Where now for EU corporate income taxes? edit
Tax rates on company profits in developed countries have fallen significantly over the last two decades. An important reason for this has been the rise in the share of economic activity undertaken within multinational corporations. From the perspective of national governments setting tax rates and tax structures, multinational firms differ from purely domestic companies in one fundamental respect: their activities are mobile between countries.
-->When choosing where to locate major new investment projects, international companies can shop around for lower tax rates and more generous tax breaks. Perhaps equally important, firms with activities in several countries have considerable discretion over where they report their taxable profits and hence in which countries they pay most of their tax. By concentrating deductible costs in high tax countries and by concentrating taxable revenues in low tax countries, multinational firms can and do achieve significant savings in their worldwide tax bills.
Faced with the rise of multinational business, governments have not failed to notice that by reducing their corporate tax rates, they can attract a higher share of investment by international firms, and a higher share of these firms' worldwide taxable profits. This process began with a cut in the UK corporate tax rate from 52% to 35% in 1984, with various allowances reduced at the same time to broaden the tax base. The USA implemented a similar reform in 1986, and this has been imitated in many other countries. While Ireland, with a corporate tax rate of 12.5%, is the extreme case, numerous EU countries including Sweden, Finland and Austria now have corporate tax rates below 30%. Some of these low tax rate countries have enjoyed notably high levels of inward investment, and notably buoyant corporate tax revenues.
This trend shows no sign of stopping. Within the EU, downward pressure was intensified by the accession of ten new member states in 2004, nine of which have corporate tax rates below 30%. Among the EU-15, the average corporate tax rate fell from 38% in 1995 to 30% in 2005. Nor were these recent rate reductions confined to smaller countries; there were significant cuts in both France and Germany over this period.
So long as corporate tax rates continue to be determined by national governments and the globalization of capital markets and business activity continues to advance, there are good reasons to expect this downward trend to continue. Corporate tax rates of 50% or more, which were common a quarter of a century ago, would now act as a major deterrent to investment by the world's leading companies, and could well result in less revenue being collected. Such tax rates are not appropriate in the current international environment.
A coherent response to these pressures would be for national governments to cooperate with each other in setting corporate income taxes. It may well be possible for a coalition of national governments to tax the profits of international firms at significantly higher rates than they could achieve by acting independently. In the limit, if all countries were to agree to adopt a uniform corporate income tax, this would eliminate the advantages that multinational firms have in being able to shift real activities and taxable profits between countries.
This argument underpins calls for greater coordination of corporate income taxes within the EU. However the current proposal from the European Commission for a common consolidated corporate tax base stops well short of suggesting a uniform corporate income tax across all twenty-five member states. This proposal is extremely unlikely to be agreed by all member states, and would therefore be implemented, if at all, only by a core group of countries under enhanced cooperation procedures. Moreover the proposal is limited to a common tax base and does not require countries to adopt a common tax rate.
The smaller the group of countries that cooperate, the more their ability to tax multinational firms will resemble that of a large national government, rather than that of EU as a whole. Some of the smaller EU countries that perceive advantages from having particularly low corporate tax rates at present are unlikely to give up some of these advantages by adopting a common tax base. For other reasons, the chances of a UK government led by Gordon Brown embracing this proposal are virtually zero, and the Conservative opposition remains even more eurosceptic. The obvious danger for a core group of countries attempting to preserve higher tax rates by adopting a common tax base is that they will merely succeed in shifting more investment and taxable company profits from the core to the periphery.
Nor is it clear that agreement on a consolidated tax base, allocated to individual countries by some kind of formula apportionment, would reduce the downward pressure on tax rates. By offering lower tax rates, governments would still expect to attract mobile international investment. Whether they could still attract mobile taxable profits would depend on the formula used to allocate the consolidated tax base between countries.
However a more serious problem with the proposal for a common tax base is the absence of a procedure for rapidly adjusting details of the common tax law in response to changes in business practices and other international developments. Contrast the time required to secure any form of agreement on the definition of the common tax base with the volume of legislation required annually by individual countries, both to protect their corporate income taxes from various forms of tax avoidance, and to maintain the competitiveness of their corporate taxes in response to developments elsewhere. The need for such legislative flexibility will not disappear, and it is simply not clear how it could be achieved without departing significantly from the aim and the advantages of a common tax base.
Perhaps fortunately, then, there are some important benefits from the trend towards lower corporate tax rates. By attracting more investment, this can increase labour productivity and real wages. And a shift in the balance of taxation towards taxes on employment income and consumption makes the cost of welfare provisions and other government expenditures more transparent to voters.
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