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Globalization and Capital Taxation in Consensus and Majoritarian Democracies

Published online by Cambridge University Press:  13 June 2011

Jude C. Hays
Jude C. Hays
Affiliation:
University of Michigan
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Abstract

This article contributes to the growing literature on the role that domestic political institutions play in mediating globalization pressures by arguing that the capital tax constraints arising from international economic integration are the most severe for countries with majoritarian political institutions. In doing so, the author solves a tax puzzle that challenges conventional thinking about how institutions condition the relationship between economic globalization and domestic politics. He presents a formal, game-theoretic model to sharpen the basic logic of his argument and then tests some of the model's predictions empirically using both quantitative and qualitative evidence.

Type
Research Article
Information
World Politics , Volume 56 , Issue 1 , October 2003 , pp. 79 - 113
Copyright
Copyright © Trustees of Princeton University 2003

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References

1 Swank, Duane, Global Capital, Political Institutions, and Policy Change in Developed Welfare States (Cambridge: Cambridge University Press, 2002), 247.CrossRefGoogle Scholar

2 For empirical evidence that there is a globalization dilemma, see Rodrik, Dani, Has Globalization Gone Too Far? (Washington, D.C.: Institute for International Economics, 1997)Google Scholar. For research concluding that globalization does not impose significant tax constraints, see Swank, Duane, “Funding the Welfare State: Globalization and the Taxation of Business in Advanced Market Economies,” Political Studies 46, no. 4 (1998)CrossRefGoogle Scholar; Swank (fn. 1); Swank, Duane and Steinmo, Sven, “The New Political Economy of Taxation in Advanced Capitalist Democracies,” American Journal of Political Science 46 (July 2002)CrossRefGoogle Scholar; and Garrett, Geoffrey and Mitchell, Deborah, “Globalization, Government Spending and Taxation in the OECD,” European Journal of Political Research 39, no. 2 (2001)CrossRefGoogle Scholar. For a review of the economic literature, see Hines, James R., “Lessons from Behavioral Responses to International Taxation,” National Tax Journal 52 (June 1999)Google Scholar.

3 For a survey of the tax competition literature, see Wilson, John Douglas, “Theories of Tax Competition,” National Tax Journal 52 (June 1999)Google Scholar; and Oates, Wallace E., “Fiscal Competition or Harmonization? Some Reflections,” National Tax Journal 54 (September 2001)CrossRefGoogle Scholar. A model of fiscal competition that can support either a race to the bottom or a race to the top (or efficient levels of taxation) in equilibrium is provided in Wooders, Myrna H., Zissimos, Ben, and Dhillon, Amrita, Tax Competition Reconsidered, Warwick Economic Research Paper no. 622 (Coventry, U.K.: Warwick University, 2001)Google Scholar.

4 Oates (fn. 3) discusses the importance of this assumption (that is, a limited range of tax instruments).

5 The data are from Volkerink, Bjorn and de Haan, Jakob, “Tax Ratios: A Critical Survey,” OECD Tax Policy Studies, no. 5 (November 2001)Google Scholar. Volkerink and Haan update the estimates originally provided in Mendoza, Enrique, Razin, Assaf, and Tesar, Linda, “On the Ineffectiveness of Tax Policy in Altering Long-Run Growth: Harberger's Superneutrality Conjecture,” Journal of Public Economics 66, no. 1 (1997)CrossRefGoogle Scholar. The method of calculation is described below and in Mendoza, Enrique, Razin, Assaf, and Tesar, Linda, “Effective Tax Rates in Macroeconomics: Cross-Country Estimates of Tax Rates on Factor Incomes and Consumption,” Journal of ‘Monetary Economics 34 (December 1994)Google Scholar. The OECD countries included in the sample are Austria, Norway, Sweden, Denmark, Finland, Germany, the Netherlands, Belgium, France, the U.K., Italy, Japan, Switzerland, the U.S., Canada, Australia, and New Zealand.

6 See Rodrik (fn. 2); and Mendoza, Razin, andTesar (fn. 5,1994).

7 Kitschelt, Herbert, Lange, Peter, Marks, Gary, and Stephens, John D., Continuity and Change in Contemporary Capitalism (New York: Cambridge University Press, 1999), 444CrossRefGoogle Scholar.

8 Garrett, Geoffrey, Partisan Politics in the Global Economy (Cambridge: Cambridge University Press, 1998)CrossRefGoogle Scholar. In addition to Garrett, recent research that makes the divergent paths argument includes Swank (fn. 1); Kitschelt et al. (fn. 7); Pierson, Paul, The New Politics of the Welfare State (New York: Oxford University Press, 2001)CrossRefGoogle Scholar; and Hall, Peter and Soskice, David, Varieties of Capitalism: The Institutional Foundations of Comparative Advantage (New York: Oxford University Press, 2001)CrossRefGoogle Scholar.

