The Olympics

Regulation doesn't exist in a competitive vacuum.

The Olympics

Ireland had an electrifying economic run from the mid-1990s through the Global Financial Crisis, earning the title “Celtic Tiger,” a reference to the economic miracle in South Asia.

“At the start of the 1990s, Ireland was a relatively poor country by Western European standards, with high poverty, high unemployment, inflation, and low economic growth.^[1] The Irish economy expanded at an average rate of 9.4% between 1995 and 2000, and continued to grow at an average rate of 5.9% during the following decade until 2008, when it fell into recession. Ireland's rapid economic growth has been described as a rare example of a Western country matching the growth of East Asian nations, i.e. the 'Four Asian Tigers'”

It stands as an example of how public policy can stimulate progress.

“Historian R. F. Foster argues the cause was a combination of a new sense of initiative and the entry of American corporations such as Intel. He concludes the chief factors were low taxation, pro-business regulatory policies, and a young, tech-savvy workforce. For many multinationals, the decision to do business in Ireland was made easier still by generous incentives from the Industrial Development Authority. In addition European Union membership was helpful, giving the country lucrative access to markets that it had previously reached only through the United Kingdom, and pumping huge subsidies and investment capital into the Irish economy. Frederic Mishkin has also suggested that the economic boom partly resulted from the austerity plan of Charles Haughey (Taoiseach from 1987 to 1992). People and businesses expected a stable economy, boosting their confidence to spend and invest due to anticipated stability in output.^”

Low taxes, efficient (i.e., not excessive) regulation, a young, educated labor market, and financial capital made the Irish miracle. I remember working in Frankfurt for a few weeks in 1995. There were a number of Irish skilled workers living in Germany, all of whom were either in the process of returning home or considering it. The lack of opportunity in the years leading up to the transformation had caused a significant brain drain. A restless, educated youth, bereft of domestic opportunity, migrated abroad for experience and money. By the mid-1990s, they were trained, networked, hungry, and homesick. They came back to Ireland in large numbers once the conditions permitted them to do so. Poor governance had chased them out; credibly sustainable liberating policy pulled them back.

Ireland engaged in what economists call tax competition.

‘Tax competition, a form of regulatory competition, exists when governments use reductions in fiscal burdens to encourage the inflow of productive resources or to discourage the exodus of those resources. Often, this means a governmental strategy of attracting foreign direct investment, foreign indirect investment (financial investment), and high value human resources by minimizing the overall taxation level and/or special tax preferences, creating a comparative advantage.’

Countries, regions, states compete for financial capital and human capital with which they can facilitate economic growth. The timing of the Irish miracle was fortuitous in that it coincided with an era of liberation for both types of flow. Money and talent streamed into Ireland, which benefited, in turn, from its population’s facility with the English language, EU access, and physical proximity to the United Kingdom. It was perfect execution.    

Other countries, particularly in the EU, resented Ireland for its behavior, characterizing it as unfair competition. Yet, there was little they could do. Ireland retains sovereignty over its domestic tax and regulatory policy notwithstanding its membership in the European Union. Other countries in Europe could have matched the Irish tax policy in what some on the left refer to as a “race to the bottom.” However, this was politically infeasible, especially in regimes with high personal tax rates.

If this was the 100 meter men’s sprint, it was as if Ireland was taking steroids, while competing in the Special Olympics.

The pressure on Ireland to “behave” was immense, coming to a head with efforts by the United States to implement a global consensus in favor of higher corporate tax rates. The US would lead a worldwide framework of enforceable coordination.

According to the Tax Foundation, “In October 2021, after negotiations at the Organisation for Economic Co-Operation and Development (OECD), more than 130 member jurisdictions agreed to an outline for new tax rules. Large companies would pay more taxes in countries where they have customers and less in countries where they have headquarters, employees, and operations. Additionally, the agreement sets out a global minimum tax of 15 percent, which would increase taxes on companies with earnings in low-tax jurisdictions.”

Ireland put up a fight before capitulating. As late as July 2021, the New York Times reported the Irish resistance before its eventual collapse:

“At stake is Ireland’s low official corporate tax rate of 12.5 percent and a tax regime that helps global companies based there avoid paying taxes to other countries where they make profits, a setup that has put billions of euros into Ireland’s tax coffers and created hundreds of thousands of jobs.”

Note that, despite being a tax haven, the offsetting stimulative impulse from its previously renegade  tax and regulatory policy grew the tax base, enabling Ireland to collect more tax than during its stagnant lost years.

