Globalization and tax policy

Abstract

How does economic globalization affect national taxation? According to the conventional wisdom in political economy, it increases fiscal stress by exposing citizens to new economic risks and thus driving up voters’ demand for social protection (the so-called compensation thesis) and/or by triggering a competitive race to the bottom that undermines governments’ ability to fund social protection (the so-called efficiency thesis). We show that economic globalization can also have the reverse effect. It can also mitigate fiscal stress by providing additional revenues for national treasuries and relaxing demands for social compensation—but only in some countries. While economic integration significantly affects fiscal policy everywhere, it does not do so evenly and equally. There are winners and losers. We discuss the mediating effects of three domestic factors: country size, regime type, and state capacity. We show that the fiscal winners of economic globalization are generally small, well-governed democracies. We conclude by illustrating the theoretical and political implications of our argument.