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10 Lijphart, Arend, Patterns of Democracy: Government Forms and Performance in Thirty-Six Countries (New Haven: Yale University Press, 1999)Google Scholar. For the connection between corporatism and consensus democracy, see Lijphart, Arend and Crepaz, Markus, “Corporatism and Consensus Democracy in Eighteen Countries: Conceptual and Empirical Linkages,” British Journal of Political Science 21 (1991)CrossRefGoogle Scholar.

11 There is a similar relationship between consensus democracy and the capital tax rate. Also, the bivariate relationship is robust when alternative measures of consensus democracy are used—for example, Crepaz's measures of government “encompassment.” See Crepaz, Markus, “Constitutional Structures and Regime Performance in Eighteen Industrial Democracies: A Test of Olson's Hypothesis,” European Journal of Political Research 29 (January 1996)CrossRefGoogle Scholar. Garrett and Mitchell (fn. 2) also find (controlling for a large number of economic variables) that majoritarian democracies like Canada, the U.K., and the U.S. tax capital at a higher rate than other countries.

12 For a similar argument, see Meltzer, Allan H. and Richard, Scott F., “A Rational Theory of the Size of Government,” Journal of Political Economy 89 (October 1981)CrossRefGoogle Scholar.

13 Crepaz (fn. 11).

14 Austen-Smith, David and Banks, Jeffrey, “Elections, Coalitions, and Legislative Outcomes,” American Political Science Review 82 (June 1988)CrossRefGoogle Scholar; Persson, Torsten, Roland, Gerard, and Tabellini, Guido, “Comparative Politics and Public Finance,” Journal of Political Economy 108 (2000)CrossRefGoogle Scholar.

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16 For an excellent defense of this argument, see Boix, Carles, “Setting the Rules of the Game: The Choice of Electoral Systems in Advanced Democracies,” American Political Science Review 93 (September 1999)CrossRefGoogle Scholar.

17 Dehejia, Vivek H. and Genschel, Philipp, “Tax Competition in the European Union,” Politics and Society 27 (September 1999)CrossRefGoogle Scholar; Basinger, Scott and Hallerberg, Mark, “Remodeling the Competition for Capital: How Domestic Politics Erases the Race-to-the-Bottom” (Paper presented at the annual meeting of the American Political Science Association, Washington, D.C., August 2000)Google Scholar.

18 Rodrik(fn.2), 89–95.

19 According to Rodrik, these costs include, among other things, establishing a business in an unfamiliar environment, communicating with subsidiaries, and shipping goods back to the home economy. See Rodrik (fn. 2), 90. Thus, the capital flows in this model represent foreign direct investment rather than portfolio investment.

20 Becker, Gary, “A Theory of Competition among Pressure Groups for Political Influence,” Quarterly Journal of Economics 98 (August 1983)CrossRefGoogle Scholar.

21 In other words, my model is a pure model of income redistribution. Shareholders are taxed and wage earners are subsidized. In this way, the model resembles those of both Rodrik and Becker.

22 Becker(fn.20),377.

23 Olson, Mancur, The Logic of Collective Action (Cambridge: Harvard University Press, 1965)Google Scholar. It may seem that collective action should be endogenous in the model given the size differences between shareholders and wage earners. Wage earners should face severe collective action difficulties tipping the balance of influence in favor of shareholders. This is certainly true in consensus democracies, where the cost of collective action in equilibrium is high. These costs should create a strong incentive for individual wage earners to free ride off the efforts of other workers. However, since I argue that wage earners have more political influence in majoritarian democracies, modeling the collective action problem would only strengthen my main result. This is discussed in more detail below.

24 Boix(fn. 16).

25 Rodrik (fn. 2); Swank (fn. 2,1998); Garrett and Mitchell (fn. 2); Quinn, Dennis, “The Correlates of Change in International Financial Regulation,” American Political Science Review 91 (September 1997)CrossRefGoogle Scholar.

26 For example, Swank and Steinmo (fn. 2).

27 The data used in this section are available at http://sitemaker.umich.edu/jchays/files/wp.zip.

28 The data needed to compute these tax rates are available from OECD, Revenue Statistics and National Accounts: Detailed Tables (Paris: OECD, various years)Google Scholar. The Mendoza, Razin, and Tesar (fn. 5, 1994) capital tax rates have been used by Rodrik (fn. 2), Swank and Steinmo (fn. 2), Garrett and Mitchell (fn. 2), Garrett (fn. 8), and Garrett (fn. 9), among others.

29 Quinn (fh. 25). In short, while there is a strong secular trend in the degree to which countries restrict financial transactions, the correlation between time and capital controls is far from perfect. Every country in the sample changed its capital and financial controls policy over the period of analysis, however. These changes were relatively large for countries like the United Kingdom, Norway, Finland, and New Zealand and relatively small for countries like Japan, Switzerland, the United States, and Germany.

