TAX COMPETITION YIELDS PROSPERITY

"Zurich will be the biggest Google location outside the US"


Stefan Keuchel, Google Spokesman in Switzerland


Tax federalism is a marvelous system. It allows different preference to come into action but as the most important thing - it creates the structure of tax competition among governmental units so that when the competition among various units, firms, individuals or even political units is established, no statist welfare (anti-growth) programs could yield better results. It is very much an empirical recognition.

In Europe, the cradle of state welfarism, high tax rates on corporate and individual income are combined with rigid structure of the labor market through which extensively restrictve governmental regulation creates the environment of labor sheltering which is a gateway to structural unemployment. It usually becomes very tough to tackle it, when policymakers are unwilling to pursue structural reforms in various fields. High tax jurisdiction presents a striking punch to human capital creation.

According to a vast amount of empirical studies, human capital is the main driver of economic growth. When strongly progressive tax rates are put into action, human capital switches its behavior towards the evasion. This comes into effect when brain-drain explodes. In recent years, numerous educated and highly sophisticated graduates have escaped European countries because high taxation did not allow them to enjoy the fruits of economic growth. High tax rates in Germany, France, Sweden, Slovenia and Italy as well as in several other environments, punitively penalize the productive behavior.

Thus, policymakers in such countries are constantly concerned with tax revenue instead of being focused on how to implement incentives to produce and serious tax reform. High tax legislation inevitably reflects the cage in which the government has fallen. Interest groups and rent-seekers spent a harsh amount of time on putting pressure on policymakers not to implement structural and tax reforms because, as a consequence, an important part of their non-market income would decrease significantly.

As a matter of fact, if we take a closer look at the budget outlays, we see that the pressure of social groups on the government is endless. Those groups present an important source of financing political campaigns and political support as well. The government has to collect enough revenue to finance those groups through taxpayers' money. Thankfully, basically logical principles cannot fall off the cliff. Laffer Curve clearly explains the behavior of tax rate-tax revenue relationship.

When tax rates are low, government collects more revenue than when tax rates are climbing high. Empirical evidence shows that low tax rates energize productive behavior such as risk-taking, work and entrepreneurship. Low (flat-rated) taxes enable more disposable income. In the long run, the cumulative effect of low tax rates, reflects higher level of prosperity as well as a standard of living much higher than it would if the productive behavior were penalized through extensive strongly progressive taxation of corporate and individual income.

But there is an exception in Europe. Switzerland. Tax competition among cantons is spinning further as cantons are given a full degree of decision making about corporate tax rates. In recent years, tax rates on corporate income fell dramatically in the majority of cantons. Numerous international companies have set their holdings there in search of lower tax rates.

Kraft Foods has moved their headquarters into Zurich. By the middle of the year, the European headquarters will be moved from London and Vienna to Zurich. Kraft has rented office space that can house up to 600 people near Zurich airport. The relocation service has offered prime conditions for companies. As announced, Google will radically expand its business activities at the Hürlimann industrial complex in Zurich. The new premises provide a space for a total of 1,600 employees. After India, this will be second software development center abroad.

Prime business conditions for companies, coupled with solidly sophisticated infrastructure, are often the main channel for further influx of foreign firms. In Switzerland, good transport links, sound supply of financial services and a quality of life that attracts a high educated workforce and research facilities offered by Federal Institute of Technology (ETH) and Zurich University, are among the most stunning pillars of a growing capital inflow from abroad.

Google, for example, has recruited ETH spin-off technology firm Cybercity to help develop an interactive map Google Earth. Cybercity has utilised its skills to put detailed faceds on blank buildings on the internet program.

Swiss economic and business climate is boosted by low corporate tax rates offered by cantons in Switzerland. The Swiss strategy has been awfully criticized by its neighbouring countries. The EU, for example, has been roaring loudly against the tax competition model in Switzerland. Many foreign firms, including Kraft, have moved to Switzerland to reduce the aggregate tax burden caused in typical environments with punitive corporate tax rates.

The strategy of offering tax breaks to investors is largely a reason why Swiss business environment is the most wanted from international companies seeking to reduce the cost pressure resulted from unfair high taxation of corporate and individual income. Companies evaluate a business location in accordance with operational conditions.

ow tax rates on corporate and individual income are not a sole factor in attracting companies from abroad. Sophisticated and high-quality business framework for companies and investors vibrantly attract them as taxation and labor issues in high tax countries are becoming irresistable. Saving taxes and generating profits enable company to reinvest in its business and expand largely.

The competition among cantons to set corporatate tax rates independently from the federal government, was hot at the beginning of the last year, when Obwalden slashed its rates to 6,6 percent (!). Obwalden attracted 376 firms in the first 11 months of 2006, three times more than in 2005.



Tax competition is what has made Switzerland an economic tiger on an international basis. Very competitive domestic as well as international corporate tax rates are inviting international companies to set their facilities and holdings there. Tax competition is a vibrant mechanism through which physical and human capital engine the productive behavior.

Tax competition is a "big-mac" opportunity for small countries such as Slovenia, Estonia, Denmark and Iceland. Small countries carry a feature of faster adjustment to real competitive advantages in the global economy. Without the implementation of radical structural reforms, competitive tax reform, liberalization and deregulation, entrepreneurs from various countries will not go to Switzerland solely on vacation, they will probably go there forever.