For a long time, economists have known that rising globalisation can bring substantial aggregate gains, but also produce winners and losers. The source of this growing inequality may be heterogeneous effects on employment, wages, and prices. Trade barriers have been shrinking since the end of World War II, reaching its lowest levels in the years since the fall of the iron curtain. This increasing globalisation may lead to negative effects on the employment in certain industries, states, and countries. Workers in those affected markets may then require substantial support from the government in the form of social insurance or unemployment benefits or training and support in order to transition into new jobs or industries.
Globalisation-induced inequality, in theory, could be dampened via local policies that aim to redistribute part of the gains from globalisation away from the winners and towards the losers, ensuring that everyone benefits. Yet, despite the substantial aggregate gains from trade, the backlash against migration and trade (think, the yellow vest movement and the support of Brexit, as well as of Trump tariffs and border wall) would suggest that such redistribution mechanisms may not be in place or have been ineffective in distributing the benefits of trade to those negatively affected.
A natural and widely used redistributive policy tool is personal income taxation. Countries commonly employ progressive tax schedules whether that progressivity comes in the form of multi-step marginal tax schedules or tax credits/deductions for those at the lower end of the income distribution. Increasing globalisation should then go hand in hand with increasing progressivity of the income tax, ensuring that individuals with higher incomes carry a relatively higher tax burden than those with lower incomes. However, a new study demonstrates that since mid-1990, globalisation has had the opposite effect. A relatively lower tax burden has been placed on the top 5 per cent and has shifted a larger relative burden onto middle and upper-middle income workers.
Figure 1. Average corporate and income tax rates
Figure 1 illustrates how the average corporate and labor income tax rates in the 65 largest economies have changed between 1980 and 2007. The average corporate tax rate (red line) has consistently fallen, depicting “the race to the bottom” – a term for how competition to attract and retain businesses among different countries, states, or localities has driven down corporate tax rates across all locations.
Moreover, Figure 1 also points out that the top 1 per cent of income earners may have experienced a similar downhill race since the 1980s. This trend may be further exacerbated by the fact that a significant portion of these workers’ incomes comes from non-labor sources, which may be subject to even lower taxes. On the other hand, the median worker’s average tax rate has been steadily increasing since 1980. The question that arises is then why did the workers around the middle of the wage distribution experience such vastly different tax outcomes relative to corporations and, more specifically, the rich?
We find the answer in globalisation itself. Reduced barriers to trade and migration make firms and high-income earners highly footloose. This potential mobility affects the degree to which governments can tax them, before they opt to relocate in order to reduce their taxes. In a globalised world, the effectiveness of progressive taxation therefore is weakened by the possibility that firms and mobile workers can escape higher taxes through relocation.
Lower effective tax rates have also been shown to be a significant factor in attracting foreign firms and high-skilled workers. However, those income earners around the middle of the wage distribution are significantly less mobile. This immobility could stem from the fact that their skills may not be as easily transferable across borders or from the pure cost of relocation. Governments around the world have started to rely relatively more on those immobile workers around the medium income level in order to stabilise their tax base.
Photo by Deniz Altindas on Unsplash
The authors estimate that in response to rising globalisation between 1994 and 2007, the top 1 per cent of income earners in an average OECD country realised a reduction of their relative labor income tax burden of 0.59-1.45 percentage points. In stark contrast, the tax burden of the median earner has risen by 0.03-0.05 percentage points. These globalisation-induced changes in the income tax progressivity would seem to have aggravated rather than tamed after-tax income inequality. This dismal trend is very likely to continue as the mobility of large firms and high-income (high-skilled) workers continues to rise.
In a 2014 survey, the Pew Research Center found that roughly 60 per cent of respondents believed growing inequality to be a major challenge. Progressive taxation could be one of the ways to tackle this growing problem. However, increasing the progressivity of taxation may not be as simple as tacking new top marginal tax rates onto the labor income tax schedule or adding in more deductions in a globalised world. The high potential mobility of high-income individuals drastically limits governments’ ability to tax them; therefore, as long as countries aim to attract and retain highly productive workers (and the firms that employ them), reducing inequality via traditional means of progressive taxation will be very challenging.
Another possibility could be the harmonisation and coordination of international labor income tax policy. This suggestion arises from the paper’s case study of the multi-layered tax system of the U.S., which uses cross-state migration in lieu of cross-national globalisation and relative tax burdens in both the subnational and total (national + subnational) tax layer. While the reduction of the relative burden persists for those at the top of the income distribution, the overall effect is reduced when adding the federal and state level together. A supranational tax layer, or at least supranational coordination, may tamp down the negative globalisation-induced changes to the relative tax burdens across the income distribution. While tax coordination and policy harmonisation has been on the academic and policy agenda with a view on capital taxation, there is much less of a discussion regarding the international coordination of personal income tax rates. It might be worth exploring the costs and benefits of such coordination though, especially, in light of growing mobility and public dissatisfaction with inequality.
- This blog post appeared previously at LSE Business Review and is based on the authors’ paper The Taxing Deed of Globalization, American Economic Review, vol. 109, no. 2, February 2019
Note: This article gives the views of the author, and not the position of USAPP– American Politics and Policy, nor of the London School of Economics.
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Peter Egger – ETH-Zürich
Peter Egger is professor of applied economics at the Swiss Federal Institute of Technology in Zürich (ETH-Zürich) and research fellow at the Centre for Economic Policy Research (CEPR). He holds a number of research positions in other institutions. His research focuses on applied and theoretical panel econometrics (time-invariant variables, long- and short-run estimates, spatial econometrics), applied and theoretical international and regional economics (outsourcing, multinational firms, trade volumes; economic integration, new economic geography), industrial organisation and multinational firms.
Sergey Nigai – University of Colorado Boulder
Sergey Nigai is an assistant professor of economics at the University of Colorado Boulder. His research focuses on international trade and consumer welfare. His published research papers and working papers can be found here.
Nora Strecker- ETH-Zürich
Nora Strecker is post-doctoral researcher at the chair of applied economics at the Swiss Federal Institute of Technology in Zürich (ETH-Zürich). She received her PhD in economics from ETH Zürich and also holds a BA and an MA in economics from New York University. Her research interests focus on public economics, in particular labor income taxation and social security.