Harmful Tax Competition: How States and Local Districts are Straining Economic Stability

Since the Organization for Economic Co-operation and Development (OECD) published its landmark report on harmful tax competition in 1998, world leaders have been trying to diminish the practice’s deleterious effect on economies.

Harmful tax regimes, including tax havens and corporate side deals, erode the tax base of neighboring jurisdictions often causing a race to see who can offer the lowest rate. The OECD defines harmful tax practices as being characterized by a combination of a low or zero effective tax rate with a lack of transparency or a lack of information exchange. While the United States government—along with most other world leaders—has supported efforts to rout out harmful tax competition internationally, it has not been as vocal domestically.

One example is the corporate shift from California, New York, Washington and Illinois to states with much lower taxes like Florida, Texas and Louisiana. Tech companies have been flocking from Silicon Valley to Texas and Florida. In fact, within weeks of each other last year, tech giants HP and Oracle both relocated to Texas to take advantage of better tax rates.

The issue is so stark that Sacramento State finance professor Sanjay Varshney told CBS that, “It has to do with taxes, clearly, because the states that have been winning recently are the states that don’t have any income tax or corporate taxes.”

Tech companies have also been relocating further east in Tampa Bay and Miami, Florida. With one of the lowest corporate income tax rates in the country, the state has become attractive to big firms needing relief from California’s corporate rate, which is more than double Florida’s. According to the Miami Herald, around 17 large companies have moved from the Bay Area to the beach.

This may seem like healthy competition—states competing for tax dollars from big businesses— but in the long term it’s a disaster. When states and municipalities tailor their tax rates to attract businesses or cut deals with big companies to reduce their tax burdens, it hurts the surrounding jurisdictions and creates a regional setting that is not conducive to economic stability.

When the time comes for infrastructure spending from airports to railroads, states like Florida are getting a piece they haven’t contributed to, while those with higher tax rates have to make up the difference.

If states and local jurisdictions don’t stop racing to the bottom on corporate and sales taxes, the regional economies in these areas will become increasingly unstable.

To avoid that, tax competition among states must be reduced and there needs to be more uniformity in sales and corporate taxes.

Although many economists have generally endorsed and even encouraged tax competition between states, the critical question emerging is whether state tax competition is detrimental to regional economic growth during the pandemic downturn and the eventual recovery. Suppose states and local jurisdictions continue to outstrip one another. In that case, the regional economies may become progressively volatile, perhaps leading to sluggish expansion and growth, even with abundant federal assistance.

To avoid this debacle, tax competition among states at this time must be diminished, balanced, and needs to become regionally consistent.

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