Tax competition in Switzerland: Myths and empirical evidence

A guest post by Fabio Wasserfallen:

Although the populist, disproportionate and indiscriminate initiative of the Swiss People’s Party on the deportation of foreign delinquents absorbs most attention, the Social Democratic “fair tax” initiative, which will also come to vote on November 28, picks up pace in the final stage of the campaign. This initiative aims to eliminate cantonal tax competition for high income earners by setting a minimal sub-national tax rate for income and wealth.

The political debate on the initiative is despite – or may be better because of – the complexity of the issue rather trivial. For the left, tax competition is the source and manifestation of any terrible element of society and politics. And the opponents of the initiative argue that the high standard of living in Switzerland is straightforwardly due to tax competition. Both sides effectively construct ideologically motivated tax competition myths. Like in other topics, politicians prefer thinking in cognitive shortcuts, which fit their “Weltanschauung”, instead of engaging in nuanced, time-consuming and sometimes confusing analysis of complex problems. Empirical findings are in the current tax competition debate only of interest, as long as they reinforce predisposed views.

However, the real world is too complicated for simple black and white politics. In fact, many interesting and challenging empirical questions surround the almost experimental-like tax competition setting in Switzerland. So if you are interested in empirical evidence, here are some findings on three critical points:

1. Are people choosing their place of residence because of tax rates?

A week ago, some wealthy people, like the elevator entrepreneur Alfred Schindler, threatened the electorate that they will leave the country when the initiative will be adopted. Despite all the disagreement between proponents and opponents of tax competition, both assume that people, in particular the wealthy ones, choose their place of residence depending on the level of taxation. Some studies support this assumption, while others find no evidence of tax-induced migration in Switzerland.
Although taxation might be a factor influencing residence decisions, the bottom line question for policy makers should be, whether this effect is marginal or substantial. A recent study on cantonal inheritance taxation by Marius Brülhart and Raphaël Parchet provides the most compelling empirical analysis in that regard. Inheritance taxes have been abolished or cut throughout the country in a domino-like dynamic. The two economists from the University of Lausanne show that competition, or in other words the need to attract wealthy retired tax payers, was by far the principal argument in cantonal debates. Furthermore, empirical findings indicate that changes in inheritance tax burdens have no statistically significant effect on migration patterns of wealthy retired people. Therefore the authors conclude that “the alleged forces of tax competition do not in fact seem to have been at work.” In other words, tax competition is to a large extent driven by wrong assumptions of policy makers, and not real competition pressures.
The adoption of the initiative would be a fantastic opportunity to study the effect of tax rate changes on migration in a detailed causal inference study, as the quite extensive tax increases in some low-tax municipalities would constitute an exogenous shock (see also these previous posts).

2. Are cantons competing with one another?

Yes, they are. Econometric analysis indicate that cantons react to tax changes of their neighbors. Fabrizio Gilardi and I also show, based on spatial analysis using theory-driven connectivity measures, like commuting patterns, that cantonal policy makers change tax rates in an interdependent competition dynamic. Yet we also find that institutionalized exchange in regional networks of finance ministers mitigates tax competition. So if one is interested in taming tax competition, strengthening inter-cantonal institutions would be an effective way to do so.

3. Is there a race-to-the-bottom in income taxation for high income earners?

No. During the last two decades effective income taxes decreased in all income categories, while the most substantial aggregate downward trend appeared in the low income categories. The overall picture of the data is pretty much the opposite of what the media coverage suggests. A rich literature in political science has shown that political, fiscal and economic factors prevent wasteful RTTB dynamics (see, e.g., here, here, or here).

The latest polls indicate that the initiative will not get through. Debates on tax competition will continue. Next in line are initiatives for a federal inheritance tax and proposals to end the practice of negotiating preferential tax deals with wealthy foreigners, a movement triggered by a surprising decision of the electorate in Zurich at the beginning of this year. Smart ways to deal with tax competition distortions would be the improvement of the financial equalization system to level the playing field for cantons (see this post for a proposal), and the enactment of more comprehensive regional agreements regulating joint financing of public goods with regional importance, like cultural or educational institutions. Stuff like that is not spectacular, but effective.

4 thoughts on “Tax competition in Switzerland: Myths and empirical evidence

  1. »The latest polls indicate that the initiative will not get through.« That is a fairly speculative interpretation of the data, in fact one might conclude just the opposite: 46% of voters are in favor of the initiative – compared to 39% who are against it.

  2. @ Philipp Wampfler: This sentence could indeed be formulated more cautiously. However, as approvel for the initiative declined quite extensively from 58% in mid-October to 46% in mid-November, I think it will be difficult for the initiative to get through. In particular the Ständemehr will be a very tough burden.

  3. What the Swiss people should do is abolish income tax – and all those ridiclous taxes on labour and capital – and replace it with a high, flat land tax.

    The left (e.g. Stiglitz, William Vickery) like land tax as it makes sense that when you build roads, trams, other infrastructure etc, that obviously increases land values, and that that increase (the “unearned incremeent”) should belong to the community itself. So the rise in “land values” should be “recycled” into public coffers to fund the infrastructure project. Thus, it is “fair” and is based not on who you are, but where you are.

    The right or ‘liberals’ (William Buckley, Friedman, JS, Henry George) like it as its efficient: no paper work, no “theft” by attacking your income and capital, needed to grow. Plus, if Switzerland is to stay competitive like Singapore and Hong Kong (which have a land tax) – labour and capital can flee if you tax it. Land can’t. Furthermore, given the high density living in Switzerland, any land in the CBD that is “vacant” (for speculative reasons) must be relinquished and come onto the market – this depresses rents, stabilise bank collateral in the long-run and reduces homelessness as it does not keep people out of the housing market.

    Land tax, also, of course, stops boom and busts cycles (think America and Ireland and its speculative orgy in the housing market – easily could have been stopped by introducing a land tax, as any “profits” are recycled into the public revenue – notwithstanding in a fiat currency system taxes actually don’t “fund” government (yes, that’s right – YOUR taxes don’t fund government; the central bank spends *before* it recieves taxes – it only taxes to control inflation, influence behaviour and any social justice aims).

    So look into abolish income, capital gain, payroll taxes etc., and replacing them with a flat land tax. Ideally, I’d like to see a “single tax” society on land, but there may be other taxes needed to influence behaviour.

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