Competitive federalism in action

The suggestion that Australian states should compete for business and investment is sometimes viewed as fanciful.  The states relinquished their income tax powers during the Second World War and are now heavily reliant on the federal government for revenue. Their residual taxation powers are pretty limited and many of their regulatory functions have been referred to the federal government.

Nonetheless, competitive federalism does exist in some parts of the world. In Switzerland, it is working exactly as it should. Swiss cantons, which have considerable independence from the federal government, are actively competing to attract business and investment.

An article in the Wall Street Journal describes what is happening: 

Low taxes have long given Switzerland a strong hand in the battle to lure the operations of big multinational companies. Now, an intramural war is on in which individual Swiss states are competing harder for business.

Switzerland’s cantons are offering low tax rates to tempt multinationals to establish regional headquarters or other operations in their jurisdictions. In doing so, other states are trying to take business away from Zug, the canton that has mastered the game of attracting business to such a degree that it is beginning to run out of space.

Switzerland as a whole is battling with countries such as Ireland, the Netherlands, the U.K. and Germany for business. While Switzerland’s research universities, efficient public sector and strong intellectual-property protection are attractive, its low tax rates are a huge draw.

Switzerland’s federal corporate tax rate is 8.5%. When average cantonal and municipal taxes are included, the average corporate tax rate in Switzerland is 21.2%, compared with about 30% for Germany and 25.5% for the Netherlands, according to KPMG.

But in Switzerland, cantons—which enjoy far more autonomy than U.S. states—are the main drivers in luring multinationals. Two-thirds of total taxes are levied by the cantons, which have wide autonomy on social-security contributions, business permits and construction rules.

There is additional detail in the full article, but you get the picture. Rather than seeing business as a cow to be endlessly milked, which every level of government in Australia seems to regard as absolute truth, the Swiss cantons are vying to bring business into their locations. Particularly big multinational businesses. And taxing them less, not more.

The closest we come to that in Australia is when one of the state governments reduces payroll tax by 0.25%. (And keeps spending as if the revenue never stopped as well.)

I’m not optimistic that we will ever get competitive federalism working properly in Australia. But Australians are rarely keen to try something that nobody else has attempted. With Switzerland setting an example, at least that objection does not apply.

15 thoughts on “Competitive federalism in action

  1. Federalism rocks, no doubt about it. The devolution of power allows people to be freer and to achieve better outcomes for themselves. The US really amazes me with its devolution of power to the states, even with all the trouble its in and a ‘big government’ flavoured administration in Washington, it will still pull itself out because the devolution of power inherent in their system prevents the quashing of the people’s ability to innovate, capitalise on their talents, or pursue happiness. And really Switzerland is the only other example I can think of where I can seen anything like this happening on anything but the smallest scale.

  2. My suggestion: devolve income tax (in exchange for GST), as well as all health & aging responsibilities. That will fix VFI & health duplication as well as encourage more tax competition.

  3. I agree Switzerland is a fine example of federalism. The main refinement I would wish for would be to prohibit constitutionally any taxation by the central government. The closest example of such a federalist scheme is the EU. Whilst the instincts of the EU are a long way away from classical liberalism the setup has several advantages over the US. Firstly the individual states retain sovereignty including full military capacity. The tax powers of the central administration is incredibly weak. The region enjoys free trade across borders, no notable restrictions on internal movement and a common unit of account (the Euro). Davids article lists several nations within the EU structure that are competing for business. There are internal threats to this rather fortunate structure and the EU administration does manage to churn out some rather illiberal laws, however the current structure is quite a good one in federalist terms.

    In an ideal world we would have free trade, open immigration and a universal global unit of account (probably gold) and no need for any federation anywhere. It sounds a little like what we came close to achieving two centuries ago (although that world was imperfect in plenty of other ways).

  4. devolve income tax (in exchange for GST), as well as all health & aging responsibilities. That will fix VFI & health duplication as well as encourage more tax competition.

    Hell yes, get the states taxing again. Limit the federal government to the few things it needs to do.

  5. Firstly the individual states retain sovereignty including full military capacity.

    The US has the National Guard which is devolved in terms of command to the state level as far as I’m aware. Funding is still from the federal government, but it doesn’t mean in times of crisis the state governments couldn’t take over.

    The tax powers of the central administration is incredibly weak.

    That’s the real benefit and what the US needs to do again. But how long will the EU stay this way? I’m not confident it will be too long!

    The region enjoys free trade across borders, no notable restrictions on internal movement and a common unit of account (the Euro).

    The US states have all of this.

  6. Yes the US has those also. These were not meant as points of advantage but good points in common.

    In terms of the future of EU tax powers there are good institutional reasons to be optimistic but cultural reasons to be pessemistic. Modifying the US constitution to allow central income taxes was technically easier that modifying the EU equivalent. Even the proposed lisborn treaty still gave every EU member state a veto on tax centralisation.

  7. I think the US constitution has few lucky strengths in that regards. The Bill of Rights will almost certainly remain as is, I doubt it could ever be changed. However, the addition of another amendment(s) regarding taxation, limiting government control etc are quite possible. Difficult but possible. One was proposed quite recently but didn’t get out of committee. There’ll be more.

  8. I’m not convinced that the military decentralization in the US is at all comparable to the EU. The EU does not have the military might to oppose a secession. The US government does and it has previously used it, all be it a long time ago.

  9. Sure, it’s not my biggest concern. Of course, the US does have decentralisation of the military to the lowest level possible (militia), something that would never get up in Europe outside of Switzerland. But how long do you think it will be before the Eurocorps idea becomes reality, with the accompanying Euro-tax?

  10. I’m not sure who the Eurocorps are however I agree that a central income tax is a possibility but at the moment it is quite remote. I’m hopeful that it won’t happen. The biggest threat in the centralised tax arena is probably some form of carbon tax.

    Switzerland is an example of federalism where the power has remained regional. Much more so that the US and certainly more so than in Australia or Canada. It is interesting to ponder what it is about their system that has caused this resilience.

  11. The Swiss cantons spoke different languages when they joined together, and they still do. So one way to encourage regionalism is to promote local languages, to encourage local thinking.

  12. Switzerland is an engima. As you point out, their federalism and direct democracy systems are well advanced, and as such one could see them as a libertarian state. It also runs like clockwork.

    However they are the biggest nanny state in Europe. The welfare system is extremely generous (e.g. unemployment benefits at 85% of your last salary), and the level of control the state over citizen’s lives is approaching 1984 levels. There are millions of petty laws and the Swiss will cheerfully report anyone who breaks even a tiny rule to the authorities.

    Just one example – you must find out the sex of your child and name them before they are born. In order to register to give birth and be admitted to hospital the child must be booked in by name. If the Swiss could reliably schedule the exact date and time of natural births months in advance I’m sure that would be compulsory too.

    The scary thing is, the Swiss like it this way and get very upset if anyone doesn’t follow all the rules. Though there is a big drug problem in cities like Zurich which some say is a rebellion against their repressive laws.

  13. Hey Terje, in view of our discussion above on having a common currency, this is interesting:

    The leaders of Europe in the early 1990s believed that a common currency would bring, among other benefits, an end to European wars. In many ways it was a political rather than an economic decision.

    What the political leaders of the day failed to grasp – though it was hotly debated at the time – is that it’s extremely dangerous to have a series of sovereign nations linked by a common currency.

  14. I don’t agree with the last paragraph. I see more upside in a common unit of account than downside.

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