30 Quinn's (fn. 25) broad measure of financial openness reflects restrictions on both capital and current account transactions. Other measures of capital mobility like capital flows can be problematic. Low flows between two countries, for example, do not imply low capital mobility, if the return to capital is the same in both countries. For a discussion of these measurement issues, see O'Rourke, Kevin H. and Williamson, Jeffrey G., Globalization and History: The Evolution of a Nineteenth-Century Atlantic Economy (Cambridge: MIT Press, 1999)Google Scholar; and Hallerberg, Mark and Basinger, Scott, “Internationalization and Changes in Tax Policy in OECD Countries: The Importance of Domestic Veto Players,” Comparative Political Studies 31, no. 3 (1998)CrossRefGoogle Scholar. The secular trend is an imperfect proxy for technological change. The estimated coefficients will include the effect of any trended variable. Technological innovation is probably the most important of these, but it is not likely to be the only trended variable. Nevertheless, the time trend provides a good starting point for the empirical analysis. In the sample, the capital account openness variable has a mean of 3.06 and ranges from .5 to 4. Its correlation with the deterministic time trend is .516. The financial account openness variable has a mean of 11.189 and ranges from 5 to 14. Its correlation with the deterministic time trend is .575. The sample correlation between Quinn's measures of capital account openness and financial openness is .917.

31 These data are provided in the Penn World Table, the data source used by Quinn and Inclan to examine the impact of capital endowments on financial liberalization. Quinn, Dennis and Inclan, Carla, “The Origins of Financial Openness: A Study of Current and Capital Account Liberalization,” American Journal of Political Science 41 (July 1997)CrossRefGoogle Scholar. In the theoretical model the impact of globalization on capital tax rates is a function of the initial capital endowment rather than the relative endowment of capital to labor. This is because I assume the labor supply is fixed and therefore does not affect the return to capital. In the empirical analysis, it is important to account for the fact that countries have different labor endowments.

32 For partisanship, I use the percentage of cabinet seats held by left parties provided in Swank, Duane, “21-Nation Pooled Time-Series Data Set, 1950–1999” (Manuscript, Marquette University, 2002)Google Scholar. The corporatism scores are from Hall, Peter and Franzese, Robert, “Mixed Signals: Central Bank Independence, Coordinated Wage-Bargaining, and European Monetary Union,” International Organization 32 (Summer 1998)Google Scholar. For a discussion of the theoretical literature on size and capital taxes, see Haufler, Andreas and Wooton, Ian, “Country Size and Tax Competition for Foreign Direct Investment,” Journal of Public Economics 71 (January 1999)CrossRefGoogle Scholar. Small countries are theorized to set lower capital taxes. See also Dehejia and Genschel (fn. 17). The population data used in the analysis are from the OECD's Labor Force Statistics (Paris: OECD, 2003)Google Scholar. The Single European Act—which established a common European market by eliminating all obstacles to the movement of goods, services, labor, and capital— was signed in 1986. This dummy variable takes a value of one starting in 1986 for the countries that were members of the European Union when the Single European Act was signed and is zero otherwise.

33 This control for spatial dependence is discussed in Beck, Nathaniel, “Time-Series-Cross-Section Data: What Have We Learned in the Past Few Years?” Annual Review of Political Science 4 (2001)CrossRefGoogle Scholar; it is used by Franzese, Robert J., Macroeconomic Policies of Developed Democracies (Cambridge: Cambridge University Press, 2002)CrossRefGoogle Scholar.

34 The results of joint F-tests are reported in Table 2. Omitting fixed-unit effects when they are needed creates special problems for regressions that include a lag of the dependent variable on the right-hand side. Because the lagged dependent variable will be correlated with the omitted fixed effects, the estimated coefficient for the former will be biased upward and this will undermine the explanatory power of the other regressors in the model. For a discussion of this bias, see Hsiao, Cheng, Analysis of Panel Data, 2nd ed. (Cambridge: Cambridge University Press, 2003)CrossRefGoogle Scholar, sec. 4.3.1. The consequences for other explanatory variables are considered in Achen, Christopher, “Why Lagged Dependent Variables Can Suppress the Explanatory Power of Other Independent Variables” (Paper presented at the annual meeting of the Political Methodology Section of the American Political Science Association, Los Angeles, July 20–22, 2000)Google Scholar.

35 The degree of international capital mobility that a country faces is determined not only by its own policies but also by the policies of other countries from which foreign capital might come or to which domestic capital might go. A similar set of results is obtained when the average values of capital account openness and financial openness in the other (N-1) countries for each time period are used as the measures of capital mobility. These results are available at http://sitemaker.umich.edu/jchays/files/wp.zip.

