Restricting preferential tax regimes to avoid harmful tax competition

Abstract

Governments fear that tax competition erodes national revenues. Preferential tax regimes, which levy different taxes on distinguishable tax bases, are particularly criticized for accelerating a race to the bottom. According to both the EU and the OECD, countries should refrain from this kind of tax discrimination. This viewpoint was recently queried by [Keen, M., 2001. Preferential regimes can make tax competition less harmful. National Tax Journal 54, 757–762]. He argues that preferential regimes soften interjurisdictional competition. The present paper, by contrast, defends the original objections to preferential treatments. If investors have a home bias (which is in line with empirical evidence), moderate restrictions on preferential regimes always increase equilibrium revenues. Moreover, we present sufficient conditions under which a total ban on preferential treatments is optimal from the governments' perspectives.