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date: 17 February 2025

Taxation in the Open Economylocked

Taxation in the Open Economylocked

  • Kimberly A. ClausingKimberly A. ClausingUCLA School of Law

Summary

The international mobility of capital presents important tax policy challenges, as the scope of economic activity exceeds the reach of national governance. Consequently, countries’ tax policy choices have important spillover effects outside of their own borders. For example, in the context of mobile multinational companies, countries that charge high tax rates may benefit their trading partners by increasing the competitiveness of their companies, while countries lowering tax rates have negative consequences for the competitiveness of trading partners’ firms. Further, countries’ noncooperative tax policy choices may entail too low tax rates (and too lax tax regimes), since they do not fully internalize the negative consequences of their choices on their partners, nor do they account for the dynamic effects of their choices on policy evolution abroad.

Climate policy also generates important spillovers. Since greenhouse gas emissions are a truly global externality and the benefits of any mitigation policy action are only partially captured by the government undertaking the effort, countries will have an incentive to free ride on the efforts of others. Beyond this free-riding problem, there are also competitiveness spillovers. For example, governments imposing costs on their emissions-intensive firms put them at a disadvantage relative to firms abroad, whereas governments subsidizing clean energy advantage their energy-intensive firms in the competitive marketplace. This dynamic makes it more difficult for countries to adopt cost-imposing policies.

Both of these policy spheres demonstrate the value of international tax policy coordination. The international tax agreement of 2021, in the process—as of 2023—of being implemented across the world, provides one possible model for enhanced coordination. So far, international climate policy lacks a similarly strong coordinated policy effort, but possible models include building from the European Union’s proposed carbon border adjustment and considering adoption of a climate club.

Subjects

  • Environmental, Agricultural, and Natural Resources Economics
  • International Economics
  • Public Economics and Policy

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