Effectiveness and Economic Impact of Tax Incentives in the SADC ...

6-4 EFFECTIVENESS AND IMPACT OF TAX INCENTIVES IN THE SADC REGION
Community is prepared to pursue full tax harmonization, Member States cannot be expected
to “avoid” all such “prejudice.”
Is there a more operational way to deal with the real problem of inefficient investment
diversions due to tax competition in the region? This question can best be answered after
examining some pertinent theoretical concepts.
6.2 Theory of Tax Competition 82
A starting point for examining the theory of tax competition is a pioneering model of inter-
jurisdictional tax differentials known as the Tiebout hypothesis. For a decentralized fiscal
system, Tiebout postulated that tax competition promotes efficiency by allowing states or
localities to cater to different tastes of citizens for taxation and the provision of public goods.
Some jurisdictions will choose low taxes and limited public services, while others choose high
taxes and more extensive public services. Within a union, individuals can then “vote with
their feet” by moving to a jurisdiction that suits their preferences. In the Tiebout model, tax
differentials are fundamentally benign.
In the international context, individuals cannot so easily move to a compatible fiscal regime.
Yet the model aptly describes the fact that some governments choose to restrain the tax
burden while others adopt high-tax, high-expenditure outcomes to suit the preferences of
their constituents. Equally, jurisdictions differ legitimately in their preference regarding the
structure of the tax system. Some countries depend more heavily on consumption-based
taxes, while others place more weight on income taxes. Moreover, inter-jurisdictional
competition can be a positive force for encouraging tax reform and improving efficiency in the
administration of public services.
Although it is useful to recognize the healthy side of tax competition, this view obviously
omits considerations that lie at the heart of the debate about harmful tax practices. The
decision by one state to pursue a low-tax strategy creates fiscal externalities for other
jurisdictions. These include 83
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Factor movements to the low-tax state (LTS), which erode the tax base in the high-tax state
(HTS). Even if HTS offers better public services overall, the additional expenditure may fall
in areas (such as social services) that appeal to voters but not to potential investors. If so, the
service differentials will not compensate companies for the higher tax rate. Thus, investment,
jobs, and taxable income will shift to LTS.
82 This section draws on the survey by Lemgruber (1999).
83 This is only a partial list. Gordon (1983) identifies six inter-jurisdictional tax interactions in a non-cooperative
equilibrium, including the first two above plus equity effects, congestion effects, effects from changes in
consumption patterns, changes in the cost of public goods, and changes in the terms of trade (relative prices)
between jurisdictions.