36 I used the software developed by Tomz, Michael, Wittenberg, Jason, and King, Gary, “Clarify: Software for Interpreting and Presenting Statistical Results,” version 1.2.1 (Cambridge: Harvard University, June 1, 1999Google Scholar; http://gking.harvard.edu/). For a discussion of the advantages of using simulation methods for interpreting statistical results, see King, Gary, Tomz, Michael, and Wittenberg, Jason, “Making the Most of Statistical Analyses: Improving Interpretation and Presentation,” American Journal of Political Science 44 (April 2000)CrossRefGoogle Scholar. The experimental results can be computed analytically as well.

37 Others who study the consequences of globalization for domestic economic and social policy have made similar arguments—for example, Rodrik (fn. 2), 38. Dehejia and Genschel (fn. 17) use the EU to test the predictions of their tax-competition model.

38 Lijphart(fn. 10).

39 Dehejia and Genschel (fn. 17).

40 This assumption is common in the literature; for example, Garrett (fn. 8) makes this assumption.

41 For excellent surveys of Conservative tax reform in Britain, see King, Mervyn A. and Robson, Mark H., “United Kingdom,” in Jorgenson, Dale W. and Landau, Ralph, eds., Tax Reform and the Cost of Capital: An International Comparison (Washington, D.C.: Brookings Institution, 1993)Google Scholar; and Leape, Jonathan I., “Tax Policies in the 1980s and 1990s: The Case of the United Kingdom,” in Knoester, Anthonie, ed., Taxation in the United States and Europe (New York: St. Martin's Press, 1993)Google Scholar.

42 For a good discussion of the end of imputation in Britain, see Gammie, Malcolm, “The End of Imputation: Changes in U.K. Dividend Taxation,” Interfax 25, no. 10 (1997)Google Scholar.

43 For a hypothetical illustration of the revenue consequences, see Hughes, David, “Recent Changes to the U.K. Tax Credit Regime, the Abolition of ACT, and Certain Related Matters,” Bulletin for International Fiscal Documentation 52 (January 1998)Google Scholar. For actual revenue estimates, see Organization for Economic Cooperation and Development, OECD Economic Surveys: United Kingdom (Paris: OECD, 2000)Google Scholar.

44 Due to missing data for the operating surplus of private unincorporated enterprises, I am not able to extend this chart beyond 1998.

45 Quoted from the official English translation of the PvdA's 1998 election manifesto. See van de Arbeid, Partij, Eenwereld te Winnen (Amsterdam: PvdA, 1998)Google Scholar.

46 For a good discussion, see Organization for Economic Cooperation and Development, OECD Economic Surveys, 1999–2000: Netherlands (Paris: OECD, 2000)Google Scholar; and Cnossen, Sijbren and Bovenberg, Lans, “Fundamental Tax Reform in the Netherlands,” Working Paper no. 342 (Munich: CESifo, 2000)Google Scholar.

47 Cnossen and Bovenberg (fn. 46).

48 OECD(fn.46).

49 Young, Garry, “The Influence of Foreign Factor Prices and International Taxation on Fixed Investment in the U.K.,” Oxford Economic Papers 51 (April 1999)CrossRefGoogle Scholar. The international dimension is important. The reforms made Britain a more attractive location for investment by foreign firms, in particular, French and German firms. As for capital outflows, the survey evidence suggests that British firms are sensitive to cross-national differences in tax rates. See Devereux, Michael and Pearson, Mark, Corporate Tax Harmonization and Economic Efficiency, Report series no. 35 (London: Institute for Fiscal Studies, 1989)Google Scholar.

50 These numbers were calculated using data from the IMF's International Financial Statistics (Washington, D.C.: IMF, 2003)Google Scholar. The sample includes Australia, Austria, Canada, Denmark, Finland, France, Germany, Italy, Japan, Netherlands, New Zealand, Norway, Spain, Sweden, Switzerland, the U.K., and the U.S.

51 Ministry of Finance, The Budgetary Policy of the Second Kok Government (Amsterdam: Central Information Directorate, October 2000)Google Scholar.

52 OECD(fn. 46).

53 Lange, Peter, Wallerstein, Michael, and Golden, Miriam, “The End of Corporatism? Wage Setting in the Nordic and Germanic Countries,” in Jacoby, Sanford M., ed., The Workers of Nations: Industrial Relations in a Global Economy (New York: Oxford University Press, 1995)Google Scholar; and Western, Bruce, “A Comparative Study of Working-Class Disorganization: Union Decline in Eighteen Advanced Capitalist Countries,” American Sociological Review 60 (April 1995)CrossRefGoogle Scholar.

54 Hallerberg and Basinger (fn. 30); and Basinger and Hallerberg (fn. 17).

55 Garrett(fn. 8).