globalization, they write, means that “all countries are becoming small open economies.” This means, they write, that “the use of expenditure taxes [as opposed to taxes on personal and corporate income] is likely to increase.”
They also assert, without providing evidence, that globalization increases the demand for government spending.
Is there a way to avoid expenditure taxes and, instead, keep having high marginal tax rates on personal and corporate income? In their last paragraph they suggest a way out, writing:
International agreements have the potential to play significant roles in these strategies. It is already the case that governments cooperate in international settings such as the World Trade Organization to promote international trade and investment, and bilateral and multilateral tax agreements and initiatives serve the function of facilitating tax enforcement and avoidance of double taxation of international income. Doubtless governments will come to rely more heavily on international agreements in the years to come, but it remains to be seen whether they will accelerate or offset the recent trend in the direction of expenditure taxation.
In other words, Hines and Summers seem to be suggesting that governments get together and form tax cartels that would lessen the competition between governments for economic activity. Given Summers’ current role as head of President Obama’s National Economic Council, this article could well be more than an academic exercise. Summers bears watching.