The Times article anticipated Ireland’s eventual assent, meaning that their competitiveness in other dimensions would take on added significance.

‘“Ireland has benefited a lot from the tax advantage it has provided to multinationals,” said Ricardo Amaro, a senior economist at Oxford Economics in Dublin. “Going forward, they will have to come up with a strategy that relies on nontax tools such as a stable regulatory environment and skilled work force to lure investment.”

Tax competition is a subset of a broader phenomenon called regulatory competition.

‘Regulatory competition, also called competitive governance or policy competition, is a phenomenon in law, economics and politics concerning the desire of lawmakers to compete with one another in the kinds of law offered in order to attract businesses or other actors to operate in their jurisdiction. Regulatory competition depends upon the ability of actors such as companies, workers or other kinds of people to move between two or more separate legal systems. Once this is possible, then the temptation arises for the people running those different legal systems to compete to offer better terms than their "competitors" to attract investment. Historically, regulatory competition has operated within countries having federal systems of regulation - particularly the United States, but since the mid-20th century and the intensification of economic globalisation, regulatory competition became an important issue internationally.

‘One opinion is that regulatory competition in fact creates a "race to the top" in standards, due to the ability of different actors to select the most efficient rules by which to be governed. The main fields of law affected by the phenomenon of regulatory competition are corporate law, labour law, tax and environmental law. Another opinion is that regulatory competition between jurisdictions creates a "race to the bottom" in standards, due to the decreased ability of any jurisdiction to enforce standards without the cost of driving investment abroad.’

The global movement to harmonize corporate taxes ratchets up the pressure for international regulatory competition.

Evidence of tax and regulatory competition is plentiful within the United States; it drives massive flows of financial and human capital. During the Pandemic, it would appear as if states revealed their underlying regulatory preferences under the contrived pressure of the exigencies of the moment. Some states promoted freedom, others centralized control. People have been voting with their feet ever since.

‘As pandemic patterns of U.S. population growth are normalizing, three economically successful states have remained among the U.S. jurisdictions which are shrinking. According to a December release by the Census Bureau, California, Illinois and New York - along with West Virginia, Louisiana, Pennsylvania, Hawaii and Oregon - lost population in 2023 compared to 2022. Throughout the new Census first released in 2020, all three states have shown continuously sinking population numbers. New York and Illinois even started to see their populations decline under the old Census since 2016 and 2014, respectively, while California experienced a stagnating number of inhabitants in 2019.’

To the contrary, states with the fastest population growth include Utah, Texas, Idaho, Nevada, Colorado, and Florida. Texas, Nevada, and Florida have a top marginal state income tax rate of 0%.  Utah (4.55%). Colorado (4.40%), and Idaho (5.80%) compare to New York’s 10.90% and California’s 13.30%.  Utah, Colorado, and Idaho have flat tax rates in contrast to the graduated income tax regimes in New York and Colorado.

Tax competition is alive and well. The deductibility of state income taxation on federal tax forms is a form of fiscal federalism in which the federal government transfers money from low-tax states to high-tax states, in effect. Conversely, if it’s reasonable to believe that there is a limited amount of tax room for authorities, at all levels, to dun their citizens for revenue before output drops or political resistance begins to succeed, then high-tax states, in occupying more of that space, dictate a natural limit to federal taxation.

Excessive regulation is an asset in that it is stored, potential energy. Cutting regulations at every level is a way for regimes to compete, either intra-state, inter-state, or internationally. The more red tape there is to eliminate, the more potential gain there is. The counter-argument is that this is a race to the bottom. If every state does it, then the competitive advantage deregulation confers goes to zero. But there are still states that are adding rules. It’s only a race to the bottom if everyone gets the joke.

If the purpose of Closest Point of Approach is to make predictions based on general principles of bureaucracy, then here’s one. Regulatory competition will continue to drive the migration of financial and human capital. If anything, it will accelerate. Who, for example, could have predicted a credible challenge to Delaware’s supremacy in corporation law? Yet, Texas is doing it.

‘The Lone Star State, 40 years later, is now ready to flip that script. The Texas governor last year signed legislation to create the Texas Business Court to hear commercial cases worth more than $5mn or $10mn, depending on the type of dispute. Specialised state and federal courts are not unusual in the US. But in business matters, Delaware and New York state law remain pre-eminent. Texas advocates, however, believe they can not only build from scratch a court to challenge the incumbents, but that it is a worthy use of their resources to do so.’

What’s next?